What does speculation have to do with the increase in the price of gas

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In the last year, the price of gas has reached unprecedented levels and often politicians and commentators – especially in Italy – have blamed the increases on the speculation of financial investors, who with their profit-oriented operations would have helped to keep prices very high.

Giorgia Meloni, president of Fratelli d’Italia and winner of the political elections, has also argued for some time, who recently at a Coldiretti event in Milan said she was opposed to continuing to compensate for the increases in bills “to give money to speculation”. The Minister of Ecological Transition Roberto Cingolani has also spoken several times of unjustified deviations in prices on the financial markets, in particular on the Dutch one which regulates gas transactions in the European Union.

The price of gas has been on the rise for months, first due to strong growth in economic activity after months of lockdown, and then due to the start of the war in Ukraine, as Russia has begun to use gas supplies to the West as a tool. political retaliation against sanctions, which has led to fear of an interruption of flows. In all likelihood there is a speculative component of the energy price increases, but it does not appear to be the main force.

In the market movements of recent months, in fact, all those signals that would typically be associated with speculation are absent: in particular, there have been no (or a small part of) massive purchases that push the price upwards with the sole objective. to resell at a higher price to make a profit. Sales not linked to the physical delivery of gas, and therefore purely financial, have not increased in recent months, as might have been expected in the event of speculation.

In her speech at the Coldiretti event, Giorgia Meloni spoke of ongoing contacts with Mario Draghi’s outgoing government to ensure an orderly handover between one executive and another, especially on the subject of energy price increases. You mentioned the importance of a European gas price ceiling because “let’s face it: if we think we can continue to offset the cost of bills that continue to rise to give money to speculation at a national level, we’re making a mistake”. According to Meloni, the issue is not finding resources but “how speculation stops”.

Sunday, during an interview with the program Half an hour more Minister Cingolani expressed similar positions. The price of gas would be the subject of a «speculative process not connected to supply and demand, as it should be in textbooks. Europe lost 39 billion cubic meters from Russia and replaced them with 45 billion cubic meters. Therefore, since there is more gas than before, the price should drop ». More than deliberate financial speculation aimed at profit, Cingolani spoke of the fears and fears of operators of a possible shortage of gas, which would push the price higher.

This is exactly how the prices are formed, based on the expectations of the operators: if you think that there may be a shortage of a good, therefore that the demand exceeds the supply, then the price will go up; on the contrary, if it is believed that there will be an abundance of a good, therefore that the demand is less than the supply, then the price of a good will go down. These are therefore normal market dynamics, which however, according to the minister, would not be justified at this time by a real shortage of gas.

“The TTF, the gas market, works on the basis of projections. If I am afraid that gas will fail, I increase the price. The absurd is the more we fear the more the price rises. And so today the price of gas has reached stunning figures “

Roberto Cingolani a #mezzorainpiu pic.twitter.com/QiK7ntgf9g

– Half an hour more (@Mezzorainpiu) October 2, 2022

Most of the gas arriving in Europe is purchased through long-term supply contracts: the agreement is signed between distributors, for example the Italian Eni, and producers, such as the Russian Gazprom. The seller, ie the producer of the gas, undertakes to supply the buyer, the company which typically then resells it on the retail market, with a given quantity of gas, at a given price and for a certain period of time. In this way, supplies should be stable and reliable over time.

However, those interested in selling and buying gas can also do so outside of these agreements, for example in the event that the supply of gas is to be rapidly increased beyond what was foreseen in the supply agreement. Distributors can therefore turn to the financial markets for gas, also known as hub, that is virtual places where raw materials are bought and sold. You can buy it with physical delivery at the moment or with the so-called futuresi.e. contracts with which you undertake to buy it at a given moment in the future (after a day, a month, a year and so on) at a fixed price, in order to protect yourself from any price increases.

The reference market in Europe is based in the Netherlands and is the Title Transfer Facility (TTF). In the European Union there are various similar markets (for example, in Italy there is the PSV, the Virtual Trading Point), but it is the Dutch TTF that sets the reference prices for the entire continent, because it is where the most part of the exchanges. Compared to other international realities, however, the Dutch market is, on the whole, small. In the US market, the so-called Henry Hubthousands of billions of cubic meters of gas are exchanged every year, against only a few hundred billions in the European TTF.

Although most of the gas arrives in Italy through long-term supply contracts, therefore not negotiated on the virtual market, it is the price determined on the TTF that acts as a reference for the entire market. According to a document from the Italian Energy Authority, ARERA, between 70 and 80 percent of these contracts has an import price linked to the TTF.

The price of gas has been on the rise since the spring of 2021, when the effects of the reopening after the lockdowns began to be felt: economic activity recovered faster than expected and the supply of energy failed to keep up. Gas was perceived as a commodity that was in short supply and therefore the price increased. Tensions between Russia and Ukraine have increased since the autumn, sustaining the upward trend until the start of the war in February 2022, when prices hit unprecedented levels.

Russia was the main supplier of gas to the European Union and it was feared – in retrospect with good reason – that sooner or later it would cut off its flows in response to Western sanctions.

After the peak in August, when gas exceeded 300 euros per megawatt hour, prices are at lower levels in recent weeks.

It is obviously difficult to understand what has pushed the prices so high. Were traders really afraid that raw materials would run out or did investors take advantage of the situation to speculate on high gas prices? The line between normal investing and speculation is sometimes very thin, because in both cases the stocks are driven by traders’ expectations.

Simplifying a lot, and bearing in mind that gas is a physical asset, to be treated a little differently from a share or a government bond, a normal market dynamic would predict that its price varies according to the quantity that traders believe it will be available in the future. Is there expected to be a shortage? Then the price increases, because the good is as if it becomes more precious and desirable. Instead, is there expected to be a lot? The price is bound to go down, because you will no longer be willing to pay high bucks to buy something that is widely available on the market.

Gas speculation mainly uses the i channel future, that is those contracts with which one undertakes to purchase a certain quantity of cubic meters of raw material on a certain date and at a certain price. Obviously, speculators do not physically buy the gas, because they would not do anything with it, but they buy and resell these contracts, but never arrive at the moment of the actual purchase of the raw material. Taking advantage of the upward price expectations, which actually push the prices up, they buy massive quantities of future betting to resell them at an ever higher price, thus fueling an upward spiral.

Let us now try to understand which is the force that drives the price of gas the most, whether the traditional one or the speculative one.

First of all, it is true that the FTT is a financial market, but it still provides for the physical delivery of gas and by its nature it is therefore strongly anchored to supply and demand. However, unconventional operators also participate, such as investment funds, banks and so on, whose positions are defined as “speculative” because they are not motivated by commercial activities in the energy sector, such as those of distributors such as Eni.

According to a report by the Intesa San Paolo study center, the activity of financial operators has remained constant in these months of sharp rises in prices. Comparing the dynamics of the price of raw materials in the TTF with the trend of these speculative positions, that is non-commercial ones, it is possible to note how financial operators have kept their exposure stable in recent months, without increasing purchases as prices rise.

If speculation had played such a large role we would have seen an increasing number of transactions by financial operators. It is true that a sharp rise is seen between February and March 2022 and that the values ​​are higher than a year ago, but after an initial increase in interest in gas there have been no increases in these speculative purchases. This is because the wide volatility and unpredictability of gas prices has made it very difficult for operators to successfully invest in this market, because it is really difficult to make forecasts that can turn out to be profitable.

In fact, therefore, it seems that financial sales have not amplified the increases, which according to the Intesa San Paolo research center are mainly explained by a shortage of raw materials on the physical market.

That said, it is true that the European gas price formation mechanism has caused problems. First of all, because the TTF is a relatively small market compared to all the gas consumed within the European Union. Few exchanges determine the price at which one buys and sells on an entire continent, which has caused many distortions. In fact, as these are relatively small volumes, the fluctuations due to the movements of a few operators can be very large. This has created many problems of volatility, that is, of sudden variations, even very large ones.

For this reason, as Minister Cingolani explained during his interview in the broadcast Half an hour more, Italy will present a proposal on how to limit these fluctuations. First of all, the government thinks of a mechanism by which the price of gas is a sort of average between the prices of the various world trading centers, in order to untie it from the FTT market, which is too small and unstable. In addition, it would like to indicate a range within which the price can vary, a sort of “fork”, in order to contain excessive increases and excessive decreases.

– Read also: What does it mean to untie the price of gas from that of electricity