Already dazed from months of extreme volatility, Europe's energy markets enter the second quarter of 2022 with no sign of a let-up in the daily turmoil brought on by the conflict in Ukraine.
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The gas market -- already bowing under the weight of record high prices -- is set for further unprecedented change as the EU looks to slash demand for Russian gas and new storage obligations shift trading dynamics.
The TTF day-ahead price hit a new all-time high of Eur212/MWh ($233/MWh) on March 7, according to S&P Global Commodity Insights assessments, a 1,190% increase year on year, as the fall-out from Russia's invasion of Ukraine on Feb. 24 continued to roil markets.
Fundamentals of supply and demand have largely given way to price movements driven by the Ukraine war and the related gas-focused responses from both Europe and Russia.
The radically changed geopolitical landscape has fed into the gas market, with the EU taking swift action on storage and supply security, imposing mandatory storage obligations on member states in a bid to avoid a repeat of concerns over stock levels this winter.
European storage sites were filled to just 77% of capacity last summer, with facilities 26% full as of March 30, according to data from Gas Infrastructure Europe.
The first regulatory phase under the EU's storage reforms will see member states obliged to fill storages to 80% of capacity by Nov. 1, 2022, with intermediate targets through the year that must also be met.
The traditional gas injection season in Europe begins in April, but it remains to be seen whether there will be sufficient gas supply to help boost inventories at a time when Russian flows remain curtailed.
The US has pledged an additional 15 Bcm of LNG this year to help Europe, with other suppliers such as Azerbaijan and Norway also pumping at maximum capacity.
Russian deliveries via Ukraine have increased to their contractual maximum since Moscow's invasion as spot prices surged, making Russian gas delivered under long-term contracts more competitive.
However, Russian flows through the Yamal-Europe line remain erratic and mostly at zero.
Any impact from hostilities on the transit system in Ukraine would likely trigger more panic on European gas markets.
EU leaders have also agreed to set up a joint gas procurement mechanism to present a more unified stance toward sellers, and details of the initiative are likely to emerge in Q2.
The EU finds itself in a difficult position, however. It still needs Russian gas to fill storage sites through Q2 but has also pledged to cut demand for Russian gas by two thirds by the end of 2022.
Analysts at S&P Global Commodity Insights believe gas prices will remain supported by continued concerns over Russian supply reliability which, in turn, prompts other suppliers to target Europe to provide alternatively sourced gas.
Norway continues to pump at maximum levels, regularly breaching the 350 million cu m/d export level to markets in Europe, while LNG is also expected to come in large volumes in Q2 after high supplies in Q1.
"Platts Analytics forecasts continued strong LNG deliveries and record Norwegian gas production for Q2, with production permits increased, maintenance delayed, and gas over oil prioritization continuing," it said.
Norway's Aker BP is pivoting toward gas at its Skarv field, while Equinor plans to maintain higher gas output at its Heidrun, Osberg and Troll fields after increased production permits were approved by the energy ministry.
High prices are also leading to some European demand curtailments that are set to continue through Q2.
"Industrial and power sector gas demand destruction and switching are also forecast to continue, with residential/commercial demand in Europe now trending below 2018-2021 averages," S&P Global analysts said.
Low nuclear hampers diversification
Ramping up Europe's remaining coal plants could reduce Q2 gas-for-power demand by 6 Bcm in Europe's main markets, but long-term low nuclear generation is set to offset the bulk of these efforts.
"Europe is about to head into a summer with significant risk of tightness due to low French nuclear availability and low hydro stocks in Southwest Europe which has the potential to see a feedback loop of regional power prices chasing each other higher in order to attract net imports," S&P Global Commodity Insights' head of European power analysis Glenn Rickson said.
S&P Global forecasts a year-on-year decline in Q2 nuclear output of around 24 TWh, the energy equivalent of 4.5 Bcm of gas.
Elsewhere, solar and wind capacity gains and the prospect of demand destruction due to high prices could help further offset the loss of nuclear.
Nevertheless, France has become the premium market with Q2 baseload in a range of Eur250-300/MWh for much of the second half of March, EEX data showed.
New French links to Italy (the 1.4 GW Piedmont-Savoy) and Britain (the 1 GW ElecLink) are to start commercial operations during the period.
Closer to the conflict, Finland's new 1.6-GW Olkiluoto-3 nuclear reactor is set to produce some 3 TWh in Q2 ahead of commercial production in July, reducing imports of Russian electricity that climbed to 9 TWh in 2021.
In summary, European power's ability to turn down gas demand this spring and summer is limited by relatively low hydro stocks, weak nuclear and supply constraints at coal and lignite plants.
Anticipated demand destruction, with Q2 demand projected some 0.8% lower year on year assuming average temperatures, offers little hope for hard-pressed consumers enduring costs some way beyond their worst projections.
"A return to business as usual is hard to imagine [with] the coming weeks and months likely to see a series of wide-ranging policy responses which will likely be as severe an intervention into Europe's power market design since power market liberalization began in the 1990s," S&P Global's Rickson said.
Downside risk for carbon
Following a sharp drop in March linked to Russia's invasion of Ukraine, EU carbon prices have rebounded, leaving the outlook slightly bearish going into the second quarter of 2022.
EU Allowance prices for December 2022 delivery rebounded to Eur78.38/mtCO2e at the close March 30, from a low of Eur58.19/mtCO2e on March 7.
The rebound has left prices exposed to a slight downside risk going into Q2, with milder temperatures expected to limit energy demand.
On the supply side, the market was also looking healthier after EU member states allocated 54% of the available pool of free allowances to industrial companies for 2022, according to European Commission figures released March 17.
A total of 288 million allowances had been issued as of that date, from an eligible total of 533 million for 2022, the figures showed. Countries yet to allocate included Italy, Poland and Spain, and the volumes entering the market could limit upside for prices going into Q2.
EUA prices are forecast to ease slightly to Eur77.20/mtCO2e on average in April, Eur75.40/mtCO2e in May and Eur73.60/mtCO2e in June, according to a forecast by S&P Global Commodity Insights in its European Emissions Trading System Market Outlook released March 18.
"The escalation of the Russia-Ukraine conflict has led to a dramatic fall in speculator and financial interest in the EU ETS market, as investors de-risk and take profits following near-record high EUA prices," S&P Global said.
The power sector has added bearish pressure on EUAs since escalation of the conflict, as EUAs are sold in favor of covering higher oil, gas and coal commodity prices, it said.
Wider doubts over the macro-economic picture in Europe also represent a bearish risk factor for carbon prices moving into Q2.
"There are concerns that EU industrial production will fall amid current high energy costs, with signals indicated by the glass and fertilizer sectors," S&P Global said.
"We expect power sector demand to weaken into summer 2022 with receding seasonal demand but expect uplift to winter 2022 prices with increased coal burn following reduced imports of Russian gas," it said.
Upside risk factors include further disruption to natural gas supplies which could favor greater coal burn for power generation in 2022.
Equally, the supply side could offer additional support for prices amid ongoing regulatory efforts to reform and expand the EU ETS, including a possible phase down of free allocation. Negotiations are ongoing among EU member states under the French presidency of the EU Council which ends on June 30.
Those factors point to tighter supply over the long term, which could re-attract investor and compliance interest in carbon allowances.