Q1 cliff

Published at 15:40 27 Aug 2019 by

Our forecast for weak injections over the next two weeks and a sustained drop in pipe supply in September mean we think European storage will now only reach maximum capacity at end-September. This forecast relies on low prompt prices keeping supply slow, otherwise stocks will reach capacity sooner. Russian nominations will need to be much lower y/y next month to offset Gazprom’s strong electronic sales platform (ESP) sales for September and higher LNG supply y/y. The Nov-19 price is now below the forward curve due to the market acknowledging the risk that stocks could be full by October and that there might be stronger Norwegian and LNG supply y/y in the winter. With no incentive to make material withdrawals until December, Europe should enter Q1 20 with record-high stocks, which would keep the region well supplied even if there is an unusually cold winter. This indicates that if Gazprom and Ukraine strike a transit deal before 2020, there will be a significant downward pricing of Q1-20.

Full storage capacity only at end-September   

A 1.8 bcm injection last week (-0.6 bcm y/y) and an even lower forecast injection of 0.4 bcm this week holds out at least a possibility that European storage will only reach its maximum working gas capacity by end-September. With an August storage carryout of around 91 bcm, Europe will hit tank tops by end-September if it injects the same 6.7 bcm it did in September 2018. Some September fundamentals differ from last year, chiefly heavier Norwegian maintenance. Differences in Norwegian constraints y/y will be most pronounced in the coming two weeks. Flexible Norwegian supply is likely to be the weakest of the summer until at least 5 September, after which the giant 0.12 bcm/d Troll field is scheduled to return from a 12-day annual shutdown. Even after Troll returns, there is still little incentive to ramp up flexible supply given that prompt prices are so much lower than the curve at the TTF. Norwegian gas exports are therefore likely to stay weak, at a minimum, we expect Norwegian pipeline supply to average 73 mcm/d lower y/y in September, a deeper cut than the 58 mcm/d y/y reduction seen in August.

The strong contango structure in the curve is another key difference between this September and September 2018, and that has implications for our Russian supply forecast. European prompt prices at a discount to forward contracts should provide an incentive for customers to keep Russian nominations low throughout September. A sharp drop in Russian nominations will be crucial for Europe to balance given that short-term selling on Gazprom’s ESP is already at a high 1.04 bcm for September delivery. ESP sales for August so far have totalled 1.8 bcm and even that only helped keep the y/y reduction in Russian flows to an average of 80 mcm/d in August.

The other striking difference in fundamentals this year is strong LNG supply, which has supported injections into storage. LNG supply into Europe should remain brisk given persistently low JKM prices and more LNG liquefaction y/y. Our forecast suggests that European sendout in September should average around 46 mcm/d higher y/y, which is above the 33 mcm/d y/y gain in August so far.

Given that y/y losses in pipeline supply should offset higher LNG sendout, aggregate supply could well be lower y/y as we go through September, which will ease the storage injection rate y/y so that sites will not reach capacity until end-September. However, that lower-supply scenario does rely on prompt prices remaining low and should be taken in the context that Europe injected almost 11 bcm in September-October 2018, while spare capacity this year will only allow injections to be no greater than about 7 bcm.

Fig 1: Y/y Norwegian pipeline supply, mcm/d Fig 2: Y/y storage surplus & Russian supply, bcm
Source: Gassco, Energy Aspects Source: Country SOs, GIE, Energy Aspects

Q4-19 pressured on many fronts

The bearish price dynamics of the Q4-19 contract have been increasingly driven by the realisation that there will be 10 bcm more gas in EU storage y/y and an incremental 3 bcm could be in Ukraine customs warehouse for winter supply for the EU. The Ukrainian figure is based on an early August report by Ukrtransgas, which put warehouse gas inventories around 1.5 bcm, with almost three months of injection still to come. Q4 19 looks very well supplied given the possibility of higher LNG supply y/y, full LNG storage tanks, some European floating storage, and the start of a new gas year contract suggesting that the downturns in supply in Q3 19 cannot be relied on to continue with customers likely wanting to fulfill a large part of their annual contract quantity over the winter.  Add in the potential for even higher Norwegian supply owing to incremental supply from new fields like Aasta Hansteen and Dvalin, and Q4 19 will need some very high demand to balance. Oct-19 has come under pressure as there will likely be no capacity for injections into storage in October, and the Nov-19 contract has started to head down too.

However, the risk of no Ukrainian transit of Russian gas in Q1 20 has started to drive a wedge between the two winter quarters. The Q4-19–Q1-20 spread has been widening and was trading at over -2.5 €/MWh early on Tuesday (27 August). That Q4-19 discount is a crucial signal to the market to keep gas in storage over that quarter so it will be available in the event that there is a significant disruption to Russian supply through Velke Kapusany in Q1 20.

Given the existing contango structure on the curve, Europe is likely to head into December with record high stocks and the promise of incremental LNG supply. Barring a colder-than-normal December, Europe could still have a storage inventory of roughly 83 bcm (+20 bcm y/y) at the start of Q1 20. Over the past five years, aggregate Q1 demand has peaked at 168 bcm, while demand in Q1 19 was 162 bcm. Even if we assume an unusually cold Q1 20 leads to a 6 bcm y/y rise in demand, a 20 bcm y/y storage overhang will leave Europe very well supplied provided Russian exports via Ukraine are not disrupted. This also suggests that if a transit deal between Naftogaz and Gazprom is reached before 1 January 2020, a fairly significant downward pricing of Q1 20 is likely.

Fig 3: Supply-demand outlook and storage forecast for NW Europe, mcm
Source: Country SOs, Energy Aspects



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