Super summer bear

Published at 13:40 15 Feb 2019 by

The narrative around European gas markets has shifted to be very bearish following a Q4 18 featuring milder-than-normal temperatures and a January with largely normal temperatures. The bears are being fed by bulging European stocks, which were 4.4 bcm higher y/y by the end of January. Even an end to winter with normal temperatures will leave the end-March storage carry 15–20 bcm higher y/y.

Incremental LNG is still going to come into Europe despite much lower injection demand this summer. Our global balances suggest that Europe will take 12 bcm more LNG y/y this summer. This is a conservative view given that 2.6 Mtpm of new supply capacity was added in H2 18 (1.5 Mtpm in December alone) and another 1.5 Mtpm of supply is due to come online this summer.

European balances in summer 2019 will be looser by 32 bcm y/y due to higher stocks and more LNG. The market will balance, at least partially, by getting more gas into power. Gas contracts for delivery in summer 2019 are currently pricing off the 5% fuel switch trigger (gas-fired plants with a 5% efficiency advantage over a coal-fired plant would be in merit), compared to the 15% trigger that largely prevailed over summer 2018. Coal-to-gas fuel switching is already taking place. At the 5% trigger, a maximum of 12 bcm of added demand could come from the power sector.

While the 5% trigger will allow most of the available fuel switch from hard coal to gas to be realised, just how low hub gas prices need to go to stay at that trigger will be dictated by where coal and carbon prices go. We are getting increasingly bearish on Cif ARA and EUAs for summer 2019. Current European coal prices at just above 70 $/t are below where we would expect them given crude oil at $60. With Cif ARA detaching somewhat from its oil price tether, coal and gas look set for a race to the bottom to secure power sector market share. Even so, some support is likely to come from oil, as well as Asian coal markets, and this could make it harder for Cif ARA to fall to 60 $/t.     

In a market with falling gas and coal prices, many wonder how bullish the emissions market can stay. We had been consistently bullish on EUA prices in 2019, expecting to see a summer average of around 27 €/t. However, it does feel like it is time to reassess that bullishness. While some big risk events have been present in Q1 19 (e.g. the ongoing Brexit saga and the German coal commission final report on plant closures), hindering any market upswing, most remaining upside for EUAs in 2019 comes from speculative money coming back into the market once the risk events dissipate. A key part of the willingness of speculative money to come into the EUA market last year was a broad consensus that the fuel switch price was high (over 30 €/t) and the EUA market would need to move to that level to balance in the next two years. If the fuel switch is largely happening anyway at current EUA prices due to low gas prices, then has most of that upside potential come off of the table? With carbon finally breaking out of its seven-week range to the downside, it is hard to expect much upside this summer.  

If current prices prevail, with Cif ARA coal at 70 $/t and carbon at 21 €/t, we forecast a summer mean TTF gas price at 17.4 €/MWh. If Cif ARA drops to 60 $/t and carbon trades at 17 €/t, this suggests a summer mean of 14.4 €/MWh. The latter scenario might be a super summer bear story, but it is far from unlikely. Upside is much harder to find, and even if oil ticks back up towards $70 as we expect, this is likely to do little more than to put a floor under coal.  

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