PSV-CEGH gas hub merger would increase TAG flows, reduce PSV gas prices: report

London — A merger of the Italian PSV gas hub with the neighboring Austrian CEGH hub would lead to increased and cheaper gas flows from Austria to Italy, and ultimately bring PSV gas prices down, showed a study conducted by DFC Economics and Frontier Economics consulting firms for Austria's E-control and Italy's ARERA.

The report, which was published late on Jan. 19, aims to offer a prerequisite for a full cost-benefit analysis of the market zone merger, and come as the regulators of both countries are evaluating the possibility of merging the two hubs into a single trading region.

In the base scenario explored by DFC, a PSV-CEGH hub merger would have two main consequences.

The first one would be an increase of gas flows reaching Italy via Austria via the TAG pipeline.

The Central European gas market is highly integrated and is supplied with gas through different transport routes. As gas gets distributed through the highly connected pipeline network across Europe, several supply routes may lead to the same destination. Assuming perfect competition, the cheapest transport route will be used more extensively compared to more expensive routes, according to the report.

As the elimination of entry-exit fees on the Austrian-Italian border would reduce the cost of transporting gas to Italy via Austria, this route would become more attractive relative to Italy's more expensive supply routes such as Gries Pass, the interconnection point on Italy-Switzerland border and Italy's most expensive supply route.

"Supply routes which have become cheaper might be used more, on the other hand transportation of gas through Switzerland might diminish," the report reads.

Over the modeling years considered by the report of 2020, 2025, 2030, transit from Germany or France to Italy through Switzerland would cease, and would be substituted by transit via the Czech Republic, Slovakia and Austria, and additional supply from Russia via Slovakia. Some LNG imports would be substituted by pipeline gas coming via Slovakia as well.

Impact on price

While before the merger prices are higher in Italy than in Austria, a PSV-CEGH merger would trigger an alignment of prices between the two areas, according to the report's base scenario.

This happens as the current marginal or inframarginal supply route of one of the two countries, would become the marginal supply route of the new merged area.

For the scenario year 2020, the report calculates that a market merger would lead to Italian prices reduced up to the Austrian level by minus Eur1.170/MWh on annual average, while Austrian prices would remain largely the same.

In a year 2025 scenario, Italian prices would decrease but to a lesser extent, by minus Eur0.250/MWh on average, while Austrian prices would increase by an annual average of Eur0.800/MWh.

Finally, in a year 2030 scenario, Italian prices are expected to decrease by an annual average of Eur0.630/MWh, and Austrian prices to increase by annual average of Eur0.450/MWh, the report shows.

Wholesale price formation

The consulting firms were able to come to this conclusion after analyzing the key drivers in the formation of wholesale gas prices in Europe and develop a specific gas model.

According to the report, absolute price levels in the European gas market depend on the same overall supply/demand situation in Europe, with regional prices mainly differing by transport costs.

This happens thanks to a high degree of integration of Europe's markets, which means that a single price reference, such as for example LNG price, is able to influence the level for the wholesale gas prices across various market areas, with suppliers adjusting their supply prices according to this reference price, net of the transportation cost to reach the supplied region -- net back pricing logic.

The modelling framework optimizes endogenously both gas transport flows and storage usage to minimize supply costs to the EU.

All infrastructure projects with a final investment decision have been taken into account. In addition to this we assume Nord Stream 2 and the TAP pipeline to be commissioned after 2020, the report stated.