Contracted Gas Volume as Factor of Price Formation on Natural Gas Markets

Long-term contracts (LTCs) are the hallmarks of the European and Asian gas markets. The dominance of LTCs in international trade leads to their “gravity-center” function in relation to spot prices. When regional gas market is tight, spot prices reside above the LTCs prices. When market is loose they reside below the LTCs prices, but in any case LTCs’ prices serve as anchor for spot gas prices. Taking into account that all market imbalances are concentrated in the spot or non-contracted segment of the market, its prices are overreacting to even insignificant market imbalances. Size of the uncontracted segment thus plays an important role in price formation for natural gas as it becomes a self-sufficient factor determining the volume of demand. Overcontracting, which artificially downscales the size of demand in the uncontracted market segment, often causes a negative spread between spot and contracts price. The paper examines the role of this factor in price formation by measuring correlation between the size of the uncontracted segment and spot price formation. Concerning Europe, the research showed a nearly linear relationship between the LTCs to imports index for pipeline gas and spot/contract price spreads. Such a relationship allows to build up a regression model for forecasting the spot prices. In Asia, ovecontracting leads to high volatility of spot prices. Their dependence on the size of uncontracted segment fully reveals itself in the periods of seasonal picks of demand for natural gas.