RWE: Anatomy of a gas portfolio16 Jul, 2012
The gap between gas hub and oil indexed contract prices has been a key factor driving the evolution of the European gas market over the last five years. The availability of cheaper gas at trading hubs has been the main factor behind market liquidity development. It has also caused suppliers to suffer substantial losses on their ‘take or pay’ volumes of oil-indexed gas. As a result, large volumes of gas under long term contract are currently undergoing a price review process to determine revised contract price levels. RWE, one of the players at the core of this dispute, has recently published a breakdown of pricing across their gas portfolio which provides an interesting insight into the impact of contract re-negotiations.
Chart 1: RWE gas supply portfolio (source RWE)
42% of RWE’s gas is procured via long term oil-indexed contracts. Of this volume, roughly 10% is sold to customers on a similar oil-indexed basis, with the remainder exposed to deviations between gas hub and oil indexed contract prices. It is this volume which is the focus of RWE’s current contract price review negotiations as illustrated in Chart 2.
Chart 2: Profile of RWE gas contract volumes under review
The chart shows that the majority of RWE’s 19bcm of oil-indexed gas is currently subject to price review. Given the dominance of Russian and Norwegian gas, the resolution of these negotiations will primarily come down to the stance that Gazprom and Statoil take on adjustment of (i) absolute contract price levels and (ii) replacement of oil with gas hub indexation. While the negotiations are happening behind closed doors, there have been some interesting indications from price review conflicts that have been resolved this year.
E.ON’s settlement with Gazprom at the end of June suggests that Gazprom are willing to compromise on absolute contract price level much more than they are on diluting oil-indexation. This goes some way to addressing the P&L hit that E.ON has suffered (E.ON revised its profit indications up by around £2bn after the announcement). However it does not address the structural risk that E.ON faces as a result of the difference in pricing basis between the oil-indexed price it pays for gas and its hub driven end user pricing.
Gas hub indexation has for some time been the dominant pricing structure in the European origination and I&C customer markets. In response, Norwegian and Dutch suppliers appear to be taking a more pragmatic approach to their long term contract pricing. Resolutions of contract disputes to date suggest that they are willing to dilute the level of contract dependence on oil-indexation in favour of gas hub pricing.
While this places some competitive pressure on Gazprom, it is unclear as to whether it will follow suit. A narrowing of the gap between oil-indexed and gas hub prices recently may ease the pressure on Gazprom to reduce the level of oil indexation. The outcome of E.ON’s price review negotiations suggests that the structural oil vs gas price risk will remain as a key driver of gas portfolio value. The results of RWE’s arbitration process are not expected until late in 2012, but it will be very interesting to see to what extent they show any shift towards gas hub pricing.