Natural gas prices are soaring around the world in what has become something of a global supply crunch.
Prices in the U.S. recently hit a 7-year high, natural gas prices in Europe are soaring, and LNG prices in Asia have hit a record high. Higher natural gas prices are forcing up the cost of electricity, and some analysts warn of inflation. But while the supply picture is rocky in the short run, high prices and volatility only undermine the argument for gas in the energy mix over the long run.
A global price rally
U.S. nymex prices shot up close to $5/MMBtu this week, a price not seen since the polar vortex of 2014. Prices have now increased by nearly 100 percent this year. Bloomberg notes that traders are placing a premium on futures contracts for March deliveries, which is not coincidentally at the end of the winter season, perhaps when the market could be at its tightest.
The outages of 77 percent of the U.S. Gulf of Mexico natural gas supply due to Hurricane Ida is not helping matters. In the American West, extreme drought has undercut hydropower generation, forcing a greater reliance on gas.
But the high prices are not a unique feature of something unfolding in the U.S. – the phenomenon is global. European natural gas inventories are low and prices have soared. So too have carbon prices on the European Trading System, and even coal prices are skyrocketing. As a result, German and UK electricity prices have hit a record high.
Behind the broad natural gas price rally is a convergence of factors. The main backdrop is the mismatch between stagnant supply stemming from the pandemic, and rebounding demand.
The pandemic induced a meltdown in energy markets.
On the eve of the pandemic in early 2020, U.S. natural gas prices had already plunged below $2/MMBtu, due to oversupply. Rigs were scrapped. The pandemic then induced a meltdown in energy markets, which culminated in Asian LNG prices in the summer of 2020 falling below $2/MMBtu. Dozens of LNG cargoes were cancelled.
The response was a sharp pullback in drilling worldwide. But with economies coming out of hibernation over the course of 2021, demand is now draining natural gas inventories around the globe.
Extreme weather is also playing a role. A cold winter in various parts of the world earlier this year dramatically reduced natural gas inventories. Inventories were reduced further this summer amid brutal heat waves across the northern hemisphere, itself the result of a worsening climate crisis. High heat has set the stage for low inventories heading into winter again.
“We’re experiencing a bit of a perfect storm at the moment,” Rajiv Gogna, a partner at Lane Clark and Peacock LLP, told Bloomberg. “We’re still exiting the summer period, with a number of summer outages across the gas fleet further reducing availability, and the global increase in gas and carbon prices continuing to apply upward pressure on prices.”
“It is the perfect storm.”
Indeed, the “perfect storm” analogy has become a common refrain. “It is the perfect storm, prices are galloping due to China’s heatwave, shortages with Coal India and power plants, high freight rates, increased appetite in the rest of Asia, tightness due to Indonesian rains, Hurricane Ida in the U.S., and in general a supply crunch,” Puneet Gupta, founder of Indian coal marketplace Coalshastra, told Reuters.
Another factor has been lower-than-expected gas pipeline flows from Russia into Europe. And adding even further pressure recently has been lower power generation from wind in Europe. Drought in southern Europe has also reduced hydro generation in Spain, Italy and France, according to Bank of America.
With inventories at low levels in many places, buyers are looking to import more LNG. That, in turn, has pushed LNG prices up. In Asia, the JKM marker shot up to all-time highs above $20/MMBtu.
Analysts see risk to the upside. “With a limited storage cushion, any disruptions to supply from Russia, Norway, or LNG or simply a cold winter could send TTF prices and European power prices soaring,” Bank of America said in a note.
Undermining the case for gas
High natural gas prices are set to deliver a windfall to drillers, which could translate into more drilling. For now, they are heeding investor advice to keep the rigs mostly on the sidelines, but $4 or $5/MMBtu gas certainly looks more enticing to frackers than sub-$2 gas.
But while high prices are good for producers, they are painful for everyone else. Leaving aside the role of gas in fueling climate change – a very significant role to be sure – high prices undercut the case that gas should be relied upon.
Extremely high prices and vertigo-inducing volatility are not exactly features of “reliability,” as industry proponents often describe natural gas.
While some may say more gas drilling is needed, and high prices are the result of misguided energy transition policies, others see precisely the opposite. “The reality is we need to switch to renewables faster,” Greg Jackson, chief executive of Octopus Energy, a British utility, told the New York Times.
Many developing nations will also balk at high prices for LNG. In late August, Bangladesh’s state-run Petrobangla said it plans to stop buying spot LNG cargoes for the rest of the year because of sky-high prices. Pakistan has cancelled cargoes over high prices as well.
In early 2021, a previous rally in LNG prices forced Pakistan and Bangladesh to ration gas and cancel LNG cargoes.
That price risk is exactly what some analysts have warned about when it comes to LNG. For example, in a report in July, the Institute for Energy Economics and Financial Analysis (IEEFA) analyzed the risks of a country like Bangladesh from building coal and gas-fired power plants.
“Reliance on expensive fossil fuel imports will undermine the financial sustainability of Bangladesh’s power system,” the report said. In addition, “a switch to LNG will further expose Bangladesh to a fossil fuel with even greater price volatility than coal.” IEEFA has repeatedly sounded the alarm about the financial risks of relying too heavily on LNG.
Short-term demand destruction could easily translate into the erosion of long-term demand. If countries opt against building LNG import terminals in the face of eye-watering price tags for LNG cargoes, and they instead move on to renewable energy, that strikes a blow at natural gas. Notwithstanding today’s high prices, which will increase cash flows for gas producers, such an extreme rally should worry the industry.
“Wind and solar are intrinsically deflationary, whereas fossil fuels are intrinsically inflationary.”
Not only is renewable energy the cheapest option for electricity in many parts of the globe already, but renewable energy also has no fuel costs. That keeps a lid on electricity prices and can also provide a deflationary effect, an attractive feature for policymakers worried about price inflation. “Wind and solar are intrinsically deflationary, whereas fossil fuels are intrinsically inflationary,” Mark Lewis is chief sustainability strategist at BNP Paribas Asset Management, wrote in the FT late last year.
Some governments are already taking note. In reaction to high electricity prices, Spain recently announced that it would auction 3.3 gigawatts of solar and wind capacity in October. The stipulation in the auction is that 600 megawatts must come online by September 2022. “The results of the auction will translate into direct savings in electricity bills,” Spain’s energy ministry said in a statement.