European gas stuck between expensive Asian LNG and bullish carbon

Whilst the large (and growing) European gas inventory deficit has been the underlying fundamental driver of higher natural gas prices this summer, the combination of expensive marginal supply (due to strong Asian LNG demand) and expensive demand destruction (due to high carbon prices shifting the gas to coal switching channel higher) has poured fuel on the fire. Prior to a meaningful increase in Russian flows once Nord Stream 2 (NS2) is operational, we expect LNG to remain the marginal source of supply to the European market. The broader LNG supply-demand balance, and JKM prices, will thus be critical for European gas price formation for the remainder of the summer. The North Asian bid for LNG is likely to remain robust through July and August, with peak cooling requirements regionally intersecting with robust industrial demand in China. These dynamics will continue to support TTF prices through July and August. Whilst August balances do seem better supplied (with Norwegian supply maintained at relatively high levels and Russian piped exports recovering from maintenance), the inventory deficit will continue to be the dominant fundamental driver influencing price formation. The continued Asian bid for flexible LNG will ensure this deficit is not satisfied with LNG. Beyond the next two months and approaching winter, prices will be greatly influenced by the trajectory of Russian flows, and specifically the commissioning schedule of NS2. The solution to this conundrum is critical for European gas balances over winter, as if more marginal demand is met by additional Russian flow, there is a reduced requirement to compete with Asian importers (via TTF pricing close to JKM) for marginal LNG over the premium winter months. In our base case, we expect NS2 to be operational in the fourth quarter, so see the JKM-TTF spread widening over Q4-21. Our price forecasts are slightly below the curve for the remainder of 2021 and are relatively tight to the curve for 2022. We expect the JKM-TTF differential to remain tight for the remainder of summer, before easing into winter with the assumed start-up of NS2 in Q4-21.