Due to the publication of the hydrocarbons law 8/2015 on May 21st, Magnus Commodities wants to open the debate on the implementation of a natural gas hub in Southern Europe.

But firstly, what is really a natural gas hub?

In general terms we can see that there are three types of gas markets based on their organization:

1.     National Gas Market: It is a market that includes all natural gas transactions carried out for supplying the gas inside a country. It is dominated by direct bilateral negotiations, aiming to ensure the gas supply and security of supply in the long term. The formation of prices in each national market is based on the balance of supply and demand.

2.     Gas Hub: is a physical or virtual location within the gas system in which it is possible to transfer the legal ownership of gas between different market players. The hubs are mainly used as field operations negotiating OTC (Over the Counter), managed by a third operator which requires standardized contracts. Overall, the hubs are usually used to cover adjustments of gas supply or demand (changes in the short term) or gas balance.

3.     Organized Market (Exchange): A platform market managed by a market operator that allows trading of standardized products and assumes the role of partner in negotiations. The main goal is to cover adjustments of supply or demand balance for gas, to cover risks in the short or medium term or speculative trading.

In this sense, until South Europe gets into the phase of creating a futures market or Exchange, we will not have the risk management tools linked to hub prices. Nonetheless, the creation of a gas hub will increase competition in the sector through more transparency and a possible price decline. On the contrary, we may see an increase in prices due to an increase in operational management costs because of stricter market rules regarding the balancing duties.

In fact, a lax regulation regarding imbalances in the networkmade expendable to implement a gas hub in the Iberian Peninsula before. In other words, the current balance frequency in the Iberian gas market is relatively low compared with other European hub-based markets. Being balanced is that in a specific moment in time the amount of gas inserted into the system must be equal to the sum of outputs plus the change in inventories. As long as the frequency of balance increases having a liquid price reference in the short term is crucial.

What has happened in Spain in terms of natural gas legislation?

In regards of legislation, the Spanish gas market has been created around the following legislative packages:

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Furthermore, the last law approved amended the Law 34/1998. Theoretically it is the law that should lay the foundations for the effective establishment of the gas hub in the Iberian Peninsula. Although there are some parts of it that need to be developed in future decrees.

According to the CNMC (Comisión Nacional de Mercados y Competencia) the next steps that should be doneto achieve the gas hub are:

1. The modification of the sectoral legislation for the creation of an organized gas market and the figure of the Market Operator.

2. Designation of the Market Operator, subject to proof its technical competence and independence, which would be under the supervision of the regulator.

3. The Market Operator must, in collaboration with the Technical System Operator (TSO) and the market players, propose the market rules, that should be approved by the CNMC, as regulator and supervisory body. Rules should establish the conditions to be gathered by operators wishing to participate in the market, the characteristics of the products to trade, the matching and settlement mechanisms and the information that should be provided to the Market Operator and the Technical System Operator for ensuring the proper functioning of the gas system.

4. To promote Market Liquidity. It could be done by gas purchase obligations imposed on certain agents, the realization of the balance mechanisms or the promotion of “market makers”.

With the publication of the Law 8/2015 has been fixed the first 2 points, which is the reason why we consider that the law is incomplete.

What are the key points for the suitable development of the Gas Hub?

We, at Magnus Commodities, would like to make our contribution towards the proper organization of the Iberian gas market to make it an efficient and transparent marketplace with appropriate price signals.

The regulation should provide incentives and minimize costs in managing imbalances by supporting access to the wholesale market for traders from different profiles. Thus, it will boost liquidity in the gas hub. On the contrary, the project seems to rely on the so-called market makers (agents that must make a minimum number of deals per day). To certain extend, Magnus Commodities believes market makers would help, but it cannot be the only way to create liquidity. As a result, suppliers would probably control the market price and that is precisely what it has to be changed.

If you look at European hubs like the NBP (National Balancing Point) in the UK and the TTF (Title Transfer Facility) in the Netherlands, they were born as a result of imbalances management and development of network codes. Depending on how often they should be balanced, it will increase to a greater or lesser extent liquidity based on the trading of gas in the short term to avoid TSO penalties. For example, if the agents must be balanced by the end of week will surely create a “spike” of transactions just before the penalties are calculated. If the balance is daily, every day there will be liquidity and if, as it is in the case of TTF, the balance must be hourly based, then we could talk about a very advantageous regulation for the ultimate goal of the HUB.

The development of the Gas Hub today

The initiative of “Iberian Gas Hub” has led the project since its inception and today is in an advanced development stage despite the project is still lacking some services to its full development.

As regards of contractual services and support, IBGH is regularizing the contractual situation of their clients according to the known framework and is working on new versions of documents. The key point is not yet developed which is the contract of mandate and representation for the notification of transfer of gas between balance portfolios.

As far as computer systems and business tools are concerned, it began the testing services in the PVN. It still lacks telematics connection with Enagas (GTS) and OMIClear (clearinghouse) but the negotiations platform is up and running (by phone), along with the web’s client area connected to the Trayport trading platform and the computer servers.

Regarding auxiliary services, IBGH is developing a tool that will provide to the trading and logistic departments of the suppliers a range of tools aimed to facilitate the management of balancing.

Finally, in terms of forward products, IBGH have not yet standardized them for the Exchange, but they are in constant communication with the CNMC and the CNMV for its correct definition.

Although there are still certain areas for development, the IBGH has already met certain milestones including the following:

• A gradual and sustained growth of traded volumes and counter-parties

• Commercial interest of more than 20 prospects (dealers of Spain and Portugal, European traders and global LNG operators).

• The brokered products to date include from day-ahead to year-ahead purchases in the AOC (Commercial Operational Storage). The products are mainly swaps between pipeline gas and LNG and international interconnection, such as Spain-France.

As a consequence, at Magnus Commodities we have great expectations in the proper development of the hub and the benefits it can bring to final consumers. Nonetheless, it is remarkable to note a couple of characteristics of the Iberian market, which could influence its beginning and possible development:

1. The stochasticity of demand given the combination of wind generation and combined cycles as the gas consumption depends largely on the so-called thermal gap, in other words, the thermal gap is the electricity demand that remains after deducting the part covered with “non-manageable generation” (nuclear, hydro and renewables).

2. The strong dependence on international LNG market, since more than 50% of our supply comes through this channel. To the extent that international LNG price is below the Algerian pipeline’s import price, the LNG market share will tend to rise, always considering the take or pay clauses that will act as a barrier.

In this regard, it will be necessary to have large doses of both flexibility and liquidity, as well as a wide range of forward products that allow the agents to effectively manage its risk.

Albert Puell | Energy Consultant

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