As the summer ends in the northern hemisphere on new highs for natural gas prices and volatility, and markets brace themselves for a winter of unprecedented uncertainty of supply due to Russia’s behaviour, security of energy supply has become a priority issue for consumers and policy makers across major consuming markets. A complete shutdown of Russian pipeline flows to the European Union cannot be ruled out. The sharp decline in Russian gas flows to Europe and a tight power market drove European gas prices – and indirectly Asian spot LNG prices – to record highs in the third quarter of 2022. Meanwhile, prices in the United States reached their highest summer levels since 2008. This has come with extremely high price volatility, which further increases financial pressure on market participants and the risk of defaults, limiting the number of active market participants and resulting in further volatility.
Russia’s invasion of Ukraine triggered deep concern over gas supply security in the European market and ripple effects in the global LNG market. Russia’s strategic behaviour of using natural gas as a political weapon has become increasingly obvious since September 2021. Despite available production and transport capacity, Russia has reduced its gas supplies to the European Union by close to 50% y-o-y since the start of 2022. In the current context, the complete shutdown of Russian pipeline gas supplies to the European Union cannot be excluded ahead of the 2022/23 heating season – when the European gas market is at its most vulnerable. Almost half of natural gas is consumed in the residential and commercial sectors for space heating purposes during this period, with demand strongly linked to the variation in temperatures. The following section provides an overview of the European Union’s preparedness for the 2022/23 winter and a resilience analysis in the case of a complete cut-off in Russian pipeline gas supply starting from 1 November 2022.
Our analysis indicates that maintaining adequate storage levels until the end of the heating season – at 33% of their working storage capacity as a minimum – will be crucial for a safe and secure winter. Higher storage levels would also moderate injection needs during the 2023 summer, potentially reducing some of the market tensions. Storage levels below this threshold might not be sufficient to tackle a cold spell occurring at the end of the heating season, similar to the one Europe faced in March 2018. Storage fill levels will largely depend on the evolution of demand factors as well as primary gas supply, particularly LNG inflow into Europe. The rapid build-up of regasification capacity creates the possibility of additional imports, but does not guarantee an increase in LNG supply. Increased natural gas demand due to a colder winter, stronger recovery in economic activity in Northeast Asia and unplanned outages could, separately or collectively, weigh on Europe’s winter LNG supply and lead to a more rapid depletion of underground gas storage.
The share of destination-fixed contracts has increased sharply since 2020 Flexible contracts accounted for almost 80% of the average contracted volumes in 2018-2019, driven by new FIDs in the United States. Most of these were on FOB (free on board) transport terms, which provides the greatest flexibility to portfolio players to leverage their trading capabilities. The share of destination-flexible contracts dropped to 35% in 2020 and 11% in 2021. This trend of returning to destination-fixed terms results from a declining share of flexible supply sources in contracting activity (mainly in the United States) and a corresponding rise in available supply from Eurasia and the Middle East, with a preference for fixed-destination sales contracts. The share of destination-flexible volumes among the portfolio players’ newly signed contracts in 2020 was 11%, the lowest level since 2015. China was the single largest signatory of fixed-destination contracts in 2021 with a share of almost two-thirds of the total volume.
Dry gas production in the United States is estimated to have increased by close to 4% y-o-y in the first eight months of 2022 to reach a record average of 98 bcf/d in July-August and above 99 bcf/d in the first half of September. This growth was principally driven by higher associated gas production in the oil-driven Permian Basin and higher output from the gas-driven Haynesville play. Production growth from the major Appalachian Basin appeared more limited. Natural gas output in Pennsylvania, the country’s second largest gas-producing state after Texas, posted y-o-y declines in both Q1 and Q2 2022 (down 0.6% and 0.9% respectively). These results, published by the state’s Independent Fiscal Office, were interpreted as resulting from lower drilling activity in 2020 and 2021, and from the impact of transport infrastructure bottlenecks.
In the European Union gas storage sites stood 25% (or 8.5 bcm) below their five-year average at the beginning of April, which marks the end of the European heating season. The strong inflow of LNG together with lower consumption enabled a strong storage build-up in Q2 and Q3. Storage injections were 18% above their five-year average and totalled over 60 bcm during the gas summer. Despite lower Russian flows, storage injections were 15% above their five-year average in Q3. Consequently, the European Union completely eradicated its storage deficit, inventory levels standing 2.5% (or 2.5 bcm) above their five-year average at the end of Q3. Inventory levels reached close to 90% of their working storage capacity at the end of September, surpassing the EU target of storage sites reaching at least 80% capacity by 1 November and in line with the recommendations of the IEA’s 10-Point Plan to Reduce the European Union’s Reliance on Russian Natural Gas. In Ukraine gas storage levels remain low, standing at just 30% of their working storage capacity as at the end of Q3 according to data from Gas Infrastructure Europe. In Russia storage sites were over 90% full at the end of August and may have reached full capacity by the end of Q3.
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