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Explainer-Why would Europe need an EU-based LNG pricing benchmark?

·5-min read
FILE PHOTO: Illustration picture of flames from a gas burner on a cooker in France

By Marwa Rashad and Isla Binnie

LONDON/MADRID (Reuters) - The European Union plans to create a benchmark for liquefied natural gas (LNG) to establish fair, market-based prices for gas imports that could eventually ease price differences among the bloc's different gas hubs and reduce market volatility.

Following Russia's invasion of Ukraine, Europe has become a prime LNG market, procuring massive amounts of the seaborne fuel to replace Russian pipeline gas that used to make up almost 40% of the continent's imports.

Major price divergences among gas hubs in the bloc are caused in part by their differing capacities to receive cargos of LNG. Gas prices in countries with several LNG terminals, such as France, are below other hubs like Germany which currently has no LNG terminals.

WHAT ARE THE MAJOR LNG MARKETS IN EUROPE?

LNG cargoes on a delivered ex-ship (DES) basis, which means the price includes delivery to a specific port, arrive at several gas markets in Europe. The most notable of these are Northwest Europe which includes the UK, the Netherlands, Belgium and Atlantic France, and Southwest Europe including Spain, Portugal and Italy among others.

Then there are the West Mediterranean and the Adriatic market, which includes Greece and Turkey, all of which have different import capacities and different interconnections that allow gas to move to consumers or other countries.

ARE THERE OTHER BENCHMARKS USED TO PRICE LNG in EUROPE?

Historically, the European gas price at the Netherlands' Title Transfer Facility (TTF) hub was regarded as a sufficient proxy for delivered LNG into Europe.

Britain's National Balancing Point (NBP) comes in second place after TTF in terms of liquidity and ability to attract buyers and sellers. There are other less active gas hubs in Germany, France, Austria, Italy, Spain, Belgium and the Czech Republic. British gas prices however have suffered the same volatility as TTF.

While the TTF is mostly used to price LNG in Europe, some LNG long-term contracts are still linked to the oil price.

Many pricing agencies have been using the LNG New DES index, which better reflects the price of LNG cargoes delivered on an ex-ship basis into Northwest Europe than the TTF.

WHAT IS THE ISSUE WITH THE TTF BENCHMARK?

The TTF has been widely used as a price benchmark for LNG deliveries into Europe, with a small spread added to match the costs of regasifying the gas and sending it into the grid. But a major reduction of Russian gas supplies has made the TTF price extremely volatile.

The benchmark front month gas contract at the Dutch TTF has swung this year between a low of $23 per million British thermal Units (mmBtu) in February, and a high of $89.3/mmBtu in August.

Meanwhile, LNG cargoes for delivery into Northwest Europe on a DES basis have been largely at a discount to the TTF.

Germany is currently installing five floating LNG import terminals and is building three land-based ones, which will increase LNG import capacity in Northwest Europe.

Industry sources say that the EU LNG market needs to have a price that is reflective of the actual supply and demand and to reduce exposure to the TTF, which due to the spike in gas prices is currently the most expensive compared to other gas benchmarks like the Japan Korea Marker (JKM) in Asia or the Henry Hub (HH) in the united states.

More than 70% of the LNG cargoes that arrived to Europe this year came from the United States. Such LNG cargoes have traded in a narrow band somewhere between the TTF and the HH, which recorded a very wide spread that reached $80-$90 in August, making it more difficult for companies to price LNG against these gas benchmarks.

HOW DOES LNG DES PERFORM AGAINST TTF?

Earlier this month, "SparkNWE" - an index that tracks the differential between LNG cargoes delivered into Northwest Europe on a DES basis and the TTF - recorded a discount of $20/mmBtu against the TTF price, according to Henry Bennett, head of pricing at Spark Commodities which launched the index earlier this year.

"Although more European import capacity is being planned and may alleviate these import constraints in the future, the forward curve shows that the dislocations (differentials) are being priced in for at least the next year, with the September 2023 SparkNWE discount still at more than -$8/mmBtu," Bennett said.

CAN AN EU LNG BENCHMARK MAKE A DIFFERENCE?

Industry sources said the EU does not need to create an LNG benchmark since many pricing agencies already use the LNG DES index, adding that the industry can develop it on its own.

Kaushal Ramesh, senior LNG analyst at Rystad Energy, said that trying to replace the TTF "is a gamble because it would not properly represent European fundamentals and might have unintended consequences for what has been a highly deregulated market."

Creating a benchmark on its own will not help the European energy crisis in the short term, while in the long term it would depend on whether the industry starts using it and whether banks start offering financial products around it, a European trader said.

"If there is no financial market behind it, if you cannot use that to hedge your positions, it's going to be useless," he said.

(Reporting by Marwa Rashad in London and Isla Binnie in Madrid; Editing by Susanna Twidale and Susan Fenton)