Price analysis in Energetic industry focused on gas sector

FRANTIŠEK JANÁČ, BOHUSLAV SEKERKA Institute of Business Economics and Management

University of Pardubice - Faculty of Economic and Administration Studentská 84, 532 10 Pardubice

CZECH REPUBLIC Frantisek.Janac@student.upce.cz http://www.upce.cz/fes/index.html Bohuslav.Sekerka@upce.cz http://www.upce.cz/fes/index.html

Abstract: - The aim of this paper is to explain the price structure and margin of the companies within gas industry in the Czech Republic. The gas as a commodity is one of the essential parts which we use in our common lives. The gas is mainly use for heating and hot watering and therefore each price increase influence a big amount of people. Within the Czech Republic business for DSO, TSO and partly SSO is regulated by Energetic regulatory office (ERU). ERU also oversees the market and their participants. The market is relatively new and it was partly de monopolized in 2007 when the market was opened and just distribution and transit stayed regulated. Due to this fact the margin of operators was decreased, but unfortunately the final price for consumer even though increased. This axiom would be explained within this article.

Key-Words: ERU (Energetic regulatory office), EU (European Union), Margin, TSO (Transmission System Operator), SSO (Storage System Operator), DSO (Distribution system Operator), UGS (Underground gas storage), MC (Marginal cost), AC (Average cost), D (Demand), MR (Marginal revenue),.

1 Introduction There is a clear trend in growth of energy production in the Asia & Oceania, also shows an increasing trend in Africa, while the decline in values note % North America and Europe. [1]

Natural gas is the cleanest fossil fuel, which is commonly used. Its burning is waste-free and has the highest energy efficiency and the smallest emission pollution load [7]. Therefore usage of this natural resource is growing especially due to the fast growth of electricity price. Another factor would be the surplus of natural gas on the market due to shell gas in the USA. This fact is valid not only for the Czech Republic, but also in Western Europe and in the World.

Table 1: The structure of primary energy sources All figures are in % World Western

Europe Czech Republic

Solid fuels 28,5 20,5 53,9

Liquid fuels 38 41 18,9

Natural gas 25,5 22 19,7

Others 8 16,5 7,5

Source: own according [8]

Historically the gas market in the Czech Republic was under government agencies control, although

due to the fact that the Czech Republic entered in 2004 into European Union, the gas market had to be changed. This was done in line with EU directive 2003/55/EC [5] and committed EU members to unbundle the market with the gas. Generally it meant that business with the natural gas must be split from TSO, DSO and SSO as historically it was in hand of “one” company either owned by government or in private sector and regulated by the government. The brief explanation gives following schema, which explains the barriers of the market. Picture 1: Unbundling schema

Source: [own]

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2 Current situation As the market is relatively new and final customers are not familiar with the structure of the price for consumed gas, it is necessary to get acquainted with the market firstly following structure of the price and then the margin of the major sellers can be explained to see the obstacles of this system from economical and practical points.

2.1 Market The relevant market could be understood for TSO whole nation, for all other it could be divide into regions.

The term “region” has to contain delimitation of territory and delimitation of human interest and efforts with consideration to time dimension. [2]

From supplier side the market is divided into several parts beginning with transmission, through distribution and storing up to the sales.

2.1.1 Transmission Grid (TSO)

NET4GAS, s.r.o. is the only company who owns the license for transportation within Czech Republic and neighbors states. The business is regulated by ERU. The blue pipelines represent the major gas lines for transmission usually with very high pressure. Through the pipelines the gas for consumption is distributed within the Czech Republic and transmitted to neighbor countries. Picture 2: Transmission Grid

Source: according [11]

2.1.2 Distribution grid (DSO)

Distribution grid forms the net of pipes which leads directly to the final consumers. They are in possessions of several companies operating locally. Figure 1: Number of customers in gas systems in year 2011

Source: according [6]

Table 2: Evaluation of annual natural gas consumption by customer category in the Czech Republic

Year Category

Number

of

customers

Thousands

m3

MWh

2010

High demand customers (HD_C) 1 742 3 650 038 38 677 391

Medium demand customers (MD_C) 7 021 881 004 9 332 808

Low demand customers (LD_C) 198 448 1 365 456 14 465 258

Households(H) 2 663 423 2 905 523 30 785 672

Balancing difference (BD) 177 224 1 877 230

Total 2 870 634 8 979 243 95 138 359

2011

High demand customers (HD_C) 1 707 3 544 518 37 545 675

Medium demand customers (MD_C) 7 033 782 884 8 290 205

Low demand customers (LD_C) 200 496 1 159 817 12 283 074

Households(H) 2 659 787 2 443 945 25 889 048

Balancing difference (BD) 154 608 1 637 582

Total 2 869 023 8 085 772 85 645 583

Source: according [6]

Figure 2: Evaluation of annual natural gas consumption by customer category in the Czech Republic in graphic

Source: according [6]

2.1.3 Gas storage (SSO) Optionally the gas can be stored by sellers. Storing the gas gives the sellers higher stability within winter season if any transmission fails. Other role might be a speculative or safety stock etc.

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2.1.4 Gas trader/seller

This part of market has been opened and to the 09/2012 144 licenses for gas trading has been awarded according Energetic regulatory office [10]. 2.2 Price structure

The price structure for final consumer is explained on a schema, which in detail describes major price structure. Generally the price can be split into two parts: Regulated part of the price contains:

- charge for transportation - charge for distribution (incl. charge for

connection to the grid) - commission to OTE (Operator on the

energy market) Non-regulated part of the price contains:

- price for gas consumption - supplier costs - supplier margin

Picture 3: End-user prices in the Czech Republic: the percentage composition in the value chain, the main factors - Schema Structure Conduct Performance

Source: according [3]

2.3 Margin Picture 3 shows except explaining the price structure to the final consumer also the area where could the margin of the sellers be constituted.

As the Imported commodity has major influence on the final price and from this part can be affected only 6,6 % by European spot market (indirect influence of the market) as explained on Picture 3. The traders also consider the risk of not storing the gas in Underground storages and wholesale/retail supply depended on chosen rate (direct influence).

2.4 Hypothesis The final price for gas consumption to the consumer can vary. The traders/sellers might not explain all necessary details about the price and based on motivation to get new customers have higher profit and become bigger on the market, can mislead the consumer who think that conditions are the same from companies within the market. After several years the ERU is facing new symptom, the smaller companies are more aggressive and they are not afraid to use unfair methods to get a customer.

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3 Problem Solution The main problem of above mentioned is that in past the market was under government control and it was not naturally deregulated and part of the business stayed monopoly part oligopoly with dominant firm and the market with gas as medium was opened. 3.1 TSO and DSO as monopoly market The reason for gas transportation (TSO) to be on monopoly market is very simple, the pipeline grid is not only financially very expensive, but also technically difficult and in final the company who provide this service must have special legal permit. Therefore it seems wise that this part of business is regulated. From economic view it looks as following: On vertical axis we have the quantity P/Q and on horizontal axis we have the Q. If the monopoly would set the price by them we would get price PA and quantity QA here would be valid MC=MR and monopoly would realize the profit as ΠA. Although due to regulation the government agency allows to the monopoly only to have price as PB for quantity QB, which represent formula MC =P and it represents the profit ΠB. If the price PC and quantity QC are applied then we talk about normal profit which means that economical profit is equal to 0 (this would be the best for consumer). Picture 4: Margin in monopoly market regulated by government

Source: [own]

Very similar this would apply to DSO grid only with the difference that this would apply for local distribution grid. 3.2 SSO as oligopoly market For SSO we are facing a special phenomenon. The market is oligopolistic with dominant firm. The dominant firm set the price of storing. The traders

not always buy the capacity and then it has influence on the price of natural gas. The traders part of this saving keep as profit and part offers to the customer in form of discount from final price of natural gas, so the traders can be cheaper, that bigger players. In 2009 the price for cubic meter of storing capacity was 2,60 CZK nowadays it is nearly 0,65 CZK per m3. This drop was caused due to rising number of trading companies, who are not interested in storing gas and they just directly buy it at spot markets and sell it ( as mentioned it might be influenced by shell gas surpluses). The price drop has big influence on investment and due to this reason two huge projects for building two new gas storages in the Czech Republic were canceled. Gas storage has been established primary to store the natural gas, as consequence of this it helps to eliminate drop down of gas supply from Russia to Czech and peaks can be covered from UGS facilities. It has big impact on stability of gas supply. The traders who do not store the gas might become insolvent due to not fulfilling their obligation due to fact of getting lower gas than it was ordered. This might happened when shell market decrease mining of the gas. Major SSO player has 85 % of the market capacity. The price constitution is following: Picture 5: Margin in oligopoly market with dominant firm

Source: [own]

Price PD set by dominant player has been taken over by other companies within the market. Dominant firm supply quantity QD other companies within market fill the gap on market, which represent the area between QD and QT , so in final the market gets the quantity QT for price PD. 3.3 Gas market The final price to the customer might be subject of discussion, although generally valid formula is, that either big or small traders are dividing the customers to few groups: HD_C High demand customer

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MD_C Medium demand customer LD_C Low demand customer H Household For groups HD_C and MD_C the price is usually not reflecting the market price and is set individually. For LD_C and H is the price set for certain period and usually is unchangeable for agreed time. The final constitution of the price would be done by adjusting the price to the dominant players. Smaller traders can provide lower price either they have lower internal cost compared to dominant players or they do not store gas in UGS facilities and directly buy it on spot markets, which temporally might work with higher risk. An example stylized Price Formula under the Netback Concept of Long-term Contracts [9]

(1) Pm = Po + 0.60 x 0.80 x 0.0078 x (LFOm -

LFOo) + 0.40 x 0.90 x 0.0076 x (HFOm - HFOo)

1) The gas price Pm:

applicable during the month m is a function of • the starting gas price Po • and the price development of competing

fuels compared to the reference month, in this example: Light Fuel Oil (LFO) and Heavy Fuel Oil (HFO)

2) 0.60 and 0.40 are shares of gas market

segments competing with respective fuels (no

dimension):

• Light Fuel oil / Heavy Fuel Oil • These shares will be different from the

shares of these fuels in total energy use; e.g., the share of heavy fuels used in most European markets is now rather small, however, it remains the best available alternative for most of the gas used for industrial purposes

3) 0.80 and 0.90: Pass through factors (no

dimension):

• Sharing risk and reward of the price development between seller and buyer

• Most of risk and reward for the seller (0.80/0.90)

• May be different for different fuels 4) 0.0078 and 0.0076: Technical equivalence

factors to convert the units of prices for fuel

into units of gas price

In this example: Gas in kWh (GCV), Fuel oil in t, Dimension: Euro cts / kWh / Euro / t

5) Competing Fuels

Quotations reflecting the market With or without taxes on competing fuels Time lag and Reference Period to be defined LFO: Price of Light Fuel oil LFOo: Price of Light Fuel Oil for starting month o LFOm: Price of Light Fuel Oil resulting for month m (may refer to an average value of previous months depending on reference period and time lag agreed) LFO is usually reflecting competition for medium and smaller customers whose alternative is using Light Fuel Oil (typically small industry, commercial, administration, households). small customers, and eventually more instruments to provide the flexibility needed. That would have to be taken into account in the determination of Po. HFO: Price of Heavy fuel oil HFOo: Price of Heavy Fuel Oil for starting month o HFOm: Price of Heavy Fuel Oil for month m Reflecting competition for larger customers whose alternative is using Heavy Fuel Oil (typically in boilers)

6) Determination / negotiation of Po (starting

price in month 0) reflecting the netback to

the point of delivery:

Use of Currency (of the sales market) Po determined (negotiated) as: Replacement value minus costs to bring the gas from the delivery point to the customers minus marketing incentives.

Picture 6: Price table of Natural gas commodity for period 3 years CZK/1 m3 (1 m3 = 10,5 kWh)

Source: according [12]

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Table 3: Real prices for household on market

Source: own according [13]

4 Conclusion Based on above mentioned information and price analysis, it is obvious, that the price for households does follow the price of commodity on the market with certain delay and it is set by players on the market. The question stays, why the players do not raise the price equally? From the research we figured out, that some players raised in certain time the price more, than others, which is not explainable without any deeper analysis. For this behavior might be explanation, like making reserve for future or putting profit aside on investments. The regulated business does not influence the final market due to the regulated prices, which are same for all players on the Czech market. Discussion might be about the storing gas, where major players due to elimination of risk store certain capacity. Nevertheless the price for storing is not representing comprehension to the sizes of the companies’ big issue. Storing a gas influence concerning the cost mainly the small traders, who offers better prices due to lower costs. Even though the Czech customers as the price is not only the measure of choosing the provider take into their account also the stability of supplies [4] and they prefer to have mix between the price and risk.

Concerning the margin of the major players (except traders and SSO) it is very hard to judge it, due to not transparent expenses they might claim and only the regulator can judge if they are justified. Although the fact which must be taken is, that they operating pipeline grid and due to safety they must invest several billion to keep it running.

Definitely the opening part of market has the effect on saving to the final customer due to competition.

The outputs of this paper was partly done within

TAČR TD - Programme to support applied social

science research and experimental development Omega Nr. TD -010130 Regionalization indicators of economic performance in relation to environmental quality.

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Sustainable Development, in Recent Researches in Enviroment, Energy Planning and Pollution, Proceedings of the 5th WSEAS International Conference,Iasi, Romania, July 1-3, 2011, p. 152-156, ISBN 978-1-61804-012-1

[2] SEKERKA, B. - BAŤA, R. Linear Models in Regional and Interregional Modeling. WSEAS Transactions on Mathematics, 2011, vol. 10, no. 1, s. 32-46. ISSN: 1109-2769.

[3] KLIMESOVA, A. a kol., Vývoj cen a cenotvorba na českém plynárenském trhu v důsledku liberalizace evropské energetiky. Praha. 2010

[4] JANAC,F., Spokojenost zákazníka. Pardubice. UPCE, 2012

[5] Directive 2003/55/EC of the European Parliament and of the Cou[]ncil of 26 June 2003 concerning common rules for the internal market in natural gas and repealing Directive 98/30/EC. [cit. 09.09.2012] <http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=CELEX:32003L0055:en:NOT>

[6] Energetický regulační úřad. Yearly Report on Natural Gas Supply and Consumption in the Czech Gas System. Prague. 2012

[7] Česká plynárenská unie. Informační materiál – Zemní plyn pro Českou republiku. Praha. 2006 translation to English František Janáč

[8] Czech Gas Union, [cit. 09.09.2012] <http://www.cpu.cz/zemni-plyn> translation to English František Janáč

[9] Energy Charter, [cit. 10.09.2012] <http://www.encharter.org/fileadmin/user_upload/document/Pricing_-_chapter_4.pdf>

[10] Energetický regulační úřad, [cit. 09.09.2012] <http://www.eru.cz/user_data/files/licence/info_o_drzitelich/obchod_s_plynem_kontakty_12_02.pdf>

[11] NET4GAS, s.r.o, [cit. 09.09.2012] <http://www.net4gas.cz>

[12] Kurzy cz, [cit. 09.09.2012] <http://www.kurzy.cz/komodity/index.asp?A=5&idk=43&od=09.9.2009&do=09.9.2012&curr=CZK>

[13] TZBinfo, [cit. 09.09.2012] <http://www.tzb-info.cz/prehled-cen-zemniho-plynu>

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