Dong Invests in Production as Oil Links Keep Gas Uncompetitive

Dong Energy A/S, Denmark’s biggest utility, is investing in natural-gas production and shunning opportunities to build gas-fired power plants as European prices for the fuel stay high because of contracts linked to crude oil.

“The current prices of oil-linked contracts represent a challenge for the competitiveness of gas,” Henrik Valgma, head of portfolio management and trading at Dong, said in a June 14 interview in Copenhagen. “Gas is too expensive and combined-cycle gas turbines aren’t paying off. Something has to change.”

Dong plans to double production of oil and gas in the five years to 2016 to reduce the cost of fuels it trades and uses to power generators in Denmark, Valgma said. Gas supplied through contracts linked to oil has become expensive as Brent crude closed above $100 a barrel for all but one day from March 2011 through May of this year.

Burning next-month gas to generate electricity in Germany has been unprofitable since February, according to Bloomberg calculations of the clean-spark spread that include fuel and carbon prices. Profit from using coal was about 4.50 euros ($5.72) a megawatt-hour. EU carbon for December fell 1.7 percent to 7.47 euros a metric ton on the ICE Futures Europe exchange in London at 11:13 a.m. It closed yesterday at a seven-week high of

7.60 euros a ton.

“Gas is too expensive because coal is not paying for its pollution,” Valgma said. “The CO2 price is way too low. Coal-fired power production is subsidized.”

Contract Renegotiations

Dong is among European gas buyers, along with RWE AG and EON AG, that are pushing to renegotiate long-term contracts away from oil indexation and toward spot prices.

Europe may buy the majority of its natural gas at market rates rather than at oil-linked prices by about 2014, Societe Generale SA said in a June 11 report. About 45 percent will be bought at spot rates this year, Thierry Bros, a Paris-based analyst at the bank, wrote in the report.

“We are in renegotiations and we’re trying to make these contracts more market-like,” Valgma said. “We try to find an approach with our suppliers where we share the risk rather than take all the risk. I think we’re having good discussions. It’s hard to see where it will go.”

EON’s midstream business, which handles the company’s gas purchases, posted a loss of 79 million euros in 2011. RWE Supply & Trading GmbH lost 220 million euros in the first quarter alone. Dong’s trading activities earned 633 million krona ($108 million) in 2011, up from 478 million krona a year earlier, its annual report showed.

“The more out-of-the-money the oil-indexed contracts are, the quicker it will go,” Valgma said. “Buyers cannot continue to lose the amount of money they did over the last couple of years for long. That is a headache for us, but it’s not as big as it is from some of the major continental players.”

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