All throughout the second half of last year, the market and media was obsessed with headlines about Europe running out of gas that would push it back into the dark ages. After the Russian invasion of Ukraine, EU gas prices did soar to highs of 350 Euro/Mwh, but today they are trading down below 60 Eur/Mwh despite Europe being in the peak of winter.
Commodities often move in cycles and a commodity is not like an equity. It is much more "emotional", if you don't have it and need it, the price can go to infinity. Alternatively, if you have it and don't need it, prices can fall down to below zero, as we saw back in March 2020 when WTI traded at -$35/bbl. This is why investing in commodity markets is not for the faint hearted nor for the general masses who do not understand the inner workings, or rather the games being played out of physical flows.
US gas prices started 2022 around $4/MMBtu but then traded as high as $10/MMBtu in August, when US gas has always been seen as a commodity that has been in abundance given the Shale gas revolution. In fact, these gas producers had been in trading at perennial discounts as they always overproduced and mismanaged their cash flows.
Due to the advent of LNG markets, gas markets have become more interconnected over the past few years which helped Europe replace the lost Russian flows which trickled down almost to zero last fall. US LNG tended to go towards Asia and other regions where gas prices trade at a premium vs. the rest of the world. But EU prices got to such extremes, it made even more sense to send it to the EU pulling it away from Asia.
As US production expanded, the market moved from a record inventory depletion (-995 billion cubic feet) in January 2022 to a record seasonal accumulation (+442 billion cubic feet) in October 2022. Gas consumption in the first 10 months of 2022 was 1,037 billion cubic feet (+4%) higher than in the same period in 2019 before the pandemic. But US production was also higher as prices moved higher. Exported increase by 2001 bcf, about 54% mostly from increased LNG exports! So as Europe lost its dependency on Russia for its gas flows, its dependence increased on the US via their LNG which made up for more than 80% of it.
That is the ultimate truth about commodities, there is always a physical arbitrage somewhere especially when prices are dislocated in one region, physical players will always find ways to close the gap and monetize from the situation. Hence, players like Trafigura, Glencore, Vitol and other commodity trading houses do so well at times of physical distress as they capitalize on such divergences. It is all one big physical game.
But one needs to separate the actual secular tightness from the cyclical tightness, as the latter is usually resolved in a matter of months or weeks. But the former is more about real capital investment that needs to go into the system to generate the right system response. Equity analysts mistake the cyclical from the secular always as it is never just a straight line, the balances evolve over time.
Demand plays a huge role in this equation as well and as we saw demand decline as the global economy fell back in 2H, and that eased prices too. We are past the middle of the peak of winter and even assuming this cold weather spell, inventories should close the season very comfortably. The issue then moves to the next season, spring, and one needs to monitor how well the wind and water situation is with regards to the summer storage levels.
This past year has made one thing certain, depending on one country for more than 50% of your resource needs is never a good idea, no matter how friendly they may appear. Hence the topic of national and energy security is at the tip of every leader's tongue.
