European Wholesale Gas Market

European Wholesale Gas Market Development EN00066-001/Published 05/2012

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DATAMONITOR VIEW

Catalyst As the impacts of full market opening in the European gas sector gather pace, the importance of traded wholesale gas markets will increase significantly. Both incumbent and new entrant players in markets at all stages of wholesale liquidity development will be impacted by the existence, and development of, wholesale markets in their retail operations.

Summary An examination of selected wholesale European gas markets and future projections of market developments:

Wholesale gas hub development will lead to further competition, enhanced security of supply, and greater market efficiency.

Currently, Europe's wholesale gas markets cover the full range of developmental stages.

Price efficiency levels in the European wholesale markets show varying ranges of volatility.

The polarization of the markets will reduce in the wake of market opening.

In the Netherlands, the expected trend is an increasing level of demand and a greater diversification of supply of natural gas through pipelines, storage facilities, and LNG. Due to government intervention that is pushing the TTF to become Europes main gas round-a-bout, Datamonitor expects the volume of trade to continue to increase and to reach a par with the Zeebrugge Hub.

Two other markets Datamonitor has considered, Italys PSV and the Spanish market, Centro de Gravedad, remain in an early stage of development. Liquidity in these markets is still limited. While attempts to build a

EUROPEAN WHOLESALE DEVELOPMENT SERIES

European Wholesale Gas Market Development Liquidity dynamics and evolution of main European gas markets, with a focus on the evolution of the Dutch wholesale gas market

Reference Code: EN00066-001 Publication Date: May 2012



single Iberian gas market (MIBGAS) are still under way, Datamonitor notes more encouraging progress in inter-regional co-operation through the South Gas Regional Initiative between Spain, Portugal, and France.

Sources wholesale pricing data for main European markets (sourced from Spectron)

exchange-specific pricing and liquidity data

the International Energy Agency (IEA).

European Wholesale Gas Market Development



ANALYSIS

Wholesale gas hub development will lead to further competition, enhanced security of supply, and greater market efficiency

The EU continues to strive for greater competition by promoting a single integrated wholesale gas market

European gas markets remain in a highly segmented state and gas cannot easily flow across European borders. The European Commission has long hoped for a harmonized, single, and competitive pan-European market through the convergence of gas regulations and numerous regional markets.

However, there are numerous obstacles to the goal of intra-national gas trading:

There is an array of separate transmission networks that are owned or operated by different companies

throughout Europe.

Third-party transmission remains costly and presents administrative challenges.

New entrants are often discouraged by the establishment of long-term take-or-pay contracts.

Other barriers to competition can arise from governments that are keen to shelter and promote their national champions.

These barriers continue to exist in the European market despite endeavors in individual markets, such as bundled transport

capacity in the Netherlands and Germany, or accords to increase pipeline capacity between Spain and France.

The market's traditional pricing mechanisms present obstacles to competition

At present, the vast majority of European gas supply is in the hands of relatively few incumbents. On the production front, there remain a limited number of production sources (Russia, Algeria, Norway, the UK, and the Netherlands, along with liquefied natural gas [LNG] shipments). These supplies are most commonly purchased under long-term take-or-pay contracts (with prices fixed within a range and pegged to prices in the less volatile and more liquid oil market), which tie up the dominant share of pipeline capacity.

Due to the existence of the take-or-pay pricing system, new entrants are typically driven to source gas for their retail activities on various regional and often illiquid wholesale exchanges. The development of European gas hubs is therefore essential in paving the way for further market opening and facilitating the emergence of new market players.

The development of wholesale hubs and more gas-on-gas pricing will lead to greater security of supply

With the dominant volumes of European gas purchased through long-term take-or-pay contracts, the market can at times fail to reflect supply-demand fundamentals and therefore the "true" price of gas, due to the connection between these contracts and petroleum products. Furthermore, take-or-pay contracts remain somewhat of an obstacle to competition, as

they prevent volumes from being traded by third parties. The development of traded gas hubs may therefore foment an environment in which prices more accurately reflect and incorporate underlying market balances.




More recently, however, the prices established in hub trading have begun to be used as the pricing basis for gas supply contracts, leading to the development of more "hybrid" markets where gas is priced increasingly according to hub-based short-term pricing, as well as to traditional long-term oil-indexed pricing.

Traded volumes in European exchange systems Datamonitor notes that with the exception of the developed UK hub, traded volumes in the other European hubs are

relatively small compared with domestic natural gas consumption. The role of non-conventional gas remains at an exploration stage and therefore cannot be relied on to provide a significant supply in the near future.

Datamonitor expects Europe to continue to be dependent on Russian gas for at least the next five years, despite the increasing decoupling of spot market prices and long-term gas contracts in light of continued differentials with American gas. Following this, and depending on the realization of the Nabucco pipeline, both the Southern and Northern European markets through investment in pipelines to connect to Southern markets will progressively have the opportunity to diversify their gas supplies and increase their access to Azeri gas. Not only will this allow a greater level of energy security, it will increase trade in the gas exchanges, thereby allowing the price to reflect the fundamentals of gas prices.

The Netherlands

The Netherlands' Title Transfer Facility (TTF) continues to grow in terms of traded volumes, physical volumes, and the number of traders. The TTF's traded volumes showed an impressive increase in 2011 in particular. For example, traded

volumes in February 2012 showed a 48% year-on-year increase compared to the 15% recorded in the same month by the Zeebrugge Hub in Belgium. This improvement is a result of several factors:

The Dutch government has driven the development of the TTF and wishes it to become a major hub. There is notable investment in gas transport infrastructure, storage capacity, and a new LNG terminal.

The unidirectional Balgzand Bacton Line from the Netherlands to the UK acquired virtual reverse flow in Q1 2011.

A change in balancing regimes came into effect under recent revisions to the Dutch Gas Act. As of April 1, 2011, market players are able to buy or sell gas on the TTF directly as opposed to going through the national network operator. This has visibly boosted churn trades and total trade on the hub.

Storage services have been auctioned since March 2011, organized by power exchange APX-ENDEX.

In November 2011 gas supplier GasTerra was designated as the first market maker for APX-ENDEX hourly flow products on the TTF spot within-day balancing market.

In the Netherlands, the expected trend is an increasing level of demand and a greater diversification of supply of natural gas through pipelines, storage facilities, and LNG. Due to government intervention driving the development of the TTF, Datamonitor expects the volume of trade to continue to increase and to reach a par with the Zeebrugge Hub.




Italy

Italy's Punto di Scambio Virtuale (PSV) is the oldest established gas exchange system in the emerging markets segment, having been launched in 2003. The PSV, while showing increasing volumes in response to regulatory measures to improve its liquidity, has struggled to gain momentum and remains in an early stage of development. Liquidity is very low on the PSV, typically under 2.0.

Various measures have been implemented that have led to positive developments in the market. For example, in 2010 the

amount of wholesale gas procured at the PSV increased to 22% from 15% in 2009. In particular, in 2010 the Regulatory Authority for Electricity and Gas introduced an obligation to offer quotas of imported gas on the PSV. As a result, the number of traders grew to 106 from 82 in 2009.

This progress notwithstanding, Italy's gas trading platform has yet to show improvements in liquidity, supply diversification, transport flexibility, and to a lesser extent, market concentration of production. Storage is the main tool providing flexibility to the market at present. Positive developments in the exchange could be realized through the virtual storage program that is due to start in Q4 2012, and as a result of the launch of the spot day-ahead and intra-day market M-GAS in 2010, on which trading volumes are very small.

Spain

Liquidity in the Spanish market is still limited. The country's virtual balancing point, Centro de Gravedad, was created in 2005 but there is still no organized gas hub to provide a price reference. Most gas exchange in Spain is done through the over-the-counter (OTC) market on an electronic trading platform called MS-ATR, which is managed by Enags. The volume of energy traded over the counter amounted to 1,004.7TWh in 2010 and there are approximately 33 active parties on the platform. Due to the bilateral and anonymous trading from OTC trades, information is not publically available and thus lacks transparency. Considerable progress needs to be made to promote competition and increase transparency in the OTC market.

Attempts to build a single Iberian gas market (MIBGAS) are still under way. Datamonitor notes more encouraging progress in inter-regional co-operation through the South Gas Regional Initiative between Spain, Portugal and France. The achievements of the initiative to date include the development of interconnection capacity in 2013 and 2015.

The following section examines the key concepts regarding the meaning of and evolution towards market liquidity and a mature wholesale market.




Adequate levels of liquidity on wholesale hubs are integral to the development of a competitive European gas market

Figure 1: Liquidity in natural gas markets, as defined by the IEA, incorporates four distinct market characteristics

Depth

Breadth

Immediacy

Resilience

Depth is a crucial feature as it allows for significant volumes to be traded without resulting in excessive price moves. High or low prices in illiquid markets can routinely send false price signals, as levels can be the result of large trades rather than supply-demand balances.

A market is considered wide when numerous buyers and sellers are active.

Immediacy relates to the ability to execute large trades relatively quickly.

Resilience refers to the ability of the market to return to its equilibrium state of supply/demand after having been exposed to a shock.

Depth

Breadth

Immediacy

Resilience

Depth is a crucial feature as it allows for significant volumes to be traded without resulting in excessive price moves. High or low prices in illiquid markets can routinely send false price signals, as levels can be the result of large trades rather than supply-demand balances.

A market is considered wide when numerous buyers and sellers are active.

Immediacy relates to the ability to execute large trades relatively quickly.

Resilience refers to the ability of the market to return to its equilibrium state of supply/demand after having been exposed to a shock.

Source: Datamonitor; IEA D A T A M O N I T O R




The development of wholesale markets tends to follow a preset pattern of distinct stages

Figure 2: The five distinct stages of wholesale market progression

Source: Datamonitor D A T A M O N I T O R




The wholesale market development cycle gradually builds up enough momentum to spawn the creation of wholesale support services

Figure 3: Wholesale support services emerge as the cycle builds momentum





Once sufficient structural factors are in place, the necessary support services required for wholesale market development begin to emerge

Figure 4: The interaction between structural and support factors creates a "snowball" effect





The market-based factors supporting hub development are crucial elements in facilitating and developing traded markets

Figure 5: The key support elements to wholesale market growth





Wholesale gas markets are required by different players throughout the value chain for different reasons

Figure 6: Different players engage in wholesale trading for different reasons


Currently Europe's wholesale gas markets cover the full range of developmental stages Datamonitor segments wholesale maturity and liquidity into four distinct categories.

Nascent

Wholesale traded activity is theoretically possible, but in reality is very modest.

Churn ratios are less than 1.2, indicating that less than 20% of physically transported wholesale volumes are traded more than once.

The limited volume of trade that is undertaken is for very near-term gas.

Emerging

The concept of regular trading is becoming established, with a small number of regular participants in the market.

Churn ratios are between 1.2 and 3.0.

The forward curve is very limited, generally at, or just beyond, the prompt.

Price efficiency is weak, with the market often tracking a neighboring market or oil.




Established

Regular trading activity is undertaken by at least 20 market players, driving the churn ratio as high as 5.0.

The forward curve extends beyond the prompt, out to at least one year forward.

Interest from financial players is gaining ground.

Pricing signals are reflective of underlying market fundamentals and are efficient at finding their own level.

Mature

The highest stage of market maturity, under which the market is well and truly liquid.

A large number of physical and financial players trading significant volumes, against a backdrop of increasingly complex and sophisticated financial instruments and exotic derivatives.

Price efficiency and volatility are high, with the forward curve efficient, setting market-reflective levels.

The UK remains the most mature market

This section discusses the liquidity/price changes in the three most mature markets, provides a brief overview of the remaining markets, then concentrates on the Italian, Spanish, and Dutch markets.




Europe's current wholesale gas markets cover the full spectrum of segmentation

Figure 7: Market development in Europe

NASCENTLimited liquiditychurn rate 5UK (NBP)

Germany(Various)Italy(PSV)

Spain(CDG)

Belgium(Zeebrugge)

France(PEG)

Netherlands (TTF)

ESTABLISHEDSignificant liquidity

churn rate 3 to 5

EMERGINGGrowing liquiditychurn rate 1.2 to 3

Austria (CEGH)

Denmark (Nord Pool Gas)

NASCENTLimited liquiditychurn rate 5UK (NBP)UK (NBP)

Germany(Various)Germany(Various)Italy(PSV)

Italy(PSV)

Spain(CDG)Spain(CDG)

Belgium(Zeebrugge)

Belgium(Zeebrugge)

France(PEG)

France(PEG)

Netherlands (TTF)

Netherlands (TTF)

ESTABLISHEDSignificant liquidity

churn rate 3 to 5

EMERGINGGrowing liquiditychurn rate 1.2 to 3

Austria (CEGH)Austria (CEGH)




Analysis of churn levels provides an insight into liquidity and wholesale market developments

While physically traded volumes and the number of regular market participants are useful measures of market liquidity and development, they do not provide a truly reflective insight into market conditions. One way to gain a more accurate reflection of how a wholesale market is performing is to examine its churn ratio.

The churn ratio, also known as the re-trading ratio, provides a meaningful insight into the level of liquidity and maturity in a particular market. It is calculated by expressing the proportion of wholesale traded volumes to the physically transported volume. A ratio of four, for example, means that each therm of gas was traded four times.

More established markets have higher churn ratios, while less mature markets have lower ratios. As more players enter the market and as volumes grow, churn ratios will develop.




Current levels of churn in individual wholesale markets vary significantly

Figure 8: Europe's newer, less developed markets lag far behind the established markets in terms of churn ratios

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Source: Datamonitor; National Grid; Huberator; Gas Transport Services (GTS) D A T A M O N I T O R




The National Balancing Point's maturity, deep liquidity, and strong volume growth have led to the UK's position as Europe's leading gas market

The National Balancing Point (NBP) a virtual rather than physical OTC market remains Europe's oldest, most liquid, and well-developed wholesale gas hub. The UK's drive towards market opening and enhanced liberalization was a primary catalyst for the introduction of the hub, and has contributed to its high level of liquidity. The maturity of the NBP relative to Europe's other competing hubs is also attributable to the UK's role as a key gas producer in recent decades.

Since its inauguration, liquidity on the NBP has experienced tremendous, albeit volatile, growth. Figure 8 shows that in 2010 the NBP recorded a churn ratio of 13.57, almost three times higher than that of the two other largest hubs, the Zeebrugge Hub (4.46) and the TTF (3.93). The NBP demonstrates seasonal variations in actual (physical) volumes that drive variations in the churn ratio, as can be seen in Figure 9. Despite these variations, there is an upward trend. Datamonitor notes that changes in methodology were in place from November 2000 for the NBP and from January 2010 for the Zeebrugge Hub.

After seeing healthy growth in total annual volumes in 2006 and 2007 (up by 23% and 47% year-on-year respectively), activity significantly declined to single-digit growth in 2008 and 2009. Annual volumes increased by 18% in 2010 and then grew by a modest 4% in 2011. This is, however, somewhat a reflection of the NBP's maturity, although traded volumes have continued to show an upward trend since 2010.

Figure 9: The NBP remains Europe's most liquid traded wholesale market

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The Zeebrugge Hub remains Europe's second most liquid hub

The Zeebrugge Hub was launched in 1999 and is connected to the UK (through the Bacton Interconnector), the Norwegian offshore fields, and transit pipelines to France, Germany, and the Netherlands. The Zeebrugge Hub also receives LNG shipments and is noted as the most important landing point in the EU27, a feature that has helped it to maintain its dominance over the TTF.

Much of the Zeebrugge Hub's liquidity is owed to arbitrage activity with the NBP; Zeebrugge gas prices have historically exhibited a strong correlation with the NBP, with the former's gas even traded in pence per therm. Recent years have seen an expansion in trading activity on the hub: 2010 and 2011 both showed record highs in monthly traded volumes, with a peak of 7.10bcm in December 2011.

According to Huberator, net traded volumes in 2010 actually fell by 8% compared with 2009, but increased by 16% in 2011. Conversely, volumes in physically traded gas grew over 2010 but fell in 2011, explaining some of the peak churn rates that were observed at the end of 2011.

Figure 10: Both the TTF and the Zeebrugge Hub have high levels of liquidity and churn ratios

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Source: Datamonitor; National Grid D A T A M O N I T O R




The TTF has experienced remarkable liquidity growth and continues to challenge the Zeebrugge Hub in traded volumes

Launched in November 2002, the Dutch TTF market is largely modeled on the UK's NBP. It competes with the Zeebrugge Hub as Europe's second most liquid wholesale gas hub after the NBP. The TTF has seen impressive growth in traded volumes in recent years and continues to record a healthy expansion in activity. Traded and net volumes continue to record highs and the churn rate has also continued to show peak highs, surpassing that of the Zeebrugge Hub in mid-2011.

In January 2008, volumes traded on the TTF surpassed those traded on the Zeebrugge Hub for the first time. Since then, both exchanges have been locked in a battle for second place as Europe's most liquid traded gas hub behind the NBP. The TTF's traded volumes showed an impressive increase in 2011 in particular. For example, traded volumes in February 2012

showed a 48% year-on-year increase, compared with 15% for the same month in the Zeebrugge Hub. Despite this growth, churn rates remain below those of the Zeebrugge Hub due to relatively higher levels of physical traded volumes compared to traded volumes.

Price efficiency levels in the European wholesale markets show varying ranges of volatility Datamonitor's Deviation Days Index measures price movement ranges and provides insight into price efficiency

The degree of price volatility in a market is widely seen as an indicator of price efficiency. Stable markets with low levels of price movement and volatility tend to reflect immature, illiquid markets that lack price direction and are inefficient at creating pricing signals that accurately reflect both market sentiment and underlying supply/demand fundamentals. As an alternative to the traditional standard deviation-based measures of volatility that tend to work independently of a benchmark,

Datamonitor has devised the Deviation Days Index (DDI). The DDI measures wholesale market volatility and, by proxy, price efficiency.

The DDI measures the number of days in a given month where the bid/offer spread midpoint closing price is within a +/- 2.5% range of the previous day's close. The index then provides a comparison with the number of days that the NBP was within the +/- 2.5% band. Long periods of closing prices within the +/- 2.5% band imply a lack of direction and weak price efficiency.

A DDI of 90 implies that, in a given month, the market closed outside of the +/- 2.5% banding 10% fewer days than the NBP did, and, as such, was 10% less efficient at trading outside of the narrow +/- 2.5% band and thus finding its own fundamentally reflective level. As such, the DDI highlights both how high a specific market's levels of volatility are, and how this volatility measure relates to the NBP. As Europe's most established and liquid wholesale traded market, the NBP provides an ideal benchmark for comparison purposes.

Levels of volatility in the established markets have been decreasing markedly

Figure 11 shows the relationship between the daily price movements in a +/- 2.5% range recorded by the TTF and the Zeebrugge Hub compared to the NBP. The upper zone of the chart shows how many more days in percentage terms the given market has shown a greater number of +/- 2.5% fluctuations compared to the NBP. Meanwhile, the lower zone indicates the percentage of days that the range was smaller than that recorded by the NBP.




In the early days of European wholesale gas market trading, the Zeebrugge Hub tended to lead the NBP in terms of price efficiency. However, since then the NBP has definitively established itself as Europe's most liquid and price-reflective market, and, as such, maintains dominance in terms of price signals.

A different pattern is discernable in the TTF. In the period following its launch it consistently lagged behind the NBP in terms of volatility, reflecting its relative immaturity and dependence on other markets for pricing signals. However, as the TTF grows in liquidity and continues to contend with the Zeebrugge Hub for the crown of Europe's second liquidity wholesale market after the NBP, this is likely to change. Increased traded volumes, more players, and general market evolution mean that price efficiency in the TTF is improving. This is compounded by the fact that rocketing prices in the NBP are making traders more reluctant to take significant long-term positions, which in itself has a detrimental effect on price efficiency.

Finally, Datamonitor expects that the NBP will remain the most liquid market across the region and that it will continue to function as a benchmark and point of reference for other European trading hubs.

Figure 11: On balance, price volatility on the TTF and the Zeebrugge Hub has remained significantly lower than that on the NBP

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Source: Datamonitor; Spectron D A T A M O N I T O R




Other less developed hubs The Central European Gas Hub continues to develop its traded volumes, although it is still limited by its single source of gas supply

The Central European Gas Hub (CEGH) is a nascent hub that offers a title transfer facility at the location of the pipeline import interconnections at Baumgarten, Austria, which is also the junction point of pipeline systems where Russian gas is imported into Europe. The hub was set up by OMV in 2001, although for a number of years it saw only very limited activity. The CEGH Gas Exchange of Wiener Boerse Spot Market and the CEGH Gas Futures Market were set up in December 2009.

The CEGH stands in contrast to all other European gas hubs in that the total supply from Baumgarten flows originally from Russia (Gazprom). In early 2008, Gazprom gained a 50% stake in the hub after signing an agreement with OMV Gas International. As there is only one source of gas, the majority of this is traded around long-term contracts held by incumbent European utilities, traded on the OTC market.

Although it maintains a favorable geographic location with multiple pipeline destinations to Italy and Germany, one feature that could potentially inhibit the hub's eventual liquidity growth is the role of Gazprom as its single supplier. Traded volumes, although growing for example, 0.43TWh were recorded on the gas exchange in Q3 2011, a 275% year-on-year increase are still very small compared to the level of Austrian natural gas consumption, which was 13TWh in Q3 2011.

That said, the hub has showed impressive increases in traded volumes over 2011 and 2012 to date. For example, the total

trading volume (both OTC and gas exchange) reached an all-high peak in April 2012 with 47.52TWh (4.24bcm). Further, the number of customers in the OTC market has more than doubled to 133 customers.

Datamonitor expects developments such as regulatory change and the introduction of products that will improve liquidity to drive further growth in the CEGH. On January 1, 2013 the hub will become the Virtual Trading Point for Austria, and it has been announced that a gas exchange within-day market of the Wiener Boerse will be launched by the end of 2012. In particular, the CEGH plans to launch a reference price for the CEGH spot market called CEGHIX that will show customers a transparent daily exchange index price. In addition, Datamonitor notes that the CEGH will transfer its spot and futures markets to the new Trayport Exchange Trading System in July 2012. This change in technology which is already in use in Denmark's Nord Pool Gas will improve the market's transparency by allowing traders to see bids on other gas exchanges on one screen, thereby providing an efficient view of the whole market.

Europe's emerging wholesale gas hubs continue to expand in both traded volumes and liquidity

Of the markets in the emerging segment Italy's PSV is the oldest, having been launched in 2003. However, Italy's gas trading platform has yet to show improvements in liquidity, supply diversification, transport flexibility, and to a lesser extent, market concentration of production. Storage is the main tool providing flexibility to the market. Positive developments in the exchange could be realized through the virtual storage program that is due to start in Q4 2012, and as a result of the launch of the spot day-ahead and intra-day market M-Gas in 2010.

France's Point d'Echange de Gaz (PEG) market prices typically trade in line with Europe's other hubs. Factors driving price include the colder weather in the country. Traded volumes continue to show impressive increases. For example, traded

volumes on the spot segment increased to 29.2TWh in 2011 while the number of trading members had grown to 45 by the




end of 2011, up from 38 in 2010. However, like Germany a relatively small proportion of France's total gas demand (some 7%) is delivered via the Powernext platform. Datamonitor notes that LNG prices continue to exceed the price of gas traded on the PEG, though LNG prices still remain below those paid in Italy. Datamonitor expects that the PEG will progress looking out to late 201415, when it will benefit from the France-to-Belgium interconnector that will offer up to 12bcm (134TWh) per year firm capacity to transfer gas.

In Germany, the NetConnect (NCG) and Gaspool hubs (formerly E.ON Gastransport EGT and BEB respectively) have seen a modest increase in traded volumes since 2010. Gaspool typically trades at a discount to NCG due to the market zone's large amount of storage flexibility in times of high demand. Combined volumes on the two hubs have varied between approximately 1.5TWh and 2.5TWh over 201011. Thus, the volumes traded in Germany remain small compared with those seen in other Northwestern European hubs such as the TTF or the NBP, and indeed are small compared with

Germany's consumption of natural gas. Part of this is due to the fact that the Netherlands is an important gas producer, whereas Germany is largely dependent on long-term contracts with Russia for supply. The associated take-or-pay obligations faced by German buyers means a relatively lower level of demand on the spot market compared with the TTF. Increasingly, the German border price has been decoupling with respects to the oil indexed price towards the spot gas price, indicating increasing power on the part of larger players in the market to negotiate supply concessions to reflect the price differences.

Europe's nascent markets are seeing renewed impetus towards development

Despite Denmark's long history as a gas producer, wholesale hub activity, although undergoing some changes of note, is yet to develop to any significant degree in the country. The initial impetus towards Danish wholesale trading took place in late 2003 when Gastra (the transmission system operator formerly known as DONG Transmission before legally unbundling in early 2004) and Nordpool, the Nordic power exchange, set up a joint project to examine the possibility of developing a Danish gas exchange. Various other initiatives, including the development of a standard trading contract in 2004, failed to catalyze any significant trading activity. However, in March 2008 Nordpool and Energinet.dk, the current transmission system operator, set up a gas exchange on the Nord Pool called Nord Pool Gas. In April 2011 the Nord Pool Spot took over all clearing activities in relation to trading activities on Nord Pool Gas.

The Danish wholesale market still has a high degree of market concentration. Trading volumes continue to progress at Nord Pool Gas, although they remain small in comparison to other European hubs. In February 2012 trade volumes reached a high of 819,720MWh, an increase of 46% from February 2011. The number of participants has also continued to increase and reached 19 in February 2012.

Nord Pool Gas currently offers six trade products, of which the most traded are next-day and next-month delivery products. In April 2011 the exchange introduced a within-day product and a weekend product. Future changes of note that will assist the progression of Nord Pool Gas include an initiative by the Danish energy regulatory authority and Energinet.dk to set up a transparency platform for the gas market. This is due to take the form of a joint web platform so that market information can be disclosed in a timely and transparent way. The first phase will include a limited part of the market production and grid facilities in the Danish North Sea and will be finalized by July 2012.

Also of note is the role of DONG Energy, which will become the market maker from May 2012 on a three-month trial basis. This is a step towards higher liquidity on the exchange.




The Netherlands

This section provides an analysis of the Dutch TTF market, particularly its most active players, and offers information on how GTS, the country's transmission system operator, functions on an operational level.

Market overview: demand and supply

In the Netherlands, domestic consumption of gas in 2012 is expected to be 48.2bcm, of which 23bcm will be distributed to households, 16.4bcm will be used by industrial facilities, and 9bcm will be used for power generation. Total demand is forecast by GTS to increase to 51.3bcm in 2021 and 55.4bcm in 2031. Specifically, these projections show gas demand rising modestly by 2030, driven by non-domestic (industrial and power generation) demand. Domestic demand, on the other hand, is forecast to fall due to better isolated homes and energy efficiency programs.

The Netherlands is expected to produce 83.7bcm of natural gas in 2012, up from 79.0bcm in 2009 (IEA). GTS expects Dutch production to fall to 58.9bcm in 2021 and 20.7bcm in 2031. With regards to the Netherlands' renewable energy target of 14% of renewable energy in 2020, the government has introduced a subsidy scheme called SDE+ to encourage the use of renewable electricity, heating, and green gas. The potential for green gas is estimated by the government at some 56PJ by 2020.

Future supply diversification

The Dutch government forecasts that the country will become a net exporter rather than a net importer of gas by 2025. Domestic demand for gas and export obligations are currently covered by a guaranteed supply of both domestic production and imports from Russia and Norway; however, GTS projections to 2031 indicate a substantial fall in import volumes from Norway to become approximately equal with import volumes from Russia. The decline in gas production in Northwestern Europe naturally translates into reduced flexibility in the Dutch market and a national policy of diversification of supply sources by LNG and different countries of origin.

A survey undertaken by GTS shows that long-term contracts are expected to dominate the market to 2031 in order to meet demand, while storage facilities will play an increasingly important role in compensating for decreasing production flexibility. The GTS survey is based on a survey of shippers' contracted volumes of gas to, from, and through the Netherlands over the next 20 years and provides a useful indication of the volumes of gas that will be traded out to 2030 on the TTF. The survey observed two scenarios for the security of supply: the low scenario is based on contracted volumes, whereas the high scenario is based on volumes yet to be contracted but reported to GTS.

Under the low scenario, incoming volumes vary from 112bcm in 2012 to 22bcm by 2031 while outgoing volumes range from 60bcm in 2012 to 2bcm in 2031. The high scenario estimates incoming volumes to fall from 137bcm in 2012 to 40bcm in 2031, and outgoing volumes to fall from 78bcm in 2012 to 10bcm in 2031. GTS also expects a rise in the demand for gas transport capacity until 2015, but forecasts a shortage of supply capacity after 2016 that will be met from new or expanded storage facilities, LNG terminals, and import pipelines. Therefore, supply will be geographically more diversified.




The role of non-conventional gas

In its Energy Report 2011, the Dutch government recognized the possible contribution of unconventional gas to the country's future energy mix. It has issued four licenses for unconventional gas exploration, including coalbed methane and shale gas. It is therefore at the stage of investigating the potential of such gas, while reserving the right to evaluate further exploration based on the results, risks, and benefits.

Gas infrastructure and storage investment

The Dutch government aims for the country to grow as an important national and European supplier of gas as part of its goal to achieve a lower carbon emission economy by 2050. Hence, the government is investing in gas transport infrastructure and storage capacity to support future gas trade. According to the Dutch energy regulator Dte, 500m is scheduled to be invested in additional capacity over the coming years. Through GTS, additional demand for capacity has been quantified through three tenders called "Open Seasons" since 2005.

A recent project of note is the North-South route that was started in 2008 with the aim of enlarging the existing gas transmission system and connecting the Netherlands to Southern Europe. The connection will provide the country with 485km of pipeline and compressor stations. The first section of the pipeline was completed in 2010 and the second phase was completed in 2011.

In addition to these, transport capacity is being created through several storage facilities:

The Bergermeer facility for hydrogen gas near Alkmaar, with a working volume of over 4bcm due to be in use by 2013.

The Zuidwending facility for low calorie gas in Groningen where a fifth underground cavern will be in use by 2014, bringing the working volume to 300mcm. Official use of the caverns started in January 2011, with working volumes of 200mcm.

The Heiligerlee nitrogen facility, due to come into use in September 2012 for the supply of pseudo G-gas to the domestic market.

A landing LNG terminal (Gas Access to Europe) on the Maasvlakte near Rotterdam with 12bcm of capacity, which has been in use since September 2011. It has a throughput capacity of 12bcm per annum and will have four storage tanks of 180,000m once the terminal reaches higher capacity.

Lastly, the Nord Stream pipeline, of which one shareholder is Nederlandse Gasunie, will provide further security of supply to the Netherlands. Gas transport began from the first line in November 2011 and the completion of the second line of the 1,224km pipeline through the Baltic Sea is expected by the end of 2012. The pipeline connects Russia (Vyborg) to the EU (Germany), which is well connected to the Dutch gas grid. Once the automated twin-pipeline is finished its capacity will be some 55bcm per year. From Germany, gas will be piped onwards to Belgium, Denmark, France, the Netherlands, and the UK. Gas delivery to the UK in particular will be made through the planned connection between Bunde and Den Helder in Northern Holland, and from there it will join with the Balgzand Bacton Line.




The growing importance of the TTF

The TTF continues to grow in terms of traded volumes, physical volumes, and the number of traders. The TTF's traded volumes showed an impressive increase in 2011 in particular. For example, traded volumes in February 2012 showed a

48% year-on-year increase compared to the 15% recorded in the same month by the Zeebrugge Hub. Traded volumes increased to almost 115bcm in 2010, 40% higher than in 2009.

Although the TTF's traded volumes have grown remarkably as shown in Figure 10 and are now comparable to the volumes traded on the Zeebrugge Hub, its churn level, which has been between 3.0 and 5.0 over the last two years, remains slightly below those of the Zeebrugge Hub. The TTF's price volatility is also lower than that of its counterpart, as shown in Figure 11. In terms of absolute prices, movements in the TTF correlate with those of the NBP, with a noticeable decoupling starting in 2010.

Figure 12: Absolute price movements on the TTF and the NBP (p/th), July 2001July 2011


Changes of note in the TTF

Price volatility in the TTF is typically driven by supply disruptions particularly with regards to Norwegian deliveries and temperature fluctuations. Market liquidity is also influenced by the interconnector utilization rate between Belgium and the Netherlands and by the amount of UK exports transported from Belgium.




A change of note and one that has driven higher traded volumes on the TTF is the fact that the unidirectional Balgzand Bacton Line from the Netherlands to the UK acquired virtual reverse flow in Q1 2011. Until then, the pipeline had only allowed physical flows in the direction of the UK due to pressure differences and a lack of compression at the UK end of the

pipeline. In February 2011 BBL Company began auctioning capacity to interruptible reverse flow (IRF) gas from the UK to the Netherlands for the period April to June 2011. In practice this change means that physical flows are canceled out from the Netherlands to the UK through the pipeline and that flows will be more responsive to demand in the two countries. The IRF service allows shippers to nominate gas flows to be deducted from the capacity booked from the UK to the Netherlands from the physical flows in the reverse direction. IRF capacity is sold in tranches of 30,000kWh, and Balgzand Bacton Line data show that all auctions up until May 2012 have sold out.

Also of note is the fact that the Balgzand Bacton Line is not likely to pursue physical reverse flow capacity. It conducted a consultation in July 2011 regarding possible market demand for physical reverse flows as required under EU regulation, but due to limited interest BBL Company indicated that it would submit an exemption request to the EU authorities in March 2012.

A second notable development that has driven higher traded volumes is the change in balancing regimes. Changes to the Dutch Gas Act (Gaswet) came into effect on April 1, 2011 to improve what the Netherlands Competition Authority considered to be limited success in the wholesale gas market to date. As a result GTS implemented a new market model and a new balancing scheme. As of April 1, 2011 market players are able to buy or sell gas on the TTF directly as opposed to going through GTS, which was previously responsible for keeping the system in balance. Also of note is the fact that in April 2011 a regulatory measure came into effect, which means that all traded gas in principle should be delivered on the TTF. As a result of these changes and the introduction of new products on the back of the new balancing regime, the churn ratio in Q2 2011 reached 5.2 due to higher volumes of trade and a fall in physical volumes. In October 2011, an all-time monthly high was reached with a total of 128.5GWh traded on the within-day market.

In November 2011 gas supplier GasTerra was designated as the first market maker for APX-ENDEX hourly flow products on the TTF spot within-day balancing market, for a period of at least six months. The aim of this was to improve liquidity in the market in addition to the market change in April 2011 that allowed participants to do their own balancing.

GasTerra started auctioning natural gas storage services in March 2011. The auctions are organized by power exchange APX-ENDEX (which has been appointed as the gas exchange operator) and followed talks between GasTerra and the Netherlands Competition Authority to improve competition in the market.

Regulation in the Dutch market

The Netherlands Competition Authority is committed to ensuring the efficiency and development of the TTF as well as encouraging a single European gas market. In addition to contributing to measures to promote competition such as product diversification on the TTF, the authority is vigilant with regards to possible anti-competitive behavior on the TTF. Developments include:

In July 2011, the Netherlands Competition Authority investigated the possibility that prices on the exchange had suffered from hedge funds and speculators and found that there was only a small degree of such activity on the TTF due to the majority of trading being predominantly physical. In the same month the authority also revised its decision regarding anti-competitive behavior by GasTerra.




The authority gave its approval in late March 2011 for GTS to experiment with an auction of bundled transport capacity between GTS networks and its German affiliate, Gasunie Deutschland. This was a step towards a single gas market and capacity prices that reflect market conditions to a greater extent.

In December 2011 the authority increased the tariffs of Dutch regional network operators of natural gas and electricity by 8.9% effective as of January 2012, thereby increasing household energy bills by some 23 per annum. This price rise, however, follows a return of 400m in excess revenues by GTS to network uses decided in October 2011.

In May 2011 the authority released the draft method decision for the regulation of GTS for the current and previous regulatory period in order to increase transparency and create greater security for future investments.

Major players in the market The Dutch wholesale gas market has seen an increase in the number of players to over 70. This section analyzes a selection of the major players and notes relevant points regarding their sales, strategies, and operations.

GasTerra

GasTerra is the largest supplier of natural gas in the country. It buys and sells gas and provides gas-related services. It has exclusive access to the Groningen gas field and also has the obligation under the government's "small fields policy" to take gas from the majority of small fields at a representative price.

GasTerra's most recent financial results revealed a record turnover of 21.1bn in 2011 and a lower volume of gas sold. This high turnover was driven by the higher-than-average price of gas, whereas the volume, which was 5% lower than in 2010 at 87bcm, was due to a relatively mild winter. Operating profit totaled 44m, a 3.5% increase on 2010, while net profit at 36m was stable. Of its total sales, domestic gas sales in 2011 amounted to 38.1bcm, a slight drop compared with 2010. GasTerra supplied 9bcm to non-domestic consumers in 2011, and 48.6bcm to customers abroad. Its major foreign customers in 2011 were Germany (18.8bcm), the UK (10.6bcm), and Italy (7.1bcm).

In November 2011 GasTerra was designated as the first market maker for APX-ENDEX hourly flow products on the TTF spot within-day balancing market, for a period of at least six months. In 2011, GasTerra expanded the range of products and services available on the TTF, providing private sector companies with more options to supply their customers. In January 2011 it announced the provision of a

virtual gas storage service to provide seasonal flexibility to the market for a total of 19TWh. GasTerra now provides a temperature-dependent product whereby gas supply is dependent on the next day's predicted temperature. Customers can also opt for its Spark Spread product, under which supply volumes will be determined based on the relationship between electricity and gas prices. This product is particularly interesting for customers with gas-fired power stations that procure gas to generate electricity as and when it is profitable to do so.




Other developments include a long-term agreement to supply natural gas to Eneco, the Rotterdam-based energy company, signed in January 2012. The gas will be supplied via the TTF, and the amount will vary each day depending on outdoor temperatures and wind speed.

Nederlandse Aardolie Maatschappij

The Nederlandse Aardolie Maatschappij is one of the largest producers of natural gas in the Netherlands, accounting for around 75% of Dutch demand, and is a jointly owned subsidiary of Shell ExxonMobil. The company undertakes the exploration and production of crude oil and natural gas. Annual production in 2010 totaled 67.3bcm, a 26.3% increase on 2009. 53bcm of the volumes generated in 2010 were purchased by GasTerra.

Essent

Essent, which is part of RWE Group, is a long-standing gas player in the Dutch market. It is the third largest power producer and the leading player in the gas retail market. Essent has installed power capacity of 4,046MW from gas, hard coal, and biomass. It also holds a minority stake in the sole nuclear Borssele plant in the Netherlands.

Essent's retail sales base in the Netherlands and Belgium numbers 4.370 million customers, of which 2.024 million are gas customers. In gas volume terms, Essent sold 50.8TWh to its non-domestic customers, compared with 36.9TWh to its domestic customers.

The company made an operating profit of 245m in FY2011 from revenue of 5,818m, a fall of 37% and 11% respectively compared to FY2010. Gas sales decreased by 16% to 3,460m, partly due to some of its larger industrial and corporate customers switching suppliers as well as lower demand in general due to higher temperatures.

Recent investments of note include Essent's two new combined-cycle gas turbine power stations, Claus C and Moerdijk 2. They came online in January and February 2010 with a net installed capacity of 1,304MW and 426MW respectively. In addition to these investments, Essent has also invested in renewable

technology research with the construction of a 100m meteomast situated 75km off the coast of Ijmuiden in the Netherlands. The aim of the research is to inform future wind farm projects far out to sea.

Nuon

Nuon, which has been part of Vattenfall Group since 2009, undertakes gas retail, trading, and storage services in the Netherlands where it has a market share of 30%. It has a client base of some 2.6 million

customers, of which 1.9 million are gas customers. Vattenfall previously had gas production capacity through Nuon Exploration and Production, but this was sold to Tullow Oil in June 2011. Nuon's net profit in 2011 was 299m from a net turnover of 4,450m. In terms of volume, its sales amounted to 5.5bcm.

Vattenfall Group's strategy appears to be focused on the core activities of sales, trading, and storage in the Netherlands. Its two other key markets are Germany and Sweden. In line with this strategy Vattenfall Group has divested its existing gas fields in the North Sea and some of its activities in Belgium, indicating that it continues to pursue investment in storage capacity.




Nuon has a number of gas-related investments in process, including:

The construction of the multi-fuel Magnum power plant in Eemshaven, which is due to be commissioned at the end of 2012. The plant has a production capacity of 1,311MW, with a predicted load factor of 58% due

to three combined cycle gas turbines composed of a gas turbine, a steam turbine, and a generator.

A gas-fired plant with an operating capacity of 435MW called Hemweg 9. The plant will be operational by the end of 2012 and will supply Amsterdam.

A gas-fired power plant is being built in Diemen with a capacity of 435MW of electricity and 260MW of heat.

Nuon is considering expanding its gas storage capacity at Zuidwending (Groningen Province) in collaboration with AkzoNobel to a maximum of four caverns and a gas installation to store high-calorific gas. This would supplement Nuon's existing storage facility in Epe, Germany, where it has 280mcm of natural gas storage as of April 2011.

GTS

Title transfers of gas on the TTF are registered by the GTS by means of a "nomination," which states the characteristics of the transfer (quantity, period, and parties). Only shippers that are admitted into the GTS and have a TTF subscription are allowed to trade. GTS earns revenue from shippers through monthly subscription fees and a variable volume-based fee.

Matched trades are nominated by GTS on the shippers' behalf. APX-ENDEX acts as the central counterparty to all trades. Contracts are fully collateralized thereby reducing risks, and settlement cycles are fully undertaken by APX-ENDEX's financial services team. All members have access to realtime credit and settlement details and a 24/7 customer support help line.

GTS allocates firm capacity on an online "first come, first served" basis. For a shipper, there is no reservation or separate conditions for transit contracts. Using the TTF, a shipper can transfer gas that is brought into one of the 50 entry points of the national grid to one of the 1,100 exit points on the grid. Should capacity be fully booked, the shipper can request interruptible capacity based on three tranches, where the possibility of interruption is reflected in the price. The proceeds

from the selling of capacity go directly to GTS's revenue. At the import points (the borders with Germany and Belgium), GTS makes high-calorific gas firm transmission capacity of over 38GW available, and at the export points with Germany, Belgium, and the UK, GTS makes firm capacity of over 66GW available. For exports of low-calorific gas at border points with Germany and Belgium, over 87GW is available.

Since April 1, 2011 shippers have benefitted from the new balancing regime and market model. Every market party on the TTF is now responsible for its balancing position and can access hourly information regarding its balancing position and that of the gas system. In the new regime, each party that transports gas can now contribute to keeping the network in balance. These players are known as "program-responsible parties." Previously, GTS was the only player that was both authorized and capable of keeping the network in balance. In practice, this meant that every day shippers had to send in a program containing predictions of their entries, exits, and trades. During the gas day, GTS would compare the program with the actual allocation on a near realtime basis to determine the portfolio imbalance. The calculated imbalances per portfolio

are accumulated and shared with market parties on an individual basis through the portfolio imbalance signal (POS). The summation of all POSs is called the system balance signal and is published on the same timescale as the POS.




If balancing is required, GTS buys gas from a balancing platform where market parties can offer gas. This system encourages shippers to keep themselves in balance as GTS can identify shippers that are causing imbalances and can target the balancing costs to them. Specifically, GTS engages a corrective bid ladder mechanism if the imbalance falls into a certain zone. Shippers that find themselves in an imbalance can use their own physical means to correct it if possible, trade on the TTF, or enter into other commercial balancing contracts,. If they do nothing they bear the costs of the bid price ladder system. The Netherlands Competition Authority is currently evaluating this new balancing system.

Italy

This section provides a summary of the recent movements in the Italian PSV market.

Market overview: demand and supply

Compared to other European countries Italy consumes a large amount of gas: some 60% of the country's electricity is produced in gas-fired plants. Final consumption in 2009 was 44bcm (473TWh), of which 27% was used for industrial purposes, 46% for residential purposes, and 24% for commercial and public services. In 2010 natural gas consumption increased, driven mainly by the residential/services and industrial sectors. Despite stagnant demand in 2011, the Regulatory Authority for Electricity and Gas in Italy expects demand for gas to increase substantially, mainly driven by the fact that the country has abandoned its nuclear power generation program. According to the authority total demand rose in 2010 to 173.5bcm (including volumes sold and resold in the wholesale and retail markets).

2009 national data and IEA data show that total domestic supply was 76.7bcm (826TWh) in 2009, of which domestic natural gas production was 7.88bcm (85TWh). Hence, imports made up the majority of domestic supply at 68bcm (732TWh). In 2010, domestic production increased to 8.3bcm and imports rose to 75.3bcm. Thus 10% of the country's gross gas demand is met from domestic production and 90% from net imports.

Italy's domestic production of gas has continued to fall, increasing its dependency on imports from non-EU markets. Most import activity is based on long-term oil-indexed contracts. Nearly 90% of gas imports originate in non-EU countries including Algeria, Russia, Norway, Libya, and Nigeria. Of these, Algeria accounts for over one third of Italy's gas demand. Most imported gas is transported through pipelines (88%); however, since 2009 there has been a notable rise in the amount of LNG transported by ship due to progressive use of the Rovigo regasification terminal (also known as the Adriatic LNG Terminal), which treats gas from Qatar.

PSV developments

The PSV has struggled to gain momentum and remains at an early stage of development. Liquidity is very low on the PSV, typically under 2.0. However, some progress has been made that is worthy of note. In 2010, direct imports of gas accounted for 51% of wholesalers' gas procurement. 22% was purchased at the PSV, up from 15% in 2009. Hence, the PSV's significance is growing and is being developed in response to regulatory measures to increase its liquidity. In particular, in 2010 the Regulatory Authority for Electricity and Gas introduced an obligation to offer quotas of imported gas on the PSV. As a result, the number of traders grew to 106 from 82 in 2009. Transactions on the PSV reached 35.9bcm in 2010, a 66% increase on 2009, representing 43% of gross national consumption at 83bcm.




Prices on the PSV are typically higher than spot hub prices and currently hover around the 25/MWh level. Further, PSV prices are more independent than prices on other hubs and follow their own fundamentals. The main reason for this is that

Italy is more exposed to potential impacts on its natural gas imports as a result of unrest in North Africa and the Middle East than other European countries, due to its dependence on Algerian and Libyan imports (Italy imports approximately 10% of gas from Libya). Imports from these two areas constitute some 35% of Italy's gas imports, which partially accounts for the higher prices observed on the PSV. Of note is the complete shutdown of gas imports from Libya via the Greenstream pipeline in Q1 2011. Although this had the potential to affect prices, in reality additional Russian suppliers compensated for the difference. Other factors that affect PSV prices, as on other hubs, include weather variations, import pipeline outages (for example, that of the Swiss Transitgas pipeline in 2010) or maintenance in the Trans-Austria pipeline, which supplies Russian gas through Austria to Italy.

M-Gas, Italy's new exchange

In March 2010 Italy's Ministry for Economic Development set up a trading platform for imported gas called P-Gas, on which importers must place their quotas of imported gas for transfer. Domestic gas quotas were introduced to the platform in August 2010. The spot market for natural gas, with Gestore dei Mercati Energetici (GME) acting as a central counterparty, was launched in October 2010 and is called M-Gas. M-Gas began operations in December 2010 and consists of a day-ahead market (MGP-Gas) with both a continuous trading mechanism and an auction trading mechanism; and the intra-day market (MI-Gas), with a single-session, continuous trading mechanism. In addition, there is the gas balancing platform (PB-Gas), which is also organized by GME. The M-Gas market currently has 33 participants according to GME.

Since the launch of M-Gas the Regulatory Authority for Electricity and Gas has considered the OTC PSV to be a secondary market that is useful for providing operators with a commercial balancing tool, as well as its ability to replicate daily capacity trading.

Trading volumes in the MGP-Gas and MI-Gas markets for the 2011/12 thermal year showed that the vast majority of trades (45,910MWh) took place on the day-ahead market, compared with 7,800MWh on the intra-day market. The volume of trade fell in the MGP-Gas market from 135,238MWh in 2010/11. The average traded volume per day on the MGP-Gas was 1,836MWh in 2011/12, a fall compared with the previous year when the average traded volume per day was 1,982MWh.

GME balancing volumes for the 2011/12 thermal year amounted to 108,019MWh, with 23 participants buying or selling.

Virtual storage program

A prominent feature of the Italian gas storage sector is that the majority of storage is controlled by Stogit, which is responsible for over 90% of storage capacity. The remaining capacity is held by Edison. Actual physical storage of natural gas capacity at the end of 2011 was 15.0bcm, an increase of 5.6% compared with 2010 due to the development and upgrade of investments made at the Fiume Treste, Minerbio, and Settala concessions.

In response to increasing demand for storage, the government introduced new measures in August 2010 to incentivize the creation of additional storage capacity and to increase competitiveness in the natural gas market. The measures allow any parties that inject natural gas into the network to increase their market share by up to 55% under the condition of building new storage infrastructure or upgrading existing ones. The targeted capacity addition was 4bcm of new storage capacity.




The proposal for this virtual storage program, which is due to start in October 2012, will mean that a section of the gas exchange for both spot contracts and long-term and monthly contracts will be dedicated to the program, allowing gas to be resold on the M-Gas exchanges. The total storage capacity available within the virtual program is 600mcm.

Competition and concentration in the market

The Italian market has great potential for development due to its geographical position, which allows it to have a strong diversity of imports, and the penetration made by gas into the power generation mix. However, Datamonitor research has shown that the spot market has made limited progress; it continues to suffer from a lack of transparency and in particular, a lack of competition in the market, which continues to be highly concentrated.

The import and wholesale sector is dominated by Eni and its subsidiaries (including Snam Rete Gas, Stogit, and Italgas), which control the majority of the market in terms of transport and storage, production, and imports. For example, the share of gas imports held by Eni Group remains dominant at just over 38% in 2010. This concentration continues to hinder the creation of a competitive gas market by limiting the amount of spot gas available in Italy.

The largest players in the market in terms of gas suppliers are Eni, Edison, and Enel, which collectively covered 73.4% of the market in 2010, a 6.1% fall from 2009. There is, however, some improvement in competition. For example, the number

of suppliers in the wholesale market increased from 94 in 2009 to 105 in 2010, while the market share of the top three companies on the wholesale market Eni, Enel Trade, and Edison fell slightly to 31% in 2010.

Regulation

The Italian regulator and energy services operator is the Gestore Servizi Energetici (GSE). As mentioned previously, GME is the entity that organizes and manages the natural gas market M-Gas, where parties buy and sell at the PSV, which in turn is operated by the Italian transmission system operator/balancing operator Snam Rete Gas. GME plays the role of the central counterparty in M-Gas. The energy market comes under the remit of the Ministry of Economic Development.

A recent decision of note was that in August 2011 the Italian government raised a tax on the energy sector, the consequence of which will be to create a tax surcharge on energy companies from 6.5% to 10.5% over three years, to finish in 2014. This levy was also extended to distribution and transmission companies. As a result, Snam Rete Gas and the largest utility in the country, Enel, saw their share value fall some 10% and 5% respectively in August 2011.

Active and major players in the market This section evaluates the three major players in the Italian gas market and notes relevant points regarding their sales, strategies, and operations.

Eni

Eni's main businesses include exploration and production, gas and power, refining and marketing, engineering and construction, and petrochemicals. Its main subsidiaries in Italy are GNL Italia, LNG Shipping, Enipower, Agosta, Societ Adriatica Idrocarburi, Compagnia Napoletana di illuminazione e Scaldamento col Gas, Ecofuel, Eni Fuel Centrosud, Polimeri Europa, and Saipem (among others).




Eni's net profit was 6.86bn in 2011, up from 6.32bn in 2010. In 2011, Eni transported 78.30bcm of gas in Italy, down from 83.31bcm in 2010. Domestic sales amounted to 34.6bcm in volume terms in 2011, a small

increase over 2010.

Recent commercial events of note include Eni and Gazprom signing an agreement to renegotiate the terms of certain long-term gas supply contracts in Italy, retroactive to the beginning of 2011.

Eni has also completed the 100% acquisition of the capital of the Belgian companies Nuon Belgium and Nuon Power Generation Walloon, as part of its strategy to consolidate its leadership in the European gas and electricity market.

Edison

Edison is engaged in power generation and electricity and gas distribution primarily to wholesale customers and distributors in Italy. The company's business areas include electric power (the production and sale of electric power) and hydrocarbons (the supply, production, and sale of natural gas and crude oil).

Its net profit was 887m in 2011, a 29.8% fall from 2010. Within Italy, Edison's total natural gas sales in 2011 were 15.2bcm. In 2011, production of natural gas, counting the output of both Italian and international operations, grew by 14.2% to 2.2bcm. This was achieved due to an increase in the production from the Abu Qir concession in Egypt. The company has three gas storage centers, one of which is under development.

In its outlook for 2012, Edison indicated that the renegotiation of the contracts to purchase gas from Libya and Qatar would account for about half of 2012 earnings before interest, taxes, depreciation, and amortization, which will be in line with the amount reported in 2010, net of the contribution provided by the sale of its Edipower operations. In 2012, following the planned divestment of Edipower and the concurrent reorganization of the company's governance, Edison aims to improve its financial profile and, consequently, its investment and development potential both in Italy and abroad.

In November 2011, Edison was awarded three new hydrocarbon exploration licenses in Norway, in the Barents Sea, the Norway Sea, and the Southern North Sea. Edison, through its subsidiary Edison International, received three new hydrocarbon exploration licenses in the Norwegian Continental Shelf that had been put out for bids by the Norwegian Oil and Energy Ministry.

The licenses include:

Blocks 7124/1 and 2 in the Barents Sea with Edison as operator with a 60% stake, through a joint venture with North Energy.

Block 6407/8 in the Norway Sea with Edison as operator with a 60% stake, again through a joint venture with North Energy.

Blocks 7/1 and 2 and 16/10 in the Southern North Sea, with Edison having a 10% stake through a joint venture with Talisman Energy (40%, operator), Det Norske (20%), Skagen (10%), and Petoro (20%).




Enel

Enel is Italy's largest power company and its activities stretch along the value chain. Some of its many subsidiaries include Enel Distribuzione, Enel Green Power, and Enel Produzione.

The company had a resulting cash flow from operations of 11,713m in FY2011 from revenue of 79,514m, in line with results from the previous year. In particular, gas sales and transportation revenue generated 3,624m, an increase of 1.4% from 2010. Domestic gas sales decreased, however, in both the mass-market retail segment and in the business customer segment to a total of 4.6bcm sold domestically. Falling sales and in particular the difficult macroeconomic situation in Italy led to a lowering of Enel's credit rating to BBB+ from A- in March 2012.

Strategic developments of note include the following:

A strategic agreement between General Electric and Enel Distribuzione (which manages 85% of Italy's distribution network) to develop projects for energy efficiency and cut carbon dioxide emissions throughout Italy. The agreement is expected to last until December 2014.

Enel reached an agreement for the purchase of 18.375% of the mineral interest in a gas field in Algeria from the Irish company Petroceltic International. Following a joint appraisal by Enel and Petroceltic of the Ain Tsila field, which is covered under Petroceltic's permit, the two companies will be in a position to

undertake formal application to the Algerian authorities to develop and extract gas from the field. Gas production would start in 2017.

Enel is planning to build a new gas storage site at Romanengo in a joint venture project with F2i. The joint venture, Enel Stoccaggi, involves the construction of a new gas compression and treatment plant and the drilling of five new wells. The project, once approved by the Ministry of Economic Development, will take at least two years and will contribute to Italy's gas security.

Enel has been active in its investments and divestments in 2011 both domestically and abroad. For example, the company

expanded its renewable position in Europe through an acquisition by Enel Green Power Espaa, which acquired a 16.67% stake in Sociedad Eolica de Andaluca. The latter owns two wind farms with a total capacity of 74MW.

Iberian Peninsula

This section focuses on providing an update on the Iberian market, and Spain in particular.

Market overview

Spain, which is the major importer of LNG in Europe, is a market that Datamonitor has previously considered as having made substantial progress and one that has significant potential. The Spanish market had two factors that could have given allowed it to develop in the short-term, namely the rapid growth of gas demand, particularly in gas-fired generation, and the proposed Iberian single gas market MIBGAS, which was expected to drive liquidity. However, both of these developments have failed to materialize.




The virtual balancing point Centro de Gravedad was created in 2005, along the lines of the UK's NBP or the Dutch TTF. However, there is still no organized gas hub to provide a price reference. Most of the gas exchange in Spain is conducted through the OTC market on an electronic trading platform called MS-ATR, which is managed by Enags. The volume of energy traded over the counter amounted to 1,004.7TWh in 2010 and there are approximately 33 active parties on the platform. Due to the bilateral and anonymous trading from OTC trades, information is not publically available and thus lacks transparency. Considerable progress needs to be made to promote competition and increase transparency in the OTC market.

Natural gas consumption continues to be high but has not grown as much as expected due to increased renewable energy production as opposed to gas-fired electricity generation. Natural gas consumption in Spain reached 400.9TWh in 2010, a 0.4% decrease on 2009. On one hand, this demand figure reflects a 10% increase in conventional demand for natural gas, but it is more than offset by the 15.7% reduction in gas demand as a result of renewable energy production. Although renewable energy subsidies for wind in the country are variable and subject to annual review, the solar photovoltaic sector in particular is still growing, with an estimated installed capacity of approximately 2.5GW by the end of 2013. Thus, demand for gas in electricity generation can reasonably be expected to continue to increase only modestly.

Attempts to build a single Iberian gas market (MIBGAS), are still under way. Datamonitor notes more encouraging progress in inter-regional co-operation through the South Gas Regional Initiative between Spain, Portugal and France.

Some brief points of interest regarding the Spanish market include:

Some two thirds of natural gas supplies to Spain and Portugal come in the form of LNG. The price paid for LNG in the peninsula therefore stands out as a key determinant of the cost of imports of natural gas in that region. Relative to other importers of LNG, both Spain and Portugal pay low prices for their LNG imports, which is clearly a price advantage given the relative cheapness of LNG compared to pipe gas delivered under long-term contracts. LNG prices for the Iberian Peninsula hovered around the 19/MWh mark in 2011, which is slightly higher than the price of LNG delivered to the UK at just under 17/MWh. Natural gas border prices in 2010 increased to 19.48/MWh.

LNG continues to dominate as the main source of domestic gas supply. Given the very small quantity of domestic production 1,201GWh in 2010, accounting for just 0.3% of demand most domestic gas demand is imported in the form of LNG (75.5%), with the remaining gas imported via pipelines from several other countries. The top four exporters to Spain include Algeria (approximately 32%), Nigeria (20.0%), Qatar (15.0%), and Norway (9.2%). In total, Spain imports from up to 14 different countries, giving it a high diversity of sources and therefore low dependency on any one source of supply.

MIBGAS remains in development, and more importantly lies within the remit of the wider South Gas Regional Initiative to create a southern regional gas market that includes France, Spain, and Portugal. MIBGAS development to date has resulted in public consultation processes on harmonizing cross-border transmission gas tariffs between Portugal and Spain. South Gas Regional Initiative achievements to date include the development of interconnection capacity in 2013 and 2015.

MIBGAS published its general principles and organizational model in 2008. It is the smallest of the regional gas initiatives but it is far from the least important on a strategic basis, in light of the amount of LNG capacity in the region.




In terms of infrastructure, six LNG terminals are operational with an additional one planned for 2013 in Gijon, in the Asturias region. The terminal will have a capacity of 300,000m. All capacity from Spain's LNG terminals is regulated and can therefore be accessed by new players. With the exception of the new Gijon terminal, approximately 61bcm per year of entry capacity is covered by LNG terminals.

New pipeline additions include the Medgaz pipeline with Algeria with an import capacity of 8bcm per year, which has been operational since April 2011. Future capacity will be added under two open season

procedures in 2013 and 2015, which will increase the interconnection capacity between Spain and France under the South Gas Regional Initiative. Three years of work between country regulators and transmission system operators have accumulated an additional 5.5bcm of added capacity as of March 2013 at the Larrau

interconnection, while 2bcm of capacity at the Irun-Biratou point in the direction towards France will be

ready by 2015. Thus by 2015 interconnection capacity will reach 7.5bcm from Spain to France.

Possible energy security risks were raised in 2011 by potential blockages of the Suez Canal, a key LNG supply route, due to political unrest in Tunisia and Egypt. However, no disruptions occurred. Measures to increase security of supply include investments in 2010 in LNG storage capacity, and three new underground storages planned over the period to 2014.

Supply diversification through Nabucco Nabucco pipeline

The pipeline was expected to come online by 2013 and create a diversification of European gas volumes as a consequence of reducing Europe's dependency on Russian imports. The pipeline thus would also give an impetus to the Austrian CEGH market. Its development is

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