A rapid re-balancing of the European gas market looks an unlikely prospect in Q4 2021 as prices continued to reach fresh record highs deep into September.
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With storage stocks at historically low levels for the time of year, Asia beating out Europe for LNG cargoes, and Russia continuing to keep a lid on exports, there is real concern that Europe could face gas shortages through Q4.
One potential potential supply-side savior would be an early approval and startup of the Nord Stream 2 pipeline, which could bring much-needed gas into Europe before the end of 2021.
But with the German regulator allowed to take up to four months -- to January -- to publish a draft decision, there is a real risk Nord Stream 2 will remain idle until well into 2022.
The unprecedented market tightness has left producers other than Russia supplying as much gas as possible to the market, from the UK, to Norway, Algeria and Azerbaijan.
Any unexpected disruption in the upstream in any of these countries could be disastrous for European balances in the absence of significant LNG supplies.
S&P Global Platts Analytics sees more LNG coming to Western Europe in Q4 than the same period of 2020, however, which could bring some relief.
It forecast net imports of 224 million cu m/d in the October-December period, up from 193 million cu m/d in the fourth quarter of 2020.
But with Platts JKM LNG price still at a premium to the TTF -- and the two benchmarks chasing each other ever higher to secure spare spot cargoes -- much will depend on the weather in the respective regions.
A cold winter could spell "trouble" for Europe, France's Engie said late September.
According to Platts Analytics, the market may need to balance on more demand destruction or substitution. "Beyond hoping for mild weather, there is no one clear solution to our balancing needs this winter, not even Nord Stream 2."
It may turn out that Q4 will end up being a demand story in European gas, with gas-guzzling fertilizer plants already having been idled or production curtailed.
"We forecast industrial gas demand destruction (especially fertilizers) and refineries switching from gas to liquids, as well as the final unprecedented source of flexibility which is gas-to-oil switching in the power sector," Platts Analytics said.
While gas demand in the residential sector was expected to remain flat in Q4 versus the same quarter of 2020, Platts Analytics expects 14 million cu m/d of demand destruction and switching in the industrial sector, and 30 million cu m/d of gas giving market away to coal and oil generation in the power sector.
Of course, not all European gas buyers are paying the current spot prices -- Russia's long-term contract holders have been in part protected from the price increases as their prices are calculated using a different formula.
Some Russian long-term contracts are still partly indexed to oil, while others use a hybrid of short- and medium-term hub indexation, often with a time lag of 6-9 months.
But with Russia seemingly linking approval of Nord Stream 2 with additional gas supply, it is coming under increasing pressure to act now to help supply the European market.
The International Energy Agency said late September that Russia "could do more" to increase gas availability in Europe and help full storage sites, which remain low for the time of year, built to just 74% of capacity by Sept. 26.
A cold winter could also tighten an already struggling supply outlook, with LNG continuing to be pulled to Asia by the sky-high JKM spot LNG price, which Platts assessed Sept. 30 at a record $34.47/MMBtu.
Scope for coal switching
Europe's power markets have tracked the gas rally closely, indicating any material correction would only come from a re-balancing in supply and demand.
"A major factor behind the increased sensitivity of power prices to gas is coal and nuclear closures over recent years," Platts Analytics head of European power analysis Glenn Rickson said.
Germany alone is set to retire 10 GW of coal and nuclear capacity in 2021.
"There is some scope for coal capacity to return online as well as a limited amount of gas-to-oil switching this winter," Rickson said.
Gas-fired generation's share in the power mix is set to fall below 20% in Q4 across the 10 markets modeled by Platts Analytics, with a 13 GW average year-on-year decline forecast.
That would likely be offset by coal and lignite burn some 10 GW higher for the period, with Germany's remaining 15 GW of lignite plant maxed out.
Marginal year-on-year gains for nuclear dispatch and wind and solar capacity would offset a lower hydro forecast, while Q4 power demand would be up 2% year on year based on average temperatures.
"Germany's exposure to wind generation on the back of 4 GW nuclear closures by end-2021 will likely spur high price volatility in Q1-22," Sabrina Kernbichler at Platts Analytics said.
More generally, new power cables may help subdue some of the volatility, with all eyes on operational testing of the NSL and Eleclink cables to the UK, following an enforced outage on the 2 GW IFA 1 link to France.
UK nuclear output is forecast to average 5.8 GW in Q4, the lowest since 2008, while French nuclear output is forecast at 44 GW, a recovery on last year.
The gas rally has lifted year-ahead power to a record Eur122/MWh in France, almost triple the regulated ARENH price at which EDF has to sell 100 TWh to domestic suppliers. While there is pressure to increase ARENH volumes for 2022, it has been resisted by the government.
In summary, upside risk remains despite current high pricing, but a mild winter and strong wind generation after a disappointing first nine months could rapidly change that picture.
EU carbon supported
EU carbon futures contracts for December 2021 delivery are expected to trade at Eur59/mt in October and November and Eur60/mt in December, Platts Analytics forecast in its European Emissions Trading System Market Outlook Sept. 22.
December 2021 EUA futures prices already rallied to a fresh intra-day high of Eur65.06/mt Sept. 27, suggesting demand remained strong from compliance entities and financials alike.
"Rising gas prices continue to provide fuel switch price signals in favor of coal generation, with risk of demand destruction; non-emitting generation [was] robust in August but fell in early September to lift coal generation and support EUAs," Platts Analytics said.
On the supply side, carbon auction volumes in Q4 are set to average at just under 45 million mt/month, down nearly 30% year on year, excluding UK volumes and after removals by the Market Stability Reserve.
The sharp year-on-year drop in supply is partly driven by the inflated volumes over September to November 2020, which included additional volume from Poland and other sources.
Upside risks for the carbon price outlook include ongoing tight natural gas markets in Europe, as described above.
A possible downside risk could emerge from industrials selling free allocations of allowances who may decide to take advantage of current record-high prices.
However, that factor may ultimately be mitigated by concerns over a longer-term shortage, prompting companies to hold on to any surplus volume.