By Alexander Jones, International Banker
Natural gas was arguably the most headline-grabbing commodity of 2022 after Russia’s curtailment of its pipeline supplies to Europe sent gas prices to the heavens during the first few months of the year. But this year, natural gas has unceremoniously crashed back down to earth, with prices once again trading at levels last seen prior to the outbreak of the Russia-Ukraine war, and has even headed further south. Why have natural-gas prices collapsed so spectacularly, with such bearishness emerging despite the conflict’s continuation?
The benchmark US natural gas futures contract, based on the physical delivery of the commodity at the Henry Hub in Erath, Louisiana, for instance, was trading at around $2 per million British thermal units (/MMBtu) by mid-April. Such low levels had not been seen since September 2020, with prices having rocketed to 14-year highs of almost $10/MMBtu by August 2022, as a dramatic US heatwave during the summer saw demand for cooling systems surge and stored gas inventories decline rapidly.
Over in Europe, meanwhile, the price of natural gas futures contracts for physical delivery at the Netherlands’ Title Transfer Facility (TTF) fell to around €36 per megawatt hour (/MWh) by early May, almost a two-year low after having spiked to outrageous all-time highs last August of €340/MWh. This record peak was mainly due to Moscow drastically cutting gas pipeline supplies to Europe in response to economic sanctions being levied against Russia for its invasion of Ukraine, as well as the power sector in Europe expanding its gas-burning requirements around the same time.
But the latter few months of 2022 and the first few months of 2023 have seen those steep post-war gains in natural-gas prices being wholly wiped out. Indeed, 2023’s first quarter saw US prices collapse by a whopping 50 percent. And while Henry Hub prices have somewhat stabilised since late February within the $2.00-$2.50/MMBtu range, Europe’s TTF prices have continued to decline into May.
This can partly be explained by the demand for natural gas in Europe plummeting since last year in response to those unsustainably high prices, with wholesale shifts being made to utilise other energy sources. In its “Gas Market Report, Q1-2023”, the International Energy Agency (IEA) noted that natural-gas consumption in OECD (Organization for Economic Co-operation and Development) Europe declined last year by an estimated 13 percent, or more than 70 billion cubic metres (bcm), which is its all-time steepest decline in absolute terms. The Paris-based agency also noted that more than 40 percent of the reduction in annual demand was concentrated in the fourth quarter, when natural-gas consumption fell by an estimated 20 percent (33 bcm) year-on-year.
McKinsey & Company’s analysis published on April 25 similarly found that in response to the price spike in 2022, Europe observed a 57-bcm drop in gas demand—11 percent lower than 2021 levels—that “balanced the market”. The consulting firm also noted that the reduction was mainly driven by a drop in demand in buildings from 2021 levels during the 2022-23 winter—suggesting “a behavioral change in response to the spike in gas prices”—as well as in industry—as companies leveraged energy-efficiency measures to reduce gas consumption, and energy-intensive industries (such as fertiliser, chemicals, and steel) experienced significant production curtailments, which, in turn, lowered the demand for natural gas.
Gas-fired power generation, meanwhile, dropped by more than 10 percent year-on-year in the fourth quarter, with the IEA citing lower electricity demand, strong wind-power output and continued gas-to-coal switching as the chief factors for the decline. Coupled with this tepid demand were record-high storage levels in Europe following policies implemented by European governments that required storage operators to maximise storage injections to ensure sufficient natural-gas supply during the winter. By November 1, which marks the official start of the heating season, storage stocks were 95 percent full, well above the average for the 2011–22 period of 89 percent. And the fact that both Europe and the United States were able to fill up their storage capacities well ahead of this date sent a hugely bearish signal to their respective natural-gas markets.
A notably mild 2022-23 winter throughout the northern hemisphere also kept the lid on heating demand and thus only further swelled storage inventories. By the end of Europe’s heating season on April 1, storage had reached all-time high levels for that time of year at 2.02 trillion cubic feet (or 56 percent full). At the end of January, February and March, storage stocks were also at their highest recorded levels for those months. As outlined in recent commentary from the U.S. Energy Information Administration (EIA), Europe’s high levels of natural gas in storage “are the result of an exceptionally warm winter that reduced heating demand, lower natural gas consumption resulting in part from a Europe-wide effort to conserve natural gas, and record levels of liquefied natural gas (LNG) imports, which helped offset lower imports by pipeline from Russia”.
In the United States, meanwhile, booming natural-gas production has been cited as one of the main factors responsible for the price decline. Already the world’s largest natural-gas producer, the US is now pumping out vast quantities of natural gas, with the country’s biggest shale field—the Permian Basin of Texas and New Mexico—producing record-high gas volumes for every month this year thus far, according to the U.S. EIA. Much of this supply uptick has come in concert with the rise in crude-oil production off the back of higher oil prices. “About a third of US gas production is associated gas—produced from oil wells,” Jacques Rousseau, a managing director at research firm ClearView Energy Partners, told Reuters in early April. “This production is unlikely to decline given current oil prices.” As such, the amount of gas sitting in storage in the US is around one-fifth higher than is normal for this time of year.
One also cannot ignore the outsized impact LNG (liquefied natural gas) is now having on the natural-gas market, with a wave of new export terminals coming online over the next few years likely to weigh heavily on prices. Indeed, with gas supplies from Russia to Europe being severely curtailed, something of a supply frenzy has emerged as LNG exporters step in to replace this shortfall. The US, for one, is set to expand its export capacity significantly, with several LNG projects on the US Gulf of Mexico coast that use Texas shale gas expected to launch soon.
Although the US was only the third-largest LNG exporter at 76.4 million metric tonnes per annum (mmtpa), energy consultancy firm Wood Mackenzie expects the resumption of production at Freeport LNG’s export plant in Texas, following an eight-month outage, to enable the US to surpass Qatar and Australia this year by exporting 89 mmtpa. “Record-high prices and the need for energy security drove buyers, which included portfolio players and US producers and infrastructure companies, to seek long-term US LNG deals in 2022 and created huge contracting momentum for projects,” Giles Farrer, Wood Mackenzie’s head of gas and LNG asset research, said in February. “Last year alone, 65 mmtpa of long-term US deals were signed, dwarfing the 18.5 mmtpa we saw in 2021. This activity has pushed a host of pre-final investment decision (FID) US projects forward, and we could see a wave of FIDs this year and next.”
But while this wave of supply might seem bearish for natural gas, some believe prices could head higher again in the short term. Indeed, some major natural-gas producers have already signalled this year that falling prices could force them to begin slowing output. “Growth in gas supply is not needed in the short term. We do think the industry should acknowledge that and may reduce growth in the near term,” Chesapeake Energy’s chief executive officer, Nick Dell’Osso, said in late January.
Prices may also be buoyed by a recovery in LNG demand in Asia, particularly in China, where the IEA believes demand could rise by as much as 10 percent this year following the lifting of pandemic restrictions. “Last year was extraordinary for global gas markets. Prices are returning to manageable levels, particularly in Europe, where a mild winter and demand destruction have helped to cool markets,” Keisuke Sadamori, the IEA’s director of energy markets and security, noted. “China is the great unknown in 2023. If global LNG demand returns to pre-crisis levels, that will only intensify competition on global markets and inevitably push prices up again.”
This is a view shared by the world’s top buyer of LNG, Jera Co., Inc., which recently warned that another price spike could well materialise amid renewed market volatility before the end of the year. Yukio Kani, Jera’s chairman and global chief executive officer, told Bloomberg on April 30 that rising import capacity in Europe and China’s resurgent demand following the ending of domestic pandemic restrictions could send prices skywards should severe weather conditions arise. As such, there’s no opportunity for buyers to “let their guards down,” Kani added.