The European gas market is going through deep structural change. The geography of production and consumption is being reshaped, domestic output is falling sharply in the North Sea, and new sources are emerging without the respective shares of pipeline and LNG suppliers yet being settled.
Shipper behaviour is changing too, moving towards short-term, tightly adjusted bookings that make flows more versatile and infrastructure bookings more uncertain. European market rules encourage that shift, and the expiry of long-term contracts facilitates it: volumes delivered under those contracts were set to fall 50 % between 2015 and 2025, and by more than 80 % by 2035.
Four contradictory trends
- The EU targets a low-carbon economy by 2050 and pushes for new gas infrastructure, while uncertainty around financing it over its lifetime is high.
- The market value of infrastructure capacity is low, yet it is credited with an important role in security of supply.
- Market valuations of operators are very high, even as their financial risk rises.
- The Gas Target Model drives market area consolidation, but its implementation is contested by many stakeholders, including national regulators keen to keep their prerogatives.
What regulation does not protect against
Our interviews with executives at twelve major European operators lead to a counter-intuitive finding: revenue cap regulation does not eliminate stranded asset risk.
If an asset’s utilisation falls to zero, regulators are unlikely to let end consumers bear its full cost. Most interviewees do not believe regulators would remove a stranded asset from the regulated asset base before full depreciation, but increased tariff pressure would lower their revenue.
For transmission system operators, the impact of adverse scenarios on equity value would range between 0 % and -20 % by 2035. Risk levels vary widely by asset depending on the type of regulation, existing long-term bookings, domestic demand outlook and the share of transit. Transit pipelines look more exposed than storage, the latter being seen as critical for security of supply.
The nature of the risk also differs. For assets outside revenue cap regulation it takes the form of lower revenue proportional to lower bookings. For the others it is increased regulatory pressure on tariffs. Interviewees unanimously anticipate tougher negotiations with national regulators, some estimating that 10 to 20 % of revenue is at stake through pressure on the cost of capital and operating cost incentives.
Four mitigation levers
- Regulatory negotiation, decisive in securing framework stability and an appropriate allowed revenue. The depreciation rate of the asset base in particular needs realigning with anticipated utilisation.
- Advocacy on the role of gas, the only route to a stable political framework over fifty years. That means defending gas more firmly as a complement to intermittent electricity and a contributor to security of supply, and pressing for a stable carbon pricing mechanism.
- Green mobility and green gas, biomethane and hydrogen from electrolysis, with forward studies pointing to gas networks decarbonised by more than 50 %. Interviewees generally favour direct involvement, which requires innovative models with regulators, but differ on their legitimacy as direct players in mobility.
- External growth, which creates value through operating efficiency and risk reduction, but where value creation is limited by incentive regulation and by transaction prices pushed well above net asset base value by financial investors. More and more operators are considering combinations across infrastructure types, LNG, transmission and storage, gas and power.
Confidence that remains strong
Despite these threats, interviewees firmly assert their confidence in the lasting role of gas in the European energy mix, since scenarios of drastic long-run demand reduction are not considered likely. That confidence shows in private equity appetite for these assets, and in recent transaction prices widely judged excessive on purely industrial criteria, a sign that investors believe value can be increased.
Even so, mitigating actions differ in impact and accessibility. The ability to prioritise and implement them will be decisive, and the initiative should be taken now in order to shape long-term trends.
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