The gas sell-off for contracts relating to this winter/spring & coming summer has continued in the last few days. On January 16th alone, contracts closed down c15%-17% on gas contracts for this spring and through into summer. This is despite some analysts predicting that gapping-up would occur on the promise of imminent cold weather. As it happens, the current forecast suggests such a cold spell is likely to be short.
These price falls continue the big stepped reductions from the August 22 levels witnessed in the Autumn. The February contract for example is now at a sixth of those “Everest peak” prices of last summer. As remarkable as those prices were, so also is the fall away we have seen, particularly since Christmas.
We should not get too excited. Price sentiment is relative to your benchmark. Gas prices remain 2-3.5x historic norms, and well above previous decade highs experienced in the Autumn of 2018 (of around 90p/therm inflation adjusted). Benchmarked to June 2021 prices, the February NBP contract is just over twice that level, but summer contracts remain elevated over 3x.
These prices are considerable improvements even if they imply continued high energy costs for households and businesses. What is certainly true is that with every week right now the price outlook improves.
So, what is going on and what can we expect for the rest of the year…
What’s going on?
- European underground gas storage remains at c81% full this year. Whereas the average over the last five years would be closer to 60%. The impending short cold spell and the short December cold spell haven’t offset the impact of atypical temperatures over Christmas & new year. In fact, for periods over the festive holidays, Europe was increasing storage inventories. Not entirely unprecedented, but highly unusual, particularly in a winter beset by fears of crisis. The weather has been massively helpful.
- There are no real issues on Liquefied Natural Gas (LNG) supply for Europe to worry about. True, the US LNG export facility at Freeport looks likely to be delayed in reopening again beyond this month but that’s probably priced into both US and European markets.
- Remaining Russian pipelines still flow. Volumes are reduced in 2023 so far, but that’s because of European demand being lower rather than supply being constrained artificially. Yamal is still not flowing following a long-running dispute, but that’s been the situation now for many months. Europe continues to utilise Russian LNG too.
- JKM (Japan LNG) prices are higher than in Europe but post freight costs, the price spread isn’t a dial mover, and Japanese and broader Asian demand is still relatively low at these prices.
- European gas demand has been consistently lower, reflecting milder temps and some fuel switching in industry and some lower output concentrated on certain sectors that could not economically maintain operation.
- Chinese demand is not making a dent on the spot prices of LNG at this stage of very recent reopening. In fact, reports (Bloomberg) are still of China redirecting optional volumes toward Europe still.
- Probabilities that European aggregate underground gas storage could end winter at 50% or higher are rising as time passes. Using the latest data this outcome becomes more and more possible. If we take the five-year average net withdrawal/injection trends for the remaining winter season and apply them to the current level of storage, then 50%-60% is well within the bounds of plausibility. If we do end winter with European gas storage at these levels then refilling to 90% could happen by August 23, if we assume post-NS1 closure volumes of injections of last summer are applied to summer 23.
Virtually everything on the scorecard of swing factors – weather, infrastructure availability, energy demand, geopolitics, and macroeconomics – have swung in favour of beneficial gas price outcomes in recent weeks. And as the picture on end-of-season storage solidifies, and winter gets timed out, risk shedding is driving prices ever lower. This may continue if the storage picture solidifies further in the coming weeks with lower-than-average withdrawals, and unless we see weather forecasts suddenly print out for prolonged arctic cold. The weather could change in that direction of course, but if not, near-term gas prices could yet fall further if the idea of strain this winter is truly put to bed. Then as storage is refilled, we could see them crest and subside in a summer wave of volatility.
Yet, we still see warnings from many quarters that the crisis is not over, and the outlook remains uncertain. Overall, we would agree that we cannot use the past as a predictor of the future, mainly because there are so many widely uncertain variables still in play, which the European market has not had to wrestle with before, even during 2022, when lest we forget, Russian pipeline gas availability was far higher. Additional major global new supplies of gas are not anticipated in 2023-2024 so the possible variables are against this backdrop:
- The demand from China is a big factor. Gas demand from China did not temper as much as their reduced LNG demand suggests, as they increased supply from other sources, and thus reopening may not have as big an effect on European LNG sourcing as some may expect. But overall, it is infeasible that the reopening and sudden growth of one of the world’s biggest economies and biggest consumers and importers of energy could occur without impacting global energy dynamics. We already see some early signals in metals, but this is yet to feed through into energy. Chinese New Year holidays last until the end of January, and reopening is still early days, so it really is too soon to spot any trends beyond the weather. China sources gas from a variety of sources, with locational variances, and an awful lot under long-term contracts. An economic growth bounce back could drive increases in spot LNG demand if domestic ex-terminal prices rise higher than LNG in areas not well supplied by pipeline gas. Will the Chinese economy return to growth trends? Will demand influence gas prices majorly? Or can China fuel growth from other sources than imported gas? Much rests on the answers.
- Russian pipeline volumes could frankly go each way. Turkstream and Ukraine routes aren’t NS1 in orders of magnitude, but still important in an uncertain environment. There were talks of Yamal restarting too but equally, in a period of bluff and subterfuge it’s hard to say without being inside the mind of the regime what will really happen. What is and is not rational depends on the goal and motivations of the actors. For Russia, energy is likely to remain tied up with geopolitics, and whilst their leverage is much lower, it is not negligible. It could go either way, and the timing of actions or outages could be crucial. Non-Russian gas infrastructure has maintenance cycles and is not invulnerable to accidents. Both could reduce availability for limited periods, and summer will be an important storage refilling period. Russia is not entirely a passive spectator as some have now painted it to be.
- European demand levels are also hard to pick. Demand falls have in some cases been spectacular but against a backdrop of prices which created the sharpest of incentives to change behaviour, even with government support. In industry lower prices in 2023 versus 2022 could invite higher output from ever-increasing segments of the economy over time, but without additional gas supply, this will also build price pressure over time. In power, coal-to-gas switching may kick in again if prices fall further, delivering some upward pressure on demand which reverses price movements. This isn’t likely in the very near term, but clean spark and clean dark spreads don’t stand still. Macroeconomic outlooks for European countries, whilst still challenging, have been revised upwards on the better end-of-year data, and this too may signal less demand shedding from recessionary effects. Or we could see deeper recessions from Central Bank’s continuing to raise rates. The consensus has been wrong on these issues repeatedly. Today, reality versus expectation suggests more economic demand than previously anticipated. Maintaining gas demand reductions is feasible but not guaranteed.
- Weather can still deliver upward pressure, both via a cold tail to this winter, but also ironically if we don’t get normal winter conditions or a warmer dryer summer. Lower snowfall now could feed through to lower hydro stocks. Like last year, heatwaves could trigger higher energy demand for cooling in summer, and droughts could once again effect cooling and lower river levels for key fuel delivery routes for non-gas generation. Or we would have a mild, windy and wet spring and summer, interspersed with normal temperatures and solar irradiance and this will see an easier period for Europe as it benefits from much expanded renewable capacity. It is way too early to say which way the weather will go.
- Japanese gas for the forecast 2023 reductions in power demand are predicated on restarting more nuclear reactors which are still subject to regulatory approval, and supply chains. Japan is an underestimated energy market. It is of a huge scale, so how their power decarbonisation strategy unfolds is important in determining the global gas picture.
- News stories suggest that there are large unhedged or unprofitable gas storage positions taken by the likes of THE (German gas market area manager) which need to be unwound at some stage, with crystallisation of losses, and probably downward pressure on gas prices. There may yet also be energy company casualties arising from margin compression and mark-to-market exposure which could disrupt the sector. On the other hand, we have gas storage refilling strategies and potential coordinated gas buying across EU states, which may see large volume buying return to the markets, with state enabling, creating upward pressure on prices as these strategies are enacted.
We have said previously that we are humbled by trying to piece together a confident view when faced with such a diverse, complex, and agent-based suite of factors. When we released our wide-ranging estimates of the Energy Price Guarantee (EPG) costs we stated unequivocally that it was extremely difficult to say exactly what pathway energy prices would follow from here until Spring 2024. We still believe that to be true.
Unless there is a sudden renaissance of Russo-European peacetime energy relations, we can say with some certainty that Europe will need to compete for LNG. Thus, the inter-market spread with Asia, competing for LNG exports mainly from the US, could define the coming years. This sets a dynamic price benchmark of sorts. This idea too is probably driving some sense of a “new normal” emerging, but just quite what floors and ceilings will apply is very hard to predict given the diversity of influences we see in the market. The futures market volatility suggests this is an opinion widely shared.
We have also said that policies for consumers and the governments that stand behind them are best designed to be targeted, elastic, and flexible. More particularly, we think that in such an environment of this, hubris and overreaction to market prices is as dangerous when they fall as it is when they rise. Not only because we have not yet seen the full lag effect of the energy prices of last year fully play through for consumers, and self-congratulation therefore can appear tone deaf, but also because 2022 taught us that all we think we know about market drivers can be turned on its head very quickly. We haven’t had a stable cycle in the economy, let alone the energy sector, for three years. 2023 could be the year in which we get some respite, but if we do, it will be as much by a number of disparate factors aligning favourably as anything else.
In our view, energy policy right now should work on the basis of “expect the unexpected”.
