Размещено на http://www.allbest.ru/

Influence of european hub-based pricing development on gazprom export strategy

Introduction

gas market gazprom strategy

Energy market is one of the most volatile, changing and developing market nowadays. Gas market has been undergoing considerable changes, especially in Europe. The rapid development of spot trading as a new alternative to gas delivery under long-term contracts has changed the European gas market conditions dramatically that directly influence foreign export companies' strategies.

The two gas hubs - National Balancing Point (NBP) in Great Britain and Title Transfer Facility (TTF) in the Netherlands - are nowadays the most developed hubs with the high number of market participants and gas volume traded there. These two virtual gas hubs provide the European market with an ability to buy gas not only under long-term contracts but also at spot prices that enables fast gas purchase. Furthermore, the possibility to trade gas through forwards and futures at gas hubs makes spot trading at TTF and NBP lucrative financial activity. Other European hubs have low liquidity levels and thus cannot be considered as mature hubs where prices potentially respond to market changes in supply and demand.

With the development of gas hubs at Europe spot prices are considered to be dominant gas pricing mechanism nowadays while oil-indexed contract prices for gas delivery are labeled as “outdated approach” for gas pricing. While long-term contract prices are formed based on a special pricing formula that contains oil indexation and thus defines the relationship between LTC and oil prices, there is no united opinion on whether spot prices depend on oil prices or they represent independent pricing mechanism.

A number of researchers claim that there is no or very slight correlation between spot and oil prices that explains a relatively low level of spot prices in comparison with LTC prices for gas delivery (Hulshof, Maat, & Mulder, 2015). These scientists reckon that gas hubs where spot trading takes place are developed enough in terms of liquidity levels that directly depend on number of hub participant and gas volume traded to provide market with spot prices that reflect market equilibrium, e.g. market supply and demand intersection that is profitable for both buyers and suppliers.

Other scientists claim basing on their empirical research that even if liquidity levels at hubs are high spot prices could not be considered as an independent pricing mechanism that is forcing out LTC prices. These researches report that there is still quite strong correlation between spot and oil prices (Asche, Misund, &Sikveland: 2013; Komlev, 2016). Furthermore, S.Komlev (2016) claims that spot prices could be only considered as “a secondary” prices in relation to LTC prices that creates “pricing ceiling” for spot ones. Thus, in this case spot prices are not considered as an independent gas pricing paradigm since they follow oil and LTC price dynamics.

Thus, there is no united opinion on the existence of the correlation between spot, oil and LTC prices. The result of the dispute is the lack of clarity about the nature of spot prices: what in reality drive spot prices, how they correlate with oil and to what degree they represent supply and demand changes. The uncertainty regarding this issue leads to the fact that export strategy of export companies cannot be consistent enough since the analysis regarding spot prices does not have stable basement.

Furthermore, the highly rapid development speed of the European gas market requires quite often updates of the analysis. The research prepared by S. Komlev in 2016 covered the time period from 2007 till 1.01.2016. The current research covers the time period 31.12.2008 - 31.03.2018 and, thus, presents the most up-to-date analysis that include the prices even for the beginning of 2018. This enables to see the status-quo of the European gas market nowadays and its development over the last 10 years.

Finally, in the current research paper it is aimed to examine not only the existence of the correlation between spot prices, oil prices and LTC prices, but also to analyze how this correlation have been changing over a particular time period. The time period taken for the analysis is divided into three sub-periods in order to examine how correlation between spot, oil and LTC prices have been changing over time.

In this regard research questions are: is there a correlation between spot price at TTF and NBP and Brent oil prices? Is there a correlation between spot prices at TTF and NBP and BAFA long-term contract prices? If the correlation exists, is the correlation between TTF and NBP spot prices and Brent oil and BAFA prices is weakening over a particular time period?

Thus, the object of the research paper is spot prices at TTF and NBP gas hubs. The subject of the current research is the relationship of spot prices with Brent oil prices and BAFA long-term contract prices and the strength of this correlation.

The Chapter 1 comprise an overview of the European gas market and Russian gas market status-quo, the notion of the liquidity and its importance for hubs efficiency assessment, main pricing paradigms in gas market and an overview of main European gas hubs. An overview of the European gas market is presented in this research in order to show the current market reality and how the European market has been developing over the recent years. The Russian market overview and the Gazprom export strategy is discussed in the paper since managerial implications are focused primarily for Gazprom and at the second place for other exporters all over the world. Two pricing paradigm are analyzed in detail in order to have a deep insight of pricing approaches in the gas market and to reveal an absence of unique opinion on the nature of spot prices. An overview of main European hubs were elaborated in order to create the finished picture of the European gas market and to show the development process of spot trading in the market.

In the Chapter 2 the methodology for the analysis is discussed. The rational for choosing the time period 31.12.2008-31.03.2018 is explained. Furthermore, data choosing for the research and the sources where data for the analysis were extracted are reported. Finally, the research method - the regression analysis - is explained and preliminary research plan is elaborated.

The Chapter 3 presents the results of the regression analysis and the conclusions. The scenario analysis is carried out in order to get deep insights of risks for Gazprom in the current market situation and potential strategy paths how to adjust the company's export strategy to volatile new market reality. Practical and theoretical implications of the research are explained. For practical implication to be done the scenario analysis is prepared where 4 scenarios are considered based on the scenario matrix 2x2.

1.Literature review

1.1 European gas market: the path of development

The most important process in the European gas is the gas market liberalization. A number of official policy documents, that are presented in the Figure 1, have been established by the European Union in order to facilitate this process.

Figure 1 Policy documents for the market liberalization framework Source: Haase (2008)

The liberalization of natural gas market in Europe was officially started by the establishing of gas Directive of 1998 (Haase, 2008). Since then two more gas Directives (2003, 2009), two additional gas regulations (2004, 2005), and the Third Energy Package (2009) have contributed to the process. The liberalization process addresses major obstacles for the European gas market in the way of its development: low supplies competition, high import dependency, and gas market place with strictly determined national boundaries. Thus, the main and primarily goal of the reforms is to introduce competition to the European gas market alongside with integrated gas market creation.

According to the official website of the European Commissionhttps://ec.europa.eu/energy/en/topics/energy-strategy-and-energy-union/energy-security-strategy, the European Union imports more than half of all the energy. Its import dependency is particularly high for natural gas (66%). In 2013, Russian energy suppliers exported 39% of EU natural gas import that equals 27% of the EU gas consumption. Moreover, six countries of the EU are heavily dependent on a single external supplier, including several countries (Sweden, Finland, Lithuania, Latvia, Estonia and Bulgaria) that rely entirely on Russian natural gas export, where the main gas exporter has been Gazprom (Kulagin&Mitrova, 2015). As a result, this dependence makesthose countries vulnerable to supply disruptions that could be caused by political disputes, supplier disrupt or infrastructure failures. For instance, a 2009 gas dispute between Russia and Ukraine, that is a transit country in Russia-Europe gas deals, left many EU countries with severe shortages.https://www.theguardian.com/business/2009/jan/07/gas-ukraine Moreover, in 2017 the total natural gas imports to the EU have risen by 5.5% in comparison with 2016 figures. Moreover, Russia is still the main gas importer as in 2017 it has provided over 40% of natural gas to Europe (Figure 2).https://www.mckinseyenergyinsights.com/insights/the-2017-european-gas-market-in-10-charts/In order to minimize the import dependency and to diversify gas suppliers, the European Commission reported a newly developed European Energy Security Strategy in May 2014. The goal of the strategy has been the reduction of Europe's high energy dependency.

Figure 2 Natural gas imports by suppliers

Source: Eurostat Estimates, 2017

E.V. Kislitsinand V. K. Pershin (2016) suggest several solutions to this issue of suppliers diversification. Firstly, new gas pipelines from the Netherlands and Norway could be constructed as these countries have considerable gas supply. The main drawback is that in 2013 the Netherlands claimed the decline in gas extraction so the capacity of a planned pipeline will be inefficient in relation to the construction and maintenance costs. Secondly, the place of Turkey as a potential main gas supplier in the European market should not be underestimated since it is possible for the EU to meet the demand for gas and at the same time to reduce the amount of gas imported from Russia only through the cooperation with Turkey (Pershin & Kislitsin, 2016). However, the necessary infrastructure for importinggas from Turkey is absent nowadays. Till recently there has been a large scale project with Turkey - a new gas pipeline “Nabucco” - that should meet the demand for gas in the European market by delivering gas from the Middle East and the Caspian region to Europe. However, it was decided to stop the construction of “Nabucco” in 2013. This decision has led to the inability of the EU to reduce its energy dependence on the Russian gas import. Thus, the large share of gas imported to Europe is still supplied by Russia. Finally, Pershin and Kislitsin (2016) reports that the full usage of currently existing liquefied natural gas (LNG) plants could be a solution for the European Union in energy dependence issue. However, the author highlights that LNG is still quite an expensive energy source. Thus, there are drawbacks in every approach suggested by the authors that reflects the complexity of the import dependency issue.

In 1990s it was discovered that one of the key issues regarding European gas market structure was the dominance of incumbent monopolies, namely vertically integrated companies that controlled import and prices for gas as well as transmission assets (Katsis, 2013).The goal of competition enhancement and was not achievable with that kind of infrastructure. In order to enhance suppliers competition the EU has implemented a number of liberalization policy tools in order to mitigate the power of monopolies and develop market infrastructure. These policy tools are based on the standard regulatory prescriptions for the competition introduction into network industries (Joskow, 1996; Newbery, 2004). The unbundling (e.g. carving out natural monopoly services) gas transportation from trading activities and the providing third-party access to the gas network have been established in the Second Gas Directive and the Third Energy Package and aimed at opening the access to the infrastructure to new suppliers and market participants. It is stated that the same entity cannot possess control over generation, production and/or supply activities and at the same time have control over transmission system operator (TSO) (CEER Status Overview on TSOs Unbundling, 2016). Thus, the unbundling and the third-party access grant energy companies non-discriminatory access to the infrastructure.https://ec.europa.eu/energy/en/topics/markets-and-consumers/wholesale-market/access-infrastructure-and-exemptions

Thus, despite several actions taken by the EU to introduce competition into the gas market high import dependency and low suppliers competition are still two main issues to be solved in the future.

In order to create a fully integrated gas market where national boundaries are eroded, the EU takes such actions as the increase in underground gas storage capacity, the infrastructure development (especially for reverse gas flows), and the creation of easy access to gas storage facilities.According to V. Kulagin, 16 interconnectors for reverse gas flows were developed, modernized or constructed. Moreover, cross-border connective networks throughput capacity has grown by 14% from 1992.http://neftianka.ru/gaz-v-evrope-konkurenciya-narastaet/Moreover, the unbundling and third-party access that have been discussed earlier also facilitate the infrastructure development. All these actions lead to infrastructure development that is an important step for integrated market creation.

In 2011 the EU developed Gas Target Model where the idea how the European gas market should function was emphasized. It is supposed that competitive European gas market with entry-exit zones, with liquid virtual trading points (VTPs, or hubs), with gas freely moved between market zones to the locations where there is a high demand for that gas in that particular moment should be created (ACER, 2015). Thus, the hub gas trading development strongly facilitates integrated gas market creation.

With the hub gas trading development there is a paradigm shift from oil-indexed long-term contract pricing to hub-based pricing (Kulagin,Melnikova, Galkina, Osipova, &Kozina, 2016). The new pricing paradigm is still dependent on the old one, but nowadays it is considered to be a dominant pricing approach. On the Figure 3 the proportion of oil-indexed prices to hub-based prices in 2005 and in 2015 is presented that could be a proof of hub-based pricing paradigm dominance in the gas market. The process of pricing paradigm shift and related issue will be considered further in the separate section.

Figure 3 Percentage of oil-indexed prices to hub-based prices in 2005 and 2015

Source: Platts, 2016

The competition enforcement, import dependency mitigation, suppliers diversification and integrated market creation areaimed to achieve energy security that is the centre of liberalization process. Energy security is an issue that is of high importance for many stakeholders such as policy markers, businesses and major energy consumers in particular, and a larger community whose life quality strongly depends on secured and uninterrupted energy supply in the market (Ang, Choong, & Ng, 2015). Nowadays, there is an absence of consensus about energy security definition in the scientific literature. In formation of energy security definition some researchers are mainly focused on the security of energy supply and availability of a type of energy in the market, while others highlights the influence of energy security on economic and social welfare. Ang, Choong and Ng (2015) in their article reckon that the notion of energy security is highly dependent on the context where it is used (Ang, Choong, &Ng, 2015). The authors identified seven main dimensions of energy security: energy availability, social impacts, energy prices, governance, environment, infrastructure, and energy efficiency. Mansson, Johansson and Nilsson (2014) are mainly focused on assessing energy security from the side of energy supply. The authors also highlights the complexity of the notion of energy security that vary between different disciplines and over time (Mansson, Johansson, &Nilsson, 2014). In the article it is also emphasized that the notion is broadly perceived as the guarantee from threats to national security due to dependence on a few oil and gas producers that corresponds to the situations in the European gas market.

Thus, energy security integrates all actions taken by the EU in relation to competition reinforcement, supplier diversification, import dependency diminution and integrated market creation. Energy security is the corestone of the gas market liberalization in Europe that is one of the main triggers of the industry development in Europe.

1.1.2 Gas consumption, production and demand in Europe: main trends

The liberalization of the gas industry in Europe is accompanied by main trends in gas consumption and gas production within the region that influence the development of the industry.The market share of natural gas in Europe has increased rapidly from less than 10% of the total primary energy supply (TPES) in the early 1970s to approximately 24% in 2012 (Honorй, 2014). In 2012, 35 countries in Europe consumed 539 Bcm of natural gas, representing about 15.6% of the world consumption (Honorй, 2014).

However, in recent years Europe has become the only geographical region with negative gas consumption figures (Kulagin, 2015). After 2010 when the gas consumption achieved its peak position, it started to decline gradually and in 2015 fell to the consumption levels of 1995, so the consumption dropped by 23% over the period 2010-2015. This negative dynamics has determined the decline in demand for natural gas in Europe (Kulagin & Mitrova, 2015).

The negative gas consumption trend could be caused by pursuing the goals of active energy saving and energy efficiency. In 2010 the EU has adopted the package called “EU 20-20-20”, where one of the main goals was to increase the energy efficiency by 20% by 2020 by decreasing primary energy consumption by 20% (Kulagin & Mitrova, 2015). The consumption decline could be observed in European electricity power generation, where active energy saving takes place.

Other reasons for the negative gas consumption trend could be vulnerable economic situation in Europe and in the world, and the competition between different energy sources, e.g. intefuel competition. The main energy “competitors” of natural gas in the European market are coal and renewable energy sources (Kulagin, 2015). In spite the fact that the European Union has claimed the “low-carbon” energy policy in the region under which it is supposed to supplement the use of coal by natural gas, coal consumption decline is considerably lower (from 29% to 26%) in comparison with gas consumption decline (from 21% to 16%). At the same time the renewable energy level has risen from dramatically (Bros, 2017). The Figure 4 below shows the changes in each fuel's consumption.

Figure 4 Fuel consumption in Europe by types

Source: International Renewable Energy Agency, 2017

The renewable energy has become a priority of the European energy. According to the official website of the European Commission, it is possible for the EU to lower its energy dependency on imported fossil fuels.https://ec.europa.eu/energy/en/topics/renewable-energyMoreover, the use of renewable energy is considered by the European Commission as a key element of the current energy strategy since it will facilitate the decoupling of energy prices from oil ones.http://ec.europa.eu/eurostat/statistics-explained/index.php/Energy_statistics_introduced In some European states the costs of renewable energy production is almost equal nowadays to gas price in the market because of constantly developing technologies and well organized government support and diversified subsidy (Kulagin, et al., 2016). The EU is active in addressing climate changes. Thus, the substitution of carbon-intensive energy by renewable energy sources is an important reason for the increase in renewable energy share in Europe (Report of European Environment Agency, 2017).Finally, the renewable energy strategy is also linked to the issue of energy efficiency and energy savings. According to the report of the European Environment Agency (2017), the increase in the RES share since 2005 has resulted in a 2% EU-wide reduction in primary energy consumption in 2015.

However, in 2015-2016 the gas consumption and gas demand in Europe started to recover slightly, but the figure is still quite low in comparison with pre-2010 level (Bros, 2017). According to the official website of Eurostat, in 2016 consumption of natural gas in the EU increased by 7.0% in comparison with 2015.http://ec.europa.eu/eurostat/statistics-explained/index.php/Natural_gas_consumption_statistics The recovery of the European gas consumption continues in 2017. It was forecasted by the European Association of Natural Gas Industries that the gas demand of 28 EU state members has grown by 5.9% in comparison with previous year.http://pr.euractiv.com/pr/higher-gas-demand-2017-helps-lower-emissions-160216Eurogas reckons that the increase in 2017 gas consumption level stems from lower temperatures in a number of EU countries, stable economic growth, the replacement of coal-fired large-scale plants with modern gas-fired plants and the increased gas usage in transportation sector.http://www.snam.it/en/Media/energy-morning/20171107_2.html Furthermore, it is supposed that the positive trend for gas consumption in Europe over three consecutive years (2015-2017) facilitates the CO2 emission reduction that is one of the main goal of the EU.

At the same time, the situation is accompanied by negative gas production trend in Europe. In 2004 the gas production in Europe began to decrease gradually. On the Figure 5 it is shown that the overall gas consumption and production in Europe was being declined over 2008-2016, but starting from 2015 these two figures have decoupled.

Figure 5 Gas consumption and production levels in Europe 2008-2016

Source: International Monetary Fund, 2017

In these market conditions there is still gas import dependency in Europe. Thus, the liberalization process aimed at achieving energy security by import dependency mitigation and competition reinforcement is closely linked with gas consumption and production trends. The increased gas consumption accompanied by decreased production complicates the achieving of energy security since import dependence issue is still relevant.

In conclusion, the European gas market has changed over recent years. The changes occurred in the market have impact on main gas exporters to Europe, where Gazprom takes the leading position.

1.2 Gazprom export strategy in the Russian market framework

According to the EIA official website, Russia held the world's larges natural gas reserves.https://www.eia.gov/beta/international/analysis.cfm?iso=RUS Currently Russia's reserves account for about one quarter of the world's total proved gas reserves. Most of these reserves are located in large natural gas fields in West Siberia. This fact enables Russia to rely on its revenues come from energy industry and to be one of leaders in global energy sector.

Russian economic growth is mainly driven by gas exports primarily to Europe. Russia and Europe are interdependent in terms of energy. Europe is dependent on Russian gas deliveries: more than 70% of imported gas to Europe came from the Russian Federation in 2016.https://www.eia.gov/beta/international/analysis.cfm?iso=RUS Russia in its turn is dependent on Europe since this is the major target market for Russian gas exports (Gazprom Export Global Newsletter, 2017).

Gazprom is a Russian transnational gas company and the main exporter in the European gas market. Moreover, the principle of unified export channel preservation that has its legal acceptance in the law “About natural gas export” established in 2006 provides the company with the legal guarantee for the unique right to export Russian gas.http://www.gazprom.ru/about/strategy/implementation/ Thus, Gazprom is the main exporter of the gas and the increase of gas volumes delivered to Europe could be related to the effective company's strategy (Figure 6).

Figure 6 Deliveries by Europe's major exporters in 2016 and 2017

Source: Gazprom Export, 2017

There is 7.2% increase in export volumes in comparison with 2016 figures. It should be mentioned that there was a decline in gas export amount in 2010. However, beginning from 2015 there is a positive dynamics in gas export volumes by Gazprom to Europe (Table 1).

Table 1 Natural gas export volumes by Gazprom to Europe

According to the offcial website of Gazprom Export, the Western Europe consumes the largest part of gas supplied to Europe. In the Figure 7 the main gas consumers (including Turkey) are presented. The most important target buyer is Germany.http://www.gazpromexport.ru/en/statistics/in this sub-region Gazprom have sold 155.9 billion cubic meters of gas in 2017.

Figure 7 Western Europe gas consumers supplied by Gazprom in 2017

Source: Gazprom Export, 2017

Despite the fact that the Easetrn and Central Europe consumes smaller amount of gas , this regions if of hogh importance for Gazprom because of its territorial proximity to the Russian Federation. In 2017, Gazprom has sold 36.3 billion cubic meters of gas in this sub-region (Figure 8).

Moreover, Gazprom gas deliveries continues to grow even after the end of the winter heating season and has risen by 6.3% since the sart of 2018.http://www.gazpromexport.ru/en/presscenter/news/2134/The largest increase was particularly demonstrated by the main importer of the russian gas - Germnay. The last-years growth in Russian gas supplies was driven by the following factors: weather conditions, gas production decline in Europe and competitive prices for Russian gas (Gazprom Annual Report, 2016).

Figure 8 Eastern Europe gas consumers supplied by Gazprom in 2017

Source: Gazprom Export, 2017

The basis of the Gazprom export pricing strategy is the system of long-term contracts with the “take-or-pay” principle and oil indexation of gas prices (e.g. where gas prices are pegged to the petrolium product prices, in particular oil prices) that are calculated on the base of a special pricing formula.http://www.gazprom.com/about/strategy/implementation/ The central strategy with oil indexation in long-term contracts for gas delivery enables the company to receive stable revenues from export sales and to guarantee secure gas supply for consumers.

Moreover, in 2015 and 2016 the company performed three gas Auctions.http://www.gazpromexport.ru/en/strategy/gas_auction/ The acution mechanism of export gas sales complementns the existing company's strategy of long-term constracts sonce gas auction corresponds to challenges of the evolving energy market. The first gas acution tested the possibility of gas sales through the Nord Stream pipeline in 2015. The second gas auction happened in 2016 through which Baltic States were supplied with russian export gas. The third auction has resuted in signing long-term contracts with 11 European countries for gas delivery during the winter season 2016/2017.

Furthermore, the company proceeds with proactive dialogue with clients in order to make mutually effective and beneficial decisions in the conditions of constantly changing market. The company expands its business activities in liberalized deregulated markets and is currently active in spot and short-term trading of natural gas. http://www.gazprom.com/about/strategy/implementation/

However, despite the fact that Gazprom develops its gas export strategy in terms of new trading forms (spot and short-term trading), it ismainly based on long-term contracts wit oil indexation. The abolishment of such long-term contracts will undermine gas supply security in the Euroepan gas market and will mean a sharp decrease in Gazprom export revenues since the majority of gas volumes is currently traded under LTCs (Henderson, 2015). However, a conservative export strategy with merely no adaptation to market changes can lead Gazprom to loosing market share. Thus, the company is pushed for further export strategy development. Several actions have been already undertaken by the coampny in 2009 to make the pricing srategy more flexible so that it quickly react to exteranl market changes. The company has introduced discount systems for short-terms trading (estimated at 7 to 10%), the reduced gas volume for obligatory purchases by customers and, as it has been mentioned eralier in the paragraph, the selling of gas in spot market (approximately 15% of gas is traded in spot market) (Boussena & Locatelli, 2017). Furthermore, the company has revised its pricing formula by two ways: either by reducing the base price, or by changing the relative weight of the different petroleum products in price formation and pricign formula for long-term contracts. Finally, the “spot” component was added to the pricign formula that is resulted in realigning Gazprom's contract-based prices with oil indexation with hub-based prices formed at the European gas hub prices (Boussena & Locatelli, 2017). In addition the company has changed central clauses in order to make the pricing formula more flexible. As a result periods of time governing prices reviews processes have become shrter (Boussena & Locatelli, 2017).

Furthermore, Gazprom is currently developing its LNG sales in new markets, mainly in Asia-Pacific region, supplying gas to both traditional consumption markets (Japan, South Korea, Taiwan), as well as to the dynamically-developing markets of India, China and Southeast Asia.http://www.gazpromexport.ru/en/strategy/markets/

As it was mentioned earlier, Gazprom is the main exporter of the Russian gas. This fact reflects the main characteristic of the whole gas industry in Russia - the high level of monopolization(Aune, Golombek, Moe, Rosendahl, & Le Tissier, 2015). The natural gas sector has remained centralized under Gazprom that is the main reason for low competition level in the Russian gas market. The company has had a monopoly on the main gas market segment including transmission system. However, this monopolized system has been questioned since nowadays the Russian gas industry is in the transition phase that could be characterized as modest decentralization (Ozdemir & Karbuz, 2015). The changes have been triggered by development in the domestic gas market and in the European gas market that has been discussed in the previous paragraph (Locatelli, 2013). Currently Russia is funding a way how to deal with the aim of the EU to create a competitive, integrated and transparent gas market with increased competition and diversified gas suppliers that was reflected in the Third Energy Package in 2009.

In this regard in recent years Gazprom has faced increased competition, mainly in domestic market. Currently the gas sector is being transformed into a four-player structure: Gazprom that remains the leader in the industry, Novatek and Rosneft that are considered as main Gazprom competitors, and other independent gas companies (Lukoil and other small companies) (Belyi, 2013).

Novatek is Russia's second largest gas company, and it is also ranked in the top five quoted companies in the world on the base of proved gas reserves amount (Henderson, 2015). The company's plan is to double its gas extraction by 2020 (Novatek (2011).Rosneft appears also to have significant gas reserves and the marketing ability to increase its sales in the domestic market (Henderson, 2015).

Thus, competitive market place is emerging in the industry that hinders the monopolistic position of Gazprom (Aune et al. 2015). Another factor that challenges the position of Gazprom is the decrease in volumes of gas extraction in Russia (Boguslavska, 2015). The share of Gazprom in the domestic gas production has been roughly to two thirds of the overall production (Lunden et. al., 2013). However, according to the Bloomberg official website, the domestic production of gas in Russia has risen by 7.9% in 2017 that was mainly driven by Gazprom sales to Europe and rising domestic demand.https://www.bloomberg.com/news/articles/2018-01-02/russia-posts-highest-ever-natural-gas-output-in-expansion-drive Moreover, the domestic production of gas has achieved its highest level for the whole history of the Russian gas industry.

Thus, the decrease in gas production volumes (except the last year figures) and intensified competition from independent producers challenge the monopolistic position of Gazprom. In 2016 the Gazprom production share equaled 64% while in 2009 the share was 85% (Simola & Solanko, 2017). The decrease is significant and could be considered as a proof to intensified competition in the domestic market.

In conclusion, Gazprom is currently influenced by changing domestic and European gas markets. In Russian market the increased competition stimulates the company to further develop its strategy in order not to lose its unique right for Russian gas export. Furthermore, the decreased gas extraction levels in domestic market andchanges in European gas market regarding liberalization process and increased role of gas hubs stimulate Gazprom to find more flexible export pricing strategy so that Gazprom prices for exported gas could be compatible with hub-based prices in Europe. The export strategy adaptation to new market realities enables the company to keep leading position in Europe and extract high profits.

1.3 The notion of liquidity and its value for natural gas market

The majority of attention has been paid to liquidity in the shares, bonds and money markets. In all these markets, liquidity is seen as desirable. However, there is little attention in the literature for the measuring of liquidity specifically for the gas market or energy markets as a wholehttps://www.gasterra.nl/en/news/what-is-liquidity-and-how-do-you-measure-that. In reality energy markets also require an optimal level of liquidity for an adequate operation and obtaining a reliable commodity price benchmark. Furthermore, the liquidity level allows to roughly identify the market development stage, market success and market efficiency (Heather, 2015).

According to the Energy Procurement Consultancy Company Magnus Commodities, liquidity could be defined as the degree to which a product can be quickly bought or/and sold without affecting its price and without incurring in significant transaction costs.https://www.magnuscmd.com/liquidity-and-its-impact-on-energy-markets/ Furthermore, liquidity market is defined in the Nasdaq official website as a market where there is a possibility to buy or sell a large quantities of an asset at any time and at low transactions costs.https://www.nasdaq.com/investing/glossary/l/liquid-market The Office of Gas and Electricity Markets (OFGEM) definition of the liquidity highlights the same features of this notion. It defines the liquidity as anability to quickly buy or sell products or services without a significant change in its price and without incurring significant transaction costs.https://www.ofgem.gov.uk/electricity/wholesale-market/liquidity

It could be observed, that all mentioned liquidity definitions emphasize the same features. Firstly, the transaction intensity is quite high in markets with high liquidity that is related to the issue of huge traded volumes that will be discussed later. A high number of transactions within a particular time period could be assign of high liquidity level since any transaction, roughly speaking, could be fulfilled at any time in this casehttps://www.gasterra.nl/en/news/what-is-liquidity-and-how-do-you-measure-that. Secondly, liquidity implies low transaction costs. In this regard, bid-ask spread should be analyzed, which is the difference between the maximum price at which market participants want to buy (ask) and the minimum price at which market participants want to sell (bid).https://www.magnuscmd.com/liquidity-and-its-impact-on-energy-markets/ A narrow spread provides market players with low transaction costs and at the same time with a certainty in price level to be achieved. Thus, the lower the spread, the higher the liquidity level. Furthermore, trading costs also is an indicator for market liquidity since lower trading costs (e.g. costs for brokers or taxes) stimulates a number of transactions and by this leads to higher liquidity.

Another important factor that is an indicator for a high liquidity level in the market is price volatility. According to the official website of GasTerra, there is no consensus found in the scientific literature regarding this indicator. However, it is generally accepted that lower price volatility provides market participants with a confidence that a price reflects the product's real value. A lower price volatility generally results in a higher liquidity.https://www.gasterra.nl/en/news/what-is-liquidity-and-how-do-you-measure-that

Patrick Heather (2015) distinguishes a number of important elements that identify the market development stage and hubs' development stage in particular. The first element to consider is market participants, especially market participant diversity. The number of companies trading at a gas hub is an important indicator driving the development of that market since it not only shows the willingness of traders to `get involved' in the market deals but also reflects how easy it is to participate within a particular market or gas hub. Furthermore, the more participants there are, the less chance in generalof one company dominancein the market. Finally, another important criterion is the number of participants that are currently active within the market: the more companiesthat regularly trade, the more liquidity there will be (Heather, 2015). However, it is quite complicated to define “an active” market participant as it is quite a subjective decision since no precise benchmark exists. For instance, “an active” player could be defined as that who traded once per week/per day/per month etc. Thus, since this metric regarding identifying active participant is quite ambiguous and vague the whole number of market/hub participants is preferred when identifying market/hub efficiency.

The second element that is an indicator of an efficient market or a gas hub is products available for trade. P. Heather (2015) considers this metric as an important one since if there is a variety of products available in the market/hub, there are risk management opportunities for players. The author reckons that risk management opportunities are a signal of a mature efficient market/hub, and only a risk management hub could provide a benchmark prices for products traded. P. Heather (2015) highlights that liquidity attracts liquidity which in turn leads to a market success and in the future to the `mature' market withreliable prices.

The third element is Tradability Index (Heather, 2015). The concept of Tradability Index is a natural benchmark for products or services tradability, e.g. how much they are actually traded (Bykova & Stцllinger, 2017). This index serves as a measure of how narrow bid-ask spread is, indicating a high level of liquidity as it has been menti9oned earlier in this chapter. It is not sufficient metric by itself to define the market/hub development stage, but if analyzing with other factors Tradability Index makes the picture of the market/hub status-quo more detailed (Heather, 2015).

The fourth element mentioned is traded volumes. As it has been mentioned earlier, transaction density is strongly linked to traded volumes - a metric that is considered to be one of the most important factor for liquidity level assessment since they are a component of the churn rate formula that will be considered next (Heather, 2015). This metric shows how intense the market activity is. In a nutshell, market/hubs with high traded volumes show high churn rates, that usually means a diverse variety of participants and the absence of price manipulation.

The last and the most important element in assessing market/hub efficiency and success is churn rate (Heather, 2015).The churn rate is defined as a portion of traded volume to actual physical output.https://www.magnuscmd.com/liquidity-and-its-impact-on-energy-markets/ To makes the definition clearer, it could be said that churn rate is a measure of the number of times a `parcel' of gas is traded and re-traded between its initial sale by a producer and the final purchase by a consumer. P. Heather (2015) claims that all other metrics considered earlier are reflected in this one last element: if there are many participants in the market/hub who traded a variety of products in huge volumes, churn rate will be also high that indicates high liquidity level. There is no consensus on the churn rate threshold value: some market participant won't trade in a market/hub where churn rate is below 10, others will take a value of 12 or 15 as a benchmark for decision making (Heather, 2015; Konoplianyk, 2009). Thus, churn rate is considered to be the most important and vastly used metrics for liquidity level assessment in most commodity and also financial market.

To summarize factors that help to assess liquidity level, the Figure 9 is created. All metrics are grouped into three parameters: cost, time and volume. To assess the liquidity level more precisely, the systematic analysis should be carried out where all factors are considered.

Figure 9 Liquidity level determinants

Thus, the high liquidity level is an evidence of a strong developed market (or of a hub in a particular case) where transaction costs are at minimum levels, products flow is free, where prices reflect the real value of a product or services since they reflect changes in supply and demand quite effectively. This fact is highly important for market participants since decisions regarding trading and investment activities (product capacity, transportation capacity, storage, etc.) will be efficient.https://www.magnuscmd.com/liquidity-and-its-impact-on-energy-markets/Thus, it is quite important to analyze liquidity as this is an effective tool of market analysis.

1.4 Gas pricing: oil indexation and hub-based prices

Generally, there are two main types of gas pricing mechanisms: oil-indexed contract prices and hub-based prices for gas. There are different points of view among scientists what pricing mechanism is dominant nowadays in the market, and what prices are appropriate signals of actual supply and demand and, thus, represent an actual value for gas. In order to better understand the gas market status-quo, we propose to analyze each pricing mechanism, in particular its development process, variables that influence this or that pricing paradigm, dependence of each prices from global oil prices etc.

According to the article “Evolution of Gas Pricing in Continental Europe: Modernization of Indexation Formulas Versus Gas to Gas Competition” written by A. Konoplyanik (2010), the initial stage of gas pricing formation process was cost-plus pricing concept that implies a gas price based on production and delivery costs incurred by a producer/supplier. Thus, it is logical that cost-plus pricing depends on a producer's behavior. Cost-plus prices are not often exposed to fluctuations as they are based on projects' economy, e.g. within any development project needed for gas production quite stable, predictable costs for a long period of time could be calculated that determines monotonous and constant fluctuations of such costs. Thus, the cost-plus prices based on aforementioned production costs are also not so volatile and have quite constant fluctuation character.

However, historically the dominant gas pricing paradigm has been based on the determination of gas price basing on its replacement value with other energies in the end-user sector (Konoplyanik, 2010). The use of the replacement value implies linking gas prices through a particular formula represented in long-term contracts (LTCs) to the other energies competing with gas. The main energies competing with gas in the final energy consumption have been residual fuel oil or heavy fuel oil (HFO) and gasoil/diesel or light fuel oil (LFO). In contrast to cost-plus pricing, the residual value-based pricing depends on consumer's behavior and are more volatile since such prices are linked to prices at commodity markets where volatility dynamics is quite high. Komlev (2016) highlights that gas is the only commodity which prices rely on the replacement value pricing principle. This replacement value concept was the centre of the Groningen model that was developed in 1962.

The intent to implement a new pricing concept - Groningen-type long-term contracts concept - was to maximize the revenue for gas producing countries/companies and to mitigate risk appeared from hug investments required for gas production (Komlev, 2016). Groningen-type contracts may be characterized by several key features. Firstly, the switching from cost-plus pricing approach to replacement value pricing approach happened with the implementation of Groningen model that has been a milestone in the gas pricing historic development.

Secondly, it is long-term contracts between a gas producer/supplier and a customer that play a role of compromise for conflicting interest of both parties (Asche et al., 2013). On one hand, the buyer would like to have some volumetric flexibility to have an ability to adjust imported gas volumes to demand fluctuations since the storage of das glut in periods of low demand is quite expensive for buyers/importers. Furthermore, buyers would prefer gas prices be responsive to gas substitutes prices since this gives customers an opportunity to resell gas, and for this gas price should be compatible to other energies in the market. On the other hand, the gas producer/supplier would like to be assured that there will be an opportunity to sell a particular amount of gas over some period of time that ensures stable and long-lusting demand for gas. Such a sustainable demand could mitigate non-commercial risk because such production stages as extraction, processing and transportation are quite expensive in terms of investments. In other words, the producer would prefer to deliver a constant gas stream at maximum utilization capacity. Moreover, the producer would like to receive a fix minimum price as a guarantee for stable and to some degree predictable cash flows for the entire delivery period. Long-term contracts provide both parties with a trade-off.

This trade-off could be partially found in “take-or-pay” provisions that are included in LTCs (Vazquez & Hallack, 2016). Under “take-or-pay” provisions buyers take volumetric risk since they are obliged to pay a predefined for a minimum amount of gas. In case a buyer is able to resell acquired gas in short run, the LTCs play a role of a hedge mechanism against short-term market volatility. Thus, “take-or-pay” provisions define a minimum amount of gas that should be delivered by a gas producer/supplier, and the corresponding minimum unit price for gas purchases. The risks related to gas delivery and gas purchase is thereby shared between two mutually linked parties - producers and buyers. Thus, both parties of long-term contracts are interested in providing supplied/purchased gas at a marketable price that can compete with other marketable energies.

Thirdly, under Groningen model the market price for gas is calculated in accordance with special formula which is an integral part of LTCs. Since LTCs rely on replacement value concept, there should be alternative fuels integrated in this formula so that gas price could compete with other energies. As it was mentioned earlier, there are basically two gas alternatives that are included in the formula: gasoil/diesel fuel or light fuel oil (LFO) which competes with gas in household sector and residual fuel oil or heavy fuel oil (HFO) which competes with gas in industrial electricity and heat generation sectors (Konoplyaanik, 2010). Historically, LFO has the weight of 60% in the formula, whereas HFO has 40% (Konoplyanik, 2010).