Commodities - Winter Gas Market Shaping Up

After a brief period of consolidation in mid-September, energy prices have gone ballistic after China vowed to secure energy supplies at all costs to avoid damaging growth - this comes amid low global inventories of oil, gas and coal. Energy prices were then lifted further by the EU's pledge of swift action to protect its economy. Policymakers around the world now seem to have some stark choices to make and will likely be forced to outbid China to secure energy supplies if the winter is cold. The first shipment via Nord Stream 2 could ease the pressure on prices, but it is the weather that will be the decisive factor this winter.> Deviations in winter gas demand from Northern Asia (Japan, South Korea and China) and Northwestern Europe and Italy are usually comparable. Power and heating demand rises or falls substantially in winters that are either colder or warmer than normal. > Under our base case, a winter in line with the 10-year average, amid lower industrial demand for gas due to high prices, would result in European gas storage finishing the season just under the usual range. Gas prices would remain elevated in this scenario, but well below the current record levels. By the end of a normal summer, European storage would be back to historical levels and prices would be on a downward trajectory throughout the next gas injection season.> However, a cold winter could turn the gas market on its head. Northern Asia would need more LNG, meaning less LNG available for Europe. Chinese LNG demand would rise the most, with its northern provinces Tianjin, Hebei and Shandong importing more to meet heating demand fluctuations. Europe could end up with almost no gas left in storage after a colder than normal winter (though gas in storage would be above seasonal norms at the end of a warm one). A cold winter would deplete gas storage in both Asia and Europe to such an extent that the two markets would remain in competition for LNG cargoes well into the summer of 2022 and perhaps into the following winter, extending the gas price rally.> Asia's biggest markets for LNG are ready for a normal winter, but Europe is not. One reason is that Japan and South Korea have ensured that their LNG inventories are in a better state entering this winter than last. They stretched the limits of their long-term supply contracts, leading to limited spot LNG availability globally this summer.> Europe's supply-demand balance should remain unusually tight heading into the winter, pressuring prices upward. The tightness is exacerbated by lower Russian flows this winter (Russia is taking care of its own needs), the imminent phase-out of the Dutch Groningen field and lower LNG arrivals. This is a situation that higher US supply cannot make up for, although a small degree of relief is possible from higher Norwegian gas flows in 4Q21 and possibly the first supplies via the Nord Stream 2 pipeline in November-December. Still, Europe will need to endure high prices for LNG for the foreseeable future, until the next big wave of LNG supply projects are commissioned. Some new LNG capacity will come online next year, but the big additions will not arrive until late 2023 at the earliest. Just as easily though, a warm winter could lead to Europe being a sink market (i.e. if there is a surplus, the unwanted volumes will be dumped there).> Global gas demand generally recovered this year, but Chinese demand recovered the fastest given the effect of the coal-to-gas switching initiatives. The country is set to overtake Japan as the top LNG importer this year. Investors are now primarily focusing on how much downside there is to gas demand as industries curtail activity, which will in turn strain economic growth.> Despite China's recent push to bolster its energy supplies, the government continues to encourage local authorities to shift from broad curbs on power use to policies that are "more differentiated" by user, but also compliant with emissions-control targets. This means that the policies of most southern regions, which entail limiting the supply of power to sectors with a higher emissions intensity, could be extended across the entire country as a first response to price-induced shortages, and in order to reach emissions reduction targets as the winter progresses. The sectors most frequently cited in local government policies are metals smelting, non-metal minerals manufacturing (e.g. cement), chemical products and textiles. Higher electricity prices will also weigh on the margins of some heavy industries. In Europe, the losses are less intense and so far confined largely to ammonia and fertilizer plants.