We are on the cusp of the gas winter and the TTF M+1 contract has been surging upwards, with Q1-19 closing above 29.0 €/MWh by mid-September, the highest closing price in a decade. The root causes of the rally are likely to stay around for a while, with both the stubborn y/y storage deficit and the super bull run in carbon prices unlikely to ease in the coming months.
The persistent y/y storage deficit has been driven by low LNG receipts and the failure of Russian supply to return to the high levels of Q2 18 after Nord Stream came back from annual maintenance. The former has been driven by strong Asian LNG buying, but the cause of the latter is less clear. Theories include Russian pipeline and/or field maintenance, commercial positioning by Gazprom, and little additional flexibility left under long-term Russian supply contracts due to heavy nominations in the first three quarters of gas year 2017-18.
Whatever the real story, the result has been that the storage gap has widened over Q3 18. Memories of the price spikes at the end of last winter are still fresh in the market’s mind, so considerable risk premium is being fed into the curve while the prompt is desperately trying to get gas out of power and into storage. As we outline in our Insight: Winter outlook: All that bullish?, Sep 2018, a return to normal weather would result in the y/y storage deficit in Europe being plugged in November. If colder-than-normal temperatures occur, then that date would get pushed further into the future and that storage gap might not get plugged at all. Given the above, a relative softening in prices could only begin in November at the earliest.
The other key driver of the rally has been the super bull run in the carbon market, which has seen EUA prices go up threefold since January to around 22 €/t. We acknowledge that there is an underlying fundamental reason for the EUA bull run, namely the impending start of the market stability reserve (MSR), which is set to curtail around 400 Mt of supply in each of 2019 and 2020. While this is undoubtedly the root cause, the surge in EUA prices has a large speculative component. Participants are content, for now, to buy and hold the commodity. While such positions will eventually be liquidated, we see no meaningful trigger for profit-taking before the expiry of the Dec-18 EUA futures and options. That leaves plenty of time for EUAs to add another 5 €/t or so, and this will mean that even if the gas market starts to ease in relative terms against coal, flat prices could stay supported on carbon.
While this is all bullish, one bearish development is the progress on the 55 bcm Nord Stream 2 (NS2) pipeline. Pipe-laying has already started in Russian waters and preparatory construction work is set to begin on two of the three sections of the downstream EUGAL pipeline in Germany, so NS2 is now a train that has left the station. While there is still political opposition to the pipe in some parts of the EU (and the US), it is very hard to see this project being stopped. We expect NS2 will start to send gas through the first line in Q2 20, when we think that more LNG will be available to Europe. While this points to a lower-price environment, carbon prices could be even higher by then, so flat price development could still be kept reasonably buoyant.