On August 26, the European natural gas price hit a new intraday record of EUR 340 MW/h, before falling at the time of writing this note to EUR 230 MW/h.1 The price has increased by about 200% since mid-June and is about six times higher than its 2021 average. Furthermore, the European price of natural gas is almost eight times more expensive than the US Henry Hub benchmark.
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Are EU natural gas prices sensible?
The European price of natural gas recently exceeded EUR 300 MW/h driven by concerns about supplies from Russia ahead of the winter. In this Macro Flash Note, GianLuigi Mandruzzato looks at the fundamentals of the European market to the outlook for natural gas prices.
Chart 1. Natural gas prices (EUR per MWh)
Source: Refinitiv and EFGAM calculations. Monthly average data as at 30.08.2022.
As natural gas is used to produce electricity, for home heating, and as an input in many industrial processes, including chemical and fertiliser production, its high price is one of the main reasons for the high inflation in Europe that clouds the economic outlook.
Many commentators explain the surge in European natural gas prices in recent months with the collapse of supplies from Russia, with reduced electricity production by French nuclear power plants and the hydroelectric sector due to the drought in Europe. The spectre of gas shortages next winter that could lead to rationing would have pushed sector operators to purchase at any cost at a time of increased demand for gas for electricity generation.
The evidence casts doubt on this interpretation. Despite the panic raised by the 80% contraction of Russian natural gas exports to Europe, EU storage of gas has risen to over 80% of capacity, up from less than 67% at this time of the year in 2021. It is notable that it has risen steadily in the last two months, suggesting that there was sufficient electricity generation capacity available elsewhere in the system to meet demand.
Chart 2. EU natural gas inventory and prices
Source: AGSIE, Refinitiv and EFGAM calculations. Monthly average data as at 30.08.2022.
In fact, European countries are much less dependent on Russia for natural gas supplies than earlier. Since the invasion of Ukraine, European natural gas imports from Russia have fallen and now represent only about 10% of EU total imports, down from more than 40% in 2020.
Chart 3. Sources of EU natural gas imports (GWH/d)
Source: Refinitiv and EFGAM calculations. Monthly average data as at 30.08.2022.
In this period, liquified natural gas (LNG), mainly imported from the US and the Middle East, has become more prominent along with pipeline supplies from Norway and North Africa. Supply capacity from Norway will rise further when the new Baltic Pipe comes online in October, delivering gas to Denmark and Poland. In addition, in early 2023 new LNG terminals will be operational, further reducing European dependence on Russian supplies.
Reduced demand, also because of high prices, contributed to the improved availability of natural gas. In the first seven months of 2022, consumption of natural gas in Europe fell by 15.4% from a year before, and more measures to limit its demand for non-industrial purposes, including reducing by 1 degree Celsius the heating of homes and offices, are under discussion among European leaders. As a result, at the end of August, the coverage of days of demand guaranteed by natural gas storage is much higher than last year and the 2017-2020 average.
Chart 4. EU natural gas stocks in days of demand
Source: Refinitiv and EFGAM calculations. Monthly average data as at 30.08.2022.
In conclusion, the increase in natural gas prices in Europe reflects more the fear of a possible shortage during the coming winter than an actual scarcity of gas. The diversification of suppliers has already significantly reduced the European dependence on Russia and allowed abundant stocks to be accumulated well ahead of the winter. Even in the event of a complete stop to Russian exports to Europe, the impact should not be as devastating as it would have been only 12 months ago.
Furthermore, new supply from Norway and new LNG terminals will soon be available and the reduction of natural gas and electricity demand because of surging prices has increased the resilience of the European economy to the unpredictability of Russian supplies.
This should moderate European natural gas prices to more sustainable levels, although markets will likely wait until the beginning of winter to assess how meaningful the risk of an actual shortage is. If the energy bills for European households and businesses will stay high in the short term, there are reasons to believe that they will fall in and beyond 2023.
1 The European benchmark is the one-month delivery futures contract to the Title Transfer Facility (TTF) in the Netherlands.