Natural gas loses decades-old tie to oil in landmark deal

By Tara Patel
Bloomberg BNA

A contract for France’s largest natural gas company to buy the commodity from Azerbaijan shows the decades-old structure of Europe’s energy market is starting to crumble.

For the first time, GDF Suez SA signed a 25-year contract to buy gas from BP Plc and partners in the former Soviet republic at prices tied to those in Western Europe’s domestic gas markets, a person with knowledge of the matter said, asking not to be named because the terms are confidential. The change matters because purchases previously were made at prices tied to crude oil, which has doubled in the last five years, an expense then passed on to consumers.

Europe’s gas contracts have been tied to oil since the 1960s as a way of providing certainty to suppliers who would then invest billions to build fields and pipelines. More recently, as gas prices fell and oil rose, utilities including GDF and Electricite de France SA as well as Germany’s EON SE and RWE AG pressed Russian gas-export monopoly OAO Gazprom and Norway’s Statoil ASA to revise long-term agreements.

As the crisis in Ukraine pushes relations between Russia and the European Union to their lowest ebb since the end of the Cold War, regulators want more flexibility in gas prices as Europe looks to diversify supply, said Thierry Bros, a gas-market analyst at Societe Generale SA. Gazprom supplied about 30 percent of EU gas last year, but will likely be competing with exports from the U.S. as well as Azerbaijan in coming years.

Oil-indexed prices

“Producers want to stick with oil-indexed prices under a system that dates to 1962, while European regulators are saying consumers should pay gas prices,” Bros said.

BP (BP/), which is leading Azerbaijan’s Shah Deniz gas project and the Trans Anatolian gas pipeline that will bring the gas to Europe, said terms of gas contracts were confidential and declined to comment further.

The Shah Deniz partners have agreements to sell more than 10 billion cubic meters of gas year starting in 2019 to nine different buyers, including Italy’s Enel SpA (ENEL) and EON. The deals are equivalent to more than 2 percent of European demand.

GDF’s contract for 2.6 billion cubic meters a year will help to diversify European supply routes and sources, the company said in September when the deal was announced. Details of how much the gas would cost weren’t disclosed at the time.

EDF arbitration

State-controlled EDF has gone to arbitration in the past to win lower prices on natural gas supplies from Algeria, Libya, Qatar and Russia, Pierre Vergerio, chief operating officer at its gas arm Edison SpA, said in November.

EDF and GDF Suez face pressure from the French government to win spot-market rates from suppliers as the country seeks to cut energy bills.

“There is a push from consumers and regulators in favor of market flexibility,” Aldo Flores-Quiroga, secretary-general of the International Energy Forum, said at a conference in Paris Friday. “It’s still a discussion that hasn’t been completely solved because long-term certainty is needed.”

Gazprom will probably reduce the price it charges European buyers in a bid to overcome competitors such as Azerbaijan, Societe Generale said in a March 19 report.

Gazprom’s market share in Europe is expected to plateau at about 29 percent in 2016 to 2018 after dropping to as low as 22 percent in 2010, according to the report.

Shah Deniz’s second development phase, estimated to cost $28 billion together with the associated pipelines, will start producing in 2018.

BP holds 28.8 percent of the Shah Deniz project, while Norway’s Statoil has a 15.5 percent stake. Azerbaijan’s state oil company Socar has 16.7 percent and Total SA (FP) holds a 10 percent stake. The other shareholders are Russia’s OAO Lukoil and the state oil companies of Turkey and Iran.