The race to the bottom in the European energy space appears to be on. The TTF M+1 shed 5.2% w/w to close at 14.46 €/MWh on Friday, while Cif ARA coal shed 5.3% w/w to close at 66.5 $/t. With carbon also a big loser w/w, dropping by 8.0% to 20.6 €/t as Brexit risks weighed heavily , the fuel switch triggers continued to soften. Given that the European gas markets this summer will need a response from both the demand side (more coal-to-gas switching) and supply-side (less pipeline and LNG supply) to balance, how low will the market need to go?
Looking at the key pricing points in the market, the 5% fuel switching trigger (45% efficiency gas-fired plant vs 40% efficient coal-fired plant) is now around 13.6 €/MWh (4.5 $/mmbtu) after last week’s moves in coal and carbon prices, while the parity trigger is now down at 11.6 €/MWh (3.9 $/mmbtu). Much available demand-side response should happen around the 5% trigger, while it should all be exhausted at the parity trigger. Across the EU, maximum fuel switch potential would lead to around 13 bcm more power sector demand y/y over summer 2019. As most of the fuel switch potential is in markets where prices trade at a premium to the TTF, the TTF will have to move lower than the fuel switch trigger levels to stimulate enough switching in the continental European market.
As the market starts ebbing towards the 5% trigger level, at what price will LNG supply start to be choked off? In particular, given the comparatively flexible nature of US LNG supply contracts, at what point does it stop being economic to export LNG from the US? Henry Hub prices have a summer 2019 strip of around 2.8 $/mmbtu, while current freight rates have consistently fallen and are around 30,000 $/d. Given those current inputs, the arb will close when European prices dip below 12.5 €/MWh (4.15 $/t), which is the delivered price to NW Europe (TTF) at the Henry Hub price, increased by 15% for liquefaction (to 3.2 $/mmbtu) plus transport costs of 0.6 $/mmbtu and regas costs of up to 0.3 $/mmbtu.
Taking the fuel switch triggers and LNG arb closing level together points to a certain convergence of equilibrating prices around 4 $/mmbtu, where both demand-side response would occur and LNG supply into Europe would start to decline. Of course, leaving cargoes in the US is likely to have a bearish impact on Henry Hub prices, although how much depends on the length of time that arb window is closed. Also, Cove Point is drawing gas from the NE US, which trades at a basis discount to Henry, so choking off those cargoes would require TTF prices to dip even lower.
Even a few months ago it seemed unthinkable that some of summer 2019 would test the closing of the Henry Hub–TTF arb, but that now seems like a more likely possibility.
|Supply-demand outlook and storage forecast for NW Europe, mcm|
|Source: Country SOs, GIE, Energy Aspects|