Market reformists who are trying to put an end to oil-indexed gas contracts fail to understand the unique value of the current “hybrid” pricing system Europe enjoys in the gas market.
If they get their way, Europe will lose the protection of long-term contracts altogether and will move to a purely hub-based short-term pricing model as exists in the US, warns Sergei Komlev, Head of Contract Structuring and Price Formation at Gazprom Export. This model, he says, is not suitable for an import-dependent market like Europe. It will leave Europe at the mercy of short-term market forces without any regard for security of supply.
We often hear today that Gazprom is fighting a losing battle to preserve its oil-indexed contracts at a time when Europe is moving at high speed and with great enthusiasm to hub-based pricing.
In reality, however, there is no reason why oil-indexed and hub-based prices cannot continue their historic synergistic relationship, in other words coexist peacefully and with mutual benefit. Any real or perceived conflict between the two can be mitigated if properly handled. In fact, I am convinved that European hubs will flourish in the ‘shadow’ of oil-indexed long-term contracts.
The pricing model that currently exists in the European gas market is best described as “hybrid”. It consists of a combination of mainly oil product-indexed long-term contracts and short-term hub pricing. I use the term hybrid to indicate that these two different pricing methods do not exist in parallel worlds. They are closely interconnected and operate as a single, unique, mechanism.
Under the existing model, oil-indexed prices play a leading and dominant role, while hub prices play a balancing and subordinate role. Together, they comprise a purely market-driven and highly competitive system, although competition manifests itself in a different way compared to the U.S. supply-demand pricing model. What I will try to demonstrate is that the Continental European market not only has its own unique organization but is already mature enough to perform the functions that it is designed for. There is no cause for an inferiority complex on the part of the Europeans, which seems to be one of drivers of the proposed changes to the market model.