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Europe: LECG consultancy study offers three options for Europe gas model

https://www.chemnet.com   Mar 09,2011 Platts
A new study released by UK energy regulator Ofgem late Monday presents three main models as possible options for the future of Europe's gas market.

The study was prepared by consultants LECG for Ofgem as a contribution to ongoing debates by European regulators.

TWO WAYS TO DEFINE MARKET STRUCTURE

The paper says that there are two main ways to define market structures: size of price zone and allocation of cross-border capacity.

Price zones could be small like in the US gas market, medium-sized and mostly national as for example the current UK NBP and Dutch TTF hubs, or could be big and international.

Cross-border capacity can be allocated in two main ways. It can be explicitly auctioned, with space in pipelines sold to traders, who then decide how they want to use their transmission rights.

Or a "market coupling" model, as has grown recently in the European electricity market, can be used, with the prices set at exchanges used to calculate how to allocate the space in pipelines between the different price regions so as to best smooth out any price differences.

Some traders say that market coupling in electricity has resulted in greater harmonization of spot power prices in northwest Europe, and that it is reducing the profitability of the markets for traders by closing down arbitrage opportunities.

THREE FUTURE OPTIONS

The LECG paper focuses on three main models as options for Europe's future target model.

The "Framework Guidelines Model" combines medium-sized, mostly national hubs, with explicit trading of capacity rights between hubs. It is currently emerging as the standard approach in the European gas market.

Another option would be the "Merged Markets" approach. This would involve mergers of zones (for example the TTF and German GASPOOL/NCG zones perhaps could be merged), but retain explicit trading of capacity at the borders of these larger zones.

A third option is the "Coupled Markets" approach. The zones would remain at current sizes, but there would be implicit auctions to allocate space in the pipelines between the zones, as in the French/Belgian/Dutch day-ahead power market and the Nord Pool electricity market in the Nordic region.

THE ANSWER DEPENDS ON THE QUESTION

The LECG report says that which of these models is the best for Europe depends on what regulators identify as the key problems to solve.

A fundamental question is how far there is a problem with traders hoarding capacity on pipelines between market zones.

If regulators think that capacity hoarding is a big problem, they might prefer to move away from the "Framework Guidelines Model" to the "Merged Markets" or "Coupled Markets" approach, in which transport between zones is solved by either enlarging the zones or automatically allocating the rights between them.

However, regulators may not think capacity hoarding is impossible to deal with. Use-it-or-lose-it rules are in place to deal with capacity hoarding. And pipeline companies could also try to tackle hoarding by over-selling capacity.

If operators sold more capacity than was actually physically possible, then even if one buyer tried to hoard unused capacity, the pipes could still be physically full because other buyers would use the pipes instead.

National Grid oversells capacity in the UK, later buying capacity back if necessary, and airlines often overbook customers on flights, relying on some passengers not turning up, or being prepared to switch to a later flight.

The "Merged Markets" model would rely on physical congestion being relatively limited within the new, larger zones. If the large zones had a shortage of transport capacity within them, it would be hard to justify a single price across the zone.

The "Coupled Markets" approach tackles capacity hoarding and provides a larger number of price zones to reflect possible congestion between zones.

REGULATORS SHOULD ANALYZE CONGESTION

The LECG recommends that regulators and other industry members analyze the amount of pipeline congestion and the dangers of capacity hoarding to help the industry decide which model is best.

Producers and importers should also analyze how these models would impact long-term contracts that still govern huge volumes of gas imported into Europe. For example, if market zones were merged, that might change the delivery point of an existing long-term contract.

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