Investment Insight | The natural gas price squeeze
Prices of energy commodities are spiking globally with gas, oil and uranium all rising significantly this year. Gas has spiked to levels not seen since 2014. In fact, gas prices have got so high in Europe it is forcing some industrial companies to temporarily shut down production as it is no longer profitable to produce their goods.
With governments around the world focussed on the fossil fuels to green energy transition to reduce carbon emissions, the current gas price crisis serves as a timely reminder of how reliant on fossil fuels we still are.
Glut in demand
The surge in gas prices has been driven by many factors all coming together. The global economic slowdown caused by the COVID-19 crisis significantly reduced the demand for gas. This demand reduction pushed global gas prices, which had been falling since late 2018, into a deep bear market. By mid-2020, global gas prices were at the lowest levels seen since 1995. Naturally, the deeply depressed prices led to a sharp pullback in drilling and capital investment in oil and gas which reduced worldwide gas supply levels.
Economic bounce back
The global gas market did not expect the speed of the economic recovery that has occurred throughout this year thereby leading to a significant tightening of the gas supply and demand situation. As the economy recovered and output levels from key industrial producers rebounded – in many cases to levels above pre-COVID-19 – they increased demand for energy which often comes in the form of gas.
Extreme weather events
Gas is a market which is heavily influenced by both hot and cold weather patterns. In cold weather the consumption of gas increases significantly as it is used for heating. However, the consumption also increases in hot weather due to air conditioning which consumes an increased level of electricity which in turn increases the demand for gas-driven power stations.
The United States experienced a colder than normal winter at the start of this year, including the big freeze in Texas that made global headlines. This was followed by two unusual cold spells in Europe in April and May and was then followed by a hotter than normal European summer.
The price of gas spikes to high levels when the storage reserve levels of gas get low and it creates concerns over the ability to obtain gas in the future. Europe's storage levels have decreased to alarmingly low levels. The other key factor contributing to this has been supply issues in obtaining gas from Russia, which is one of Europe's key import markets.
High energy costs cause inflation
The result is that gas prices in Europe have recently exceeded $24/mmBtu (metric million British thermal unit) which compares to a price of $3.90/mmBtu only 12 months ago! Gas is a global market therefore the gas price spike situation in Europe has flow-on effects to the American and Asian markets.
The United States has in recent years become a significant exporter of Liquid Natural Gas ('LNG') due to its relatively abundant oil and gas reserves. When gas prices spike in Europe and Asia, consumers of gas in these regions import gas from the United States instead, which thereby drives up the prices in the United States. With gas storage levels also reducing in the United States the gas price has risen to $5.40/mmBtu which is the highest level since 2009.
While gas prices are probably not a commodity most of us tend to follow at all, severe spikes like this can have very real impacts on our consumption costs. For example, electricity prices in the United Kingdom are currently three times the level they were two months ago. Industrial producers of all sorts of products from fertilisers to sugar have had to temporarily shut down production to avoid producing at a loss. This is contributing to higher inflation across all sorts of commodities we consume daily.
The current situation highlights the reliance the global economy still has on fossil fuel for electricity generation. We discussed in Investment Insight | 13 September 2021 | Clean Energy the important role that nuclear energy is playing to reach carbon neutrality. Higher gas prices also encourage further investment in other forms of renewable energy.
NZ Funds' portfolios
The unique situation in global gas markets will drive up prices. Our ability to own commodities provides several investment opportunities for NZ Funds clients to generate returns and protect themselves from inflation.
One way we are doing this is via uranium prices, as the gas price situation highlights the need for nuclear power generation. We have also invested directly into United States natural gas futures and options. While the European gas prices have already spiked to a very high level, United States gas prices have significant upside as the global gas shortage continues to get worse. If the United States and Europe see a colder than average winter, we could potentially see a very severe gas price squeeze in the United States.
With governments around the world focussed on the fossil fuels to green energy transition to reduce carbon emissions, the current gas price crisis serves as a timely reminder of how reliant on fossil fuels we still are.
Glut in demand
The surge in gas prices has been driven by many factors all coming together. The global economic slowdown caused by the COVID-19 crisis significantly reduced the demand for gas. This demand reduction pushed global gas prices, which had been falling since late 2018, into a deep bear market. By mid-2020, global gas prices were at the lowest levels seen since 1995. Naturally, the deeply depressed prices led to a sharp pullback in drilling and capital investment in oil and gas which reduced worldwide gas supply levels.
Economic bounce back
The global gas market did not expect the speed of the economic recovery that has occurred throughout this year thereby leading to a significant tightening of the gas supply and demand situation. As the economy recovered and output levels from key industrial producers rebounded – in many cases to levels above pre-COVID-19 – they increased demand for energy which often comes in the form of gas.
Extreme weather events
Gas is a market which is heavily influenced by both hot and cold weather patterns. In cold weather the consumption of gas increases significantly as it is used for heating. However, the consumption also increases in hot weather due to air conditioning which consumes an increased level of electricity which in turn increases the demand for gas-driven power stations.
The United States experienced a colder than normal winter at the start of this year, including the big freeze in Texas that made global headlines. This was followed by two unusual cold spells in Europe in April and May and was then followed by a hotter than normal European summer.
The price of gas spikes to high levels when the storage reserve levels of gas get low and it creates concerns over the ability to obtain gas in the future. Europe's storage levels have decreased to alarmingly low levels. The other key factor contributing to this has been supply issues in obtaining gas from Russia, which is one of Europe's key import markets.
High energy costs cause inflation
The result is that gas prices in Europe have recently exceeded $24/mmBtu (metric million British thermal unit) which compares to a price of $3.90/mmBtu only 12 months ago! Gas is a global market therefore the gas price spike situation in Europe has flow-on effects to the American and Asian markets.
The United States has in recent years become a significant exporter of Liquid Natural Gas ('LNG') due to its relatively abundant oil and gas reserves. When gas prices spike in Europe and Asia, consumers of gas in these regions import gas from the United States instead, which thereby drives up the prices in the United States. With gas storage levels also reducing in the United States the gas price has risen to $5.40/mmBtu which is the highest level since 2009.
While gas prices are probably not a commodity most of us tend to follow at all, severe spikes like this can have very real impacts on our consumption costs. For example, electricity prices in the United Kingdom are currently three times the level they were two months ago. Industrial producers of all sorts of products from fertilisers to sugar have had to temporarily shut down production to avoid producing at a loss. This is contributing to higher inflation across all sorts of commodities we consume daily.
The current situation highlights the reliance the global economy still has on fossil fuel for electricity generation. We discussed in Investment Insight | 13 September 2021 | Clean Energy the important role that nuclear energy is playing to reach carbon neutrality. Higher gas prices also encourage further investment in other forms of renewable energy.
NZ Funds' portfolios
The unique situation in global gas markets will drive up prices. Our ability to own commodities provides several investment opportunities for NZ Funds clients to generate returns and protect themselves from inflation.
One way we are doing this is via uranium prices, as the gas price situation highlights the need for nuclear power generation. We have also invested directly into United States natural gas futures and options. While the European gas prices have already spiked to a very high level, United States gas prices have significant upside as the global gas shortage continues to get worse. If the United States and Europe see a colder than average winter, we could potentially see a very severe gas price squeeze in the United States.
Source: Bloomberg.
For more information please contact NZ Funds.
This document has been provided for information purposes only. The content of this document is not intended as a substitute for specific professional advice on investments, financial planning or any other matter.
While the information provided in this document is stated accurately to the best of our knowledge and belief, New Zealand Funds Management Limited, its directors, employees and related parties accept no liability or responsibility for any loss, damage, claim or expense suffered or incurred by any party as a result of reliance on the information provided and opinions expressed except as required by law.
For more information please contact NZ Funds.
This document has been provided for information purposes only. The content of this document is not intended as a substitute for specific professional advice on investments, financial planning or any other matter.
While the information provided in this document is stated accurately to the best of our knowledge and belief, New Zealand Funds Management Limited, its directors, employees and related parties accept no liability or responsibility for any loss, damage, claim or expense suffered or incurred by any party as a result of reliance on the information provided and opinions expressed except as required by law.
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Andrew Curtayne is Portfolio Manager for New Zealand Funds Management Limited (NZ Funds) and a member of the NZ Funds KiwiSaver Scheme. Andrew's comments are of a general nature, and he is not responsible for any loss that any reader may suffer from following it.
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