Italian Natural Gas Market Report

 

Italian Natural Gas Market Report

Jacob Lee

2019-03-13

• The figures are not compatible with word press, therefore, they have been omitted

1. Introduction

Italy is geologically located in Southern Europe. Taking advantages of its central location, Italy is trying to make itself as a natural gas hub in Southern Europe. Along with market liberalization and development the natural gas network in and outside Italy, the country is becoming more and more favorable environment to be a natural gas hub. Of course, there are hurdles in this direction. For one thing, Italy imports most of the natural gas from overseas: Russia (45%), Algeria (32%), Libya (8%), and Netherlands (5%). Also, the demand for natural gas is smaller than when it peaked in 2005. After the world economic crisis, its gas demand had gone downward trend until it reversed in 2014.

Natural gas market in Italy will experience structural changes in the foreseeable future. In this market report, I will pay attention to factors that might influence a prospective investor’s decision to join the Italian natural gas market. As for the methodology in this paper, I used Michael Porter’s five force framework to analyze the business environment in the Italian gas market. A prospective investor should be aware of each of the framework’s threats and opportunities to seize its profit opportunities and mitigate the risks associated with the investment in the Italian natural gas market.

2.1. Analyzing Threat of New Entrants and Opportunities

– Dominating players in both gas and power market

Until the late 1990s, ENI, the state-owned company, controlled a national gas market as a legal monopoly. Market liberalization started in 1999, finally making the natural gas market move from ‘command and control’ system to a ‘market-based’ system. Although many developments have been made to provide a plain competitive environment along the way, dominant players exist in the market.

In Italy, there are three dominating players in the natural gas market: Eni, Enel and, Edison. These three firms import 87.2% of the gas that entered the Italian market in 2017.[i] Moving down to the wholesale market, there are also dominating players: Eni (22.8%), Engie (13.6%), Edison (10%) and Enel (9.1%). Four of the leading companies’ share accounted for 55.5% of total wholesale market share in 2017.[ii] Although their market share is in decline, it is a slow and gradual change.

Major gas players are also very active in the power market. This would make these players more powerful in terms of securing sales of gas for power generation. Natural gas is not only used for heating but also used for power generation. Therefore, the integrated dominant market share in both the gas and power sector prevents more competition from happening. As shown in the figure 1, the combined share for generation from Eni, Enel and, Edison is 35% for the generation. In the retail market, their presence is evident with the combined share of 45% in 2018.

Figure 1. Italian Power Market Players (Source: BNEF) – Omitted in the word press

– Non-discriminatory Access to the Gas Network & Long-term Contract Expiration

As the market liberalization has progressed over the past years, the Italian government has passed laws to guarantee the gas network easily accessible to the third-party operator because the access to the gas network is essential for new entrants in Italian gas market. However, it seems the truely open and non-discriminatory access has yet to come.

First of all, most of Italy’s natural gas imports come through international pipelines; 75% of gas come through pipeline and 25% come through LNG.[iii] ENI still continues to hold exclusive transmission rights in transit pipelines located outside Italy, which were built when it was a vertically integrated monopoly.[iv] Additionally, import infrastructure, storages are also heavily owned by ENI in Italy. The dominant position ENI enjoys both in and outside Italy is likely to discourage new entrants to invest in a power plant or gas import infrastructure.

For example, there is a case that new gas network investment was driven by ENI’s own interest. ENI delayed investment in the Trans Tunisian Pipeline company in a fear of such an investment would improve the ability for competitors to import Algerian gas to Italy. This was accused publicly, and the Italian competition authority imposed a fine on ENI.[v] Given the combined market share of the leading companies in Italy, discriminatory behavior can show up again at any given time.

Secondly, long term contracts get a priority access to pipeline access. In 2016, the total import capacity was 120.1 G (m³)/year.[vi] Of which, approximately, 70% of import capacity was reserved for the long-term contracts. Fortunately, the import capacity is likely to be allocated to the unreserved access as the long-term contracts terminate over the next years. 42% of long-term contracts will terminate within 5 years.

Figure 2. Structure of contracts active in 2016, according to residual life (Source: Arera) – Omitted in the word press

2.2. Analyzing Competitive Rivalry and Opportunities

– Wholesale market is getting less dominated by leading players, especially supply from PSV

The main trading platform in Italy’s wholesale market is ‘Punto di Scambio Virtuale (PSV).’ At this virtual point located between the entry and exit point of the natural gas transportation network, people can trade natural gas. While the gas network in Italy is still dominated by leading players, they have lesser dominant presences in the wholesale market. In 2016, the combined share of dominant three companies dropped to 30.8%.[vii] Since 2014, the share is in a constant decline. Particularly, the small and medium-size operators were most active in PSV. In 2011, ENI share in the PSV market was just 1.9% while the medium size operator share was 43.6%[viii]

There are lots of suppliers in the Italian gas market. According to Med Reg[ix], 541 active suppliers are in the Italian gas market. Of which, the majority operates in the wholesale market. In comparison to other European countries, France had 69, and Spain had 41 companies, respectively.

2.3. Analyzing Threats of Substitutes and Opportunities

– The renewable energy source being a substitute for Natural gas

It is expected that renewable energy will negatively affect total natural gas capacity, making it more and more back-up energy source in the long run. It has proven itself as a powerful competitor for the electricity market in Italy. Noticeably, two drivers are pushing the renewable energy forward: A strong government’s determination for the renewables along with renewable energy policy and renewable energy technological advancement.

– National Energy Strategy

Italy passed the Law no.99/2009, which provided fundamental guidelines for the future energy strategy. This set a national binding target for renewable energy to meet 17% of total energy consumption by 2020. Furthermore, different targets were set depending on the sectors: heating and cooling (17.09%), electricity (26.39%) and transportation (10.14%).[x]

In 2017, the Italian Government renewed the National Energy Strategy with a view to 2030. The binding target for renewable energy was raised to 28% by 2030 with the higher proportion for each sector relative to 2017 level: heating and cooling (30%), electricity (55%) and transportation (21%).[xi]

As shown in the graph below, the previous gross energy consumption target is already in an achievable range. The Italian government is determined to meet the 2030 target with renewable energy policies and technological advancement.

Figure 3. Renewable energy share target (Source: 2020 binding targets and NES 2017 targets) – Omitted in the word press

–  Renewable Energy Policy

The Italian government has implemented a series of renewable energy policy drives over the years. Feed-in-premium tariff, tradeable green certificates and all-inclusive feed-in tariff, the indirect sale of electricity, net metering and Feed-in tariff are examples of these policies.

In addition, the Ministry of Economic Development released a new draft decree implementing a new auction system for renewable projects over 1 MW (6MW for wind) on September 7, 2018.[xii] This decree is currently being reviewed by the European Commission. If approved, Italy would allow auction systems for large-scale renewables.[xiii] This policy will drive renewable energy implementation even further.

Accordingly, it is expected that thermal power capacity will face even more difficulties in terms of competition with the renewable. Italy does not have any nuclear power plant to shut down. In addition, the total capacity of oil and coal-fired capacity is already low relative to other sources. Therefore, the increase of renewable energy will negatively impact natural gas capacity more than oil and coal capacity proportionally. Of course, once the gas share shrinks to a certain degree, it would likely flatten to compensate for the intermittency problem of renewable energy.

Figure 4. Electricity Mix (Source: BNEF, Italy profile) – Omitted in the word press

– Renewable energy cost reduction
Renewable energy sources are getting more and more competitive in terms of cost. It is not just government policies but also technological advancement driving renewable energy implementation broadly. According to International Renewable Energy Agency, in 2017, Italy reduced Levelized cost of electricity of commercial PV (up to 500 kW) by 77% relative to the level in 2009.[xiv] In fact, Italy has already achieved commercial solar grid parity, which means LCOE for solar is competitive in terms of retail electricity prices.[xv]

Figure 5. LCOE Historic range – Left: Wind onshore, Right: PV non-tracking (Source: BNEF, Italy Profile) – Omitted in the word press

In comparison, the LCOE for gas combined cycle fell in a range between $ 42 per MWh and $ 78 per MWh in 2018. As of now, a relatively cheap natural gas trend helps the gas combined cycle to maintain a competitive LCOE range, however, this can change depending on the natural gas price trend in the future.

2.4. Analyzing Bargaining Power of Customers and Opportunities

– The Future Demand Forecast

According to SNAM, an Italian natural gas infrastructure company, Natural Gas demand in Italy will increase, however, it will be a gradual increase. Even under high case scenario, it is not until 2030 that Italian Gas demand would achieve 83.8 bcm, which is a comparable amount to 2008 level when the world economic downturn occurred. The detailed estimation is shown in the table below.

Billion of cubic meters	2020	2026	2030	2035
Residential and Commercial	28.2	27.2	25.9	23.8
Power generation	23.2	28.2	31.5	31.2
Industry	14.1	13.1	12.4	11.6
Other*	3.6	8.3	11.4	14.3
Consumption and losses	2.1	2.5	2.7	2.6
Total	71.3	79.2	83.8	83.5

Other*: consumptions for Agriculture and Fishing, Chemical synthesis, automotive and bunkering

Figure 6. Natural Gas Demand Forecast (Source: Snam)

We can see that the end use of both residential and commercial and Industry will decline. On the other hand, power generation and other end-users will increase.

– The declining of industrial, residential, and commercial use.

Until 2014, natural gas consumption in Italy went downward trend. Italy saw a 5.1% drop per year between 2008 and 2014. This decline can be explained by the combined effect of the economic crisis, milder winters, and lower gas-fired electricity production. This trend turned around from 2o15 due to the cold weather and higher demand from the power sector. And yet, industrial demand has not recovered its previous share. The major sub-sector of industrial end-use are iron, steel, chemical, paper industries. Unfortunately, it does not look like that these industrial uses will grow in Italy, dramatically. For example, the steel industry is suffering from a global oversupply of steel. Because steel is a global commodity, along with not enough demand and a steep rise in Chinese steel production, the steel industry is facing an oversupply. In fact, Italian steelmakers might not have survived if they had not received public money from the government in the past.[xvi] Under this circumstance, it would be challenging for the Italian industry to find a substitute industry that consumes as much gas as the steel industry would use. Additionally, there is already a high gas penetration in the industrial sector. This indicates that there is less growth potential in expanding industrial natural gas buyers in Italy.

As for the residential and commercial use, the growth does not look bright, either. The amount of natural gas future consumption would be decreasing according to SNAM’s estimation. While there are various factors – including winter weather in the short term, population growth in the long term – I would like to pay more attention to energy efficiency within the EU context.

In 2012, the EU established the Energy Efficiency Directive (EED) to achieve its 20% energy efficiency target by 2020. Italy, as one of the European countries, is also required to use more efficiently all stages of the energy chain, from production to final consumption.[xvii]

In 2016, EU commission proposed an updated EED, which includes 30% energy efficiency target by 2030. Most recently, in 2018, the commission reached a political agreement which includes 32.5% energy efficiency target by 2030. If fully enacted, Italy has an obligation to follow the EED, increasing the efficiency further. As a result, natural gas consumption in residential and commercial use is expected to drop largely.

– Consumer switching activity

As market liberalization progresses, consumer gets more options to choose their supplier. Italian gas market also experienced consumer switching activity. However, the switching activity rate in Italy turned out to be quite low compared to other European markets. In 2017, Consumers who changed their supplier were 23.2% in non-house hold segment and 6.2% in the household segment, respectively. In comparison, Portugal showed 55% in each segment.[xviii] This can be partly explained with stages of market liberalization. Italy started market liberalization in the late 1990s. So, the initial consumer switching activity already took place in Italy, and it has become a mature gas market.

 2.5. Analyzing Bargaining Power of Suppliers and Opportunities

– A higher gas price and its mechanism in Italy  

Italian gas price is higher than the average European market gas price. According to Wholesaler gas price survey 2017 edition, only the Czech Republic and Germany had a higher average wholesale price than Italy in European countries, which was a little over $6 per MMBTU.[xix] In comparison, the UK and France’s average wholesale price were $5.7 and $5.8 per MMBTU. A higher spot price in the wholesale market reflects the lack of liquidity and competition as a whole. This is a contradictory result given the fact that there are 541 gas players in Italy.

In Italy, natural gas is subject to excise tax and Value-Added Tax (VAT), and additional taxes at the regional level. The VAT is differently applied depending on the amount of natural gas consumption – 10% for gas up to 480 cubic meters, 21% for over 480 cubic meters.[xx] Consequently, Italy has a higher post-tax total price.

Figure 7. Natural Gas prices for household consumers (Source: Eurostat) – Omitted in the word press

Also, Italy still maintains regulated prices. Even though Italy opened its gas market in the late 1990s, the regulated price has not been removed, yet. In fact, the removal of the gas tariff in Italy was pushed back to 2020 by the Constitutional Affairs Commission of Italy’s Senate, which was the fourth time the removal has been postponed.[xxi] As of 2017, liberalized market accounted for 47% while regulated market took up 53%.[xxii] Consumers in the regulated market pay more than consumers in the liberalized market.

Historically, the natural gas price has been indexed with on oil product prices with long term take-or-pay contract. Although the liberalization helped gas on gas (GOG) price mechanism start to get implemented in Italy, the GOG in the pipeline has only slowly grown. However, this trend was accelerated with renegotiation with Russian contracts in 2014 and the change in Algerian contract in 2017, making GOG share to 39% in 2017. As for the LNG price mechanism, GOG takes up 28% and oil-indexed price takes up 72%.[xxiii]

– Natural Gas Hub

Italy is a geographical center of the natural gas network. Natural gas from Northern Africa can pass through Italy and go to other European countries. Also, gas from Russia pass through Italy and reach to the Eastern European countries as well. Recognizing this potential, many of private or public companies have proposed a number of gas pipeline projects. Additionally, LNG has diversified gas entry points in Italy. Diversification of supply sources is a fundamental component for a natural gas hub. In this regard, Italy has a great potential to be a natural gas hub in Europe. This Italian hub can function as a central pricing point for the natural gas network.

Italy has already built the natural gas pipeline network and been determined to expand its network through the proposed natural gas LNG and pipeline projects. In addition to the transit system, Italy also has a relatively sizable amount of storage capacity. It can store approximately a third of its annual requirement in stock. This is important because gas in storage can be traded and moved at a quick notice, which is another important component for a gas hub.

Since its geological location, Italy can diversify its natural gas supply. Currently, the major supplier is Russia with 45% supply of natural gas. The second most crucial supplier is Algeria with 32% share. Recently, huge natural gas reserves were found in Israel and Cyprus. Internationally, Italy has worked to reduce its dependence on Russia and Algeria, partnering with Israel and Cyprus. Italy recently agreed to lay a pipeline that goes through these countries.[xxiv] On the other hand, domestically, market liberalization is progressing, making Italy more favorable and mature environment to be a natural gas hub in Southern Europe.

[i] The Italian Regulatory Authority for Electricity, Gas and Water, “Annual Report 2017,” https://www.arera.it/allegati/relaz_ann/17/AnnualReport2017.pdf

[ii] ibid

[iii] ENI, “The Transport,” http://www.eniscuola.net/en/argomento/natural-gas1/extraction-and-distribution1/the-transport1/

[iv] Morena Skalamera, “Italy’s path to gas liberalization,” Last Modified April 23, 2015, https://www.tandfonline.com/eprint/QUKGWaYXfRC4HvaVJjtX/full

[v] Philip Lowe, “Effective unbundling of energy transmission networks,” http://ec.europa.eu/competition/publications/cpn/2007_1_23.pdf

[vi] The Italian Regulatory Authority for Electricity, Gas and Water, “Annual Report 2017,” https://www.arera.it/allegati/relaz_ann/17/AnnualReport2017.pdf

[vii] ibid

[viii] Anouk Honoré, “The Italian Gas Market,” https://www.oxfordenergy.org/publications/the-italian-gas-market-challenges-and-opportunities/

[ix] MEDREG, “Assessment of natural gas competition and market prices within member countries,” http://www.medreg-regulators.org/Portals/_default/Skede/Allegati/Skeda4506-253-2018.4.24/COMPETITION_INDICATORS_AND_RETAIL_GAS_PRICES_new.pdf?IDUNI=madrdhx3p20bocbc1iojqhou4257

[x] IEA Bioenergy, “Italy,” https://www.ieabioenergy.com/wp-content/uploads/2018/10/CountryReport2018_Italy_final.pdf

[xi] ibid

[xii] Emiliano Bellini, “Italy to hold first 500 MW wind-solar auction in January,” Last Modified September 7, 2018, https://www.pv-magazine.com/2018/09/07/italy-to-hold-first-500-mw-wind-solar-auction-in-january/

[xiii] Emiliano Bellini, “Italy tops 20 GW of solar,” Last modified February 21, 2019, https://www.pv-magazine.com/2019/02/21/italy-tops-20-gw-of-solar/

[xiv] IRENA, “Renewable Power generation costs in 2017,” https://www.irena.org/-/media/Files/IRENA/Agency/Publication/2018/Jan/IRENA_2017_Power_Costs_2018.pdf

[xv] Deloitte, “Global Renewable Energy Trends,” https://www2.deloitte.com/content/dam/insights/us/articles/4624_global-renewable-energy/DI_global-renewable-energy-trends.pdf

[xvi] The Economist, “Why the world has too much steel” Last Modified May 2016, https://www.economist.com/the-economist-explains/2016/05/05/why-the-world-has-too-much-steel

[xvii] European Commission, “Energy Efficiency Directive,” https://ec.europa.eu/energy/en/topics/energy-efficiency/energy-efficiency-directive

[xviii] MEDREG, “Assessment of natural gas competition and market prices within member countries,” http://www.medreg-regulators.org/Portals/_default/Skede/Allegati/Skeda4506-253-2018.4.24/COMPETITION_INDICATORS_AND_RETAIL_GAS_PRICES_new.pdf?IDUNI=madrdhx3p20bocbc1iojqhou4257

[xix] World Gas Conference, “Wholesale gas price survey 2018,” https://www.igu.org/sites/default/files/node-document-field_file/IGU_Wholesale%20Gas%20Price%20Survey%202018%20Final.pdf

[xx] OECD, Italy: Inventory of estimated budgetary support and tax expenditures for fossi fuels, http://www.oecd.org/site/tadffss/ITA.pdf

[xxi]Gianluca Baratti, “Italy further postpones elimination of regulated natural gas, power tariffs,” https://www.spglobal.com/platts/en/market-insights/latest-news/electric-power/080618-italy-further-postpones-elimination-of-regulated-natural-gas-power-tariffs

[xxii] MEDREG, “Assessment of natural gas competition and market prices within member countries,” http://www.medreg-regulators.org/Portals/_default/Skede/Allegati/Skeda4506-253-2018.4.24/COMPETITION_INDICATORS_AND_RETAIL_GAS_PRICES_new.pdf?IDUNI=madrdhx3p20bocbc1iojqhou4257

[xxiii] World Gas Conference, “Wholesale gas price survey 2018,” https://www.igu.org/sites/default/files/node-document-field_file/IGU_Wholesale%20Gas%20Price%20Survey%202018%20Final.pdf

 

[xxiv] Toi Staff, Israel, Cyprus, Greece and Italy agree on $7b. East Med gas pipeline to Europe, Last Modified November 24, 2018, https://www.timesofisrael.com/israel-cyprus-greece-italy-said-to-agree-on-east-med-gas-pipeline-to-europe/