As the world is moving towards de-globalisation, prices of essential commodities are soaring and money is our pockets is shrinking. Continuing Russia-Ukraine conflict and deluge of liquidity infused as part of post lockdown measures, have pushed the prices to decades high. While crude oil rally has recently cooled down due to recession / fears, natural gas prices in Europe remain stubborn.
Exhibit 1: Prices of Natural Gas, EU - Natural gas prices continued to soar aggressively over last few months, adding to the agony of gas-dependent nations.
Exhibit 2: Crude Oil Prices have cooled down from multi year highs
About Natural Gas
Before moving to the details, let me share a brief about this headline making commodity. A methane based gaseous hydrocarbon which has lesser carbon emissions as compared to fossil oils and its affiliates is Natural Gas. Major use cases of Natural gas are in the areas of generation of power & electricity and transport. With increasing climate change goals, traditional fuel is being replaced with Natural Gas. Another major domestic use is for heating purposes in cold countries and for cooking fuel. This makes northern hemisphere major consumer of Natural Gas, evidently Europe and North America.
Global Trade Scenario
1. Major Producers of Natural Gas - United States and Russia are two largest producing nations. contributing to United States (24%), Russia (18%), Iran (6%), China (5%), Qatar, Canada, Australia (4% each), India (1%).
Exhibit 3: Global Natural Gas Producers (source: Statista)
2. Major Exporting countries: Russia, the second largest producer of Natural Gas leads the export market of Natural Gas across the world. Thus, dependency of many countries on Russian gas is evident. Second leading exporter after Russia, is United States followed by Qatar and other top producing nations like Norway, Australia, Canada.. (Exhibit 4).
Exhibit 4: Leading Gas Exporting Countries in 2021 - Russia leads
3. Major Consumers of Natural Gas: Major consumption of Natural Gas happens in the European and North American countries. Major consumers of Russian gas are European Union, followed by China, Netherlands, Germany, Italy (source: tradingeconomics.com). Thus, these countries are largely dependent on Russia for their energy needs and any disruptions in the supply chain would cause havoc in the energy markets and the prices to shoot.
Exhibit 5: Imports of Gas from Russia by EU countries
Russia supplied the EU with 40% of its natural gas last year. Germany, Europe's largest economy, was the largest importer in 2021, followed by Italy, Netherlands, France, Poland, Hungary, Spain and Belgium.
Gas & Oil Trade with Russia
With the commencement of Russia's attacks on Ukraine on 24 February, a large number of other countries began imposing package of sanctions in areas of trade, transport, petroleum, banking and capital markets with the aim of crippling the Russian economy.
On 8 March 2022, US ordered a ban on imports of crude oil, gas and coal from Russia to the US.
In April, UK pledges to end dependency on Russian coal and oil and end gas imports as soon as possible. In response to the military aggression against Ukraine, EU has imposed slew of sanctions on Russia in areas of trade, transport, banking etc. EU introduced measures prohibiting import of coal, crude oil and petroleum products from Russia into the EU. Since the dependency of EU and UK economy on Russian gas is large, it is not possible to flip off the switch so quickly. As a result of the ban, Russian crude oil imports into EU and UK fell to 1.7 million barrels per day (mbpd) in August from 2.6 mbpd in January 2022, but EU still remains biggest market for Russian crude, according to IEA (International Energy Agency). UK has already stopped importing Russian crude and EU will ban imports from December to strip Russia from revenue for war.
Imports from the United States have replaced about half the 800,000 barrels of lost Russian imports. The United States could soon overtake Russia as the main crude supplier to the EU and the UK combined. Interesting point here is that US does not import any gas from Russia. Crude oil was imported from Russia in 2021 which was 3.5% of total US' oil imports, a multi decade high. Thus, dependency of US on Russia for natural gas and crude oil is negligible. Canada was major source of US gas and oil imports in 2021. US does not import gas from Russia, but they get affected when Russia restricts supplies to Europe as it causes the global gas prices to rise. High oil and natural gas prices have increased the cash flows of most U.S. shale producers, leaving many of these companies with hefty amounts of cash and with choices to make. Source: S&P Global.
The Nordstream Story
The Nord Stream 1 pipeline stretches 1,200km (745 miles) under the Baltic Sea from the Russian coast near St Petersburg to north-eastern Germany. It opened in 2011 and can send a maximum of 170m cubic metres of gas per day from Russia to Germany. The pipeline is owned and operated by Nord Stream AG, whose majority shareholder is the Russian state-owned company Gazprom. Germany had also previously approved the construction of a parallel pipeline - Nord Stream 2 - but the project was halted after Russia invaded Ukraine.
Gas supplies cut from Russia to Europe
In June, Russia reduced gas deliveries through Nord Stream. In July, it closed down pipeline citing maintenance reasons. Shortly after reopening, gas supplies were halved citing another set of similar reasons and now all gas supplies to Europe are completed halted. Thus, 40% of Europe's gas supplies are hampered.
The IMPACT
Natural Gas Price Rise
The gas prices in Europe have soared more than double since Ukraine's invasion. The Dutch TTF prices soared from EUR 86 per megawatthour (Mwh) in February to EUR 241 per Mwh in August. A year before the prices were at EUR 55 per Mwh. (Dutch TTF means Title Transfer Facility and is a virtual trading hub for gas in the Netherlands and is the primary gas pricing hub for the European gas market).
Increase in cost of living & risk of shutdowns
Consumers and corporations are hard hit by the price rise. Electricity bills have already tripled. Major industries have begin furloughing workers and cutting back expenses due to high electricity bills. This has made situation of Europe utterly dire and have forced them to reopen previously renounced coal plants and nuclear sites. Due to high temperatures during this summer, the energy consumption touched peak owing to large use of air conditioning. With the hot temperatures, severe droughts crippled hydro & nuclear power generation. Shifting for electricity from natural gas to coal has driven up the coal prices.
70% of European fertilizer companies rely on ammonia extracted from natural gas. Thus, operations of these companies have also halted. This has led to increase in the cost of fertilizers which further translates into increase in food prices. Even operations of core manufacturing companies like that of steel and glass also are at risk.
Inter play of Supply & Demand
Since the disruptions into its energy systems, Europe has been scrambling to re-align its supply chain and energy sources. While reducing reliance on cheaper Russian gas, it has to look onto other sources like Qatar, United States and others. Long term changes in supply sources would require increase in production by production hubs, laying down pipelines (pipeline is the cheapest mode of transport) and storage terminals, which generally can happen over a period of 2-5 years. Even though Europe wants to re-align its supplies, it can happen over a period of time. Over the short term, there are limited countries that can shore up supplies in the short term. Investment in natural gas infrastructure is expensive. Demand is expected to increase as cold winters approach. Thus, the European economy is on a double edged sword. As the supply side is not expected to get resolved in short run, the only way to address the situation is to reduce demand through rationing. However, in winters it will be difficult to reduce the demand for heating purposes. Europe stands most affected and vulnerable from the aftermath of sanctions. It can be collectively inferred that reducing demand and rationing is only way for Europe to cope with the energy crisis.
Downward economic spiral
Inflation in Europe is rising fast. In August 2022, Inflation was 9.1%, a rise from 8.9% in July 2022. The interest rates, one of most resorted mechanism to fight against Inflation is still at 1.25%. Increase in the interest rate makes borrowing costlier and thus reduces demand and economic activity. While ECB has best assured their inclination to increase the interest rates to tame inflation, considering the economic situation of Europe and high debt of many EU countries, Europe again has less room to increase the interest rates. I have covered this in my previous article - https://www.risingcurve.info/post/the-bond-alarm
Over last 4 weeks, natural gas prices have somewhat cooled down, as the inventories have increased owing to stock piling for winters. The Dutch TTF prices closed at EUR 185 per megawatthour last week. Gas storage sites continue to fill as countries switch from gas to coal in power plants and industry and increase imports of LNG. Storages are generally filled during summers and are expected to get empty as winter sets in. They are brimming at 80% of their capacity and target to each 95% of capacity by November. Mild or harsh winters will further guide the natural gas consumption of the continent.
As of now, paying more than double prices for energy, Europe still stands at the risk of manufacturing shutdown with uptick in the demand across the globe. This may have devastating impact of unemployment, high inflation, low economic activity, with likely public unrest and divisions. Crippled with fragile energy and economic situation, Europe in all likelihood is heading towards a recession with higher inflation - a stagflationary situation. New policies and sanctions by nations will further guide the energy markets and the global economic situation.
- Ushma Zunzavadiya
Sources:
Statista, IEA Reports, Fed Database, BP Reports.
References:
Comments