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The fine(d) art of gas consumption – why some gas reduction measures could cost money

19 January 2023

Gas consumption reduced, yet penalty to be paid – this contradiction has been preoccupying the Hungarian press during the last few days. The overall political intention is to consume less gas, then why several district heating companies end up paying a penalty, when they did nothing wrong, but reduced their gas consumption. This article will argue that there is a complex contractual and regulatory matrix in modern gas trading, from which one element (penalty for undertaking) cannot be singled out.

Sometimes absurd things happen in modern energy trading: offtaker of electricity get money just for buying electricity (the so-called negative hours on electricity exchanges – see January 1, 2023 on the German EPEX), while others are working hard to save gas, yet they must pay a fine.

No one had thought of price jumps, when the energy markets in Europe, especially in Central and Eastern Europe, were liberalized: commodities were “reasonably” priced and price fluctuations were more the exception, than the norm. One of the less recognized but very important “side effects” of the terrible war in Ukraine is exactly that the traded price of natural gas started to jump up and down. All traded markets are based on price movement (volatility) – traders do not touch markets where prices do not change. The strange thing about the 2022 price movements was that market fundamentals were stable, yet gas prices “exploded” or “crashed”. We do not know, but may assume that a large Eastern supplier through various Western (financial) partners actively manipulated European natural gas trading. What exactly happened and who did what, national regulatory bodies (like ANRE and MEKH), and the pan-European ACER will certainly investigate for many years. What is important from the point of view of our present story is that European traded gas prices began to jump up and down quite absurdly in the second quarter of 2022. In Hungary, Black Friday was on August 26, 2022: the price of natural gas traded on the futures market went above EUR 340/MWh. Natural gas is an input price for electricity production, so European electricity exchanges blindly followed gas price developments: on the aforementioned August day, one MWh of electricity for 2023 was around a thousand euros: never Hungarian electricity traded before in four-digit territory. Most of the traders felt that this price level was unrealistic and unsustainable, but the market did not – it was in a “bid on” mood. There were still bids at the last traded price: some of such bids coming from the Western European “friends” of the East European dominant gas supplier, as was mentioned above. Today, these natural gas contracts have lost 80 percent of their value: if someone bought natural gas for ten euros in August 2022, that contract today is worth approximately two euros.

But what does Hungarian district heating producers have to do with this volatility? The district heating season lasts from mid-October to mid-April. The so-called “Gas Year” (the time frame all gas industry specialists use) also begins in October and lasts until the end of September of the following year. This is precisely why major changes in the gas industry (price, settlement, regulation, etc.) usually take place on October 1. Last October, the Hungarian gas industry lived under the spell of the “super volatility” described above: no one knew that in one/two/three months the market price of natural gas would be EUR 1,000/MWh, EUR 500, or EUR 9.

When, sometime last Summer, district heating producers and gas traders signed contracts at a fixed price for the 2022-2023 heating season, the so-called the business value of under/over consumption was particularly high: the more prices “jump” in any markets, the more expensive traders price down/up deviation from the contracted quantity. At that time, there was already a lawsuit regarding overconsumption between a district heating producer in Western Hungary and its former gas supplier. Therefore, it is not surprising that, in connection with the new heating season starting in October 2022, gas suppliers paid particular attention to under/over consumption section of the new gas contracts to be signed with district heating companies. Recent comments in the Hungarian media mentioned in the introduction shows that some of the district heat producers may not have understood exactly what new clause they had accepted for this Gas Year.

District heat is rather weather-dependent: if the winter is warm, district heat generators will offtake and burn less gas. In this year’s heating season, an extra consumption-reducing factor also appeared in Hungary: several public institutions (so-called separately managed institutions) were closed, and those that remained open were required to reduce energy consumption by at least 25 percent. Even in a normal winter, district heat producers would have off-taken less gas, than originally planned. This winter was anything, but normal: all heat records were broken, white Christmas was replaced with mild Easter weather in Hungary These two, completely independent but mutually reinforcing factors (warm winter and closed public institutions) reduced the gas consumption of district heat producers. This bearish environment came under further down-pressure in some cities, where geothermal heating was switched on. Hungary is a thermal water superpower: five hundred thermal wells are currently operating and estimated thermal water reserves are sufficient for approximately 200 years. Why burn Russian gas to heat up water, when at approximately two thousand meters below Earth, 70 percent of Hungary’s territory seems to hold thermal water at over a hundred degrees temperature? This argument is correct, but local district heat producers should have estimated how geothermal heating would reduce their natural gas consumption, before they signed new contracts for this year’s heating season.

Where the above-mentioned mild winter, plus the “combo factor” of closed public institutions, was further reinforced by the gradual entry of geothermal heating, local district heat producers did not have a chance to off-take even the minimum quantity fixed in their natural gas supply contracts.

What does this under-consumption mean for gas traders? If the district heat producer does not off-take the gas now, because the weather is hot, because public institutions are closed, because geothermal heating has started, then gas traders can choose between two options: either sell the gas on the spot market now or keep the gas in underground storages. For the gas bought in the Summer at a price of 340 euros/MWh when contracts with district heating companies were signed, the gas trader will receive today a price close to 70 euros/MWh. And the trader can only keep gas in storage until April 2023 only: then this storage year will end and before the new storage cycle would start gas in storage should be “marked to market” – the price then might be even less, nobody knows. Both options are financial disaster for the gas traders involved: Summer gas is too expensive now.. This is why gas supply agreements contain a pre-agreed penalty that is a contribution to mitigate the so-called mark-to-market loss gas traders will suffer, if and when district heating companies do not off-take even the minimum volume set forth under the relevant gas supply agreements.

Under current market conditions, the 25-30% penalty traditionally fixed in such gas supply agreements does not cover losses gas traders will realize on these deals: as I mentioned above, compared to August, natural gas contracts lost 80% of their value during the last four months.

What is the solution for the future? How to contract better? The European natural gas market has now calmed down: it looks as if the EU has found an alternative to Russian gas. But “super volatility” described above could reappear at any time in European natural gas (and electricity) trading. Therefore, the business value of under/over consumption will remain high. District heat producers and gas traders must work together (and not against each other) to find out who can take what extra risk at the lowest possible extra cost. In these negotiations, the above mentioned penalty for under-consumption will surely be on the top of the list to be discussed.



* The article originally appeared in the online publication

Despre autor Jozsef Balogh is a senior business developer for Axpo Solutions, Switzerland, with a special focus on Central European and Ukrainian electricity, gas and CO2 opportunities.  He had been active in the Central European energy industry in various roles since 1992.  He has been especially active in Ukraine and Hungary.

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