Commodities & Futures: Gas costs: a burning question

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THE RELATIVE costs of coal and gas have dominated the great coal debate. But, while great effort has been put into determining exactly how much a lump of coal will cost, the way gas prices will move has been virtually ignored.

There is an assumption that the current European system of long- term contracts will be continued. The new gas-fired power stations have all made 15-year commitments to buy from a supplier, with an 'escalator' formula incorporated linking rises to a basket that might include the oil price and the retail price index. It is easy to assume that this will stop the gas price ever becoming volatile.

This may be a mistake. The Americans have had a natural gas spot and futures market at Nymex for some time. If the EC does not lose its nerve, similar markets could develop in Europe.

In the latest issue of Pipeline, the International Petroleum Exchange's magazine, the energy minister Tim Eggar believes 'competition will eventually develop and flourish, along with a variety of market mechanisms'.

The long-term contract will not disappear completely, but a spot market as well as short- to medium-term contracts with mechanisms for hedging will emerge.

The IPE itself is looking beyond this. It is carrying out a feasibility study on a gas futures contract which its marketing director, Alastair Harris, says could be in place in five years' time. The US dismantled price controls in the late Seventies and allowed 'gas- to-gas' competition to develop. But in Europe until recently gas was kept firmly in the hands of national monopolies.

As gas was difficult to transport and store, governments took it upon themselves to build the massive infrastructure needed. An international pipeline network was constructed, mainly to import Russian gas.

The UK led the gradual move to a freer market. Although British Gas was privatised in 1986, it was not until 1990 that the first sales of gas direct from oil companies to industry were made.

Last year BG agreed with the Office of Fair Trading to cut its market share to 40 per cent by 1995-96 and 32 companies were set up to buy and sell gas, using BG's pipelines. By the end of 1992, 25 per cent of big gas users were buying from the independents.

Most gas in Britain is still sold either at British Gas tariff rates or on long-term contracts. A small spot market is, however, developing as users enter short- term deals to make up shortfalls.

The EC wants the rest of Europe to follow the British lead, allowing an international market to develop. But deregulation is not enough - the pipeline network will have to be capable of allowing a true European market.

The electricity generators are watching developments with interest. With a fixed long-term contract for gas, the ability to respond to surges in demand can be restricted by lack of fuel.

A spot market will allow power stations to top up - but only at a price. By using a futures market in tandem with the existing electricity futures contract, generators should be able to buy extra gas while protecting themselves against a surging spot price.

Mr Harris concedes that a futures market is some way off. Assuming the EC pushes ahead with liberalisation and the necessary transport and storage facilities are built, a spot market will continue to develop as buyers and sellers make deals to top up long- term contracts. A forward market will then naturally emerge, finally establishing the conditions for a futures contract.

What will all this do to gas prices? Producers in the US complain it has led to a collapse. But no one in Europe is prepared to say which way the market will go.