Gas prices across Europe have continued to surge, reaching highs seen only a few times before, particularly at this time of year, with European natural gas contracts reaching their highest levels in almost 13 years. So, what's behind this unprecedented rise?
Cold Weather & Pipeline Maintenance
There are several factors that have contributed to this "perfect storm." Firstly, we saw a prolonged spell of cold weather extend well beyond the 'normal' winter period in both the U.K. and Europe, with temperatures significantly below seasonal norms, stretching well into May. This meant that gas demand for heating remained much higher, for much longer, than expected, which in turn meant more gas being required. This led to many European countries having to turn to / tap into gas previously held in medium and long-term storage to meet the increased demand. Unsurprisingly, the amount of gas currently held in storage has fallen to unprecedented levels - less than 50% against what normally would be expected at this time of year - the lowest in the last decade.
Secondly, the supply of natural gas – in particular natural gas coming into Europe via Norwegian pipelines. Norwegian gas exports have been severely impacted due to planned and unplanned maintenance, many of which incurred delays and extensions, all of which contributed to a series of gas outages and a reduction in the volume of gas flowing through these pipelines. Simultaneously, natural gas flowing into Europe from the East – most notably from Russia via Ukraine – has also been impacted due to Russia's unwillingness to book additional available pipeline capacity to allow more gas to be pumped through and ease the tight supply situation.
The more cynical amongst us – and perhaps with some justification – might see this as an extension of Russia's (read Putin's) intent - to exert even greater political control over Europe's dependence on Russia for gas. What better way to help ensure the completion and acceptance of the Nordstream 2 project – designed to double the pipeline flows of gas coming directly into Germany from Russia - by simply refusing to open the taps and allow gas to flow freely through the alternative routes via Ukraine? Either way, this situation has also contributed to the lack of available gas in the marketplace.
Generally, when the supply of natural gas is tight, European markets look to Liquified Natural Gas (LNG) to help fill that void. LNG plays a key role in gas market integration, especially between European and Asian markets. Asia has very little by way of its own natural gas supply outside of China's pipeline connection with Russia. Consequently, Asia relies far more heavily on LNG than Europe. Because of the nature of LNG – i.e., it's shipped from key producers such as Qatar, Australia, U.S.A, and Russia – it can easily be directed and re-directed to whichever market is bidding the highest price for the product.
Yet again, a combination of factors including increased industrial demand in China, cold weather in Asia at the start of the year, followed by a heatwave currently across Japan, peak seasonal demand in the Middle East, and higher demand in Brazil due to low levels of hydro-electric generation - have all contributed to diverting LNG shipments intended for Europe elsewhere. Add into the mix that the LNG supply has also been affected by maintenance schedules in both the US and Australia - it is not difficult to see why the LNG import levels into Europe have dropped off dramatically, further exacerbating what was already a tight supply situation.
It is not just the gas markets that have risen sharply over the recent months. The wider commodity markets (from oil, coal, copper, and iron ore - to soya beans, wood, and grain) have all experienced unprecedented price increases as investors awash with cash, fuelled primarily through central bank easing and government support programmes, seek places to invest these funds. And where better to put cash than into commodities, with an expectation of a prolonged post-pandemic economic recovery supported by the rollout of successful vaccination programmes?
These elements have individually and collectively contributed to pushing European gas prices up to levels that few would have predicted only a few months ago. The upward pricing pressure seems to be far greater in the price of near-term contracts – as evidenced by the degree of backwardation in forward contract prices. As such, a correction of some description seems likely – nonetheless, we can expect to see considerable volatility until such times as more gas starts to flow and storage levels increase.
More: Research Notes, Natural Gas, Nord Stream 2