Winter outlook: All that bullish?

Published at 12:06 19 Sep 2018 by . Last edited 11:18 22 Aug 2019.

Europe is heading into the heating season in a bullish mood, with a combination of low storage levels and high prices in the generation complex (coal, carbon) having supported gas prices.

The coming winter holds risks to both the upside and downside. Given that a number of months last winter were colder than average, a return to normal temperatures would leave res-com demand lower y/y in all months but October and January. We expect the biggest y/y demand drops to be in February and March, although both Q4 18 and Q1 19 will in aggregate see a y/y demand reduction of 15 bcm, assuming mean-reverting temperatures. While the commercial forecasters differ somewhat on seasonal forecasts, there is some indication of a mild Q4 18, followed by a colder-than-normal peak winter (January-February) and then a milder-than-normal end-winter (March).     

While res-com demand looks much weaker based on a return to normal weather, power sector gas demand could see support. Power demand could well drop on normal weather, but European hydro generation looks low due to the big y/y deficit in the Nordic region. Nuclear availability in France is expected to be higher y/y this winter and there is more EU renewable capacity, but these sources will only partially offset a drop in hydro generation. How much gas is available for power will determine that sector’s gas demand and what price is needed to secure market balance.    

As for supply, it is clear the EU will not see any additional LNG this winter, although there is uncertainty over just how much less LNG will arrive. We think y/y drops will be marginal, around 1.0 bcm, in Q4 18 because of more supply on the water and some pockets of very weak demand, particularly in Latin America and North Africa. Only Asia is providing real demand upside, mostly from China. So, the main EU story will be about pipeline supply and the biggest uncertainty here is Russia. While North Sea supply should largely be flat y/y and Dutch supply down by around 2.5 bcm y/y, Russian flows that have been lower y/y for much of Q3 18 and well below capacity have upped the risk premium for winter. Until the market becomes convinced that Russian flows will backfill any supply gaps, the market will carry a heightened risk premium.

While flat price direction will be attuned to supply and demand dynamics, the super bull run in the carbon market continues to provide support for gas contracts. It is hard to rule out another 5 €/t or so being added to EUA prices over the next two months. For our expected mean winter fuel switch trigger, which is at 27.6 €/MWh with an underlying carbon price of 20 €/t, that would increase to 29.8 €/MWh with a 25 €/t carbon price (with coal at 100 $/t in both cases). Outside of the carbon bulls dragging prices upwards, gas prices should trade around that fuel switch trigger, potentially heading lower through Q4 18 and then strengthening through January.

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