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Mikhail Krutikhin: Those Beautiful Curves


Source: RusEnergy

Making prediction of energy prices is unreliable, by default. It’s hard to capitalize on the future, which can play dirty tricks on seers. The past is occasionally tricky as well.

Take a look at the curves in graphics of natural gas prices in Europe for example. Many analytical groups (at BP, Statoil, Wood Mackenzie, etc.) demonstrate that the price of piped gas sold on long-term contracts has been invariably higher than spot prices for the past two years, and the gap is to remain in the range of $20 to $35 for 1,000 cubic meters for a while. Honest analysts take the basic data of the prices at the NBP hub and compare it with the prices of piped gas on the German border.

The choice of the benchmarks is perfectly reasonable. The National Balancing Point is the pricing and delivery point for natural gas futures contract; and it is the most liquid gas trading point in Europe. It handles three to five times more gas volume than TTF in the Netherlands, or NCG in Germany. Its churn ratio, showing the liquidity of a hub, is 14.5 as compared to just 3 at TTF or 2.1 at NCG. It is, to all counts, the most representative indicator of the European spot market of natural gas.

The selection of the price on the German border is also a good benchmark. It shows how much Gazprom charges for the gas it sells on long-term contracts. Germany is its largest customer, consuming about 35 bcm a year, which roughly equals a quarter of Russian gas sales beyond the borders of the former USSR. It is also representative enough for the purpose of comparative statistical analysis.

Backed by this data, analysts can make a conclusion that does not bode well for Gazprom: the Russia monopoly’s prices are higher than the spot market, and it will experience pressure from traditional customers who are likely to request revision of contracts.

Moscow, however, is full of another type of analysts who prefer to remain on the safe side of Gazprom and its friends in the Russian government—or are financed by Gazprom-affiliated entities. They insist that the gap a) is not so large; b) occasionally spot prices are higher; and c) the Europeans will be losers if they change the pricing formula in Russian contracts.

Their curves are also quite convincing, at first blush. It is the choice of benchmark data that shows how the trick is performed. They take the prices at TTF rather than at the more representative NBP and the ‘average’ price of Gazprom’s long-term contracts. The latter is hard to justify because it resembles the average body temperature of patients in a big hospital. Moreover, it is based on the prices Gazprom reports to the Russian government although the company actually sells most of its gas through friendly and associated intermediaries, with a good premium.

Next time when you see beautiful curves in PowerPoint slides, take a closer look at the basic sources of data. Are they really representative?

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