European forward gas prices become unanchored

European forward gas prices have disconnected above gas-to-coal fuel-switching levels this week, signalling that gas prices will need to soar enough to force deeper demand-side responses this winter.

The Dutch TTF front-month market closed yesterday almost €14/MWh above the level at which a modern, 59pc-efficient gas-fired unit would be uncompetitive even with an older, 36pc-efficient coal-fired plant, of which few are still operational. It moved above this resistance level for the first time at the end of last week, having been as much as €10/MWh below it in mid-July (see fuel-switch graph).

And the TTF front-month market was about €7.70/MWh above the level required to price in these same gas-fired units against 33pc-efficient coal-fired plants, having exceeded this level for the first time only a day earlier. The first-quarter 2022 market was around €11.60/MWh above.

European prompt prices have occasionally climbed above the top of the gas-to-coal switching threshold in previous winters, but only during exceptionally cold weather or unplanned supply disruptions.

Forward gas prices already above this threshold well ahead of the delivery period signals that gas prices will need to soar enough to trigger a deeper demand-side response not called upon for several years — such as gas-to-oil switching in the power sector, a switch to other fuels in industrial processes where possible or industrial plants being idled.

There is likely no remaining flexibility for Europe's gas supply to respond to higher prices, which will force the response to come from the demand side.

Production from the Netherlands' Groningen field — which used to be a key flexibility source — is set to be minimal this winter as it will be capped by a permit which seeks to limit seismic activity in the region while still meeting security of low-calorie supply across northwest Europe.

Norwegian gas output is in any case generally maximised in the winter. The addition of Troll West will provide some incremental supply, but the downstream Kollsnes plant — which processes gas from three smaller fields alongside Troll — could act as a bottleneck, likely preventing Troll output from hitting its new daily nameplate capacity of around 125mn m³/d. While Norwegian production is likely to edge up this winter from a year earlier because of Troll and the flexible Oseberg being run slightly harder, October is the only month in which there is scope for a large increase given the field's delayed ramp-up last winter (see TTF winter spreads graph).

The upward quantity tolerance in European buyers' long-term contracts is likely to set the limit for how much Algerian and Russian gas is sent to Europe.

Fourth-quarter Algerian deliveries to Spain may slow sharply from a year earlier because of offtakers hitting their contractual ceilings under contracts running on the calendar year. And pipeline export capacity could force flows lower than in previous years if transit through the Morocco-Europe pipeline ends, although state-owned Sonatrach may be able to meet its long-term commitments by delivering some supply as LNG to Spain's underutilised liquefaction terminals.

Russian state-owned Gazprom's export forecast for this year is close to its overall long-term contractual commitment, implying weak flows in the fourth quarter given quick sales earlier in the year. A combination of factors has limited Gazprom's ability to sell additional gas to Europe on top of long-term obligations — the firm ran some key fields hard earlier in the year, which could force a slowdown later on in order to meet production quotas, while a strong domestic stockbuild in the autumn could absorb more supply than usual and the fire at Novy Urengoi cut into its gas production.

And European firms cannot count on being able to outbid northeast Asian buyers for LNG cargoes at short notice. Northeast Asian LNG prices have already long surpassed oil parity levels — when it becomes economic to burn fuel oil rather than LNG in the power sector — suggesting there is no limit to how high Asian buyers will bid in order to secure Atlantic-basin cargoes. And forecasts pointed to a La Nina weather event, which could bring cold weather to the region.

And underlying the fragility of Europe's gas market this winter are its low gas storage inventories. Firms will want to preserve inventories in early winter regardless of storage spreads — another way in which supply may be unresponsive to price signals (see TTF 4Q21-1Q22 spread graph).

By Natasha Fielding