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Less rushed, better thought out? Europe agrees gas price cap

By: Harry Altham, Energy Analyst, Market Analysis EMEA & Asia

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Less rushed, better thought out? Europe agrees gas price cap
 
Harry Altham
Energy Analyst, EMEA & Asia
harry.altham@stonex.com

This morning has seen further strength in WTI versus Brent, as markets price in tightened conditions due to the repurchase of 3M bbl of crude for the heavily (268M bbl) depleted SPR in the United States. This has caused the WTI/Brent deficit to narrow to $3.77/bbl; the differential has not been tighter for nearly six months. It has also pushed the WTI Jan/Feb spread into the second widest contango in two years (and is threatening the $0.27/bbl intervening record set earlier this month) because the aforementioned repurchase is to be delivered to the SPR in February 2023. However, the rest of the forward curve has moved into a deeper backwardation as this morning’s fundamentals provide further support to near dates in the structure. Of particular note, the Norwegian Petroleum Directorate has announced its November output fell 8.7% beneath expectations (crude and condensate output was 1.95M bbl last month).   

image 58545
Source: ICE, CME, StoneX

One point to be aware of today; although Transneft CEO Nikolay Tokarev’s comments on the Russian oil industry look bullish (2022 Kozmino exports 40% in excess of capacity, increases in capacity in Baltic and Black Sea ports etc.), we believe it paints an incomplete picture. Russian exports from the Sakhalin region have fallen by 50% m/m as orders dry up, there remains a significant risk that Baltic and Black Sea exports could follow now that Western Russian blends have risen above the $60/bbl price cap (as of yesterday), and there are increasing risks of CPC pipeline outages as Russia struggles to procure spare parts to maintain its facilities. Our view is that Russia’s oil industry struggles will tighten market conditions in early 2023; the increase in port capacity is merely a necessary response to its disappearing oil product export markets. In order to support oil market revenues, Russia must export more crude to refineries in secondary markets due to the European embargo; capacity will take time to add and there remains the issue of a shortage of buyers with sufficient refining capacity in the near term. 

Europe works on a gas price cap
Yesterday, we reported that the European Commission was making a final attempt to secure a gas price cap before Christmas. Late in the afternoon, the Czech Republic (who holds this year’s European Presidency) managed to find approval for its draft proposal to cap prices at €180/MWh on a temporary basis, with the cap thought to be reviewable at any time. The trigger would be initiated should the Dutch TTF contract exceed €180/MWh for three successive days, while also exceeding the price of LNG price assessments by €35/MWh (both parameters must be met). The figure is below the initially considered €275/MWh mark as 12 countries – including Italy and Belgium – saw that as inadequate in the attempt to curtail prices. Interestingly, Germany (Europe’s largest consumer) the Netherlands and Austria opposed the cap altogether, citing energy security fears. The cap is expected to be introduced on 15th February 2023. 

image 58547
Source: ICE, StoneX
Before examining the cap’s possible effects, it is paramount to distinguish this from the oil price cap. The oil cap is set exclusively on Russian oil, and only has an indirect impact on European markets due to the impact of tightened Russian output on the global oil picture. Here however, the price cap applies to all forms of gas by any European country from any state, including Qatar, Russia, or the United States. Hungary has secured an exemption that allows it to deal with Russia directly, all other E.U. countries will adhere fully to the rules. 
Our estimate is that Europe could face a 6% shortfall in gas imports in 2023 versus pre-invasion 2021 due to structural factors (25bcm); namely the lack of LNG ports in the Baltic and the weak pipeline system in Southwest Europe (this falls to less than 1% should Russian flows into Hungary and Slovakia continue uninterrupted next year). However, this estimate is contingent on the efficient utilisation of Europe’s LNG ports by way of unhindered purchases of cargoes. To that end, the clause that ensures the Dutch TTF contract can’t surge over €35/MWh ahead of the LNG price assessment level certainly helps Europe navigate some of the concerns about its competitiveness in global LNG markets. It ensures the bloc can still bid above the global LNG market should prices move higher, meaning it is considerably less likely to suffer a scarcity of the fuel – although the risk does remain should extreme volatility at high prices prevail. 
Overall, as Europe finds itself the purchaser of nearly 40% of the world’s LNG cargoes, we believe the measures have a considerable chance of reducing natural gas price volatility – one of the continent’s key objectives. As a ceiling is in place, other importers across Asia (who compete for the same cargoes as well as from Russia, Australia and Iran) will be aware that Europe is unlikely to push bids too far beyond a level, which reduces the likelihood of runaway prices. However, such an outcome would also mean Europe can be comfortably outbid by Asian buyers at much lower prices, and this is where the possibility of shortages becomes more significant. 
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