What are the effects of market integration on gas prices and gas flows?

The ACER Gas Target Model (AGTM) proposes merging gas market areas to improve the functioning of wholesale markets and increase their liquidity. Against this background, ARERA and E-Control have commissioned Frontier to examine the effects of merging the Italian and Austrian gas market areas. In a qualitative and model-based quantitative approach, Frontier and DFC Economics have analysed the price formation in the respective market areas and their development in the event of an integrated market area. However, this study does not provide a complete cost-benefit analysis (CBA) of a market area merger.

The results of the study now published by ARERA and E-Control provide insights into the main drivers of current and future price formation at the European gas hubs and at the Italian and Austrian wholesale markets CEGH and PSV in particular. The study shows that in large parts of Europe, wholesale prices for natural gas have been tightly integrated in the recent past and price differences were mainly been driven by transport costs. The study also reveals that while merging market areas can lead to relevant price effects which can be disadvantageous for some end consumers of natural gas, the exact distribution effects will eventually depend on the respective tariff calculation system in the merged market area and a clever design can help to reduce distribution effects.

As the study focuses on distribution effects caused by price changes and does not assess costs and benefits of market integration – for example an expected increase in liquidity at a hypothetical joint Italian-Austrian gas hub – it does not in itself allow a conclusion on the overall costs and benefits of market area merger. For the time being, the results of the study have led ARERA and E-Control to pursue other avenues to enhance market integration, including examining how existing capacity between the market areas can be used more efficiently to the benefit of market participants and gas consumers.

Frontier regularly advises regulators on gas market design including costs and benefits of market area mergers.

For more information please contact media@frontier-economics.com, or call +44 (0)20 7031 7000.