A Story of Success: The Evolution of TTF Trading

  • 2 Apr 2019
  • By Gregor Spilker
  • Topics: Energy

In recent years, developments in the U.S. energy landscape have dominated the headlines in the natural gas market.  The U.S. shale revolution is increasing local production and reducing extraction costs, so that U.S. natural gas and other energy products are being exported to destinations across the globe. In the derivatives space, this is increasing the global relevance of U.S. benchmarks.

The story couldn’t be more different In the Netherlands, where domestic production is collapsing, and the country has become a net importer of natural gas. The Groningen mega-field, which accounts for about half of the country’s gas output, is ageing, and seismic tremors linked to extraction activities forced the Dutch government to announce production cuts. In such a densely populated country, it is unlikely that shale resources – even if they were available and economically recoverable – could significantly increase domestic production.

Chart 1

Source: Gasunie Transport Services and Statistics Netherlands’

Perhaps counterintuitively, derivative volumes on Dutch natural gas have gone in the opposite direction of domestic production: the TTF (“Title Transfer Facility” – the virtual trading hub for the Netherlands’ natural gas market) paper market has seen an explosion of trading volumes (compound annual growth rates of 23% since 2011) just as local output decreased. TTF has become the unrivalled leading hub in the European gas market landscape, leaving the UK NBP (“National Balancing Point” – the TTF equivalent for the UK) and other hubs far behind. What has driven TTF to its success and how does it link to other developments across the global natural gas landscape?

Chart 2

Source: Gasunie Transport Services and Statistics Netherlands’

Dutch “gas roundabout” allows two-way traffic

Very early, the Dutch government recognised the potential of TTF at the heart of European natural gas markets: when the market liberalisation process was in its infancy in the early 2000s, it invested heavily in pipelines and other infrastructure. The country also provided a market friendly environment by giving open access to its gas infrastructure, enforcing transparent rules for trading and defending a level playing field for all actors across the industry. The Netherlands are strategically located next to residential and industrial customers in Germany, France and Benelux. The country has pipeline connectivity to its direct neighbours, as well as to Norway and the UK across the North Sea. BBL, the pipeline connecting the Netherlands to the UK, is currently being upgraded: in late 2019, it should allow bi-directional flows, providing another layer of flexibility and allowing the Netherlands to absorb gas from the UK. Infrastructure investments are paying off as they allow the TTF market to function both when the country is a net exporter (as was historically the case) and as a net importer. The country is leveraging its existing infrastructure to remain the “gas roundabout” for North-West Europe in both environments.

Gate Terminal is the main Dutch LNG import terminal with an annual throughput capacity of 12 BCM. It is directly connected to the national gas grid and therefore to TTF. The interconnectedness of TTF to global gas markets can be seen by the variety of source and destination countries using Gate: in 2018 vessels arrived from a wide range of countries, including Algeria, Angola, France, Norway, Peru, Qatar, Russia and the U.S. That same year, vessels left Gate Terminal to reach Brazil, Canada, China, Egypt, India, Pakistan, South Korea, the UAE, while smaller vessels set sail for Finland, Sweden, the Netherlands and Spain1.

Trading activity on TTF

TTF serves as the premier trading and risk management instrument for gas trading in Europe, mirroring the outsized role that the Dutch gas network plays for physical flows throughout North-West Europe. The TTF market is highly liquid across exchange-traded and OTC markets and TTF natural gas prices are highly positively correlated to those in neighbouring, less liquid hubs2. Price differences between those markets tend to reflect the regional supply/demand balance, transportation costs and capacity constraints between two adjacent hubs.  

European natural gas markets are steadily moving away from long-term oil-indexed contracting. Because of its high liquidity and price relevance across Europe, TTF has become one of the favoured pricing mechanisms. For instance, Gazprom Export, the Russian company’s supply arm, started selling natural gas on its electronic sales platform directly delivered on the TTF hub in February 2019. This is a first for the company and indicative of the growing relevance of TTF – it could lead to other suppliers following suit. Equinor, a large Norwegian supplier, also sees a shift towards shorter-term pricing, with day-ahead and month-ahead hub price indexation to dominate3. With its liquidity, TTF stands to profit from further hub indexation of term contracts.

Increased linkage between TTF and LNG

Beyond European markets, the use of TTF has also grown because it has become a reference point for LNG market participants. LNG exporters that have uncontracted volume can optimise flexible cargoes between Asia and Europe, and TTF has emerged as the main European benchmark price for arbitrageurs (simultaneously, Platts JKM is solidifying its lead as the main Asian marker). This applies especially to LNG cargoes loaded on the U.S. Gulf Coast thanks to the favourable difference in freight costs between Asia and Europe. This winter, the spread between JKM and TTF collapsed due to weak Asian demand and the number of Atlantic cargoes delivered in the Netherlands duly increased. This is unusual as the winter months typically see low LNG imports, as JKM is priced to attract available cargoes to Asia. Winter supply flexibility in the Netherlands used to be achieved by optimising Groningen output – this is not the case anymore and the market expects LNG to play a larger role in balancing supply and demand.

Chart 3

Source: CME Group, Statistics Netherlands’, ENTSOG (for 2019 LNG flows)

CME Group offers a comprehensive suite of physically-delivered TTF futures as well as financially settled contracts on the spread between Henry Hub, the U.S. natural gas benchmark price, and TTF. The contracts, in particular the physically-delivered futures, have found good support from the industry. Volumes and Open Interest are growing exponentially as CME Group expands its footprint in the market. Possibly reflecting the lengthening hedging horizon of participants, we have seen trades as far out as December 2021. CME Group offers unparalleled access to liquidity in Henry Hub, which remains by far the most advanced natural gas market globally. This is especially relevant to traders and risk managers seeking to capitalise on the increased linkage and arbitrage opportunities between U.S. LNG and European gas markets.

Chart 4

Lot figures were converted using 1 lot = 720 MWh. Source: CME Group.

Chart 5

Screen activity on CME Group TTF markets

Source: CME Group, March 5th, 2019, 11:00 GMT

Summary

Despite declining local output, the Netherlands and TTF play the lead role in European natural gas markets. Falling local production is offset by higher LNG imports and pipeline flows. TTF futures volumes have grown disproportionally, as suppliers move to hub indexation. LNG portfolio players form a new type of participants that use TTF as a reference price against which to optimise their destination-free cargoes. A new era of interconnectedness between gas markets requires the right tools to manage risks and capture opportunities. With its offering of outright futures and spread instruments, CME Group can help traders active in TTF and in adjacent global gas markets.

References

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