Europe's Evolving Gas Market
Future Direction and Implications for Asia

Executive Summary

This paper considers current developments in the European gas market, whether the pressure being placed on the historically predominant oil-indexed pricing structure will lead to fundamental change in the way that gas is priced in this market, and what effect this might have on the Asia-Pacific gas market.

MAIN ARGUMENT

A notable characteristic of the natural gas industry has long been its regional fragmentation, which has resulted in substantial variation in the trade and pricing of gas in different markets. In the U.S. and UK, prices are set as a function of gas-on-gas competition, whereas in continental Europe and East Asia, the predominant pricing mechanism involves indexation to oil. The limited volume of international, and in particular interregional, trade has enabled these pricing disparities to persist and prevented the emergence of a global gas market with a single price. Recently, however, the combination in Europe of an increase in supply availability, particularly of market-priced LNG, and recession-driven demand weakness has led to the emergence of a surplus that has in turn created a significant disparity between the market-based and oil-indexed gas pricing models, sparking calls from customers for more competitive pricing. While there is now the real likelihood of market reform in Europe, the dynamics of the Asia-Pacific markets prevent any broad conjecture about liberalization. There does appear to be potential, however, for China to reflect these developments in its price negotiations with potential suppliers, such as Russia, and for other nations in the region to follow Beijing’s lead.

POLICY IMPLICATIONS

• Of the potential scenarios for how Europe’s current two-tier pricing structure may evolve, the traded market price will most likely maintain a significant discount to the oil-indexed price, provoking ongoing consumer insistence on reform and leading to a shift to full market pricing in Europe.
• European liberalization could have significant implications for prices in Asia. One possible consequence is China seeking to reflect developments in the European market when negotiating future gas import requirements, particularly with Russia.
• A successful pricing change for China could then lead other countries in the region to negotiate prices lower than those of oil-indexed markets, effectively liberalizing AsiaPacific gas markets.

Peter Hughes is currently Director and Head of the Energy Practice at Ricardo Strategic Consulting in the United Kingdom. His career in the international energy business spans more than 30 years, during the course of which he has held positions at the most senior levels in both the corporate (BP, BG Group) and advisory (CERA, Arthur D. Little) sectors.