A Series of Unfortunate Events – Explaining European Gas Prices in 2021: The role of the traded gas hubs

The dramatic rise in European, and indeed in global, gas prices over the summer of 2021, leading to unprecedented prices in Q4, has been the subject of much debate. Is it simply a market reflection of stronger than expected demand and weaker than expected supplies? Or is it a step change in the context of the energy transition and uncertainties surrounding the role of gas as a ‘balancing fuel’ in power generation? Is this the price of flexibility and growing exposure to global LNG markets? What role did Russian supplies (or lack thereof) play in the price spike and to what extent did volatility on the traded markets exacerbate the price increases?

In this OIES trilogy titled ‘A series of unfortunate events’, Jack Sharples, Patrick Heather and Anouk Honoré look back at 2020 and 2021 to unpack the supply and demand factors that contributed to the spike in European gas prices alongside the trading activity and levels of volatility that accompanied this surge in prices.

This Insight analyses the role of trading activity in the gas markets over the past two years, and especially over the course of 2021 as prices grew steadily between March and August, followed by the extremely rapid growth from late August to the first peak in early October, and the very volatile trading during Q4-21 which resulted in the second, unprecedented peak. It forms part of a trilogy of papers published by the OIES, examining the supply, demand and trading reasons behind these unprecedented price levels. There have been some extreme price moves in the past, but these tended to be quite short-lived and generally affected just one or a few hubs; what happened during 2021 was very different, a long and protracted price rise in all contracts along the curve, culminating in the highest ever gas prices, which were over three times greater than the highest ever crude oil price. There were several physical reasons for the rally but they alone do not account for the higher prices.

The trading patterns were really quite different from Q4-20 onwards compared to previous years. They suggested that traders, having filled storage to very high levels with cheap gas during 2020, chose to withdraw it early for their winter needs rather than pay the gradually increasing gas prices (due to the severe weather in Asia raising LNG prices); when the usual reinjection cycle would normally start, global gas prices continued to rapidly rise and traders were left in a position of having to buy physical gas for their portfolios, and gas to place in storage, in a rising market, whilst at the same time performing hedging to manage their price risks. there was also a pronounced move away from OTC trading (which had already started during 2020) towards exchange trading. This indirectly had the impact of pushing already high gas prices even higher: through the clearing mechanism, which requires traders to deposit initial margins for every trade made, and variation margins whilst those positions remain open when the direction of market prices goes against their net positions. In a rapidly rising market, this can lead to a drain on companies’ financial resources if they hold short positions, and it was reported on several occasions that companies were struggling to pay their margin calls, or needed to borrow to incrtease their capital funding. Furthermore, if traders bought back their shorts, this would push the market higher still.

These factors, on top of the various supply and demand factors which were analysed in the other two papers in this trilogy, created a ‘perfect storm’ of events that led to the unprecedented 7-month sustained rise in the TTF wholesale gas price by over €100/MWh from early March to early October 2021, resulting in the first recoed peak of €116.78/MWh; following a 50% retracement and some price consolidation, a second massive rally over just two weeks took the price to a second, and new all-time high of €180.31/MWh on 21st December. Alongside the unprecedented rise in prices, there has also been an unprecedented rise in the year on year price change and the market volatility. The steepest annual price changes were in the European and Asian prices, increasing about seven-fold in August and November 2021respectively, compared to the same period in 2020. However, the additional global demand for US LNG has prompted a smaller rise in the benchmark HH price, albeit still nearly three times dearer in October 2021 as it was a year earlier. With the market trading in very erratic moves, with both many sharp troughs and many peaks, the average volatility in the period from 1st July 2019 to 20th June 2021 jumped to 71.23%, and the average volatility increased even more from 21st June 2021 to 15th February 2022, reaching 103.87%. This period contained the second major spike in volatility on 7th January 2022 of 223.57%. These are truly incredible and unprecedented levels of volatility and, as with the outright traded prices, are much higher than those of Brent crude oil.

In conclusion, 2021 turned out to be the most turbulent year ever in the history of the liberalised traded gas markets: unprecedented price levels after one of the longest sustained rallies and two sharp retracements, unprecedented six fold year on year price rises, unprecedented high levels of volatility making natural gas the most volatile commodity by far and, possibly, some of the greatest trader uncertainty also. The geopolitical situation with Russia and confusion over the climate targets and how to achieve them, with or without natural gas in the mix, is adding to these levels of uncertainty. It is still very unclear whether we are in a new price era, due to this series of unfortunate events over the past two years, and due to the continuing geo-political tensions, or are we just in an exceptional bubble?

The question is whether these levels of price and volatility are simply a short-lived aberration, or are a new normal?

By: Patrick Heather

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