Common misconceptions regarding the spot market
Not long ago Western experts were growing optimistic as the market was becoming increasingly dominated by non-hydrocarbon energy and sales on the spot market (where commodities are traded for immediate delivery, sometimes also called the cash market), which triggered the idea that perhaps there was a new gas reality in Europe. While the worth of long-term gas contracts is interdependent on oil and petroleum product prices, on the spot market, gas prices are independent. This caused many to believe that that long-term treaties would be a thing of the past and cheap gas would appear on the market. Unfortunately this is not the case.
For years, the European Union stood by long-term gas supply contracts as long-term contracts guarantee gas supplies in the required volume for the buyer and allow the seller to foresee demand for years in advance and plan ahead and make it possible to invest in the development of new deposits without fearing a drop in demand.
20-percent under-consumption is admissible under this scenario but the buyers have to pay hefty fines in case they consume less which is a drawback. Gas prices are reviewed on a regular basis, depending on the cost of alternative fuels, such as diesel fuel or fuel oil, which can replace gas in the production of thermal and electric power. Prices correlate with a six-month lag which means that the buyer can see how much they will have to pay six months in advance.
In Atlantic markets, gas is an independent exchange commodity, and prices for it are set for a short period of time, regardless of prices for alternative fuel. This is a spot market, or in other words, a short-term contract market.
The main advantage of spot trade is that prices for gas don’t depend on oil prices. However the buyer can be exposed to a gas deficit during a peak in consumption as spot contracts stipulate no guarantees of supplies in the future. This unpredictability may lead to dramatic leaps in prices and thus may hamper economic development. Similarly, the seller is deprived of long-term sales and distribution guarantees given that the longest contracts in the spot market span one, or maximum two years.
A spot market is viable on the condition gas comes from various sources. Many Europeans believe that a spot market always guarantees cheap gas. But this is wrong, since a spot market is unpredictable: it is based on a different system of price formation where any event may send prices soaring.
Optimistic scenarios were backed up and further propagated by several unrelated events which occurred between 2009 and 2010 and included the effect of the global economic crisis in reducing gas consumption and Qatar’s liquefied natural gas appearing on the markets as the country launched several large factories with an eye on the vast US market (now the project is frozen) and then the US shifting to shale gas production causing Qatar to sell off its liquefied natural gas (LNG) to Europe and to drastically drop prices. Adding to these events were Norway’s attempts to conquer the European market by supplying cheap gas which the EU did not believe would run out before the end of the decade. Thus 2010 saw Europe’s gas market glutted and prices drop two-fold compared to those set in deals carried out by Russia’s Gazprom which pushed Russian contractors into reducing imports and buying more on the spot markets.