EUROPEAN WINTER GAS RISKS

BLOOMBERG- Oct 31, 2022 - This should be the winter for companies storing natural gas to cash in on high prices in Europe: supply is short and colder weather will eventually boost demand. Yet the recent dramatic fall in wholesale prices is turning the economics of the sector on its head.

The push to fill storage facilities before the start of winter has been successful -- with many close to capacity. But some suppliers may now want to hold back those reserves until they can sell their stored gas at more attractive rates.

Such a move would push market prices higher. And further hurt Europe’s economy, already heading into recession, largely due to the impact of Russia’s invasion of Ukraine on energy markets.

Gas is usually injected into storage by utilities and energy traders during summer when prices are lower and sent back into the market in winter when they rise. This year, contracts have moved in the opposite direction. It means some operators, especially in Germany, the region’s biggest gas consumer, may lose money on selling the stored fuel used as a buffer to offset supply disruptions.

Fuel prices this summer, when injections were made into the retired salt caverns, aquifers and fuel depots that hold gas inventories, at times peaked around €340 per megawatt-hour. Benchmark winter contracts are now trading at less than half that, closer to €140.

“This is a real problem,” said Henning Gloystein, a director for energy, climate and resources at Eurasia Group in London. “It can probably only be resolved if some of the recently nationalized players re-sell expensively bought gas at a loss.”

If reserves are held back, for whatever reason, it leaves only one source of gas -- daily supplies, coming on liquefied natural tankers from the US or Qatar, or by pipelines from Norway and north Africa. The continent is already relying on those flows. Any additional call for daily volumes is likely to raise prices again after a brief relief, keeping energy bills at eye-watering levels across Europe.

“To optimize their portfolio, companies will purchase gas on a day ahead basis rather than withdraw gas from storage as long as they can maximize profits,” said Leon Izbicki, gas analyst at Energy Aspects.

The cost of securing Europe’s gas reserves this year runs into tens of billions of euros. And although traders often sell gas forward as soon as they inject -- to hedge against risks -- they could still suffer losses on price differences. This is particularly acute for utilities and traders heavily reliant on long-term contracts with Russia, which met 20% of gas demand in the European Union last winter.

Germany’s Pain

Europe has boosted storage, yet only about 10% of the gas is under the direct control of public officials through national strategic reserves, according to data compiled by Bloomberg.

Some fuel purchases over the summer were made by companies using state aid, especially in Germany. The government extended €15 billion ($15 billion) to Trading Hub Europe, the company that manages Germany’s gas market, to buy fuel for storage. The group purchased around 60 terawatt-hours of gas, equivalent to about 25% of the country’s storage capacity.

To avoid supply risks, governments could also seek to call a state of emergency. In such a case, Germany and other national authorities would have the power to order the release of reserves.

Germany has passed legislation that mandates targets for gas storage. It’s already hit the 95% target for Nov. 1 and mandates a level of 40% by Feb. 1. Operators of the facilities risk penalties if they fail to meet those levels.

Calm Before the Storm

Benchmark futures have lost about 70% of their value from their August peaks thanks to an abnormally warm October -- which has slowed demand and delayed gas withdrawals from storage sites. There are also ample supplies of LNG. Europe even faced a temporary supply glut. But the continent needs to keep its prices above those in Asia to win the competition for LNG cargoes.

Given how tight the global gas market is with lost Russian volumes, most industry watchers believe it is a question of when, not if, prices spike again.

Temperatures are already forecast to dip slightly below normal by the middle of November, according to the Weather Company.

“Cold weather, demand destruction or LNG flows under performing expectations could well see prices returning to higher levels,” said BloombergNEF analyst Stefan Ulrich. “It seems worse for utilities to be caught not having enough gas, especially given government support for purchases, than to accept losses on some of the gas they stored at higher price points.”

-----