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Q4 2020: Recovering markets look well supplied, with downside risk to the fore

Highlights

Gas stocks high as supply set to strengthen

Power demand muted but nuclear a worry

CO2 juggles weak coal burn with strong policy

London — With European day-ahead gas prices having rallied over the past two months from their record lows in May, one of the most important factors in determining how the market will develop in Q4 is likely to be the extent to which more supply comes to the market.

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Storage levels in the EU are around 94% full, leaving only limited room for further injections in the event of a warm October.

Related infographic: Gas and power markets well supplied but nuclear a worry - Q4 2020

Norwegian supplies are set to come back strongly from October onwards and LNG supplies -- especially from the US -- are set to rebound having slumped in the third quarter because of historically low prices and numerous cancelled US LNG cargoes.

Total LNG deliveries to key European markets fell 19% year on year in Q3 to 188 million cu m/d, according to S&P Global Platts Analytics.

"US LNG exports will remain critical to global balances in Q4," Platts Analytics' managing analyst James Huckstepp said.

Huckstepp said the arbitrage window between the US and Europe had re-opened, although US liquefaction terminals were still recovering from storms in late August.

Further, Europe could face competition from Asia for cargoes. "This is largely premised on resurgent Chinese demand in Winter-20, which is expected to absorb the bulk of global supply growth this winter," Platts Analytics' LNG analyst Samer Mosis said.

Mosis warned, however, that in a warm winter scenario more than a third of the 51 million cu m/d Chinese LNG demand growth this winter could be wiped out, pushing more LNG into Western Europe.

Meanwhile, Russian supplies -- which have been down by as much as 25% in 2020 -- are set to rise in Q4, with monopoly exporter Gazprom saying deliveries would be robust through the remainder of 2020.

Gazprom has pledged to inject up to 9 Bcm in European storages in preparation for the upcoming winter, giving it more supply flexibility and potentially adding bearish pressure to the market.

Ukraine also ramped up storage injections over the summer with the country acting as an "overflow" for European gas storage given its ample spare capacity and traders looking to take advantage of beneficial terms offered by Kyiv.

The extent to which surplus gas stored in Ukraine -- around 10 Bcm -- comes back into Europe this winter could also play a key role in market supply and demand dynamics.

Platts Analytics forecasts continued injections into Ukrainian storages by foreign traders through October, no withdrawals in November and minimal withdrawals in December, with the majority of foreign injected gas staying in stock until Winter-2021.

"But stronger withdrawals starting earlier presents significant price downside," Huckstepp warned.

On the demand side, Platts Analytics is forecasting a 3% year-on-year increase for Western Europe to 112 Bcm with no net impact on residential and business demand from the coronavirus.

Nuclear shortfall

While European electricity demand is set to remain below norms into Q4, record-low nuclear availability could still trigger price spikes at times of low wind and cold temperatures.

Late November/early December is a notable pinch point in France, with shifting reactor return dates at Flamanville and Bugey putting a combined 4.4 GW in play.

"The outlook for nuclear on both sides of the English Channel will be crucial over coming weeks, particularly in light of the imminent startup of the IFA 2 interconnector between France and Great Britain," Platts Analytics' Glenn Rickson said.

Overall, average Q4 nuclear generation across Western Europe is set to be 4.1 GW below Q4 19 levels.

This deficit should be partially offset by the scheduled return of two CCGTs (Claus in the Netherlands and Irsching in Germany) with combined capacity of 2.5 GW from Oct. 1, while Europe enters winter with a relatively healthy hydro balance, particularly in the Nordics where stocks are close to 90% nominal capacity.

"But even if gas will play a central role this winter in covering the nuclear shortfall, the events of mid-September [hourly prices spikes above Eur200/MWh] show how coal is still critical at times of tightness," said Platts Analytics' Giuliano Bordignon.

Average Q4 demand across 10 West European markets is seen 4% or 10 GW lower year on year at 244 GW, according to Platts Analytics.

As ever, much depends on the weather, with system operators likely to be challenged by surges in a growing wind fleet.

Two 750 MW Dutch offshore wind farms at Borssele are set to start in Q4 with 2020 on track to add at least 12 GW of wind capacity on- and offshore.

Nevertheless, assuming average wind conditions, Platts Analytics predicts Q4 average output to dip by 0.7 GW on the year to 44.2 GW because wind conditions were above-average last year.

Finally, three new interconnectors are set to start operation in Q4, aiding TSO efforts to balance volatile supply and demand.

Beside IFA 2, testing is set to start on the 1-GW Alegro interconnector between Belgium and German with go-live planned for November, while the 1.4-GW NordLink cable between Norway and Germany is already in testing ahead of a limited start from December.

Carbon phases

The outlook for EU carbon prices in the fourth quarter looks stable, albeit with potential for some short-term volatility as EU ETS participants digest the implications of tighter proposed carbon targets for 2030, as well as strong primary supply from auctions.

Weak underlying compliance demand due to lockdowns has been overshadowed by factors on the regulatory side in Q3, as the EU sought to revamp its climate goals, which would result in tighter supply of EU allowances.

Allowance futures contracts for December 2020 delivery on the Intercontinental Exchange averaged Eur27.42/mt in the third quarter, up Eur6.14/mt from Eur21.28/mt in Q2, when prices were still recovering from the March lows of around Eur15/mt amid weak demand.

Prices are expected to average Eur26.50/mt in Q4, little changed from late September, according to Platts Analytics' latest forecast released Sept. 14.

Government auctions are set to provide 213 million EUAs in Q4 versus 203 million mt in Q3. The modest increase reflects 50 million mt of EUAs from the EU's Innovation Fund added to auctions starting July 16.

Despite the stable outlook, some price volatility is likely to continue into Q4 as the end of the third ETS phase approaches (2013-2020). Phase four will see a number of important changes including a significant cut in the number of sectors qualifying for free allocation due to carbon leakage risk.

The annual carbon caps will also need to be adjusted downwards to take account of the European Commission's more stringent 2030 emissions reduction target of 55% below 1990 levels. The target needs the backing of the EU Parliament and Council before becoming law. As a result, the annual carbon caps may need to be reduced at a faster rate from 2026-2030.

A downside risk for carbon prices in Q4 is the coronavirus, with any flare-ups likely to prompt European governments to re-impose restrictions on travel and social activities at the local level, with potential to become more significant if infection rates continued to rise, weighing on industrial and economic activity.

Policy focus

The European Commission's call for the EU to cut its CO2 emissions by at least 55% on 1990 levels by 2030 will dominate the energy policy debate in the fourth quarter.

Meeting the higher target will require tightening the cap on the EU Emissions Trading System and increasing EU efforts to switch to renewables and improve energy efficiency.

The European Parliament plans to vote during October 5-8 on the draft 60% CO2 cut by 2030 target recommended by its environment committee. This could be a hard vote to call, as the Parliament's industry committee only narrowly backed an "at least 55%" target for its recommendation, over a "50-55%" option.

Both the Parliament and the EU Council will have to agree on a new 2030 CO2 target law before it can becomes binding. The council has yet to agree a position on this.

The EC has already estimated that the EU will cut its emissions by around 45% by 2030, if it fully implements all existing EU legislation.

Meanwhile, the EC plans to publish an EU methane emissions strategy and a building renovation wave strategy on October 14.

The first is to set out ways to monitor and reduce methane emissions from producing and transporting natural gas and LNG, while the second will look at how to reduce energy demand from buildings -- a major part of EU gas demand.

The EC plans to propose formal legislation on all the ways to help achieve the higher 2030 target next summer.