A Series of Unfortunate Events – Supply-side factors in the European gas price rally in 2021 and outlook for the rest of winter

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, Anouk Honoré and Patrick Heather 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.

In this first paper, Jack Sharples discusses the supply side of the equation with a deep dive into European production, pipeline imports, LNG flows and storage movements. While the decline in European production is a long-term trend, in 2021, output was also impacted by temporary maintenance. Meanwhile, LNG imports that were abundant in 2019-2020 were pulled toward the premium Asian market and to a lesser degree to Latin America, just as a number of export plants suffered from unplanned outages. As made clear by events since September, when LNG markets are tight, Europe will need to compete on prices and will become more exposed to global volatility as it is losing the seasonal swing in its own supply. Storage is therefore increasingly important, but as highlighted this year, so are pipelines. The paper looks in depth at pipeline flows from Russia, highlighting the outsized role Gazprom plays in Europe. Until October, Gazprom seems to have faced calls on its production that limited its ability to offer additional volumes into Europe. More recently, there are signs this is no longer the case, suggesting that Russian supplies may not increase significantly until Nord Stream 2 begins operation, most likely after the end of winter.

The next two papers in our ‘Series of Unfortunate Events’ trilogy include an analysis by Anouk Honoré of gas demand in 2021 in European countries, looking at the various factors that influenced gas in power generation in the context of rising coal and carbon prices and assessing the price-driven gas demand destruction in the industrial sector and the inelasticity of gas demand for space heating. The final paper, by Patrick Heather, will analyse the role of trading activity in price dynamics in 2021, from the steady growth between March and August, and the extremely rapid growth from late August to the first peak in early October, with prices subsequently remaining high and volatile in Q4.

Together, these three papers draw on the gas price spike in 2021 to highlight Europe’s ongoing challenge: Its dependence on imports amidst uncertainties surrounding gas demand in its role of ‘balancing fuel’. Combined with a growing dependence on imports, this will leave Europe even more exposed to the volatility of global LNG markets, and as policy makers continue to focus on decarbonisation, market participants will need to adjust their commercial strategies.

By: Jack Sharples