Development of the British Traded Gas Market

1. Development of the British Traded Gas Market Louise Boddy

2. Contents • Introduction to ICIS • Hub Development: US and British experience • Market development: UK gas vs UK power • NBP price drivers • Where does the NBP trade? • Trends on other European trading hubs

3. Who we are ICIS provides market intelligence services to the global petrochemicals, energy and fertilizer markets. We are part of the Data Services division of Reed Business Information (RBI). RBI is a leading business to business information publisher. The other major data services include Bankers Accuity and Xpert HR. Other key divisions within RBI focus upon marketing solutions and leading magazine brands. RBI is part of Reed Elsevier. Reed Elsevier is one of the World’s largest professional information companies, employing over 35,000 people in 200 locations worldwide, with annual revenues of just over £6 billion in 2011. It is a leading provider of professional information and online workflow solutions in science and medical (Elsevier Science), legal, risk information and analytics (LexisNexis), and business sectors (RBI and Reed Exhibitions, the world’s largest exhibition organiser).

4. What we do We provide market intelligence to the global petrochemical, energy and fertilizer industries. Companies in these markets trust us to provide accurate, relevant and timely NEWS, PRICING DATA, ANALYTICS and CONSULTINGto guide their decision making. Our information and analysis covers: • Chemicals: aromatics, olefins, intermediates, solvents and plastics • Energy: crude oil, natural gas, refined products, coal, carbon and biofuels • Fertilizers: ammonia, sulphur, nitrogen, urea and phosphates

5. Where we do it A team of over 800 people who cover 180 commodity markets in Europe, Africa, the Middle East, Asia-Pacific and the Americas.

6. Hub development: US and British experience

7. US gas market deregulation a gradual process 13 years *“Prices and Shortages” Pindyck, R 1977

8. 1966 - 1986: State-owned British Gas supply and distribution monopoly. Built and owned infrastructure to support booming North Sea gas production. British market was the first in Europe to trade 11 years • 1986: Gas Act and privatisation of British Gas. Government committed to free market to deliver infrastructure development and competition. v • 1996-1997: Network code and trading contract establish the virtual NBP hub. Trade quickly migrates from the beach and starts to build on the hub. • 1986-1996: Phased restructuring of British Gas and increasing third party access regulation.

9. Why did liquidity build so fast on the NBP? • Enforced third party access • Complete unbundling of supply from transport • Open and consultative regulatory change process • Light touch regulation after initial liberalisation • Multiple supply sources • First mover advantage attracting all European trade • Transparency of physical flows and other data • Contractually firm, virtual delivery point

10. NBP liquidity drivers – regulatory • Gas Act (1986) - removes British Gas Company’s monopoly, obliges it to transport third party gas; establishes first gas regulator (OFGAS) • Gas Act (1995) - set out in law a new licensing system fully unbundling supply from transport and retailers • British Gas - total market share falls from around 97% in 1990 to under 30% in 1996 • Network Code (1996) – establishes rules and procedures for third party access and key enabler of gas trading in Britain

11. NBP liquidity drivers - multiple supply sources • UK Continental Shelf – domestic gas production has been in decline since 2010, although still sufficient to meet around half UK’s demand • Norway – (Gassco, Vesterled, Langeled, Tampen 10) • Belgian Interconnector (IUK – commissioned 1998) • Dutch Interconnector (BBL, commissioned 2006) • Isle of Grain LNG terminal (Phase 1 commissioned 2005) • South Hook/Dragon LNG terminals (commissioned 2009)

12. NBP liquidity drivers – Data transparency www.nationalgrid.com

13. European retail gas prices 1990-2013 (inc taxes)

14. Market Development – UK Gas vs UK Power

15. UK OTC electricity market development 2004-2014 SOURCE: ICIS / DECC

16. UK power market churn rate remains low in comparison to the NBP Dividing annual OTC traded volume by annual British consumption produces a churn rate no greater than 3.5 – has fallen since 2009

17. Why was the UK power market less successful than gas? • 2000s: From a relative low point, dominance of the ‘Big Six’ vertically integrated energy suppliers on UK electricity market frequently cited as barrier to entry for smaller participants. There are many more suppliers of gas. • 2008 crash: Sluggish economic recovery from very low baseline increases need for physical participants to hedge costs for financial security – hence gradual increase in traded volume – but sudden risk aversion of banks means zero appetite for speculative trade in less liquid markets • 2010-14: Electricity market reform (EMR) causes deep energy policy uncertainty. Utilities reluctant to trade longer-dated contracts, while banks reluctant to trade at all. • 2012-14: Steady creep of EU commodity market regulation leads to exodus from less-liquid markets of what few financial institutions remain. Only a handful active on UK power today

18. NBP Price Drivers

19. What drives the price on the NBP hub? • Weather • Unplanned infrastructure outages (REMIT information) • Currency fluctuations • Global LNG movements • Sentiment – often driven by headlines • Arbitrage with long-term contract prices

20. ICIS NBP Day-Ahead (Jan ’12 to Mar ’14)

21. ICIS NBP Winter ‘14 (Jan ’12 to Mar ‘14) Russian troops entre Crimea

22. Where does the NBP trade?

23. Where trades are executed

24. Several brokers compete for OTC trade and traders aggregate the bids and offers through Trayport software Spectron ICAP GFI Trayport software aggregates bids and offers TFS TulletPrebon WebICE Griffin

25. ICE versus OTC volumes for the UK2012-2014 exchange volume averaged 66% of OTC

26. ICE contracts - some key features

27. Why companies may choose OTC or exchange for forwards contracts. Many companies trade both….

28. NBP – declining OTC volumes Banks scaling back activity. Many ex-bank traders are now at small funds – these tend to prefer the anonymity of exchange trade and may have trouble with OTC credit lines. Some hedging trade is moving from NBP to TTF and a lesser extent Germany. Diversion of LNG away from Europe lowered LNG related hedging. Some factors behind the trend

29. Trends on other European trading hubs

30. Rest of Europe volume – other hubs have minimal forwards trading

31. TTF – OTC growth continues Large scale switch from oil-linked pricing to hub pricing continues, increasing hedging activity on the curve. Traders with spot exposure all across Europe now using the TTF for hedging as hub is the clear centre for liquidity. Spread trade with other European markets is growing. Use of hub for Within-day balancing increasing from low base. Less impacted by bank scale-back than NBP as higher proportion of trade was optimisation/hedging. Some factors behind the trend

32. Dutch TTF hub volumes OTC and ICE exchange From 2012 to 2014 exchange has averaged 5% of OTC volumes

33. Zeebrugge – beach still needed but ZTP dormant Beach trade is unlikely to disappear as the Interconnector pipeline capacity traders need it. Speculative trade very low and dropping. Hard to benefit from growth in continental trade as is still in sterling. The new virtual hub ZTP has not succeeded so far. Beach traders have no incentive to shift. TTF is prime location for hedging and spread trade. ZTP growth may come from domestic balancing needs and those with domestic industrial customers. Fluxys so far ruling out a merger with the beach trade. Some factors behind the trend

34. Germany – growth, but not exponential Sales contracts to large customer increasingly flexible, dampening trend of end-users going to the hub for supply. Hard to make headway on curve volume because of existing liquidity on TTF. Regulator ruled out an NCG/GASPOOL merger. Growth still supported by hedging activity coming from inexorable trend of spot price linkage away from oil. Improving cross-border capacity access boosting spread trade with surrounding countries. Germany is increasingly an entry route for Russian gas, increasing potential for future trade and optimisation. Some factors behind the trend

35. European gas hubs by development phase IMMATURE Czech Republic Austria (CEGH) Italy (PSV) FORMATIVE Turkey Spain (AOC) Poland MATURE Britain (NBP) Netherlands (TTF) LIQUID Germany (NCG) Germany (GASPOOL) France (PEGS) Belgium (Zeebrugge)

36. Will one hub dominate pricing? • Both NBP and TTF are likely to remain centres of price formation. • TTF growing in influence but the UK is a large, mature market with pure gas pricing and diverse sources of supply. • New markets likely to trade increasingly as differentials to TTF. • Continental Europe probably doesn’t need another major hub or exchange. • You could argue that the Northwest European hubs already constitute a single zone for price formation, where fundamental shifts on one hub immediately affect the other.

37. Industry needs a reference price… • To link sale and purchase contracts to market value. • To optimise assets. • To hedge floating price deals. • To mark open positions to market to evaluate risk.

38. But what is THE reference price in a continuously traded market?It depends on the methodology used… 11 am assessment 71.8 Closing assessment 72.5 • There is no single gas price during a day – see chart. • The methodology defines what the reference price will actually be. • A weighted index of trades can only work in high liquidity and over a window of time. All day volume weighted index 72.382

39. Definitions of liquidity development

40. Factors influencing success or failure of trading hubs in Europe

41. Thank you for your attention.Louise BoddyDirector, Global Energy Marketslouise.boddy@icis.com+44 207 911 1948