Ukraine War One-Year-On: extreme times do not call for extreme benchmarking measures

By Matt Joy, Senior Project Manager for Energy and Commodities at Parameta Solutions (a subsidiary of TP ICAP)

It is hard to believe that a year has passed since the war in Ukraine broke out. Beyond the devastating human impact, there is also a huge economic cost that is continuing to affect markets across the world – none more so than natural gas. Prices have tripled in the past 12 months, hitting an all-time high of around €345 (£302) per therm before dropping back. With the war showing little sign of concluding, there are some extreme solutions in discussion as to how to deal with this unforeseen energy crisis.

In Europe, there has been widespread industry discussion about devising gas benchmarks to better reflect current market prices. Earlier this month, the European Union Agency for the Cooperation of Energy Regulators (ACER) launched the assessments as part of policies aimed at developing a new transparent benchmark to better represent liquefied natural gas transactions. But is this not the equivalent saying my car doesn’t fly so I will stick some plastic wings on it and say this will work?

Trying to invent a new version doesn’t magically make the price of natural gas go lower. It has even been muted in certain quarters that TTF, Europe’s largest gas trading hub, should not be forced to behave like a global benchmark. But it has actually got a lot of strong elements that would make it a really great global benchmark. Firstly, it is in a very accommodating time zone where it can be accessed from Asia and can be accessed from the US.

What the authorities need to grasp is it would be neigh on impossible to get market participants to abandon entrenched and trusted benchmarks, and convince them to shift to something brand new. Particularly when there is fundamentally nothing wrong with the underlying mechanics of the natural gas contracts in place. The issue is that gas prices have become exponentially high due to a prolonged period of unforeseen geopolitical circumstances, as opposed to the benchmarks themselves.

Due to these unexpected events in Eastern Europe, market participants are going to numerous destinations to secure the same product. Therefore, there has been a need to redraw trade and supply routes. The trouble is that this has left tiny gaps in-between the current benchmarks that need to be accounted for. For instance, there are lots of esoteric and nuanced physical contracts that will trade as a differential to benchmarks such as TTF in Europe, JKM in Asia and Henry Hub in the US.

Due to the fact that all three hold the lion share of liquidity, it is easier to join the dots between them – than it is to try and replace them. This happens in other markets. Take oil as a prime case in point. There is of course Brent crude, and WTI in the US. Every day, hundreds of derivatives contracts are traded between these two those benchmarks. The point is that if market participants can see all these benchmarks connected together, it gives them peace of mind to then focus on the more complicated products trading just below the surface.

Ultimately, the market needs to guard against making too many extreme assumptions around this temporary issue surrounding gas. Trying to invent a new version doesn’t magically make the price of natural gas go lower. It is just the prices have become extremely high due to a prolonged period of unforeseen geopolitical circumstances.

Events in Ukraine, however painful they may still be, should not mean traditional benchmarks will never be in use again. Instead, there needs to be a balance struck that allows firms to understand the difference between the different global benchmarks. It is not a case of the market not working, it is just starting to work differently and there needs to be a re-balance of how the existing benchmarks align to give the opportunity for gas markets to grow into the global force that investors expect it to become.