Pricing of wholesale gas in the
Netherlands - update 2008/2009
A REPORT PREPARED FOR NMAPricing of wholesale gas in the
Netherlands — update 2008/2009
1 Introduction 1
2 Quantitative analysis 3 2 . 1 G a s Te rra 's prices 3 2. 2 B en ch m ark A : Supp ly c os ts o f hypo th e tica l n e w en trant to th e
ma rke t 3
introduction
The Netherlands Competition Authority (NMa) is charged with the enforcement of the Dutch Competition Act. In this context, the NMa has conducted an investigation of the incumbent's — Gas Terra — prices for gas supply and the supply of flexibility services for various types of end-consumers over the period 2001-2007. This investigation was informed by a study carried out by Frontier Economics in 2008.'
The study which is the focus of this report expands the analysis to the years 2008 and 2009. As with the initial study we use two different approaches to develop hypothetical competitive benchmark prices:
Benchmark A: cost of different hypothetical competitors supplying the Dutch market; and
Benchmark B: supply and demand in a hypothetical market that is comparable to the Dutch market.
We then compare GasTerra's prices with the benchmark prices.
We refer to our 2008 report for more details about the context of the study and the approach to the analysis.
The remainder of this report is set out as follows- we discuss key assumptions and results in section 2 and we set out our conclusions in section 3. The report is accompanied by an annexe with selected numeric assumptions and more detailed results.
2 Quantitative analysis
In this section we develop competitive benchmark prices for 2008 and 2009 according to the two approaches described in the introduction. We then compare Gas Terra's prices to those benchmarks.
2.1 Gas Terra's prices
GasTerra provided the NMa with its retail supply prices for 2008 and 2009 for the same two customer groups for which we derive competitive price benchmarks. For large-scale end-users the prices submitted by GasTerra are €/MWh in 2008 and €/MWh in 20092. For small-scale end-users in
2UU8 the price submitted by GasTerra is €/MWh. From 2009, GasTerra has offered two different pricing systems — for 2009 we use an average of those two prices, weighted by their sales volumes, i.e. , €/MW112.
2.2 Benchmark A: Supply costs of hypothetical new
entrant to the market
In the following we present key assumptions and results for the Benchmark A analysis for 2008 and 2009. Furthermore, we give a brief overview of the methodology for the analysis, focussing on the basic approach and methodological changes from the previous study. For more detailed explanations of our approach, we refer the reader to our 2008 study.
2.2.1 Customer types
The following table summarises the key parameters of the two customer groups used for the analysis. Most parameters remain unchanged from the 2008 study. However, peak demand for small-scale customers is significantly above the previous level (formerly MWh/h).4
All figures in this report are gival in €/MWh. We use a calorific value bawd on Groningen equivalent gas of 9.77 kWh/m3.
Sales to small-scale users supplied through retailers were mcm at a price of t/MWII and sales to small-scale users supplied through Till balancing relationships were mcm at a price of
€/MWh.
Table 1. Key parameters for customer cases
nd-user Annua Pe k Peak Sto G it
de and dem nd de and v lu GWM 00 00 recant' d ( Small-scale 900 Large- 1,000 scale G+ H and G+5
Source: Frontier based on GasTerra and own estimations
2.2.2 Hypothetical competitors
As was done in the previous study, we apply the analysis for three different hypothetical competitors. Each represents a different business model for gas supply which might be attributable to the suppliers' different historical and institutional backgrounds. The suppliers' strategies are very similar to those from the 2008 study. We briefly describe the logic behind the choice of competitors' supply strategies and highlight any changes from the previous analysis In addition, Table 3 in the annexe summarises the different cost components along each competitor's supply path.
G e rm a n m ajo r c o mp a ny
The first hypothetical competitor represents a Getman based incumbent (such as EON Ruhrgas or Wingas) with access to gas imports From various countries such as Russia or Norway. We assume that these companies source their gas via long-term contracts which are typically linked to oil product prices. This competitor uses storage facilities' in Germany and imports gas that has already been structured into the Netherlands.
Tra din g c o mp a n y ( ' ' U K tr a de r )
The second competitor is a typical "asset-light" trading company which procures its gas from internationally traded markets. In this specific case we assume a
Banal on information we received from GasTerra we assume that approximately 16% of the large-scale salts are dedicated to G+ customers, which arc mainly greenhouse fanners. See Frontier's 2008 report fur more details.
trader with a strong position on the Zeebrugge hub in Belgium After procuring (flat) gas in Zeebrugge, the gas is imported into the Netherlands where the trader uses a Dutch storage facility (namely Grijpskerk in our analysis) to structure the gas. In practice there is very limited available storage in the Netherlands.
We have made one methodological change compared to the last study concerning the gas procurement strategy. Two years ago markets had lower liquidity than is the case today. We therefore required the trader to buy all of its gas needs in a "typical" trading period a few months before the delivery year starts. This is also a typical procurement strategy for traditional supply companies with a strong retail portfolio.
We recognise that there has been an increase in liquidity on European trading hubs (e.g. Zeebrugge, TIT and Germany's NCG, to name the most important continental hubs). The hypothetical trader could now switch from the more conservative strategy used previously to a more market-based approach, which means that he continuously buys gas throughout the year. In our analysis, we now specify the gas procurement price in a quarter as the average traded price of all contracts for delivery in the quarter, as traded in the quarter before.'
Using this approach, the average procurement prices for gas are €/MWh (2008) and €/MWh (2009). If another procurement strategy was assumed, different prices would result. The possible procurement prices that could be realised on the markets vary between €/MWh and €/MWh for 2008 and €/MWh and €/MWh for 2009.R However, these prices are extreme values and do not represent realistic procurement strategies.
D u t c h n e wc o m e r
The last competitor we consider is a Dutch company with a strong retail position which has expanded stepwise along the value chain. This means that the company no longer buys all of its gas from GasTerra. Rather, it procures gas from different sources — in principle imports, I II, and direct purchases from Small Field producers. In the 2008 study we assumed that the competitor bought all of its gas from imports, given the illiquidity of TTF and the supply profiles of Small Field producers. With the increase in liquidity on TTF (see subsection on the Trading Company, above), we now assume that one third of annual gas needs
For example, the price we assume for Q1/2009 is the avenge of the quarterly product "Q1/2009" as traded during October to December in 2008. The yearly price is then the average (the hypothetical trader buys his gas with a flat structure) of the four average quarterly prices.
are procured on 1TE, with the rest bought as imports (based on contracts with oil price indexation).'
Given a lack of storage capacity in the Dutch market we assume that this competitor needs to structure its gas abroad, namely in Germany, where sufficient storage capacity exists. Due to the noticeable increase in the storage fee for RWE's Kalle storage and Thyssengas' transport fee, we now use E.ON's Etzel storage facility as a reference price, in line with the assumption made for the first competitor case (German incumbent).w All other parameters remain unchanged from the previous study.
2.2.3 Results of the analysis
Given the described approach, we find that GasTerra's prices for large-scale end-users continue to be at the lower end of the range of competitive benchmark prices (see Figure 1 which includes the results from the 2008 study)." In particular, for 2008, the year when oil prices rose to nearly 150 USD/bbl, GasTerra's prices remained below all hypothetical competitor benchmarks.
io
hh
This assumption is based on market experiences. Companies typically slowly and gradually switch from traditional supply sources to new market opportunities. However, no empirical or theoretical evidence could be found for the procurement assumption we have made. We therefore provide a sensitivity analysis on the proportion of gas procured on 1TI: to illustrate the impact of this parameter setting.
Other German storages in market areas connected to GTS are regularly booked by Dutch companies (e.g. Facilities from BEB Storage, EWE or Wingas. Rheden storage). However, given the chosen characteristics for the consumers in this study, Etzel tends to be the most cost efficient storage site. Noon's and Essent's own storages in Epe are in principle also an option for structuring gas. However, no tariff information for these sites is available to the public. We do nut consider a sensitivity with lower storage fees, e.g. to reflect the possible argument that Noon and Essent have access to their own storages at their short-run marginal costs since their investments are sunk. This is because the storages could potentially be used by the owners themselves or by third parties and the opportunity costs of using their own storages should therefore reflect the fees the owners could otherwise get from thirdparties, i.e. the market price for storage.
Figure 1. Benchmark prices for large-scale end-users 2 ui —GasTerra German major — UK trader Dutch newcomer 2001 2002 2003 2004 2005 2006 2007 2008 2009 Source: Frontier
Figure 2. Benchmark prices for small-scale end-users through retailers —GasTerra German major —UK trader Dutch newcomer 2001 2002 2003 2004 2005 2006 2007 2008 2009 Source: Frontier
Table 2 shows the percentage mark-up (or discount) required to move from the benchmark price to GasTerra's price. Colour coding is used to help identify the relative levels of GasTerra's price and the various benchmarks.
GasTerra's prices to supply large-scale industrial users are:
below all three benchmarks in 2008; and
below the German incumbent and Dutch newcomer, but above the UK trader in 2009.
GasTerra's prices to supply small-scale end users through retailers arc:
below all three benchmarks in 2008; and
higher than all three benchmarks in 2009 (the premium of GasTerra's price over the benchmarks varies widely — from 1% above the Dutch newcomer to 28% above the trading company).
Table 2 Percentage mark-up of GasTerra prices over benchmark prices (2001-2009)
Small-scale end-users through retailers
German major rife Na Na 8,0% company Trading company Dutch newcomer Na Na Na Na Na Na Large-scale end-users German major company Trading company Dutch newcomer Na 5,7% -6,4% 64% n/a -3,7% -6,9% 9% -3,4% -10,8 -1,8% -167% 1,3% -18,6% -18" 460% r10, 416% ..74% 4A% 89% -8.8% -2.7% iroto -19,4% -22,0% -19,7% -10,0% •0.8% 42,5% -14,5% -29% 44,1% -14,2% Source; Frontier
Green: GasTerm below benchmark price; Yellow: GesTerna's price up to 10% above benchmark price; Red: GasTerra more than 10% above benchmark price
As discussed before, the share of gas procured from TTF as a proportion of total gas procured by the Dutch newcomer is an assumption with some latitude. We assumed that one third of the volumes are bought on the market whereas the rest is purchased as imports via long-term contracts with oil price indexation. However, any value between 20% and 50% for the proportion of ITF purchases would appear reasonable. TTF purchases are unlikely to fall below 2 0 % in an evolving market environment, as is the case with 11F. In addition, TTF purchases are unlikely to rise above 50% since the flexibility needs of retail companies (which would traditionally have been covered to a large extent by long term import contracts), including the Dutch newcomer, could not easily be met from storage in the Netherlands (e.g. due to limited third party access to storage)
In the case of small-scale customers in 2009 the choice of this parameter influences results. The GasTerra price in the reference case (i.e. where one third of gas is procured from TTF) is 1.3% above the Dutch newcomer benchmark. Reducing the parameter to 20% results in Gas Terra's price being 1.7% below the benchmark. However, increasing the parameter to 50% increases Gas Terra's price to 4.9°/n above the benchmark.
2.3 Benchmark B: Supply and demand in a
hypothetical market
2.3.1 Analytical framework
Benchmark A is a bottom-up approach where the costs of using different supply paths are simulated and compared to GasTerra's retail supply prices. Benchmark B represents a top-down or macro perspective. All sources of gas (i.e. domestic production and imports) in principle compete on the wholesale level. Assuming a competitive market, the last source needed to cover the demand (which in the case of the Netherlands also includes export obligations) determines the price in the market.' All data is provided in the annexe, Table 5.
The marginal price derived from the supply-demand balance needs to be adjusted by cost parameters for services that are needed to bring gas from the wholesale market to the customer. These are in principle the same parameters used in Benchmark A. However, Benchmark A considers the costs associated with specific delivery paths that fit the assumed supply paths (e.g. entry fees at a specific border point or storage facility to which the hypothetical supplier has access). In contrast, Benchmark B focuses on average costs for using these services.
We assume the following costs are required to bring gas from the wholesale market to the customer:13
small-scale customer: €/MWh (2008) and €/MWh (2009); and
7 large-scale customer: €/MWh (2008) and €/M \VII (2009).
2.3.2 Results for 2008
Figure 3 illustrates the merit order curves for 2008. The black curve is based on actual imports and production volumes whereas the red line is determined by
12
For a detailed description of the economic logic applied to this approach see our 2008 study report. 13 In principle, mark-ups arc based on the same components as defined for Benchmark A. However,
import and production capacities. It is therefore always to the right of the black line (or at least on the same level, if all capacity has been used)."
Figure 3. Merit order curve for 2008
(3) Import via Belgium
(1) Groningen
(5) Import via Denmark
(2) Small fields (4) Imports via Germany
Demand 0 10 20 30 40 50 60 70 80 90 100 110
8CM/a
Source: Frontier
Total supply in 2008 was about 105 bcm and the most expensive supply source used (if all capacity had been used from each of the cheaper supply sources) was imports via Germany. By adding the consumer specific mark-ups, we derive benchmark prices that are 20/0 (small-scale) and 3% (large-scale) above Gas Terra's prices (see Figure 4). This is comparable to the results for Benchmark A and we discuss this further in the conclusion.
4
Figure 4. Benchmark prices based on merit order curve for 2008
2
—Merit order —Large scale price
Small-scale price - - Large-scale benchmark
Small-scale benchmark Supply costs marginal supplier
0 10 20 30 40 50 60 70 80 90 100 110
BCM/a
Source: Frontier
2.3.3 Results for 2009
Figure 5. Merit order curve for 2009
0
(5) Import via Denmark
all fields
(2) Import via Belgium (1) Groningen (4) Imports via Germany Demand 0 10 20 30 40 50 60 70 80 90 100 110 BCM/a Source: Frontier
After adding the mark-up for large-scale end-users to the marginal supplier's costs, the benchmark price is around 5% above GasTerra's large-scale customer sales price. This result corresponds not only to 2008 but also to the findings from the previous study. With the exception of 2007, GasTerra's tariffs have been below the benchmark price.
Figure 6. Benchmark prices based on merit order curve for 2009
Merit order —Large scale price
Small-scale price - - - Large-scale benchmark
Small-scale benchmark Supply costs marginal supplier
10 20 30 40 50 60 70 80 90 100 110 BCM/a
Conclusions
A comparison of GasTerra's prices with hypothetical competitor benchmark prices for 2008 and 2009 shows heterogeneous results that depend on the specific year and customer case.
For 2008 both benchmark approaches result in prices above those reported by Gas Terra. This holds for both, large -scale and small-scale customers.
For 2009 the results differ for the two customer cases.
For large-scale users with Benchmark A we find that in 2009:
c
GasTerra's price is below the benchmarks for the German incumbent (- 8%) and the Dutch newcomer (-17%); and
GasTerra's price is above the benchmark for the trading company (+14%).
Benchmark B also results in lower large-scale user prices for GasTerra than the benchmark.
By contrast, for small-scale end-users with Benchmark A we find that in 2009 GasTerra's price is above all benchmark prices:
Dutch newcomer (+1%); i3
German incumbent (+6%); and
trading company (+28%).
For Benchmark B we also fmd that in 2009 GasTerra's small-scale tariff is above the benchmark price (+14%).
GasTerra's prices for large-scale customers raise no obvious issues, although one hypothetical competitor benchmark is below GasTerra's price in 2009. This is presumably driven by different reactions of the two pricing systems (market vs. oil-indexed) to the economic crisis. An indication of this is that for 2009 Benchmark B is in line with (large scale consumers) or below (small scale consumers) GasTerra's pricing. One would expect that prices resulting from the different price regimes become more aligned in future when European economies recover.
r2J
Annexe I — Assumptions and further results
of the benchmark models
Note on quaky conversion
In July 2009 the system for charging for quality conversion services (QC)
was
changed in the Netherlands. Until then, QC had to be booked by a shipper and was charged at a specific fee paid by the user. We applied this system in the previous study and have also applied it for 2008 in this report.From July 2009, the responsibility for QC was transferred to the transport system operator, GTS. Costs for using the service are socialised among gas users in the form of a premium added to the regular transport tariffs. This applies for all entry and exit points, regardless of the gas quality. For our benchmark study we apply the new charging approach to the full 2009 year. Given that QC costs are low compared to the total supply costs, this approximation has a negligible impact on the benchmark prices.
B e n ch m a rk A
Table 3. Benchmark A- cost assumptions for hypothetical competitors
2008 2009 2008 2009 2008 2009
Supply to small-scale end-users through retailers
Gas sourcing
Transport
Storage
Other charges (QC, peak supply et al.)
Supply to large-scale end-users
Gas sourcing
Transport
Storage
Other charges (QC, peak supply at al.)
Source: Frontier
Table 4. Benchmark A: prices for GasTerra and hypothetical competitors
Small-scale end-users through retailers
GasTerra German major company Trading company Dutch newcomer Large-scale end-users GasTerra German major company Trading company Dutch newcomer
Source: Frontier, Gas Terra response to Frontier Information request
B e n ch m a rk B
Table 5. Benchmark B: key assumptions on volumes and costs
Entry cost to Capacity Volumes Supply costs wholesale (BCM/a) (BCMIa)
( €!MWh) market (E/MWh) G ro n i n g e n 44 . 00 42 . 50 44 . 0 0 40 . 50 S m a l l fie l ds 37 . 50 3 5 . 00 37 . 50 35 . 00 G e rm a n y 26 . 0 0 26 . 00 2 1 . 0 0 20 . 50 De n m a rk 2. 00 2. 00 2 . 00 1 .5 0 I m p o rts v ia B e l g i u m ( U K) 4 . 0 0 4 . 00 1 . 0 0 3 . 00
Source: Frontier based on data provided by Enenalekamer and GasTerra. Additional sources are BAFA, GTS, EGT, Flays and Enemata.
Table 6. Benchmark B: assumptions on mark-ups (E/MVVh)
2008 2009 2008 20
Marginal supplier Exit fee GTS Storage
Peak delivery tariff and QC Sum
Source: Frontier
Table 7. Benchmark B: benchmark prices based on merit-order analysis S m a l l -sc a le e n d -u s e rs G a sTe r ra p ri c e (€/MWh ) B e n c h m a r k p ri c e (€/MWh ) D iffe re n ce ( I n 513 of b e n c h m a rk) 8 % 4 % 1 3 % -2 % 1 4 % La rg e-s ca le e n d -u s ers G a s Te r ra p ri c e (€/MWh ) B e n c h m a rk p ri c e (EilVIWh ) D iffe re n ce ( i n % of b e n c h m a rk) - 1 0 % -5 % 6 % -3 % -5 % Source: Frontier
Annexe 2 — Sensitivity for small-scale
end-user prices from 2004 to 2007
As indicated in section 2.2.1 the assumption about peak demand used in the 2008 study tended to underestimate the actual booking requirements of shippers. This only relates to small-scale customers and impacts storage fees and, to a lesser extent, transport fees.
Even if the quantification of the effect differs in relation to the benchmark model and the chosen competitor and the specific year, the principle effect on the benchmark prices is quite clear. A higher peak demand leads to higher storage and transport fees and therefore increases the benchmark price in question. In other words, this reduces the extent of any mark-up of GasTerra's tariffs above the benchmark prices.
With respect to Benchmark A this change is important for the comparison between GasTerra and the German incumbent. GasTerra has (also when assuming the lower peak demand) a lower price than the two other hypothetical competitors (see Table 2). Based on recent tariff sheets the difference between the higher and the lower peak demand on storage and transport fees amounts to at least €/MWh. As a consequence GasTerra's mark-up on the German incumbent's price benchmark would be lower than in the 2008 study. However, even if the price mark-up was 5 to 7 percentage points lower, the mark-up would remain positive. The most significant change would be that in 2005 the mark-up would fall below 10%, the only change to the color code in the results table.
Also, the results for Benchmark B would be impacted directly by the change to the peak hour demand and by the required infrastructure bookings. By adding €/MWh to the mark-up on the marginal supplier's price, the price difference will be approximately 5 percentage points lower than initially. For 2005 and 2007, GasTerra would still have a higher price than the benchmark but for 2006 the difference would become negative, meaning that GasTerra's price would have been 1% below the benchmark.
