For the last several years, the glut of gas in the United States has allowed it to produce significantly cheaper gas than Europe or Asia. While the differential has narrowed, European and Asian gas continues to trade at prices several times higher than in the U.S.
That remains good news for prospective U.S. Liquefied Natural Gas (LNG) exporters – 2016 will see new LNG export capacity come online in the U.S. – but more importantly, the price difference between gas in Europe and Asia has narrowed significantly, to around 5-6 percent.
That’s a critical change not only because it eases a cost burden on Europeans, but because it levels the playing field in terms of Europe and Asia competing as regions for U.S. LNG exports. In recent years, shipping LNG from the U.S. to Asia looked like a good solution for both continents, with the Asia LNG price significantly higher. As Asian prices have come into line with European wholesale prices, the premium paid for gas delivered into Asia has come closer to the additional cost of shipping it the extra distance across the Pacific. The prospect of significant U.S. LNG exports to Europe is looking more viable if this change continues.
Europe’s strengthening natural gas market is not an entirely new phenomenon. Since 2008 the European gas markets have been evolving, with the speed of change now increasing. EU energy liberalization, such as the Third Energy package, and new infrastructure projects have driven change in what was a largely ossified, fragmented system. EU and national competition and liberalization measures have promoted hub-based pricing similar to U.S. markets. A recent study from the Oxford Energy Institute showed that hub pricing, which came online for the first time in 1996 with the UK’s NBP, will in the future increasingly be driven by “global market dynamics.”
What is newer is the addition of financial regulation to the mix. Since the financial crisis, the push to clear more financial products on exchanges and trade them electronically, has pushed markets that were entirely bilateral more and more to exchanges. When it comes to energy in Europe, financial regulation and energy regulation are enmeshed, and markets are changing as a result. In the case of natural gas, the move has been easier than other markets. That’s because major brokers, although trading bilaterally, mostly use the Trayport platform. This allows them to subscribe to feeds and see most trades transparently, and allows clearing to grow along-side the OTC bilateral market without splitting liquidity.
That is where we at CME Group saw an opportunity, and launched 18 European Natural Gas contracts on CME Europe in Janurary – 14 cash-settled and four physically-settled, and cleared through CME Clearing Europe. The European market is one dominated by utilities and energy companies that have a need to hedge, and we have seen most activity so far in our physically delivered contracts, particularly Dutch TTF. It’s a market that is still 87 percent OTC, but it is also a growth market that has attracted liquidity on Trayport. CME has a straight-through clearing link via Trayport, enabling participants to submit their Trayport deals as Block Futures to CME’s Clearport platform.
As regulation has taken effect – both in energy and financial markets – there has been a disconnect between the term and spot contracts. This has resulted in many participants trading near the end of the existing monthly futures contract and opting out of physical delivery. Our physical delivery contracts bridge that gap by offering a string of daily contracts that follow monthly expiry. This is most pronounced in the TTF contract. For example, The June 15 physically delivered NBP & TTF contracts expired last week, with 2.25 million therms of NBP (UK Hub) and 0.3024 terawatt hours of TTF set for physical delivery via the cascade into physically delivered daily contracts
With six major hubs and a market that is built for the physical trade, the futures market for natural gas still has some room for growth in Europe – we see the growth of liquidity in the cash-settled market ahead, for example. But it is also one that has been carefully positioned over the last decade to trade on fundamentals, and to compete on a global scale. We’re seeing that already with the opportunity for exports to Asia. We also see it in the way the market has absorbed the Russia/Ukraine conflict, and moved forward in a way it may not have only a few years ago.
With the rise of futurization and the further adoption of physical and cash-settled contracts, the opportunities for growth will only expand. Derivatives markets will continue to play a role, as participants look to manage risk across the energy complex. We’ve already expanded our energy portfolio to include electricity futures. Further developments are on the way for our markets, and most assuredly for Europe’s place in the competitive landscape for natural gas.