Gas crisis in Europe: causes and possible consequences for the population and economy

Gas prices in Europe began to rise in April of this year and have risen eight times since then: gas futures quotes at the TTF hub in the Netherlands reached the level of 1969,2 dollars per one thousand cubic metres. For information: back at the beginning of the year, futures were trading at $265. Natural gas accounts for about 22% of electricity production in Europe, and, as a result, electricity tariffs for the population and industry have sharply increased: in Germany — up to 302,5 euros per megawatt hour, in Spain — up to 288 euros. The columnist for Realnoe Vremya, economist with many years of banking experience, Artur Safiulin, suggests to look into the reasons for such a sharp rise in prices.

Reasons for growth

  • Increased demand amid economic recovery

The restrictions associated with the pandemic have significantly reduced the demand for energy resources. Gas consumption decreased by 1,9%. Against the background of the recovery of economic activity in 2021, the World Bank forecasts an increase in energy demand by 5,6% — this is a record figure for the last 80 years. Gas producers (in any form) have reduced LNG production during the crisis. Own natural gas production in Europe (EU + UK) decreased by 24%, or 12,5 billion cubic metres compared to the same periods of 2019-2020. Now we are clearly seeing a gap between supply and demand. The market is unbalanced.

  • Seasonal demand growth

Due to the abnormal cold weather last winter, the demand for gas in Europe increased sharply. This led to the consumption of stocks from storage facilities at an accelerated pace and eventually depleted them. In addition to the cold weather, the increased gas consumption was also affected by a sharp reduction in electricity generation from renewable energy sources: there were no usually strong winds in the North Sea to load the wind turbines standing there.

In the summer of this year, gas consumption continued due to the now abnormal heat and higher electricity consumption. Besides, the drought in the northern and southern hemispheres has led to a decrease in electricity production at hydroelectric power plants (HPPs). By that time, gas had already started to become more expensive and high prices had already begun to scare off national gas companies. The replenishment of stocks in the storage facilities paused.

If they only knew what awaited ahead: the demand for liquefied natural gas (LNG) in Asia started to grow sharply. Due to that prices in this market are always higher than in Europe, in spring and summer suppliers sent their volumes of gas to Asia, reducing supplies to Europe. Against this background, the fullness of gas storage facilities in Europe at the end of April was only 30%, by the end of summer this figure had grown to 68%. The figure of 85-90% is considered an uncritical level. For example, in 2020, the fullness rate in Europe in September was 94%. In total, 14 billion cubic metres of gas were underdelivered to Europe. With total gas consumption at 550 billion cubic metres a year, the figure of undersupply looks ridiculous (4-5%), but it was enough for the market to explode.

  • Import problems

One of the largest gas suppliers is traditionally Russia, providing about 22% of the total consumption, supplying 115-120 billion cubic metres a year. In January-August 2021, Russian exports amounted to 99 billion cubic metres, which is by 19,3 billion cubic metres less than in the same period last year. And it's not that it's Gazprom, which suddenly stopped supplying in the right amount: the whole point is the desire of the European Union to reduce dependence on Russian gas, they just buy less than before. As a result, relying on other sources, such as LNG, renewable energy, the EU decided to use the so-called spot market: in fact, the principle of “here and now” instead of concluding long-term contracts with, for example, Gazprom, where you can safely fix the price for the future, even if the spot market breaks all records. All kinds of speculators inflated the exchange value to exorbitant levels. This will be a great lesson for those officials in the EU who are planning the development of the gas market. They acted too fast and ran into a hard mine in the form of the very hand of the market.

Besides, the pandemic prevented some countries from carrying out repair work on their gas transportation infrastructure facilities. Most of the gas exporting countries to Europe, especially Norway (also a key supplier along with Russia), began repair and technical works this summer. Norway, as a result, reduced gas exports by 3,1 billion cubic metres in the first eight months of 2021 compared to the same periods of 2019-2020.

  • Accelerated transition to green energy

Recently, EU countries have begun to abandon the use of coal as fuel for power plants to reduce emissions into the atmosphere. Switching to renewable energy sources — solar, wind — was seen as an alternative. Natural gas was seen as a transitional type of fuel, as it is much cleaner in terms of emissions.

Having removed coal as an energy source and faced with a shortage of gas, the European market lost its balancing asset: when gas rose in price, they started using coal. There are already calls to use coal, despite the tough environmental agenda. In addition, the nuclear power industry was almost completely shut down (after the Fukushima accident in 2011). There are no news about the energy apocalypse from France: nuclear power is well developed there, which has a significant share in the country's energy balance. France found its balancing asset by developing green energy in parallel. Germany, having closed all its nuclear power plants, will soon begin to burn coal again.

  • Exchange factor (margin calls)

There is also an absolutely stock exchange explanation for the situation — the so-called margin calls, which have survived trading houses in Europe due to a sharp increase in the cost of gas. In the summer, when prices were already high enough, many traders bet on falling prices. Now, against the background of a sharp rise in prices, they are forced to spend hundreds of millions of dollars to increase the guarantee of their positions. Here's how it works. Companies sell gas futures to hedge transactions between the US and Europe for the period while LNG ships cross the ocean. Traders borrow funds to open short positions, 85-90% of financing comes from banks. About 10-15% of the cost of a short position (minimum margin) is covered by the traders' own funds and deposited to the broker's account. When the minimum margin reaches a critical value, the trader receives a notification from the broker about the need to replenish the account. This is called margin call. As prices rose significantly, traders had to borrow hundreds of millions of dollars.

The total volume of short positions of oil and gas traders can be estimated using the example of Gunvor, which published a report before the bond issue in the summer. In June, it held gas futures with a total value of $2,5 billion in short positions. Of course, this is a major trader, but there are plenty of others in the market. A colossal total amount! If it is impossible for traders to deposit the required amounts of collateral, brokers will close their positions (that is, buy futures) at any prices, thereby accelerating the price level even more.

Consequences and forecasts

One of the most obvious consequences of rising gas prices will be an increase in tariffs for the population and industry. The profitability of production is being eaten up by rising costs, companies will be forced to raise selling prices, which, against the background of falling household incomes and accelerating inflation, will add to the general pot of problems. Gas shortage in Europe could lead to a global crisis. The most interesting thing is that so far there is not even a possibility of lowering prices on the spot market: Qatar, Australia, Nigeria supply the Asian market, where prices, as already mentioned above, are traditionally higher. By rejecting long-term contracts with Gazprom, European countries, in fact, shot themselves in the foot in a situation where nothing suggested problems. The head of Gunvor makes a forecast that in the next two years we should not expect a decline, on the contrary, there will be further growth.

The situation can be saved by a decline in the growth of gas consumption in China — in August, the growth was 12% (compared with 20% in August 2020). Pressure on the European market may ease due to the redirection of supplies from the Asian region. In addition, high LNG and gas prices are forcing Asian importers to use more coal and oil to generate energy, which accelerates the prices of all energy carriers. Forecasts about the upcoming commodity supercycle are beginning to come true.

As for forecasts, the International Energy Agency (IEA) predicts that the current price level will remain at least until the end of the first quarter of 2022. The agency's report says that in 2022, Henry Hub prices will increase by 5%, TTF — by 10%, and spot LNG prices in Asia — by 6% compared to this year's levels. After the end of the heating season, prices will drop. In the second half of 2022, Henry Hub prices will be on average 18% lower than in the second half of 2021, while prices on TTF and on the spot LNG market in Asia will decrease by 40%.

In conclusion, I would like to note that the current crisis in the gas market was provoked by a whole bunch of factors mentioned above. But the most important one is man-made, created by the European officials themselves, who made a gross mistake in planning the energy balance in terms of green energy. It is unreliable and depends on natural conditions. The rejection of long-term contracts with Gazprom at reasonable prices was a purely political decision, and decisions need to be paid for. In this case, at the expense of the pockets of ordinary citizens. Gazprom itself, against the background of rising prices by the end of 2021, will earn about $45 billion over the planned, this has already led to an increase in the company's stock prices. Besides, our companies that produce products for export (fertilisers, for example) receive gas at a price of 5,000 rubles per thousand cubic metres (approximately 68-70 dollars). This will give them a huge price advantage. In this crisis, Russia as a whole is in a good position, all its export positions are raw materials and are growing in price. Let's wait and see.

Artur Safiulin