EU gas goes… negative?
Gas stocks are almost full, but don't rejoice yet
The European spot price for gas dipped into negative territory yesterday. Yes, you read that right: natural gas, that prized energy commodity that Russia has weaponised in its economic war with Europe, was for a moment less than worthless. What was that about scarcity pricing? Rejoice, crisis averted! Right?
Not quite. It’s a lot more complex than that. The spot (hour-ahead) price of gas traded on Dutch gas hub TTF briefly dipped below zero on Monday, before quickly rebounding into the black:
There are obvious parallels to draw with the Covid-induced US oil crash of April 2020, when month-ahead WTI crashed by a whopping $55.90/barrel, or 306% day-on-day, to close at negative $37/barrel. In both cases, an acute lack of storage (or offloading) capacity forced speculative traders to pay buyers to take long positions off their books.
Negative pricing is a phenomenon of financial products that must be settled physically at a given location. A quirk of WTI is that oil trades must be delivered at Cushing, Oklahoma – a notable pinch-point in the US pipeline network. For TTF, the physical element is nominal: gas trades must be settled at the Title Transfer Facility (hence the acronym), which is a virtual trading point operated by Dutch transmission system operator Gasunie.
There are other important differences to note. WTI turned negative on a month-ahead contract that expires at the end of each calendar month. This contract is heavily traded by institutional and retail investors and is the US benchmark price of oil. Upon expiry, and in ‘normal’ trading conditions, long WTI positions are unwound by settling delivery with a storage capacity holder. When the first wave of Covid lockdowns brought the world to a standstill, storage operators cornered the market and held ‘the longs’ to ransom.
Yesterday’s negative TTF incident occurred on an hourly contract, known as ICE Endex Next Hour. This contract is settled every 60 minutes and serves primarily as a risk management tool for high-frequency gas traders. ICE Endex Next Hour is not the European benchmark; that accolade belongs to month-ahead TTF.
The chances of the month-ahead TTF benchmark contract settling negative upon expiry are vanishingly slim, because TTF is a dynamic and deep trading hub with numerous participants using different entry and exit points. Buyers and storage operators simply cannot corner the sprawling European gas market like they can with oil at Cushing.
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Not out of the woods
A casual observer might ponder whether negative gas prices mean Europe is prevailing in its economic war with Russia. While the continent’s winter energy outlook is less scary than it was in August, it is far too early to make such a bold declaration. In fact, it is better viewed as a warning: a bitterly cold winter, combined with a complete cessation of Russian gas flows, could still leave EU gas stocks severely depleted by next spring. If anything, Europe needs to inject more gas into storage now to mitigate that risk but can’t because of infrastructure constraints. Negative price blips reflect this reality.
The big story here is the huge correction in the TTF forward curve, which is looking a lot closer to something resembling normality than it was just a few weeks ago. The price of gas for delivery at TTF in January 2023, the winter peak, has collapsed from €345/MWh in August to ‘only’ €143/MWh as of yesterday:
Ample LNG supply into Europe, combined with mild weather and strong renewable generation, took the heat out of the market. There’s an armada of laden LNG vessels waiting for a coveted slot to unload their cargoes into European terminals, driving up charter rates.
The fact that these vessels are staying put in the Bay of Biscay and Mediterranean rather than setting sail for premium Asian markets means operators see a greater chance of prices spiking again in Europe in the near term. This serves to highlight the limitations of supply-side policy, and the urgent need for an orderly curtailment of European gas demand.
The EU law to fill gas stocks to 80% by 1 November has been spectacularly surpassed, with storage facilities on aggregate 93.6% full as of Monday evening (source: GIE). That figure continues to rise as the mild, windy start to winter quells heating and power demand for gas across north-west Europe.
This is the best possible start to Europe’s first wartime winter. And yet gas rationing might still become a reality by February or March 2023, because Europe’s gas storage infrastructure is designed to cushion against seasonal swings in demand — not a prolonged cessation of pipeline imports from a major supplier. The conclusion to draw here is that demand must be lowered now to prepare for late winter market tightness and avert potential shortages.
On the face of it, EU policy is directing member states to do precisely this; the EU Council recently ratified a voluntary 10% gross power consumption reduction target and a mandatory 5% peak hours reduction target between 1 December and 31 March. This builds on a voluntary 15% gas reduction target for this winter.
But these efforts are being undermined by policymaking at the member state level. Faced by ballooning energy poverty, soaring inflation and calamitous deindustrialisation, European capitals rushed to protect vulnerable consumers and domestic industry from blistering wholesale price rises. Spain’s wholesale gas cap, known as the Iberian exception, is a case in point.
Capping energy prices is entirely understandable, but it dulls the incentive to conserve energy. Policies that fuel consumption in the face of potential winter shortages leave Europe structurally exposed to factors outside of its control: Russian supply, Asian gas demand, liquefaction plant outages, LNG vessel availability, the weather, the list goes on.
A global recession might help Europe to square this circle by draining demand out of the global energy system, blunting Moscow’s ability to inflict economic pain on consumers by withholding its gas. The tragedy is that a recession deep enough to move the gas demand needle will be painful in and of itself.
But at least there is a glimmer of hope. The gloomiest forecast of widespread energy shortages in the depths of a bitter war-torn winter is not a foregone conclusion. If European leaders act in harmony to improve efficiency and reduce energy waste, their resolve against the Kremlin’s energy terrorism will be that much more robust.
Seb Kennedy | Energy Flux | 25 October 2022