Energy Monitor June – Skipping the spring dip

by: Hans van Cleef

  • Gas prices remain elevated ahead of the summer increase in demand from cooling systems
  • Differential in gas prices between Europe and US should shrink, potentially by up to 50%
  • Lack of consensus threatens a future balanced energy mix

Gas prices skipped the spring dip

Gas prices in the UK and Europe, respectively measured by the National Balancing Point (NBP) and the Title Transfer Facility (TTF), are currently trading at higher than expected levels. Normally, gas prices drop significantly during the second quarter, on the back of lower seasonal demand. This year is different, however, as average temperatures in the UK and the rest of Europe remained far below normal. As a result, heating demand remained strong and normal spring stock building was delayed, keeping prices high.

US Natural Gas versus Gas NL TTF  (in USD / mmBtu) Source: ABN AMRO Group Economics, Thomson Reuters
US Natural Gas versus Gas NL TTF
(in USD / mmBtu)
Source: ABN AMRO Group Economics, Thomson Reuters

NPB and TTF prices, however, did drop at the end of the first quarter, after winter conditions had faded. But because the normal stock building has not taken place, prices remain extremely volatile and dependent on weather-related news. On the longer term, gas prices in Europe are expected to decline due to contract renegotiations with Russia. In the US, Henry Hub natural gas prices did not even decline at the end of the first quarter. In fact, the first contract price touched a 21-month high of USD 4.44/mmBtu, before it temporarily dropped to USD 3.88/mmBtu on profit-taking. Afterwards, prices rose back again above USD 4.20/mmBtu. This rally was triggered by higher-than-expected demand and news about the number of US natural gas rigs touching an 18-year low (Baker Hughes data). As the below-average temperatures of  the previous months will now probably shift directly into warmer weather and lead to a rise in the demand for cooling and air conditioning by homeowners and businesses, Henry Hub natural gas prices could remain trading above USD 4 per mmBtu. However, actual normalisation of weather conditions and news on stock building could still push natural gas prices back below USD 4.00/mmBtu. In our Q2 Quarterly Commodity Outlook, we raised our 2013 forecast for average US natural gas prices to USD 3.90/mmBtu from USD 3.50/mmBtu. But this increase may still appear to be too conservative. In the longer term, we believe US natural gas prices could strengthen to approximately USD 5.00 per mmBtu by the end of 2015. Above this level, demand for coal will return. As a result, the differential in gas prices between the US and Europe should shrink significantly in the coming two years, potentially by up to 50%.

Oil prices are range-bound

In recent weeks, oil prices were stuck within a small trading range, as several drivers continue to balance each other out (Figure 2). The impact of hope for the economic recovery is being balanced by the release of disappointing data, while the impact of news of increased production is countered by fears of possible supply disruptions. All in all, Brent prices seem to be stuck within the small range of USD 100-105. The second quarter also normally results in some stock building and a decline in demand for oil, leading to somewhat lower prices. We expect that this will be seen in coming weeks, at least  for Brent oil.

Brent versus WTI oil and Brent/WTI spread (1st generic future contract) Source: Thomson Reuters, ABN AMRO Group Economics
Brent versus WTI oil and Brent/WTI spread
(1st generic future contract)
Source: Thomson Reuters, ABN AMRO Group Economics

WTI has its own drivers. The Memorial Day holiday is the official start of the US driving season. During this period, which lasts until Labour Day (1 September), Americans often go on holiday by car. The driving season usually leads to a rise in demand of US oil and oil distillates. The impact is, however, diminishing. This is because the increase in the demand for cooling during the period supports oil and gas prices, due to the increased use of air conditioners and electricity. This factor has become more and more important over the past few years. As such, the higher demand may keep the price for WTI around current levels in the coming months, as it will be balanced by the expected rise in oil production in the US and Canada. Something else to watch in the coming weeks will be the developments regarding the Keystone XL pipeline. The pipeline is to transport (shale) oil from Canada to the US Gulf Coast (USGC). Although the Obama administration did not approve a part of it because of possible environmental impact, the US House passed a bill last week declaring that a presidential permit is not needed to approve the Canada-to-Nebraska leg. The bill also needs to pass the Senate to overcome the promised veto from President Obama. When complete, the Keystone pipeline will reduce the need for USGC refiners to import oil, which is seen as an important step towards US energy independence. Both Brent and WTI are expected to keep trading within small ranges during the coming weeks. If economic activity starts to pick up in the course of the summer, volatility may start to increase again, while the impact of the rising output could be overlooked. This could result in some support for oil prices towards the end of the year (Table 2). Nevertheless, we still strongly believe in our forecast for a moderate decline in oil prices in the longer term, with the rise of global oil output continuing to outpace the rise in demand.

Lack of a clear energy policy results in chaos

The lack of a clear, united energy policy, not only locally, but certainly also when taking a larger perspective (e.g. Europe, the US, Asia, or even globally), results in a chaos of energy initiatives. Due to this lack of unity, individual interests dominate. Cooperation on a wide scale would be necessary to come to a well-balanced energy mix. Such a mix is necessary to meet carbon reduction targets, to boost investment in new technology and to secure energy supply in the transition years to 2050, the target date to achieve a 100% carbon-neutral and sustainable energy offering. The European Commission is now discussing a plan to impose solar panel duties, averaging 47%, on solar cells imported from China. Such a measure was implemented in the US last year. According to the EU, the measure is necessary to support local producers, as the Chinese are selling solar panels below cost. Whether or not these duties will help is unclear. After all, solar panels from European producers are much more expensive and many consumers would buy these products only if they receive enough of a government subsidy. This action would therefore almost certainly slow the transition towards a more sustainable energy mix. Furthermore, meeting the carbon reduction targets in 2020 will be a major challenge given current market conditions, and these targets will be even harder to accomplish if the duties are brought into force. Finally, the Chinese could implement countermeasures that could hurt the economic recovery in Europe.

IEA Global Energy Mix forecast  (in MTOE) Source: International Energy Agency (IEA)
IEA Global Energy Mix forecast
(in MTOE)
Source: International Energy Agency (IEA)

But it is not only the solar market which is hampered by the lack of a common interest. Wind energy is also a topic of discussion. Many governments are building new wind terminals to increase the percentage of sustainable energy. However, affecting the landscape in this way results in opposition, not only from citizens, but also from local authorities. With fossil fuels, there is heated discussion about the use of shale technology for oil and gas production in Europe. In Germany, even the brewers rose up against unconventional gas drilling techniques such as fracking. The fear is that fracking could damage the country’s beer industry by polluting the groundwater. The ‘Energie Wende’ in Germany has already led to many complaints, (rising retail costs for electricity and remaining dependent on fossil fuels in times of extreme weather conditions)  and shows that changing the energy mix abruptly results in other problems. As long as European leaders do not find common ground to create a diversified energy mix, the national governments will continue to focus on their own policies. But with energy being much more expensive in Europe than in the US, which hurts competitiveness,  the topic will be discussed at upcoming summit talks with the aim to develop more secure, sustainable and competitive energy supplies.