ANTECEDENTES

Th e most obvious losers from liberalization to date are the wholesalers. Th e fi rst casualties in the battle between incumbents and regulators were the cozy rela-tionships whereby the wholesalers passed costs through to consumers, taking a steady margin for very little risk. Some government budgets were also aff ected.

In Germany, Italy, the Netherlands, Belgium, France, and elsewhere, the utilities were partly or fully owned by national and local governments, contributing to government coff ers and in some cases paying for libraries, swimming pools, and other local amenities.

In the last decade, loss of monopoly status and market liberalization reduced the market power of the incumbents, and, in many cases, this was followed by un-bundling, sometimes legally, other times by ownership separation. To make mat-ters worse, the decade ended with them paying substantial amounts to producers for gas they could not sell. Th e massive powers of the renegotiation clauses should not be forgotten, but these do not protect against volume over-commitments.

Although the economic pain has been relieved by recent negotiations, the threat to their livelihood has not disappeared. Th ey continue to suff er from loss of mar-ket share, albeit at a reduced rate, and a competitive disadvantage to second-tier players. In the face of further potential problems, some incumbent wholesalers may face impaired credit status and declining share value. Most large incumbent wholesalers remain within vertically integrated companies with diversifi ed cash fl ows, and this can be used to support the gas business. Th e downside is that it can make it diffi cult to argue for concessions on long-term contracts.

Th e failure of some wholesalers could, in turn, leave more room for others to expand. Some of the multi-utilities may yet become more powerful. At the entrepreneurial end of the spectrum, some of the faster-evolving companies have managed to keep up with and even get ahead of the game, expanding beyond the traditional demarcated areas and layers, and increasing their sales and trading businesses. Th e recent market conditions have helped to accelerate this trend.

NATURAL GAS PRICING AND ITS FUTURE: EUROPE AS THE BATTLEGROUND

Th e clearest benefi ciaries of the collision between spot and oil-indexed gas on the continent are second-tier buyers, local distribution companies and industrials, and new market entrants that source gas under shorter-term contracts, and who have seized the moment, capitalizing on liberalized infrastructure access to source and move cheaper gas and grow their market share.

Most upstream producers, after many years of working with oil indexation to-gether with the incumbent wholesalers, are strongly supportive of oil indexation.

In the short term, for as long as there is oversupply, it can be universally agreed that the oil-indexed prices will yield higher prices and that upstream players sell-ing into spot markets will be losers in terms of annual gas revenues. Gazprom, with its pressing need for both investment funds and contributions to state cof-fers, can justifi ably be forgiven for supporting the status quo in relation to oil indexation. Its short-term outlook is likely shared by Sonatrach in Algeria. How-ever, selling out-of-the-money gas into oversupplied markets is not a sustainable strategy, as spot market sellers will progressively gain volume at the expense of oil-indexed sales. Ultimately, in the face of continued oversupply, the oil-indexed sellers have little choice but to reduce prices or volumes. In other words, if the recent measures do not work, further concessions by the producers are inevitable.

In the context of access to European markets, the LNG sellers and European terminal operators must be considered winners in 2009 and 2010, as LNG sales have reached record highs. Without the opportunities provided by European ter-minals, the next best option for sellers would have been the oversupplied U.S.

marketplace, where netbacks would have been lower.

Having said that some major gas producers support oil indexation, some up-stream players feel that the destruction of the powerful incumbent wholesalers would put the producers back in the driving seat. Th eir arguments are many, but most powerful perhaps is that put forward by Gazprom itself that spot markets will ultimately yield higher netbacks for producers than oil-indexed deals. With the production in the hands of a few large producers, Europe risks exposure to oli-gopoly behavior (which some argue would be almost certain to emerge), enabling the producers to control prices through the gas valves on the key pipelines. Ironi-cally, the loss of the battle to defend oil indexation could result in a power shift away from the incumbent wholesalers toward the producers. Th e belief of some observers that all of their upstream producers support their oil indexation mantra may in part be a forgivable self-delusion. Th e truth is that there are wide variations between the opinions of individuals within both the producers and wholesalers.

ANTHONY J. MELLING

CARNEGIE ENDOWMENT FOR INTERNATIONAL PEACE

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Th e upstream producers could fi nd that their special relationships with ma-jor incumbent wholesalers are less important than previously. In the event that incumbent wholesalers continue to lose market share, the producers will ingly bypass the wholesalers by selling to traders, second-tier players, and increas-ing numbers of end-users. Th is change will give the upstream players a broader vision of European market dynamics, which will inevitably lead to increased mar-ket penetration. Together with an increasingly scarce resource (beyond the current oversupply), this has the potential to increase the power of the upstream players.

Th e counter to this power is likely to be increased interaction with the EU and national regulatory authorities.

Among the producers, the principal benefi ciary, due to its location and es-tablished policies favoring the husbanding of the national resource, and special buyer/seller role of GasTerra, would appear to be the Netherlands.

Current dynamics certainly point to a shift of industry power in favor of EU and national regulatory authorities. Based on the negotiated agreement of the Th ird EU Gas Directive, 2009 saw the establishment of two new European regu-latory institutions: ACER (Agency for the Cooperation of Energy Regulators) and ENTSOG (European Network of Transmission System Operators for Gas).

Participation in pan-European institutions, and the necessity of becoming well-versed in EU legislation and policy, elevates national regulators into a coordinat-ing role that becomes indispensable in the formation of national energy policy.

Th is is well illustrated by the recent issue of gas demand forecast scenarios by the UK regulator for comment within the national energy industry. Th e issue of the EU Second Strategic Energy Review scenarios in November 2008 threw many of the gas and electricity industry infrastructure and investment plans into a state of suspended animation. In the meantime, while the EU struggles to fi ll the gaps between meeting its environmental targets and fi nding a practical solution to its energy needs, the UK energy regulator was the only available candidate to bridge the constantly shifting disparity between a nebulous European energy policy and an unsettled UK energy policy. While the task itself is logically impossible, it does illustrate the point that regulators across Europe have the potential to be drawn into a similar coordinating role.

With respect to the winners and losers in the European gas market, one may agree with Charles Darwin’s statement: “It is not the strongest of the species that survives, nor the most intelligent that survives; it is the one that is the most adaptable to change.”

NATURAL GAS PRICING AND ITS FUTURE: EUROPE AS THE BATTLEGROUND

WILL OIL INDEXATION SURVIVE