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A swap is an OTC contract in which two counterparties undertake to exchange future payments, whose calculation rules and frequency are defined in the contract.
For example, it can be used to set the gas price: one of the counterparties promises the other one to pay a fixed price upon receiving the variable price (spot or indexed of other type). The settlement is made on the difference between the two amounts.
These products can be indexed to different underlyings and the formulas can be structured and adapted to specific needs. Among the available underlyings for this financial instrument, the following phisical or virtual trading points (hubs) exist, which can be classified according to the geographic area of reference:
TTF (Title Transfer Facility) – It is a virtual trading point for transfer and distribution of Dutch gas. This index is now the main reference in Continental Europe due to its high liquidity with respect to other European indexes and is expressed in Euros/MWh.
NBP (National Balancing Point) – It is a virtual trading point for transfer and distribution of gas in Great Britain and it is the most ancient hub in Europe. This index is expressed in ph/th (pence per therm).
PEG (Point d’échange de gaz) – It is a virtual trading point for transfer and distribution of French gas. This is the reference index in France since November 1st 2018, following the union of the different balancing zones in the nation: Northern Zone and Southern Zone which had PEG North and TRS as reference indexes. This index is expressed in Euros/MWh.
Henry Hub – It is a phisical trading point in the northamerican gas network, located in Erath (Lousiana). Nine of the main pipelines in US coverge to this point. This is the most liquid index in the world and is expressed in USD/MMbtu.
JKM (Japan Korea Marker) – It is a reference index published by Platts for the delivery of LNG (liquefied natural gas) in Japan and Korea which are two of the most important LNG importers in the world. This index is expressed in USD/MMbtu.
The future price of gas is set today.
No immediate disbursement
Financial settlement is made on the date of contract expiry.
Price risk coverage
Reduced exposure to market price.
The following graphs show the value of a swap contract for different levels of the underlying. In the event of a purchase, the contract has a higher value as the price of the underlying market increases. If, for example, a gas purchase contract was signed for the month of May at a price of 20 €/MWh, as the market price increases, there will be a greater gain deriving from the signing of the contract. On the contrary, in cases of price reduction, there will be a loss proportional to the difference between the market price and the purchase price.
In the event of sale, the contract has a higher value as the price of the underlying market decreases. If, for example, a gas sale contract was signed for the month of May at a price of 20 €/MWh, as the market price decreases, there will be a greater gain deriving from the signing of the contract. On the contrary, in cases of price increases, there will be a loss proportional to the difference between the market price and the selling price.