Why have gas prices3

Why Have European Gas Prices Been Falling?

ChAI
Published by ChAI
Oct 27 2022
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Earlier this week, benchmark natural gas prices in Europe dropped below €100 per megawatt hour (MWh) for the first time since June, marking a further development in an already unprecedented year for gas in Europe. Although for much of the previous decade €100/MWh would have seemed an absurdly high ceiling price for gas, the return to double-digit figures now appears to be an important step in the correction of the market. As a result, it is worth looking into why prices have fallen recently and what the outlook may be going forward.

Why have gas prices

Natural Gas TTF Prices in 2022 (Source: Trading Economics)

Sufficient Storage

The slide from this year’s peak of over €330/MWh in late August to the present price is a welcome relief for many and has primarily been driven by two key factors. Firstly, Europe has built up significant storage levels of gas, with the majority of nations now recording their storage capacity utilisation at over 90%. The energy crisis on the continent has been developing for over 12 months so countries had plenty of forewarning to maximise their supplies heading into the winter this year. This was further incentivized by the actions of Russia, with the gradual restrictions of gas flows into Europe over the course of the year adding impetus to the drive for maximising storage levels.

Indeed, the lack of spare storage capacity for further natural gas in Europe is demonstrated by the number of LNG vessels anchored offshore around the continent. CNBC reported that around 10% of the world’s LNG ships are currently awaiting to unload their supplies at European terminals but are struggling to do so. This transportation backlog may have implications down the road for the output in Qatar, the US and other gas-producing nations, but at present it indicates the success of Europe’s storage drive this year.

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Warm Weather

A major concern across Europe during the peak of gas prices this summer was the prospect of a cold winter leading to even higher prices, industry shutdowns and even power blackouts. While these events still cannot be ruled out, November is approaching and much of western Europe is still yet to experience prolonged autumn temperatures, let alone the arrival of a cold winter. Without the usual seasonal demand for heating, there has been a decreased demand for natural gas which has contributed to lowering the price on the continent.

Alongside warmer temperatures, Europeans are generally more aware of the potential issues around energy this year than in the past. Government interventions, such as the energy price cap implemented by Liz Truss in her short stint as the UK’s Prime Minister or Germany’s recently announced €200bn energy bailout for households and businesses, have increased popular awareness of the need to reduce energy consumption which has therefore helped to drag gas prices down.

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Damage Already Done?

Recently an analyst at ICIS was quoted in the Financial Times as saying demand in Europe is about 20% lower than would be expected for this time of year. While the aforementioned reasons of storage and weather certainly contribute to this, it is important not to overlook the damage that energy costs have already inflicted on European industry as it provides another reason for the reduced level of demand.

Metal production, for example, has been badly affected by the cost of power. According to an insightful piece in the Financial Times on this topic, Europe’s largest steelmaker ArcelorMittal expects its total output from European operations to be down 17% in Q4 2022 compared to Q4 last year. Similarly, around 50% of primary aluminium production in Europe is offline and all zinc refineries have cut output to some degree. While necessary at present, production decreases such as these will inevitably have negative consequences for manufacturing supply chains in the near future.

Aside from powering metal production, natural gas is also an essential component in both the fertilizer and paper industries. In the former, where the gas is used to make ammonia, around 70% of production capacity in Europe has been shut down this year due to unsustainable costs. Cuts of this scale lead to impacts across different sectors which may be surprising to the average consumer, such as the rising cost of Carbon Dioxide for the beverage industry. CO2 is emitted as a by-product of ammonia production and is then sold to be used to carbonate drinks, but due to the decrease in its production the cost of CO2 is now up over 3000% year-on-year. This is according to the CEO of a brewery who interviewed for the BBC, who also stated that a £7 pint becoming the norm is a potential consequence of Europe’s energy crisis.

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Returning to the paper industry, packaging giants Smurfit Kappa and DS Smith are both reportedly relying on their US-based, rather than European, factories to ensure supplies of paper due to the lower costs of energy there. While this may be a short-term solution at present, there is undoubtedly a growing likelihood that companies will shift their industrial production sites out of Europe on a permanent basis. The largest chemical company in the world, Germany’s BASF, announced in late October that it is planning to permanently reduce costs at its European sites, implying that a reduction in both production capacity and employee numbers is likely in the coming years. When global giants like BASF believe the costs of production in Europe are becoming unsustainable, it demonstrates the scale of the challenge facing the continent’s manufacturing sectors.

Challenges Ahead

Looking to next year, it is important to remember that even natural gas prices stay around the €100/MWh mark for this winter, when European countries begin to refill their storage capacity next year there will be considerable upwards price pressure in the market. While Europe has done well to build up sufficient gas storage for the winter of 2022, it did so with Russian gas. Russian flows were gradually reduced for over 6 months which gave plenty of warning about the importance of stockpiling but this situation is unlikely to be possible next year. Even if the conflict in Ukraine were to be diplomatically resolved and international relations between Russia and western Europe improved, exporting Russian gas to the bloc is significantly more challenging since the recent suspected sabotage of the Nord Stream pipelines in the Baltic Sea. These challenges may help drive Europe’s transition towards using green energy as countries and companies are forced to find alternative ways of sourcing power. For the time being however, many will be hoping that natural gas prices continue their slide.

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