EU should reinforce joint gas purchasing to leverage market power: Draghi

The EU should strengthen its joint gas purchasing activities to make best use of its collective bargaining power and reduce its exposure to volatile spot prices, a report on European competitiveness published Sept. 9 found.

The report by former Italian Prime Minister Mario Draghi -- called "The future of European competitiveness" -- also found that the EU faced an "increasingly volatile" gas market outlook.

It stated that Europe was overly exposed to volatile spot gas prices and that behavior on gas derivative markets also increased the impact of price shocks in Europe.

"The EU is the largest global gas and LNG importer, yet its potential collective bargaining power is not being sufficiently leveraged and relies excessively on spot prices," the report -- commissioned by the European Commission -- stated.

This, it said, threatened Europe with "more volatile" gas prices.

The report found that gas would remain part of the energy mix in Europe over the medium term and that it was key to reduce gas price volatility.

"The report recommends reinforcing joint procurement -– at least for LNG -– to leverage Europe's market power and establishing long-term partnerships with reliable and diversified trade partners as part of a genuine EU gas strategy," it said.

Record prices

In response to the record high prices in 2022, the EU introduced a coordination mechanism to aggregate and match demand with competitive supply offers -- the AggregateEU mechanism.

However, there is no obligation for joint purchasing on the platform.

Platts, part of S&P Global Commodity Insights, assessed the benchmark Dutch TTF month-ahead price at an all-time high of Eur319.98/MWh on Aug. 26, 2022.

Prices are now back closer to pre-crisis levels thanks to healthy storage levels and demand curtailments, though remain high, with Platts assessing the TTF month-ahead price on Sept. 6 at Eur36.41/MWh.

The report stated that during the 2022 energy crisis, intra-EU competition for gas between actors willing to pay high prices contributed to an "excessive and unnecessary" rise in prices.

The lack of leverage was notable especially in the case of pipeline gas, where the possibility of rerouting gas flows was more limited, it said.

The report found that the loss of access to Russian pipeline gas meant that 42% of EU gas imports arrived in the form of LNG in 2023, up from 20% in 2021.

"LNG prices are typically higher than pipeline gas on spot markets owing to liquification and transportation costs," the report stated.

It added that with the reduction of pipeline supply from Russia, more gas was being bought on LNG spot markets both in the EU and globally leading to stronger competition.

"Even gas bought in long-term contracts is largely indexed to spot markets, which are increasingly influenced by supply disruptions and demand patterns in Asia," it said.

Despite the warnings, the Draghi report said the start of new production in the coming years would likely help to settle the market.

"Tensions in gas markets are expected to ease thanks to new global supply capacity coming online," it said.

Significant new LNG supply capacity is due online in the coming years, mainly from the US and Qatar.

Speculative behavior

The Draghi report also pointed to the impact on European gas prices of speculative trading activity.

It said Europe needed to reduce its exposure to the spot market by encouraging a "progressive" move away from spot-linked sourcing and to reduce volatility in EU gas markets by limiting the possibility of speculative behavior.

"Following the US example, regulators should be able to apply financial position limits as well as dynamic caps in circumstances when EU energy spot or derivatives prices diverge markedly from global energy prices," it said.

It said the EU should also put in place a common trading rulebook applying to both spot and derivatives markets and ensure integrated supervision of energy and energy derivatives markets.

It also called on the EU to review the "ancillary activities exemption" to ensure that all trading entities are subject to the same supervision and requirements.

The report stated that financial and behavioral aspects of gas derivative markets could exacerbate volatility and amplify the impact of shocks, adding that "a few" non-financial corporates undertook most trading activity in European gas markets.

It said recent evidence presented by the European Securities Markets Agency (ESMA) suggested that there was "significant" concentration both at position and trading venue level.

It said that concentration increased in 2022 during the largest spike in gas prices.

"The top five companies hold around 60% of positions in some trading venues and their short positions increased considerably by almost 200% between February and November 2022," it said.

"Supervision of these companies' activities could be improved."

The report stated that while regulated financial entities were covered by conduct and prudential rules, many of the companies that trade commodity derivatives can rely on exemptions.

"In particular, when a commodity company's main activities are not trading, they can be exempted from authorization as a supervised investment company," it said.

In the US, there is a stricter approach where exemptions apply on some types of contracts, but commodity companies are not exempted from supervision, allowing for a more precise level of scrutiny.

"In addition, energy commodities are subject to position limits, including Henry Hub natural gas contracts," it said.