Natural Gas Pricing Mechanisms: The GOG Revolution and Its Reality
Natural gas pricing mechanisms have undergone a fundamental transformation over the past three decades, with Gas-on-Gas Competition (GOG¹) emerging as the dominant theoretical framework for modern energy markets. Understanding these natural gas pricing mechanisms is crucial for comprehending how global energy markets function today.
Essential Definition of GOG: Multi-layered Structure of Theory and Reality
GOG (Gas-on-Gas Competition) is a pricing mechanism in which natural gas prices are determined by the balance of supply and demand for natural gas itself, rather than by oil prices or regulatory decisions. However, behind this simple definition lies a complex reality that challenges traditional approaches to natural gas pricing mechanisms.
True GOG represents prices formed in an environment where multiple independent suppliers and consumers have sufficient market information and trading opportunities, and can trade freely without physical constraints. Under these ideal conditions, prices would reflect both current inventory levels and seasonal demand in the short term, as well as marginal production costs and long-term demand growth.
However, real-world natural gas pricing mechanisms deviate significantly from this ideal. Due to physical pipeline constraints, storage capacity limitations, transportation time delays, political interventions, and financial speculation, price formation occurs differently from pure supply-demand balance. What we currently refer to as “GOG prices” would be more accurately described as “quasi-GOG prices” or “hybrid prices.
¹ GOG (Gas-on-Gas Competition): A market-based pricing system where gas prices reflect actual gas supply and demand rather than oil price linkages.
Period 1 (Late 1980s-1995): Theoretical Birth of the GOG Concept
British Gas Privatisation: Transition from Thought Experiment to Reality
The history of GOG begins with the privatisation of British Gas Corporation in 1986. Implemented as part of the Thatcher government’s market fundamentalist policies, this privatisation was initially merely a sale of state enterprises. However, British Gas remained a vertically integrated monopoly after privatisation, with no actual competitive environment.
During this period, the UK gas market was ostensibly privatised, but in reality, it continued to be dominated by pricing decisions made by a single company. British Gas sold gas at “cost-plus prices” based on procurement prices from North Sea gas fields, adding transportation costs and profits. This was fundamentally different from later GOG pricing.
The critical change was the 1988 Monopolies and Mergers Commission investigation report. This report identified British Gas’s monopolistic position as problematic and pointed out the need for the introduction of competition. However, it did not provide clear direction on specific competitive mechanisms. At this point, the idea of determining natural gas prices through “market mechanisms” was itself in an experimental stage.
Incidental Effects of North Sea Gas Field Development
The large-scale development of North Sea gas fields in the 1980s unintentionally laid the foundation for the creation of the GOG market. Multiple oil companies (Shell, BP, Exxon, Total, etc.) independently developed gas fields, leading to supplier diversification. This created the possibility of competition from multiple suppliers, unlike the previous single-supplier structure.
However, initially, these independent producers also sold through long-term contracts with British Gas, and no competition existed in the final consumer market. Creating a proper competitive environment required further institutional reforms.
Period 2 (Mid-1990s-2005): UK NBP Experiment and Early Challenges
NBP Creation: The World’s First Gas Hub Experiment
With the complete liberalisation of the UK gas market in the mid-1990s, NBP (National Balancing Point) began functioning in earnest. NBP was designed not as a physical delivery point but as a “virtual trading hub” in the UK’s high-pressure gas transmission network. This was an extremely innovative concept at the time.
The design philosophy of NBP applied the power market pool system to natural gas. The transmission system operator (Transco, later National Grid) managed the supply-demand balance of the gas transmission network, while each supplier and consumer conducted virtual transactions at NBP. This mechanism enabled price formation independent of physical delivery constraints.
Early NBP prices showed theoretical seasonal variations. Apparent price differences occurred between low-demand summer periods and high-demand winter periods, reflecting actual storage cycles and heating demand. This success attracted attention as the world’s first example of “true GOG pricing.”
Early Challenges: Difficulty in Ensuring Liquidity
However, from the early days of NBP operation, the fundamental challenge of ensuring liquidity became apparent. Actual gas consumers (power companies, industrial consumers, city gas companies) alone could not provide continuous trading volumes. Particularly during low-demand summer periods, trading volumes decreased significantly, sometimes falling below the minimum liquidity required for price formation to occur.
To address this issue, financial institutions began participating in NBP trading in the late 1990s. Investment banks and energy-specialised trading companies provided continuous buy and sell orders as “market makers,” improving liquidity. However, this improvement simultaneously created new problems.
With the participation of financial institutions, factors unrelated to actual demand began affecting NBP price formation. Interest rate fluctuations, exchange rate fluctuations, and stock market trends began to be reflected in NBP prices. The original “pure gas supply-demand” price formation had already begun to change during this period.
Parallel Development of the US Henry Hub
During the same period, the US developed GOG markets through a different approach. The 1978 Natural Gas Policy Act, 1985 FERC Order 436, and 1992 FERC Order 636 gradually deregulated producer price controls and promoted the transition to market mechanism-based price formation.
Henry Hub was established by Sabine Pipe Line LLC in 1988, but full-scale GOG price formation began in the early 1990s. The fundamental difference from NBP was that Henry Hub was an actual physical delivery point. Located at the intersection of natural gas pipelines near Erath, Louisiana, Henry Hub directly links actual gas delivery with price determination.
Henry Hub price formation was based on the vast gas supply network of the North American continent from the beginning. Competition from diverse supply sources, including imports from Canada, Gulf Coast production, and onshore production from Texas and Oklahoma, achieved more stable price formation than NBP.
The NYMEX (New York Mercantile Exchange) began trading Henry Hub futures in 1990. This futures market was designed from the start to include financial investor participation, incorporating speculative elements into the market design.
Period 3 (2005-2012): European Expansion and Institutional Design Confusion
EU Third Energy Package: First Clash Between Ideal and Reality
The 2009 EU Third Energy Package (Directive 2009/73/EC) legally mandated the creation of GOG markets throughout Europe. This policy was an attempt to extend the success of the UK NBP to continental Europe, but policymakers insufficiently understood the fundamentally different market environment from the UK.
Continental European natural gas markets had structures completely different from those in the UK. Each country had supply structures based on long-term relationships with specific suppliers: Germany with long-term contracts from Russia, France with government agreements with Algeria, and Italy with pipeline supplies from Libya and Algeria.
Creating GOG hubs in this environment meant fundamentally changing existing long-term contract systems. However, policymakers misunderstood that market structures would automatically change through institutional changes alone.
Proliferation and Dysfunction of Gas Hubs
Due to EU directives, each country competitively established gas hubs. Germany established NCG (NetConnect Germany, 2009) and GASPOOL (2009). France established PEG (Point d’Échange de Gaz, 2008). Italy established PSV (Punto di Scambio Virtuale, 2003). The Netherlands established the TTF (Title Transfer Facility) in 2003. Multiple hubs were established throughout Europe.
However, many of these hubs were already in serious dysfunction from the beginning. The biggest problem was that existing long-term contracts continued at traditional OPE (oil price escalation) prices rather than hub prices. Trading at newly established hubs was limited to residual portions not covered by long-term contracts.
As a result, hub prices did not accurately reflect overall supply and demand but became “marginal prices,” reflecting only the minimal residual supply and demand. Residual supply and demand exhibited significantly greater volatility than overall supply and demand, resulting in hub prices that displayed abnormal fluctuations, disconnected from actual market conditions.
2009 Gas Crisis: First Major Test of GOG System
The January 2009 Russia-Ukraine gas dispute became the first major test for the newly established GOG system. From January 7 to 20, gas supplies from Russia to Europe via Ukraine were halted entirely. At this time, European gas hub prices should have functioned according to theory.
However, in reality, hub prices showed not rational price adjustments but panic-driven abnormal spikes. Prices at newly established hubs soared from several times to more than ten times the normal levels, representing price reactions far exceeding actual supply shortages.
The cause of this abnormal reaction was critically insufficient liquidity. During the crisis, actual demand companies refrained from trading and financial investors withdrew, causing hub liquidity to fall significantly below normal levels. This resulted in a situation where a small number of transactions significantly influenced prices, thereby hindering the price discovery function.
More seriously, hub price increases did not induce actual demand adjustments or the development of alternative supplies. Many industrial consumers received supplies at OPE prices through long-term contracts and were not affected by hub price increases. Alternative supplies were also provided within existing contract ranges, with no additional supplies responding to hub prices.
Period 4 (2012-2020): US Shale Revolution and the Illusion of GOG Revival
Shale Gas Revolution: Unexpected Saviour of GOG Theory
The US shale gas revolution of the early 2010s unexpectedly gave credibility to GOG theory. Henry Hub prices fell dramatically from $12.69/MMBtu (July high) in 2008 to $1.92/MMBtu (April low) in 2012, demonstrating to the world that this dramatic price change was the result of actual market mechanisms.
The characteristics of shale gas technology lie in production characteristics that are fundamentally different from conventional gas fields. While conventional gas fields required massive initial investments and lengthy periods before production began, shale gas required relatively small initial investments and could begin production in a shorter period. This technical characteristic improved supply response to price fluctuations.
When Henry Hub prices declined, shale gas producers operating at a loss stopped production, and when prices rose, they began new drilling. This supply adjustment led to relatively stable trends in Henry Hub prices. This attracted worldwide attention as a textbook example of GOG price formation.
Spillover Effects to Europe and Spread of Misunderstandings
US success stories provided strong arguments for European GOG proponents. The European Commission established the “Gas Target Model” in 2012, setting the goal of creating an integrated GOG market throughout Europe by 2020.
However, this goal-setting was based on excessive expectations of US success stories and overlooked European-specific constraints. Europe had limited cross-border pipeline capacity and insufficient storage capacity in each country. Furthermore, environmental regulations made new gas field development difficult, and shale gas development was practically impossible.
TTF Rise and Side Effects of Hub Integration
From around 2015, the Netherlands’ TTF began rapidly consolidating liquidity among multiple European hubs. TTF overwhelmed other hubs due to the Netherlands’ geographical advantages (pipeline connections to Germany, Belgium, and France) and Gasunie’s (Dutch Gas Corporation) aggressive market development policies.
TTF’s liquidity consolidation was superficially evaluated as “successful market integration.” TTF’s trading volume increased significantly, establishing its position as the central hub of the European gas market.
However, this liquidity consolidation simultaneously created new problems. TTF prices became excessively influenced by the Netherlands’ specific supply-demand circumstances (Groningen gas field production reduction plans, Russian dependence, LNG receiving capacity, etc.). Hub prices, which should have reflected European-wide supply and demand, became “regionally biased prices” influenced by specific regional circumstances.
JKM Creation in Asian Markets and Complication of Private Indicators
In 2009, UK-based Platts (part of S&P Global) created JKM (Japan-Korea Marker), a price indicator for Asian LNG markets. JKM was not an actual hub price but an “assessment price” calculated from limited transaction data and broker information.
The background to JKM creation was the opacity of Asian LNG markets. Previously, Asian LNG prices were individual long-term contract prices (mostly OPE-linked), with no unified market price. This created a serious information asymmetry in LNG trading negotiations, preventing buyers from judging appropriate prices.
Platts was an established information company founded in 1909 with a long track record in oil market price assessment. Having established industry-standard status in calculating crude oil price indicators (Brent, WTI, etc.), it intends to provide price indicators in LNG markets based on this track record.
However, JKM had fundamental structural problems. In oil markets, abundant spot trading existed, allowing Platts to calculate its price assessments based on actual transaction prices. However, in Asian LNG markets, spot trading volumes were extremely limited and insufficient for statistically meaningful price assessment.
Parallel Development of Singapore LNG Futures Market
During the same period in 2013, the Singapore Exchange (SGX) began trading LNG futures. SGX LNG futures were designed as futures contracts based on actual transaction prices, distinct from assessment prices such as JKM. Contracts with physical delivery options provided real-time price discovery functions during Asian trading hours.
The existence of SGX LNG futures established a multi-layered price formation structure in Asian LNG markets where assessment prices (JKM) and actual transaction prices (SGX futures) coexisted. This became a unique Asian price formation mechanism, different from Europe’s TTF market or America’s Henry Hub market.
By utilising SGX’s geographical advantages (Southeast Asian LNG hub) and Singapore’s financial market infrastructure, fundamental transaction-based price formation functions were partially introduced to Asian LNG markets.
Emergence of Competing Indicators and Expanded Market Confusion
While JKM problems were being pointed out, companies like ICIS (part of Reed Business) and Argus Media began publishing their own Asian LNG price indicators from the 2010s. Each company employed different calculation methods and offered varying price levels, contributing to price confusion in Asian LNG markets.
Major Competing Indicators:
- ICIS East Asia Index (EAX): Started in 2012, adopted a unique calculation methodology
- Argus Northeast Asia LNG: Started in 2014, adopted volume-weighted methodology
- Gas Intelligence LNG Asia Index: Monthly assessment using a unique evaluation methodology
Price differences between indicators frequently occurred, creating situations where different price assessments for the same market existed simultaneously. These price differences became serious practical problems, with the selection of price indicators becoming a major point of contention in contract negotiations.
Period 5 (2020-2022): COVID-19 and Fundamental Breakdown of Price Formation
2020 Oil Shock: OPE Contract Dysfunction
On April 20, 2020, due to a demand collapse caused by COVID-19 and production competition between Saudi Arabia and Russia, WTI crude oil prices recorded a historic -$40.32 per barrel. This abnormal situation exposed fundamental flaws in OPE (Oil Price Escalation) contracts.
Detailed Background:
- March 6: Russia refused to extend the production cut extension at the OPEC+ meeting
- March 8: Saudi Arabia announced a production increase and discount sales
- April 12: OPEC+ agreed to the largest-ever production cut (9.7 million barrels/day)
- April 20: WTI May futures closed trading at -$40.32 due to storage capacity constraints
Many OPE contracts had not anticipated “negative prices.” Contract terms used formulas like “crude oil price × coefficient + basic fee,” but the processing of cases where crude oil prices became negative was not specified. This resulted in frequent litigation worldwide over the interpretation of the law.
More seriously, OPE prices completely diverged from actual gas supply and demand. Oil demand declined significantly due to reduced aviation fuel and gasoline demand; however, natural gas demand was relatively minimally affected, largely because of changes in residential demand resulting from work-from-home arrangements. However, through OPE contracts, gas prices were forced to decline in line with oil prices.
Expansion of GOG Price Regional Fragmentation
During the same period, serious problems became apparent with GOG prices. In response to COVID-19 demand fluctuations, GOG prices in each region showed completely different reactions. During the 2020 price decline, Henry Hub, TTF, and JKM prices reached significantly different levels, with abnormal spreads that transportation costs could not explain.
The cause of this regional fragmentation was that GOG markets in each region were independent and had not formed an integrated global market. Theoretically, LNG trade should have enabled price arbitrage, converging regional price differences. However, in reality, arbitrage functions were limited due to constraints on LNG transportation capacity, port reception limitations, and contract rigidity.
China’s Large Procurement Volume Changes and Market Impact
From summer 2021, China significantly increased LNG procurement volumes. While inventory building for winter demand appeared superficially normal, the rapid changes in procurement volumes had a major impact on global LNG prices. China’s spot LNG procurement volumes increased significantly year-over-year, contributing to global LNG price increases.
China’s actions raised the issue of “large consumer market influence” in GOG markets. Traditional GOG theory assumed price manipulation was impossible due to the numerous dispersed consumers. However, it became clear that large consumers, such as China, could significantly influence market prices through their procurement actions.
These procurement actions also included political motivations. China was preparing for the 2022 Beijing Winter Olympics, making energy supply security a political priority. Therefore, large-scale procurement was executed based on factors different from economic considerations.
Period 6 (2022-Present): Geopolitical Era Price Formation Breakdown
Russia-Ukraine War: Complete Abandonment of Economic Rationality
Since Russia’s invasion of Ukraine on February 24, 2022, European gas markets became markets where political considerations, not economic rationality, dominated price formation. The European Commission announced the “REPowerEU” plan on May 18, deciding to eliminate dependence on Russian fossil fuels by 2030, beginning the conversion of supply sources regardless of economic costs.
This political decision caused TTF prices to spike temporarily to 339.195 euros/MWh (approximately $115/MMBtu equivalent) on August 26, 2022. This price level was an abnormal value far exceeding actual alternative supply costs.
More seriously, these abnormal prices did not induce actual adjustments in supply and demand. Industrial consumers reduced their demand through production shutdowns and energy conversion, but this action was primarily due to political pressure, rather than a price response.
2022 JKM Abnormal Spike: Decisive Exposure of GOG Price Formation Fundamental Limits
From August to September 2022, JKM (Japan-Korea Marker) prices spiked abnormally to over $50/MMBtu, decisively exposing the structural vulnerabilities of GOG price mechanisms. This incident became a historical case proving that the “perfect competition markets” assumed by GOG theory do not exist in reality.
Fundamental Contradiction Between Assessment Price Systems and GOG Theory
This abnormal spike was most significant because JKM recorded the highest prices compared to contemporaneous TTF prices (approximately $30-35/MMBtu) and Henry Hub prices (approximately $8-9/MMBtu), despite lower geopolitical risks. This reversal phenomenon reveals that what is referred to as “GOG prices” in each region is based on completely different price formation mechanisms.
TTF represents continuous transaction prices at actual gas trading hubs, with prices formed through actual transactions by numerous market participants. In contrast, JKM is an “assessment price” calculated by Platts from limited spot transaction data and broker information. While both are referred to as “GOG prices,” one represents actual transaction prices, while the other represents estimated prices – fundamentally different systems coexist.
Structural Vulnerabilities and Price Distortion in Spot Markets
Behind the 2022 JKM abnormal spike were structural vulnerabilities in Asian spot markets. The June shutdown of Freeport LNG (approximately 15 MT annually) eliminated an important component of spot supply to Asia. However, more seriously, such supply fluctuations changed the nature of spot trading itself, which forms the basis of JKM calculation.
During normal times, Asian spot trading was limited to several transactions per day, but was still centred on regular commercial transactions. However, after the Freeport shutdown, spot market trading mainly became emergency procurement cases. The proportion of transactions executed based on criteria different from normal commercial judgment increased, such as emergency LNG for power generation to avoid blackouts and alternative procurement to avoid contract defaults.
The problem was that such “exceptional emergency procurement prices” were treated equally with “normal market prices” in JKM calculation. In emergency procurement, high prices may be temporarily necessary to prevent damage from blackouts or contract violations. While this is rational business judgment, when such emergency prices become the basis for JKM calculation, assessment prices no longer reflect normal market conditions.
Absence of GOG Theory Prerequisites
What this incident showed was that the market conditions assumed by GOG theory are not met in reality. GOG theory assumes that numerous independent suppliers and consumers with sufficient market information can trade freely without physical constraints, achieving efficient price formation.
However, in Asian LNG markets, suppliers are mainly limited to large-scale projects in the Middle East and Australia. At the same time, consumers are concentrated among major utilities in Japan, Korea, and China. True competitive markets are not formed with a structure where the actions of a few large players significantly impact the entire market.
More importantly, LNG’s physical constraints are. Due to LNG vessel scheduling, port reception capacity, and existing contract terms, making flexible short-term supply-demand adjustments is challenging. The “rapid supply response to price fluctuations” assumed by GOG theory is significantly limited by actual physical constraints.
Serious Spillover to Real Economy
JKM’s abnormal spike clearly showed the social costs of GOG price mechanisms. Japanese power companies faced management pressure from rapidly rising power generation costs, while Korea implemented significant increases in electricity rates. In emerging countries such as Taiwan, Thailand, and India, high LNG prices have accelerated a return to coal-fired power.
Severe was the impact on consumers who had concluded long-term contracts linked to JKM. These contracts included monthly price adjustments tied to JKM prices, so the August-September JKM price spike was directly reflected in the actual procurement costs for October and November. “Market mechanism” price determination resulted in excessive burdens on actual consumers.
This incident revealed a fundamental problem: the benchmark price for annual LNG trading, worth hundreds of billions of dollars, was calculated from a statistically limited number of transactions. Major Asian LNG buyers have begun seeking an escape from JKM dependence, with China accelerating the development of its own price indicators, Japan considering government-led diversification of price indicators, and Korea initiating a review of price clauses in long-term contracts.
Current (2024) Structural Challenges: Divergence from Real Demand Due to Financialization
According to IEA data, TTF market price volatility reached 50% annually as of 2024, a level 34% above the average for 2010-2021. Behind this high volatility lies the potential for an expanded influence of financially oriented transactions, such as futures trading.
In TTF markets, the scale of financial transactions may exceed actual demand, with algorithmic trading by major investment banks and hedge funds becoming increasingly widespread. These algorithms are believed to tend toward buy-sell execution based on technical analysis and correlations with other markets, rather than actual gas supply and demand information.
This financialization may have strengthened the tendency for gas prices to reflect financial market trends rather than actual supply and demand for gas. Interest rate fluctuations, exchange rate fluctuations, stock price fluctuations, and changes in investor risk preferences may be affecting gas prices to the same degree or more than actual gas supply and demand. This means fundamental deviation from “price formation by gas supply and demand,” the core of the GOG concept.
In current Asian LNG markets, multiple price indicators, including Platts JKM, ICIS, and Argus, coexist. While these indicators publish methodologies, specific data selection in daily price calculation, discretionary judgment criteria, and real-time decision processes remain non-transparent. Situations frequently arise where different price assessments for the same market at the same time coexist, making the selection of price indicators a significant point of contention in contract negotiations.
Achievements and Limitations of 25 Years of GOG Development
Areas certainly improved through 25 years of GOG development also exist. The most notable improvement is enhanced transparency in price information. In the 1990s, natural gas prices were corporate secrets of individual contracts, but now major hub prices are published in real-time and accessible to anyone. Transparency is ensured through continuous price publication at Henry Hub, TTF, NBP, and other locations.
This transparency improvement enhanced the buyer’s negotiating power. In traditional OPE contract negotiations, buyers had no materials for judging appropriate prices, but now equal negotiations are possible by referencing hub prices and spot prices. Additionally, financial products such as futures trading, options trading, and swap trading enable the hedging of price volatility risks and diversify risk management tools.
Trends toward shorter contract periods and improved freedom in procurement source selection are also important improvements. From a traditional long-term contract focus, the proportion of medium-term contracts increased, improving demand-side procurement strategy flexibility. During the Russia-Ukraine war, Europe’s reliance on Russian energy sources declined rapidly, from approximately 40% in 2021 to around 5% in 2024, as the continent achieved diversification to alternative procurement sources, including US LNG, Qatar LNG, and Norwegian pipelines. Rapid supply source conversion, impossible under traditional 20-25 year fixed contracts, was realised through flexible contract structures based on GOG.
However, unresolved issues have more serious implications than resolved issues. The most fundamental problem is the extreme regional concentration of liquidity. In current global gas markets, Henry Hub and TTF have overwhelming liquidity, while other regions have significantly insufficient liquidity. This liquidity concentration has fixed a structure where a few giant hubs dominate global price formation. While theory suggests that multiple hubs should coexist through competition, reality shows liquidity consolidation progressing through network effects, leading to expanding oligopolization.
As demonstrated by China’s significant changes in procurement volume in 2021 and Russia’s supply adjustments in 2022, GOG markets are susceptible to deliberate actions by major players. While theory suggests price manipulation is impossible due to numerous dispersed participants, reality shows that a few giant countries or companies can significantly influence markets.
Structural Limitations of GOG Price Formation: Invariability of Physical Constraints
What 25 years of GOG development history clearly shows is that the physical characteristics of natural gas fundamentally impede the prerequisites of GOG theory. GOG theory assumes “perfect competition markets,” but due to the physical constraints of natural gas as a commodity, these prerequisites are not met in reality.
Insurmountable Storage Constraints
Underground natural gas storage requires specific geological conditions (depleted gas fields, aquifers, salt formations, etc.), with suitable locations geographically concentrated. Large-scale artificial storage requires volume reduction through liquefaction; however, liquefaction-regasification costs are extremely high, posing significant economic limitations. These storage constraints significantly limit flexibility in responding to seasonal demand fluctuations and supply disruptions.
Even at NBP and TTF, trading volumes decline significantly during low-demand summer periods, sometimes falling below the minimum liquidity required for price formation to occur. This is because surplus gas cannot be efficiently stored due to storage constraints. In true market mechanisms, low prices during surplus periods should stimulate storage demand, but physical constraints limit this adjustment function.
Market Fragmentation Due to Transportation Constraints
Pipeline transportation has fundamental limitations in flexibility due to fixed infrastructure. Construction requires long periods and massive investment, with route changes practically impossible. This results in regional markets fragmented by pipeline networks, limiting price arbitrage functions between regions.
LNG transportation also has limits for short-term supply-demand adjustments due to dedicated vessel scheduling, receiving terminal storage tank capacity, and regasification facility processing capacity. LNG vessel construction takes 2-3 years, making the supply response to rapid demand changes extremely slow.
During the 2022 Russia-Ukraine war, Europe reduced Russian dependence from approximately 40% in 2021 to approximately 5% in 2024, but this was the result of maximising existing LNG receiving infrastructure and pipeline networks, not a response through new infrastructure construction. Transportation constraints proved that complete substitution requires long periods.
Oligopolization Through Network Effects
Existing infrastructure investments form strong vested interests, making new entry extremely difficult. Henry Hub and TTF’s overwhelming liquidity is due to proximity to existing pipeline networks and storage facilities. The establishment of a new hub requires a connection to existing networks, but owners of existing infrastructure have little motivation to support the entry of new competitors.
As a result, where theory suggests that multiple hubs should coexist through competition, reality shows liquidity consolidation progressing through network effects, leading to the expansion of oligopolization. TTF’s consolidation of European hub liquidity, which began around 2015, is a typical example.
Political Constraints Due to Energy Security
A more fundamental constraint is the strategic character of energy. Natural gas is an irreplaceable energy source for power generation, heating, and industrial uses, with supply disruptions meaning shutdowns of social functions. Therefore, each government cannot politically accept allocation through pure market mechanisms.
When TTF prices spiked to over 300 euros/MWh (August 26) in 2022, European governments considered market intervention and actually implemented non-market measures, including gas demand reduction target setting, price cap discussions, and government procurement during emergencies. This shows that when GOG prices exceed socially acceptable ranges, government intervention nullifies market mechanisms.
China’s large LNG procurement volume changes in 2021 were also influenced by political factors related to the 2022 Beijing Winter Olympics, rather than purely economic rationality. Actions by giant consumer or supplier countries, based on political motivations, become significant factors distorting the GOG market price formation.
Realistic Solutions: Acceptance and Optimisation of Hybrid Systems
While fundamentally solving GOG market physical constraints is difficult, a realistic system design premised on these constraints is possible. What’s important is stopping expectations of GOG as an omnipotent system and appropriately utilising it for suitable applications after accurately understanding its usefulness and limitations.
Construction of Multi-layered Supply Structure
A realistic solution is to construct multi-layered supply structures combining different time horizons and price mechanisms.
For baseload supply, ensure a stable supply through long-term contracts. Rather than entirely abolishing traditional OPE contracts, provide cost predictability through modified OPE contracts that utilise weighted averages of multiple energy prices or fixed-price contracts with inflation adjustment functions. This allows consumers to secure basic energy security.
For swing supply, distribute risks through medium-term contracts (approximately 3-7 years in duration). Hybrid prices, which combine GOG and OPE prices or GOG-linked contracts with upper and lower price limits, restrict price volatility within certain ranges. This allows the utilisation of GOG price convenience while protecting consumers from abnormal price fluctuations.
For swing supply, ensure flexibility through short-term and spot trading. Utilise GOG prices’ rapid supply-demand adjustment functions and provide procurement rights only when needed through option contracts. This improves response capability to supply-demand fluctuations.
For strategic reserves, ensure crisis-time market stabilisation functions through government management for national security. Government market intervention during abnormal prices and international cooperation systems during emergencies reduce GOG market failure risks.
Regional Optimisation Approaches
Regional optimisation approaches according to regional characteristics are also critical. In North America, maintain and expand GOG systems centred on Henry Hub, utilising abundant domestic production and pipeline networks. By utilising shale gas production’s price responsiveness, relatively stable GOG price formation can be expected.
In Europe, construct modified GOG systems utilising diverse supply sources (Norway, Algeria, US LNG, Middle East LNG, etc.) and TTF hubs. Utilising current supply source diversification progress with reduced Russian dependence, maintain TTF liquidity while introducing mechanisms to suppress price volatility.
In Asia, construct multiple indicator systems premised on LNG import dependence. Escape from JKM monopoly by combining SGX LNG futures, national unique indicators, and new price indicators through regional cooperation, avoiding excessive dependence on single indicators.
In other regions, construct systems emphasising regional cooperation and government-to-government transactions. Gradually introduce GOG elements according to GOG market development stages and regional characteristics while basing on a stable supply through government agreements.
Expectation Management and Continuous Improvement
Most important is appropriate expectation management. GOG is not a perfect system, but it is a useful tool that can provide better results than traditional systems when appropriately utilised. The problem is ignoring GOG limitations, harbouring excessive expectations, and using it inappropriately.
The 2022 JKM abnormal spike incident and TTF price abnormal spikes reveal structural vulnerabilities in the GOG system. However, lessons learned from these incidents enable the design of more robust systems. Understanding assessment price system limitations and emphasising real transaction-based price formation, introducing mechanisms to limit the influence of giant players, and pre-establishing government intervention mechanisms during abnormal times are necessary, concrete improvement measures to implement.
Conclusions and Future Recommendations
In conclusion, while GOG is not currently an ideal price formation mechanism, it can be said to be a system with relatively superior characteristics among the options currently available. By understanding its structural vulnerabilities and limitations, and combining them with appropriate complementary measures, a practical and sustainable gas market can be constructed.
Future Recommendations: Realistic Evolution Path
The most important lesson from 25 years of GOG development history is that the key to sustainable development lies in improving practicality through gradual improvement, rather than pursuing perfect systems.
Future GOG system development requires a “constraint-accepting evolution” approach that pursues optimisation within constraints, while acknowledging the unchangeable realities of physical constraints. Also essential is recognising “mature market participation”, where GOG system users—governments, companies, and citizens—accurately understand its usefulness and limitations and appropriately utilise it without excessive expectations.
Energy markets are the foundation of national security and economic stability, requiring high reliability and predictability in their price formation mechanisms. For GOG systems to meet these expectations, realistic approaches that emphasise practical robustness over theoretical perfection and pursue continuous improvement while facing actual constraints will be the truly valuable evolution path.
Note: The analysis of market participant behaviour, policy responses, and causal relationships in this study includes analysis and speculation based on publicly available information. Some parts regarding specific purchasing behaviour and policy decision details require further verification.
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