Physical versus virtual gas trading hubs: Which is the right way to for India?

May 01, 2018 2:41 AM

India is currently the fourth-largest importer of liquefied natural gas (LNG) in the world, sourcing nearly 45% of its gas requirements from the international markets.

gas, natural gas, gas trade, gas trading hub, trading hub, tradeWith a 45% dependence on imports and coming through a few ports, the natural option for India would be to let all gas to enter and exit through a virtual hub.

India is currently the fourth-largest importer of liquefied natural gas (LNG) in the world, sourcing nearly 45% of its gas requirements from the international markets. While a large part of these imports is typically bilateral and long-term contracts indexed partly or wholly to crude oil prices, domestically-produced gas is sold on government-mandated prices based on time-lagged rates. As a result, there had always been a discrepancy between prices received by domestic suppliers and the prices paid for the imported gas.

If India is to achieve its ambitious goal of moving away from its mainstream use of solid fuels and subsequently increase its share of gas in its energy mix from the current 6.5% to about 15% in the next few years, building a national gas hub and trading platform driven by market-determined price is the need of the hour. A gas trading hub backed by necessary regulatory reforms such as price decontrol and open access to infrastructure utilities such as pipeline/storage/regasification will make way for transparent and market-driven price discovery reflecting India’s demand and supply conditions at any point in time.

A trading hub will permit market participants to buy and sell gas on a short-term or daily basis without having to go through a long-term planning/negotiation process. This will provide for purchase and sale of any shortfall or excess gas quickly and anonymously. Additionally, it will not only enable natural gas consumers optimise their supplies as per requirement, but also help the market in mitigating short-term price volatility. It will help encourage flow of investments in the upstream, thus stimulating domestic production, striking a better balance between imports and domestic suppliers. Moreover, a developed natural gas market can be a critical contributor to India’s prosperity and economic growth, as is evidenced in developed countries such as the US. For example, according to a report by the American Petroleum Institute, natural gas industry accounts for 7.6% of the US GDP and 5.6% of the nation’s employment.

Hubs in their structure may differ widely depending upon the supply structure or level of infrastructure development or the geographical spread of user industries. In general, they require a deregulated pricing environment, where suppliers have the freedom to access imports or domestic supplies, while consumers have the flexibility of choosing their suppliers. A hub can be an actual physical point such as the Henry Hub in the US, where several pipelines connecting buyers and sellers converge and serve as a transit point for transportation for consumers, distributors and storage operators. With a perpetually oversupplied long market with users spread across various states, the US Henry Hub provides for the development of a physical hub. Here, parties are required to book the same quantity for both entry and exit on a point-to-point transaction mode, assuming that pre-agreed gas injected into the network at one point will be taken off at a predetermined location.

On the contrary, a virtual gas trading hub such as the National Balancing Point (NBP) in the UK provides a trading platform defined through a pipeline grid (interconnected pipelines with no point of origin or end) representing the entire country or a trans-regional zone, managed by a system operator—the National Transmission System (NTS) in this case. Generally, it is seen that countries short of domestic natural gas supply relying on various sources of supplies including LNG imports have a virtual trading system with multiple entry-exit points. It provides for a fee-based access structure that allows traders with flexibility to inject and extract gas within the grid at any point of varying quantity as well. All gas within the virtual hub can be traded, irrespective of its actual physical location. Individual buyers and sellers can book different quantities for entry and exit into the system without a predetermined destination, thus increasing the flexibility and ease of trading than a physical hub.

What suits India’s gas economy?

A virtual hub is expected to have a greater market depth and liquidity than a physical hub, since there is no specific ‘location’ and there is flexibility to withdraw more than the traded quantity and yet pay for the excess withdrawal. Virtual hubs avoid the need for parties to account for varying distance-based transmission cost that can make price comparisons difficult and complicates trading. In developed countries, the gas shippers or large energy players who buy, trade and sell on the virtual trading platform are given financial incentives to balance out their trades in the system by buying or selling gas. Such virtual trading hubs are designed in a way that a gas shipper typically incurs extra costs in case it does not balance its trades. In case shippers fail to balance, the appointed balancer is obliged to restore the physical balance of the entire system.

With a 45% dependence on imports and coming through a few ports, the natural option for India would be to let all gas to enter and exit through a virtual hub. But with few entry nodes, and also with restricted third-party regasification access and pipelines with single convergence points at major trading centres such as Hazira and Dahej, it may suit well to start a market place following the physical hub model of the US and focus on developing interconnected pipelines to move towards a virtual hub being operated by a private system operator with a clear mandate. Moreover, given the lack of interconnectivity among most of the pipelines, the regulators shall plan an incentivised development of interconnected pipelines that will ultimately provide for grid-based trading. Also, the planning focus should be on the development of natural gas storages that can cushion prices at the time of system imbalances in the virtual hub.

Potential best fit amid current regulation and market structure

The successful British (NBP) and European experience (TTF in the Netherlands, PSV in Italy, NCG and GPL in Germany, PEG in France, and Zeebrugge in Belgium) have proved that virtual hubs can provide for rapid development of the respective underlying economy than a physical hub. Developing a virtual gas trading hub for its advantages would be an ideal solution in the long term for a country like India with a larger gas consumption potential. With a pipeline density of a mere 0.005 km per sq km, compared with 0.114 for the UK, India has a long way to go in terms of setting up a virtual hub.

So, a practical approach could be to allow trading based on a physical hub on the west coast with a policy-cum-regulatory focus on development of right infrastructure to support market growth. The start of gas trading based on a physical hub can attract market participants within a short time-frame and improve liquidity, thus creating the right investment conditions for a growing gas market.

Finally, the establishment of a virtual natural gas trading hub with market-driven price will play a central role in reducing India’s LNG import, while adjusting the supply-demand balance and promoting competition among value chain stakeholders. In the long run, this will help create a regional benchmark to facilitate trading in financial contracts on derivative exchanges. Eventually, this will place India on the global map as a hub for LNG and gas trading activities, a crucial step in safeguarding India’s energy security.

By V Shunmugam & Jayati Mukherjee

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