Integrated risk management: we have our feet on the ground
We operate in an ever more volatile energy sector – with climate risks, the ever-present threat of the Covid-19 pandemic, and the knock on economic effect on almost all sectors of the economy, all only adding up to this volatility. Our role as a business is to help our customers via offering integrated risk management.
Source: Natural Gas World
By György Vargha, MET International
Our customers have three key pricing challenges. First, they want to achieve a price that is better than what their competitors get. Second, they have a budget from an energy procurement perspective they need to stick to and third, they need to keep an eye on the prices of their end product in relation to their energy costs. The most direct link is the fertilisers market where the feedstock is natural gas, but also, to a lesser extent, companies that make things for the consumer where the output is linked to the general inflationary environment. They need to manage all three in tandem in a volatile and often illiquid and untransparent environment. We understand it is a big challenge.
Gas prices have become more volatile in the past years for three reasons. First, oil indexation in the main import contracts has been replaced by spot indexation, second CCGTs have become a much more integrated piece in the gas demand mix and third, the role of Europe as a last resort LNG buyer has increased substantially.
The historical oil-linked contracts that gas producers like Gazprom and Statoil had with large importers like Eon and GDF Suez worked in a way that was averaging a percentage of the oil prices of a period between 3 to 9 months and keeping that fix price for 1 to 3 months. These contracts usually had flexibility inside them for the buyers to take, meaning that for 1 to 3 months there was an important fix price anchor in the market to price against. Much of these contracts have been replaced by hub indices without flexibility, and as such large import volumes are only linked to the fundamental dynamics of the gas markets without fix price anchors.
Unpredictable demand, inflexible supply patterns
Aside from this, other external contributors to gas price volatility have been power prices and LNG prices. LNG prices are much more volatile than gas prices: in the last year alone, the price has moved from around 5 EUR/MWh in the summer to as much as 100 EUR/MWh this winter. LNG markets feature huge quantities in single cargo shipments, largely unpredictable demand and inflexible supply patterns. Europe is extremely important for the LNG markets to place cargoes not needed by Asia. This, nevertheless, exposes Europe to the huge volatility of global LNG prices and can remove substantial amount of supply destined for Europe in case other markets need the LNG.
Power prices are also extremely volatile with increasing renewables production presenting zero variable costs and fossil fuel-based power production with ever increasing costs due to higher emissions pricing. As such, when substantial amount of wind is blowing, power prices can easily be 0 or negative, whereas in low wind scenarios power prices have been moving between 40 and 60 EUR/MWh. However, in the very short term, prices can even be + or – 1000 EUR/MWh, insane compared to gas pricing.
As such, with gas import and production profiles becoming less flexible, higher flexibility needed to support CCGTs and the LNG push (or pull) as well as removing oil formulae as fix price anchors, it is no wonder that European gas prices have become so volatile in recent years.
How do we help our customers address this volatility? We need to help them navigate through the rough times of volatility and illiquidity to eventually manage the three – sometimes opposing – targets.
Building bridges between markets
We are an integrated energy company across wholesale, trading, sales and asset optimization perspective, managing gas, power, LNG and oil exposures across the entire European energy landscape. We are well-positioned to manage liquidity risks in an integrated way and help our customers understand the driving forces behind the price moves in the liquid markets – being a major participant ourselves.
We are eventually building bridges – between liquid and illiquid markets, between traders and originators, between professionals coming from different cultures, between physical assets and commercial feasibility.
For example, we have gas sales in the Mediterranean region in countries such as Spain, Italy, Hungary, Slovakia, Croatia, Bulgaria which are illiquid from a physical gas perspective. Local markets don’t have depth and customers don’t necessarily see what prices are. Many of these markets are dominated by state-owned companies. One way we are able to help our customers there manage risk is by connecting them to the European markets with sufficient liquidity to hedge their exposures and provide understanding to the price movements enabled by being active in the LNG and power markets as well as being fundamental drivers of the gas markets.
We recently booked capacities in the Croatian LNG terminal for a three-year period, amounting to 1.3 billion cubic meters overall. We will process 6 to 9 cargos per year there (the first full cargo this April) and if the price dynamics allow it, we can divert these cargos into other global LNG markets or even to Northwest Europe. We can also book some further slots on a short term basis. So we can import into Italy, Spain, Greece and Turkey to feed our portfolios. It makes us a Mediterranean buyer of LNG into almost all markets there, creating a portfolio effect and hedging tools into all our illiquid gas markets. It also gives us an exposure on how LNG players think – and we are ready to share this understanding with our partners.
LNG traders work in a different way compared to power or fundamental gas traders, or hedge funds. By being active on a variety of markets impacting the European gas markets – as well as the majority of the local European gas markets themselves – we also get an increased understanding on the overall dynamics and a good basis to proxy hedge exposures within this pan-European cross-commodity portfolio.
We booked capacity in the Croatian LNG terminal because the price was right, and it gave us the means to manage risk for Mediterranean customers. We just completed the acquisition of Gas-Union’s gas storage activities at four sites in Germany – Reckrod, Etzel, TGE and KGE – with a total working gas capacity of 3.4 TWh. The storage assets complement our existing wholesale positions and support the build-up of sales activities to end consumers through our 100% subsidiary, MET Germany. So all of these asset positions, be it direct asset investment or mid term positions, allow us to have a good trading understanding of the whole gas market in the most relevant regions.
Power grid stability problems in Europe
As we look to manage risk for our customers, we look to the future with regard to energy transition, but we have ‘our feet on the ground’, we are very pragmatic in terms of investment. In the medium to long term, our planned strategic investment is in renewables. For example in January, we completed the acquisition of a 100% stake in Enel Green Power Bulgaria, which owns a 42-megawatt wind park in Bulgaria. The transaction is part of MET’s growth strategy to develop a significant renewable portfolio in the CEE region. Last October, our solar power plant in the Hungarian town of Kabai started commercial operations, providing green electricity to more than 23,000 households.
But we are practical right now, and we know that power grids are struggling with the surge of renewable production because it is too volatile – the weather is unpredictable and day production is very different to that produced at night. Europe will need to solve power grid stability problems before decommissioning lignite power plants. Gas peaking plants are a possible solution, if hydrogen-based peaking technologies are well supported, if lignite and coal plant early peak emssioning is supported, if peakers are supported by the governments, then they have their role. From our point of view, we continue with opportunistic investment in areas such as gas-based generation or gas storage, production or regasification.
Because we are strategically focused on renewables in the long term and opportunistic on investment into gas-based infrastructure assets, we will not be getting into the hydrogen market in the short time horizon, where we see investments still in in the R&D phase. We do not think we have the size or the experience right now for major research and development in this area. Hydrogen is one of the solutions for the gas industry’s future, and it is a greener, cleaner fuel that has had a lot of support in Germany and Italy. Nevertheless, we believe we can add value in other places compared to hydrogen.
We have strong local management on the ground so our partners can connect to real professionals locally. Nevertheless, we are coordinating our efforts centrally to share perspective and enjoy the synergies together. Managing this cultural complexity is a key competitive advantage that we leverage on, however difficult it is. Yet with the right mindset, it can add true market value – the pursuit of which is in our genes from the outset.