Cold weather swoops without notice – gas prices take everybody by surprise
The unusually cold weather between the end of February and the middle of March sparked spectacularly big swings in natural gas prices. In this extraordinary situation, gas traders were bound to address risks arising from price fluctuation. We asked two of MET Hungary’s experts, Director of Retail Sales Márton Szépfy and Head of VIP Key Account Manager Team András Matisfalvi, about the challenges of energy procurement.
- After two relatively mild winter months, the weather tightened its grip across Europe in February. How did this affect gas markets?
- András Matisfalvi: Price swings on the spot markets were more visible at the end of February: natural gas prices from around EUR 20 jumped to EUR 102 within a week at Austria’s VTP, Central Europe’s largest virtual gas hub. Prices quadruplicated as well at the Dutch TTF platform, which is the greatest virtual trading point of Continental Europe. These impacts – albeit less aggressively – carried along the forward markets, where a surging trend appeared as well, although it did not exceed 10 percent.
Traders were the most affected by dramatic price volatility generated by temperature fluctuations. Only those industrial consumers were ‘in danger’ that failed to take care of their exposure to price volatility on the market or only limited it to a certain extent. As a result of state-controlled prices, residential consumers were not affected at all.
Was there anybody on the market who saw these impacts beforehand?
- A. M.: In January, meteorologists forecast a milder weather to come in February, however, forecasts turned to the opposite in the space of one week. The influx of cold air from Siberia raided the continent unexpectedly, it is hard to be prepared in such cases. No market player was able to price the sudden fall in temperature weeks before it happened – that would have required a crystal ball.
Nevertheless, it was interesting to see that steep price rises lasted about four or five days, than they were followed by three days of decline, so the surge was over in the course of about ten days. If plunging temperatures had been forecast earlier, the possibility of a long cold period would have resulted in uncertainty among customers. That would have generated steadily high demands, causing price increases to drag on.
- Who were able to gain by the sudden changes and who were harmed by them?
- A. M.: Traders that managed to correctly forecast consumption levels in the portfolio they supplied were able to benefit from the changes. Those that took up a short position and fell short of supplies came off badly, because they had to buy gas on the higher spot prices to meet increased consumer demand caused by cold weather. In general, traders also involved in day trading were able to gain real profits.
- Márton Szépfy: Energy trading is a zero-sum game. Market players who take the chance of buying more gas (because they expect colder weather) can make profits during a cold snap at the expense of traders who do not have enough sources at the same period. Demand rises when forecasts show cold weather, and it drops when a thaw is expected. However, we should not forget about the fact that there is a close but not exclusive connection between weather and natural gas prices. For instance, gas prices fell despite cold winter weather when Western European stock exchanges went into a tailspin during the economic crisis of 2008-2009.
Another crucial aspect may be the type of the consumers the trader deals with. Consumers with a ‘flat profile’ show no significant differences in month-on-month consumption. These are mainly industrial firms that need gas for their production technology. Glass producers, artificial fertilizer producers or automotive manufacturers for example push the Start button on 1 January and they usually won’t stop consuming gas until 31 December, while they keep their production capacity relatively unchanged. These plants do have a heating demand in winter, but it is a negligible amount compared to their overall consumption.
The other category consists of consumers with a ‘heating profile’, they are more affected by weather changes. Their natural gas consumption grows in proportion to the decrease in average temperature, while they do not need much gas during the summer, if not for hot water production. Apart from residential consumers, these customers are mainly power plants, district heating plants, among which there are very few that do not consume significantly more in winter than in summer. They account for over a third of Hungary’s gas demand. With regards to these consumers, it is important that gas traders address risks arising from temperature volatility.
- How can traders manoeuvre? Do they seek detour and buy natural gas from other resources?
- M. Sz.: There was no detour, since price hikes caused by the cold blast affected Europe as a whole and all markets surged. Hungary’s gas supply was no exception either. The source of natural gas is an important factor, but what really matters is pricing. Irrespective of the entry point at which supplies cross the Hungarian border, natural gas ultimately comes from Russia, the real question is how we price it and to what we index it.
Energy procurement is a process of multiple factors. The two most crucial of them being the price of the molecule and the cost of logistics, they amount to the bigger part of the overall costs. Customers also consider how they can attain cost advantage at a given delivery point, either from Western or Eastern sources. There is a competition between the two directions today, because price formulas are not that different. The traditional oil formula has already been replaced by Western European pricing in almost all contracts. Moreover, logistics costs do not diverge significantly either: prices are set by legislators, who now seek to create competition and ensure that former differences are not maintained.
- A. M.: When it comes to prices, the rates at Austria’s VTP (to which Hungary is physically connected) and the Dutch TTF are considered to guide trends in the region.
- How can prices be balanced?
- A. M.: It does make a difference for example whether or not large consumers buy natural gas at a fixed price or at an indexed price that follows changes on the market. Some traders allow price formulas to be changed within a contract period. For example, if someone contracts at an indexed price, but later believes that prices have dropped and expects them to stop falling, the trader may agree to fix the price. In this case, when the market starts surging, the consumer is not burdened by extra costs.
Vice versa, when prices are high enough and a downward trend is likely to begin, fixed prices can be replaced with indexed prices. When the market is declining, indexed prices enable consumers to draw profit. Prices can be fixed and unfixed again and again, several times within a contract period, which allows them to benefit from price changes in the market. In practice, the consumer and the trader should cooperate closely on shaping price formulas.
- M. Sz.: Energy procurement today is nothing but risk management or risk optimisation. Consumers alone would struggle, as the current product range is nearly endless. The pillars of a truly great procurement are a proper estimate of real demand, an exact calculation of energy costs, and finally, energy supplies available in the right time and in the right form. This requires a continuous dialogue between the consumer and the trader.
- What are the effects of the enhancing diversity of gas resources?
- M. Sz.: The diversity of Europe's gas supplies has been significantly improving due to LNG (liquefied natural gas) arriving from the US. The number of LNG terminals is constantly growing - for example in Croatia, Poland or in the Baltic states - therefore the US is getting engaged more and more in areas located close to Russian gas fields. In the meantime, several Russian projects are in the pipeline as well and they can reach Europe within two or three years. As a result of these developments, competition is on the rise, while trading profit continuously declines.
Although the number of actively trading companies is diminishing, the race for consumers and positions is toughening. In consequence, transaction margins have thinned to mere cents compared to the “good old days”. Today, even a 1-2% profit is considered as a nice result.
- A. M.: Consumers aim to access the cheapest possible sources, while traders aim to access the widest possible range of sources. If the great projects also involving Hungary are delivered, competition among the different sources will intensify. We cannot declare that natural gas prices will only plunge in the future, but the more sources compete to supply Hungary, the lower the prices can be under the same market conditions.
This article was sponsored by MET Hungary.