Triggers for recent price shocks to also be featured longer term
Weather and LNG supply are key winter factors for the European gas market
Climate change is making it more difficult to predict the future of demand
The current high gas price environment for Europe is likely to last in the medium term, as some key market drivers are set remain key factors in future, said the head of Switzerland’s trading arm, MET.
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European gas prices are at an all-time high, having reached record levels in October due to strong demand, upstream disruptions, and winter supply concerns.
“We can no longer call these high prices a blip — it’s been this way for more than three month,” Gyorgy Vargha (CEO of MET International) stated.
Vargha said that extreme weather and lower production from the COVID-19 upstream pandemic were key triggers of recent high prices. Both of these factors are likely to continue in the medium term as weather extremes will continue and underinvestment.
Vargha stated that prices have been holding steady in the Eur80-100/MWh range, and that structurally there is every reason to believe they should remain high.
He stated that while it is not certain that the price of Eur100/MWh will stay there for five years, it can jump to Eur100/MWh after six months.
Vargha stated that Europe’s “green revolution”, which has led to high gas prices, is contributing to the rise in gas prices. He said that the shift away from coal and lignite across large parts of Europe, as well as the elimination of nuclear power in Germany, will support gas demand in the energy sector.
Vargha stated that gas will be the first step in many countries. There will also be significant electrification, so there will be an increase in demand for gas in power sector.
“I don’t see any equal amount investment to cover.” [the demand]He said that the medium term was in sight.
Vargha acknowledged the possibility of a warmer winter and a cooler summer which could lead to a shift in gas and electricity prices.
He said that price volatility would likely persist due to less flexibility in the system, and unpredictable demand swings.
He stated that the European gas system was being shaped in part by the loss of Dutch flexible production in Groningen, and restrictions on Russian volumes as a result of long-term contract flexibility adjustments. However, there is less baseload supply in power, since nuclear, coal-, and lignite-fired generators are being shut down.
He said that “demand is becoming more volatile as a result of climate change, so everything is moving in an unpredictable way.”
Perspectives for the short-term
Vargha stated that weather will be the main driver of price in the short-term. A few degrees change in temperatures can have a significant impact on demand.
“The weather is the main factor in Europe’s demand set-up. He said that plus or minus 2 degrees above or lower is the equivalent to hundreds of millions of cubic metres of gas on a 1-week horizon.
According to him, MET is modelling the effects of weather changes on storage levels. European storage sites could end the winter below 10% if cold weather is resolved, while weather in recent winters could see storages finish the season higher than 20%.
Vargha stated that LNG is the other key determining factor in Europe this winter.
He said that LNG can save Europe and that more cargoes would be coming to Europe in December and February, as well as potentially more cargoes arriving to Europe in January.
The spreads between JKM and TTF prices suggest volumes coming to Europe during February. However, a cold snap in northeast Asia could also affect the market dynamics.
He said that LNG and weather are the two things we should be watching — it’s a combined system.
European gas storage holders may also consider selling their stock in January and February due to the high backwardation in market prices, rather than waiting until March when prices will be lower.
“Anyone with molecules in January or February will want them to be emptied globally. They’ll do whatever they can to make them sell, Vargha said.
Vargha stated that managing positions was becoming more important due to the high volatility in the European gas markets in recent months.
He said that the gas market was beginning to look more like the oil market in terms of price differentials and benchmarks. However, volatility at the TTF was still an “absolute insanity”, compared with Brent.
“The TTF is capable of making random 5% moves in under 20 seconds. He said that if you want to manage this, your processes must be flawless.
He said, “You need to know your positions on an ongoing basis for every book, and you have to understand how the price and your locational spreads relate to each other. You also have to be able manage this entire portfolio and understand all the pieces.”
Arbitrage is a way to arbitrage if you have the ability. Not everyone sees the relationship between fixed prices and spreads so it’s best to do so if you can.
Vargha emphasized the need to consider all elements of the European gas market simultaneously, giving an example of the interplay between LNG imports and CCGT optimizations, cross-border capacity optimizations, storage optimization, currency hedge optimization, and imports from Russia, Algeria, or Russia.
He said, “If you don’t participate in all these plays then you’re going missing a key impact which’s going to ruin you position one day it’s just like the 0 in Roulette.”