Russia’s OAO Gazprom (GAZP) agreed to cut natural gas costs for Italy’s Eni SpA (ENI) in an agreement that brings prices in line with the market, signaling challenges for the decades-old structure of indexing the fuel to oil.
The new contract terms between the two companies includes an “important change in the price indexation to fully align it with the market,” Eni said in a statement on its website today, without providing more details. The revision away from oil and in line with Italy’s Punto di Scambio Virtuale, or PSV, hub will have a “positive impact” of 560 million euros ($760 million) on the operating profit of Eni’s gas and power unit this year, Sanford C. Bernstein said.
Gazprom, which provides about a third of Europe’s gas, sells most of its fuel under long-term contracts at prices linked to oil that the company says ensures security of supply. That system has been challenged by buyers including Germany’s RWE AG and Eni, the Russian company’s biggest client, as the gap between what they paid Gazprom and the price on European markets widened. Sergei Kupriyanov, a Gazprom spokesman, declined to comment on the pricing changes in the Eni contract.
“The move to spot prices ensures the price Eni pays for its gas is more closely aligned with market prices from 2014,” said Oswald Clint, an analyst with Bernstein. “There is a potential for further benefit if Eni can recover gas it has already paid for but not received under take-or-pay contracts.”
Next-month gas in the U.K., Europe’s most liquid market, fell 35 percent this year while Brent crude declined 0.5 percent on the ICE Futures Europe exchange in London. The gas contract averaged 58.04 pence a therm ($9.78 a million British thermal units) in the first four months of 2014, compared with $10.80 a million Btu for Russian gas at the German border, according to data from the International Monetary Fund.
Europe’s gas contracts have been tied to oil prices since the 1960s as a way of providing certainty to suppliers that would then invest billions to build field infrastructure and pipelines. More than half of the gas in the continent is now bought and sold at market prices, and that share will rise as trading volume increase, Jean-Francois Cirelli, president of Brussels-based lobby group Eurogas, said May 14 in Brussels.
“There’s more and more acceptance of market reality on the producer side and I’m not talking now specifically on Gazprom, we had similar experiences with other suppliers,” Hans-Peter Floren, member of the board responsible for gas and power at OMV AG (OMV), said in an interview at the Flame conference in Amsterdam on May 21. “The big suppliers more and more accept market reality and the need for a changed approach.”
Gazprom expects a halt in price adjustments and the maximum weight of spot prices in the company’s long-term contracts is 16 percent, Andrey Zotov, a deputy department head at Gazprom Export, said on a conference call last month.
Eni’s agreement with Gazprom is part of its efforts to renegotiate all its long-term supply contracts, according to the statement. Changes to terms of a supply agreement with Statoil ASA (STL) meant a “big part” is hub-linked, Marco Alvera, Eni’s vice president for midstream, said on an April 29 conference call. Eni’s power and gas unit returned to profit in the first quarter, with Citigroup Inc. estimating the benefit from the new Statoil terms at 400 million euros ($545 million).
The revision to the Gazprom contract also enhance Eni’s ability to recover gas pre-paid under take-or-pay clauses, according to the Rome-based company’s statement. Eni declined to comment on details of the new price-indexation formula.
A move to full hub-based supply contracts could have a bearish impact on gas prices at times when demand is low, Trevor Sikorski, head of gas, coal and carbon analysis Energy Aspects Ltd., said by phone from London today. While oil-linked contracts meant companies would take less gas when crude prices rose, under hub-based pricing they can accept the fuel and sell it in the market for the same price they paid.
“When you move to paying at the hub, if you have additional gas coming in, you just put it at the hub if you don’t need it,” Sikorski said.