Energy markets are so damn fickle
And none more so than natural gas
Three weeks is a long time in energy markets. Before the Christmas break, Europe was enduring a bitterly cold snap characterised by very low wind speeds and strong heating demand. The abysmal performance of France’s ageing nuclear fleet placed extra demand on dispatchable power generation. Christmas had come early for natural gas traders, or so it seemed.
The last Energy Flux post of 2022 detailed the eye-watering profits being made by trading houses from shipping LNG to Europe. In theory, each spot cargo of American LNG could make as much as $125 million in profit from shipping gas across the Atlantic. Fast-forward three weeks, and that profit margin has more than halved, to less $60 million throughout Q1 2023.
Not only that, but there are now better profits to be made from shipping the same cargo of US LNG through the Panama Canal to Asia. The ‘Asian premium’ for gas has returned, but only because Europe – once the market of last resort for LNG – is facing a short-term glut. It is quite the turnaround.
What gives? That cold snap turned out to be mercifully brief for beleaguered European energy consumers. Temperatures soared and wind speeds picked up around Christmas time, sending European gas and power prices plunging as heating demand vanished. German spot power prices – which have at times breached €1,000 per MWh since Russia’s full invasion of Ukraine – even flipped negative.
The rapid onset of weirdly warm weather had a particularly strong impact on wholesale gas prices because the EU policy to panic-buy LNG to refill gas stocks was so spectacularly successful. EU-wide gas storage levels are nearly full, even with no gas flowing down the Nord Stream pipeline for four months. Germany even reverted to net injections of gas back into storage in late December, in the midst of a supposed EU gas supply crisis. How many people saw that coming ten months into the invasion and amid Russia’s overt weaponisation of gas?
Brimming gas stocks and weak winter demand created an opening for gas-fired power generation, which has been firmly out of the money for months. With wholesale prices on the European benchmark TTF now trading lower than before the invasion, the economics of gas-to-coal fuel switching in the power sector are no longer compelling.
Coal is still well ahead of gas in the merit order, thanks in part to a dip in the price of carbon allowances (EUAs) on the Emissions Trading System from €90/tonne in December to €74/tonne today. But it is notable to observe an illustrative 50% efficient combined-cycle gas turbine (CCGT) coming back into the money in the first half of the year, with margins positively healthy over the summer months.
We are not quite at the coal-to-gas switching point, but the sea change in prices has all but killed off Europe’s brief coal resurgence (and before it moved the needle on emissions, too). Those voices that howled gleefully at the restart of British, Dutch and German coal plants have fallen silent. Coal might still serve an important purpose keeping the lights on during black swan events, but the direction of travel is as clear as ever.
The charts above show how the market is doing its thing: signalling for a reduction in gas (LNG) imports, and calling for more power sector gas burn to stop storage facilities reaching tank-tops. So far so logical. But the pace of change, and the ability of energy markets to flip in this way, means the outlook is highly unpredictable.
European gas demand has been falling since the summer in response to unaffordably high prices, and the drop is accelerating. The crucible of European demand destruction is not the power sector but households and heavy industry. There is no reason to believe this trend will be reversed in the medium term, and lost demand cannot easily be recreated if consumers go broke, find alternative fuels, or discover they can make do without.
Deindustrialisation is the economic buzzword for Europe in 2023. The financial repercussions of stocking up on unburnably expensive gas will play out against severely reduced pipeline flows, creating a race to the bottom for both demand and supply. The potential for volatility is as high as ever.
Add to this the incoming EU gas price cap, and the outlook is even more unpredictable. The ‘dynamic’ cap of €180/MWh, triggered only when TTF is trading €35 above global LNG prices for three consecutive days, might seem irrelevant at today’s prices. But the cap would have been activated on around 40 days in August and September, according to analysts.
A late winter cold snap, an EU ban on Russian LNG imports, or a resumption in Asian LNG demand driven by China’s reopening could cause global markets to tighten rapidly. If the cap is triggered and all EU consumers are suddenly shielded from wholesale price signals, demand could rise even as supplies become constrained. And all of this could happen just as the EU is striving to hit its 90% gas restocking target for winter 2023/24.
The fickle nature of energy markets was laid bare in 2022. This year, the inherent volatility of natural gas combined with ill-conceived policies, weird weather and the vagaries of the global economy will all drive energy prices in unexpected and unpredictable ways. If this creates a feedback loop of ever-deeper market intervention and heightened volatility, then all bets are off. Hold onto your hats.
Seb Kennedy | Energy Flux | 8th January 2023