European Natural Gas prices – where are we headed

Natural Gas in Europe is a misery right now. Those selling the stuff say gas prices are not high enough and consequently they cannot make a living. Those buying it for use say that the price levels are far too high and at those levels, it is not a competitive form of energy.

Who is right? I don’t care! What’s much more interesting is – where is the journey going – and why?

Now, for all those who need guidance for their next investment pitch. The information I share with you here and now is my reasoning. If you read it and as a consequence, you feel compelled to make a decision (whatever kind) without seeking the help of someone who will dissect your particular situation and give you tailor-made advice, you have only yourself to blame for the consequences. You have been warned.

So, may I ask the fainthearted among you to walk the dog, gobble down some pasta, or have a refreshing conversation with yourself but stop reading. This is not for you.

For all the others, back to the gassier bits of our topic. I have another clarification here. I am not going to cut into the long-term price versus spot price topic in this post. Oil-linked long-term price formulas are an obscene leftover from the past giving bureaucrats wet dreams and tight jeans. They are dead. Real dead. A rock in the desert is a sprawling display of life compared to those obscenities.

If you still need waterproof undies when you see a price formula, go and read my Big Mac analogy.

OK. Where are we right now? TTF hovers around 26 EURO per MWh right now. Everything else in the Western and Central European vicinity is tracing that. What direction are we fundamentally headed to?

It’s easy to feel depressed in Europe’s gas markets. Most of those working it today can still remember the time when the market would swallow any volume of gas one could throw onto it. The question was not really – was the gas competitive? It was rather – would I get the gas in the first place?

A couple of things were conveniently forgotten by those driving the portfolios. First gravity – everything that goes up eventually will come down. European energy utilities and gas traders deluded themselves into believing that the Bonanza would be never-ending. We had those delusions in almost any industry since the dawn of time and now it has hit the Natural Gas world. Just remember the dotcom bust, when everyone thought that the sky was the limit (not even that in some cases), and even the fluffiest business plans consisting of a couple of PowerPoint slides were hailed by investors as the holy grail.

It all turned to shambles in 2000 as we all still remember (do you???) but the ensuing (it still took some time to evolve) internet business of today has gotten infinitely more powerful than we all dared to dream of. It was just not with the same players as in the late Nineties. Still, remember Altavista? Or Lycos?

Back to the topic. The current Natural Gas price problem is multi-faceted as it stems in part from the shale gas revolution in the US, flooding Europe with cheap coal that consequently pushed natural gas out of the market. But another factor sure was the current economic crisis that makes us all cringe.

All that pales in comparison to another problem that most of us are not even aware of. The fact that Natural Gas is way too expensive for its good anyhow. Let’s take a look. 26 €/MWh is a bit more than 10 USD/mmBtu at today’s exchange rates. In the US, this gas would be impossible to sell for profit. And so it is in Europe as long as the coal overhang remains. For that to go away, it would need the combined effects of much more expensive gas in the US (so coal firing would make sense again there) plus much more expensive Carbon certificates in Europe (so the penalty for producing Carbon hurts).

The certificates were meant to be a disincentive to produce airborne Carbon in the first place. They are so dirt cheap now that they are not even a serious factor in the calculation anymore. The question is not – will we produce CO2 or not? It became an OPEX element that is just being factored in without any questions asked.

But let’s look at the more long-term drivers.

Everybody talks about shale gas in Europe but I think it’s a deeply misunderstood topic. Shale gas today needs a lot of political support plus support from the population to succeed in any meaningful way. In Western Europe, this is virtually impossible to garner as NIMBY and NIMTO become extremely powerful in killing such projects before they even get dreamed up. We have a very telling example here in the Viennese basin even if I would argue that shale in Austria is a dead duck for other reasons than political activism.

But in countries like Ukraine, Turkey, or Romania those things weigh much less as they care more for cheaper gas, greater independence from the Russian bear, and job creation. Those things chime well with the general population exposed to hardship as a result of the Central and Eastern European miracles losing their luster. This is why shale has a lot of political support in those countries. It’s hard to be an activist with an empty stomach.

Let’s just imagine a country like Ukraine to go berserk on shale. They have many reasons to do so. Their gas consumption would not miraculously expand meaningfully because there is cheaper shale gas – at least not in the short term. Markets need to build up slowly even if the underlying commodity is dirt cheap. And the investment climate for other industries in those countries is poor. So this new shale gas would start squeezing out volumes of Russian gas going the Ukraine right now.

But that Russian gas is currently a source of income for Gazprom and hence the Russian state. Less gas sold (to no matter who) means less money to sprinkle on the rest of the Russian economy and for an economy as dependent on income from hydrocarbons as Russia is, this spells disaster. They would have to squeeze this gas further west to sell it off, but their oversupply is already a serious problem.

Imagine this happening with a couple of countries in the east of Europe. Even if they never exported a whiff of gas into the rest of the continent, they would still cause a deluge of Russian gas further west and would consequently push prices down. maybe even to levels as we see them in the US today. After US shale, don’t tell me that this is not on the books.

Here is the mix. Shale from the East, depressed economies all over the continent, and a coal overhang that is not going to go away easily.

Natural Gas spot prices are headed southwards and nothing is stoping that. Except maybe if Natural Gas becomes a fuel for vehicles in a meaningful way. This would sure gobble up some of the overhangs. But this also must be developed carefully and will take time.

But more on that in another posting.