Balancing rules can give rise to distortion on Italy's illiquid gas market: traders

London — A trading strategy used by companies operating on the Italian gas market has over the past few years led to regular shortness of gas volumes in the system during morning trading hours, which is leading to higher within-day gas prices, an investigation by S&P Global Platts shows.

Several traders have told Platts they can take positions in the early hours of the trading day to prompt Italy's gas grid operator Snam -- which is responsible for balancing the system -- to intervene by purchasing the missing volumes on the GME, Italy's balancing market.

When Snam purchases within-day volumes on the GME, the within-day gas price tends to rise -- sometimes by more than Eur1/MWh -- and with it the premium of Italy's PSV to the northern European hubs.

Once Snam has entered the GME and purchased the missing volumes, traders that withheld volumes in the early morning can then increase their sales on the PSV and take advantage of a higher within-day price, traders said.

According to several sources contacted by Platts, this strategy can also allow for expensive import routes -- such as via Passo Gries -- to be "in the money", which could also contribute to higher prices.

This kind of trading can be applied both to pipeline imports -- with the Tarvisio route bringing Russian gas to Italy seemingly the most utilized -- and storage withdrawals, traders said.

An Italian gas trader said he understood the trading strategy was in line with Italy's existing gas balancing regulations.

"I wait for Snam to enter the system and then I fill my pipeline and start selling at the PSV," the trader said.

A second trader from a different company said the purpose of the strategy was to create a spread between the Italian PSV and the Austrian CEGH favorable to imports.

"If the system is short, the spread widens," the second trader said. "But the same thing can happen with stocks, whose nomination rules allow even more flexibility than pipeline imports," the trader said.

"Traders wait until the PSV/CEGH within-day spread widens enough before importing from Tarvisio. Which means that they usually wait until Snam enters to balance the system," the trader said.

A third Italian gas trader said Snam had a "strong propensity" for balancing the system when it was short. "If the system goes long, the TSO waits until the system rebalances itself," the trader said.

"This behavior is triggered by the way the balancing system is structured. No trader is smarter than any other," the first trader said.

Risks and gains

The strategy is not risk-free, however.

"If the system rebalances by itself or Snam doesn't intervene, you risk losing money," a fourth trader said.

However, if several Italian gas market players adopt the same strategy and wait for Snam to intervene before starting to sell or increasing their within-day sales, that risk is minimized.

"To use this strategy, you have to be good at forecasting what is likely to happen on the market. You need to check other sources of supply, yesterday's transport capacity auctions, LNG flows, maintenances, etc. And based on this you can guess if the system will remain imbalanced and require the need for Snam to enter," the fourth trader said.

And the gains appear to be good enough to take the risk involved.

"If I could open my own trading company, I would just operate on the Italian within-day market with this strategy," the first gas trader said.

Operational balancing data published daily by Snam confirm that the Italian gas system is often short during the morning trading hours before recovering during the afternoon trading session.

Hourly gas flows published on the ENTSOG transparency platform show that imports of gas via the Tarvisio entry point fluctuate during the day: they are usually low in the morning and higher in the second half of the day.

Similar intra-day fluctuations can also be seen at the Baumgarten and Velke Kapusany entry points, which sit on the route used by Italian players to import long-term gas from Russia into Austria and Italy via Tarvisio.

GME data -- published with a three-month time lag -- show that Snam's intervention on the within-day market usually triggers an increase of that price level, both in absolute terms but also in terms of the spread between the within-day and day-ahead contracts.

For example, on July 3, GME data show that Snam intervened four times to try to balance the system that was seen short by about 8 million cu m between 0600 CET and 1200 CET time, and by about 4 million cu m between 1200 CET and 2300 CET.

Before Snam's first intervention at 1821 CET, the within-day price on the GME market stood at an average of Eur6.55/MWh.

At the end of the day, after Snam's fourth intervention and several hours of market shortness, the price rose to as high as Eur7.40/MWh, an increase of Eur0.85/MWh.

The same day, the spread between the GME within-day contract and the day-ahead equivalent moved from Eur0.40/MWh in the morning to Eur1.10/MWh at the end of the day.

Existing rules

Italy's existing gas market balancing rules require Snam to maintain the Italian gas system within a +/- 3 million cu m imbalance threshold at the end of the gas day only, and not throughout the whole gas day.

Traders are also required to balance their positions only by the end of the gas day and not during the whole day.

Traders are required to make nominations for pipeline imports and storage withdrawals on an hourly basis (with different limits during the day), but they only have to balance their positions on a daily basis.

This discrepancy between nominations and balancing rules is what allows them to import lower volumes in the morning and more in the afternoon.

"For example, I can buy the missing volumes to balance my position even at 8 pm," the first trader said.

A lack of gas market liquidity in Italy and the sector being dominated by a few major players can also contribute to traders taking such positions.

The fourth trader said the strategy has been used effectively for years, attracting new players to the Italian within-day market, which in turn had complicated the strategy somewhat.

A spokesman for European trade industry body EFET said the system was built to accommodate a level of fluctuation.

"There can be legitimate reasons why individual shippers may be out of balance at any particular time of the day," the spokesman said. "However, if any shipper is endangering the system or imposing unnecessary costs on other market participants, then they risk being subject to regulatory investigation," he said.

A spokesman for Snam said the company performed balancing actions aimed at keeping Italy's gas network within its operational limits "in the interest of the gas system, both when this is short and when this is long, according to European and Italian rules."

"Snam performs a residual balancing and is subjected to penalties when the system is imbalanced," the spokesman said.

Italy's energy regulator ARERA said there could be a case for the agency to investigate incidences of repeated "opportunistic" behavior.

"Italy's gas market is designed according to European rules and traders have gains and also risks when taking certain actions," an ARERA spokesman said.

"Obviously, should there be repeated opportunistic behavior, ARERA is ready to start an investigation to assess the situation," the spokesman said.