European gas, power off to bullish 2021 on volatile fundamentals

London — Buoyed by a strong rally in LNG spot prices, the European gas market has been on a bullish run. The new year has begun with cold temperatures in Europe and a tight LNG market, bringing more price volatility, though such factors can easily switch at relatively short notice.

The evolution of the market this quarter will depend largely on Europe's legacy pipeline suppliers being able to step up to meet demand in the event of continued cold weather.

With LNG cargoes being diverted to Asia to make the most of high JKM spot prices, Europe is likely to need to call on its traditional pipeline suppliers Russia, Norway and Algeria.

All three have the capacity to fill any gap left by lower LNG imports, and barring major unplanned outages should enable Europe to be adequately supplied.

And with gas storage sites still 73% full by the end of 2020, according to data from Gas Infrastructure Europe, Europe should be able to manage any demand spikes.

"Q1 2021 will be defined by a stronger year-on-year reliance on storage withdrawals and Russian, Norwegian and Algerian pipeline flows to cover stronger demand and replace LNG shifting toward Asia," S&P Global Platts Analytics' managing analyst James Huckstepp said.

Demand projections remain difficult to evaluate given the uncertainty around the evolution of the coronavirus pandemic, but Huckstepp said that assuming normal temperatures, compared to above normal temperatures in the previous two Q1 periods, demand should be considerably higher.

He also noted there will be instances of a double heating impact of people working from home combined with the need to heat workplaces.

"The impact of coronavirus measures on demand remains highly uncertain, although we see risk weighted to the upside with higher combined coal and carbon prices year-on-year and the potential for 'double heating'," he said.

There are other potential bullish factors to consider in Q1. While Russia has the gas to keep Europe well supplied, it will have to rely on Ukraine as a transit country for more volumes than it hoped it would have to at least in Q1 with Nord Stream 2 still not complete.

Booked long-term Ukrainian transit capacity falls from 65 Bcm to 40 Bcm in 2021, though Gazprom is buying additional capacity to meet heightened winter demand.

Norway's supplies were resilient in 2020, matching exports last year and running at close to capacity in recent weeks at some 350 million cu m/d.

This should be expected to continue through Q1, with only minor maintenance work on the Norwegian Continental Shelf ahead of a much heavier maintenance season set for Q2.

Algerian supplies are also likely to be much stronger in Q1 compared with 2020, as Sonatrach's oil-indexed contracts remain in the money. "Platts Analytics forecast Algerian pipeline flows to Southern Europe will out-turn significantly higher year-on-year, as oil-indexed contracts have fallen well into the money," Huckstepp said.

Thermal losses stir volatility

In the electricity sector, 5 GW of thermal plant closures at end-2020 have reduced flexibility and increased the risk of price spikes at times of low wind in northwest Europe.

While 2020 saw a doubling of negative hourly prices when wind was strong, scarcity prices above Eur100/MWh are also becoming more common.

Price volatility into 2021 has been strongest in Great Britain were hourly prices hit GBP1,000/MWh Jan.6 amid cold and calm conditions, and as imports were hampered by the delayed start of the IFA2 link to France and failure of the BritNed link to the Netherlands.

On balance, average monthly prices in Q1 are set to rebound after hitting record-lows in 2020, but with some gains priced in by the rally late last year, driven by stronger carbon, gas and coal prices.

German year-ahead baseload, the European benchmark, started 2021 above Eur50/MWh for the first time since Q3 2019, and versus a 2020 day-ahead average of Eur30.47/MWh, exchange data showed.

While German coal and lignite plant closed end-December, utilities RWE and Uniper have re-commissioned 2.7 GW of gas plant and this is new coal plant Datteln's first winter.

At the same time, Nordic flows to central west Europe exceeded 4 GW in early January "even as the COBRA cable was offline, with high Norwegian hydro stocks helping to fuel exports," said Platts Analytics Sabrina Kernbichler.

With NordLink entering full commercial operation, and the scheduled return of the COBRA cable, high Nordic-CWE net exports were likely to continue in Q1-21, she said, despite closure of Sweden's Ringhals-1 reactor at year-end.

"This will help ease the net loss of 4 GW in German hard coal and lignite capacity, but the closures will nevertheless exacerbate price upside at times of lower renewable generation," Kernbichler said.

France's nuclear fleet entered 2021 with eight reactors offline and Fessenheim shut, but Q1 output was forecast flat on Q1 2020 at around 46 GW, according to Platts Analytics.

"Besides the maintenance extensions at Chooz-1 and Flamanville-1, now delayed to end-February, risks of further delays remain with Bugey-2 and 3 and Paluel-2 provisionally scheduled to restart at the end of January after lengthy outages," Platts Analytics' European analyst Giuliano Bordignon said, noting another 11 reactors were scheduled to start maintenance before the end of February.

Carbon auctions return

EU carbon allowance prices may see some downside in Q1 from record highs seen at the start of January, as supply returns from government auctions in late January.

EU Allowance futures contracts for December 2021 delivery surged to a record high of Eur34.25/mt ($41.46/mt) Jan. 4 – the first business day of the EU Emissions Trading System's fourth trading phase.

Part of the surge to record highs in January was linked to an extended break in primary supply from government carbon auctions over the holiday period.

Auctions came to an end Dec. 14, 2020 and would normally start in early January under usual conditions. However, the return of auctions was delayed until late January due to technical reasons.

This unexpectedly long halt in supply meant that would-be auction buyers were forced to look to the secondary markets to acquire volume, driving additional interest and pushing prices higher.

The delay will not affect the total volume to be sold at auction in 2021 and these volumes are set to come back into the market starting Jan. 29 – potentially tempering the effects of the more bullish elements for prices.

S&P Global Platts Analytics sees EUA prices trading at Eur31.50/mt on average in January, and falling to Eur30.00/mt in February and Eur29.00/mt in March.

"We have revised upwards our price forecast for the next few months to account for the auction delays, although these withheld allowances will add downward price pressure once they begin entering the market," Platts Analytics said in its latest EU ETS market outlook dated Dec. 15.

"2021 prices will also be moderated by ongoing demand-side weakness and the large surplus overhang from 2020," it said.

Bullish price elements include a short-term outlook for lower-than-average temperatures across Europe which would support demand for power and carbon – particularly if freezing conditions persisted into February and March.

Bearish factors include uncertainty over the length of disruption to European industry linked to the coronavirus-induced lockdowns and the speed at which vaccines allow governments to lift restrictions.