Gas prices have been falling fast in the last few weeks as  EU storage tanks are nearly full. Unlike equities, which are priced on a discount to future revenue flow, gas prices are set on the day depending on how much space is left in the tanks and how much gas is being consumed. Given at the moment the tanks are also completely full and thanks to one of the balmiest Octobers in years, the price for gas could well go negative in the next few weeks.

“TTF spot gas prices fell to $990 per 1,000 cubic metres [€94.2/MWh] on high storage and warm weather in the region – the lowest level since mid-June. European storage is currently 93.6% full, while temperatures in Germany are hitting 16-18C every day, quite warm for the time of year,” BCS GM said in a note.

The downward pressure on gas prices has mounted rapidly. A flotilla of LNG tankers is currently anchored off the EU coast, holding far more gas than the tanks can accommodate. On top of that, European countries have rallied to governments’ calls to decrease consumption, further reducing demand. A Brussels-based think-tank recently estimated the pan-Europe fall in consumption at 7% and in Germany consumption has dropped by an estimated 30%.

Negative gas prices would be a repeat of oil prices that fell to less than zero for the first time ever in April 2020 due to similar bizarre market conditions cause by the coronavirus (COVID-19) and likewise turned the market on its head thanks to a massive slump in demand.

Winter is coming

Like oil, gas prices are expected to bounce back dramatically once new demand appears next month. (The Brent oil blend was trading at $92 per barrel at the time of writing, and gas at $1,035 per 1,000 cubic metres.) The fall in gas prices is widely seen as a lull before the storm, as winter is coming, warns Capital Economics.

“The reason for the relative weakness in European gas prices is quite straightforward: seasonal demand has yet to begin its upward climb as warm weather lingers in Europe, while nearly full storage means there are few options for injecting the marginal bit of imported gas,” BCS GM says. “That doesn’t mean that Europe’s energy crisis has been cancelled, or that prices won’t increase soon. Consider this the calm before the storm. Once the weather inevitably begins to cool, we expect prices to begin to rise significantly.”

Cold weather is on its way and when the flows into the EU tanks reverse and gas starts being taken out again prices are expected to jump: gas futures price gas at $1,500 per 1,000 cubic metres mid-winter and, depending on the weather, it is still not entirely clear if Europe can get to April without a shortage of gas to heat homes and power industry.

The EU has almost been too successful in its efforts to prepare for a possible end to Russian exports of gas to Europe. And indeed that gas flow has indeed largely stopped after a series of explosions destroyed three of the four strands of the two Nord Stream gas pipelines that run under the Baltic Sea on September 26. A reduced flow of gas continues to transverse Ukraine and the TurkStream pipeline continues to operate, although the capacity of that pipeline is far smaller than Nord Stream.

Another problem is that record-high European demand and customers that are willing to pay ten-times the usual market rates have sucked in a large supply of LNG carriers that now find they can’t unload their gas.

An economic slowdown in China has left it with a surplus of Russian LNG that it has been reselling to Europe, accounting for 7% of the total LNG supplies in September.

A crunch in both supply and prices may come soon, as Brussels is currently discussing how to impose a price cap mechanism on European gas imports as part of an eighth sanctions package. Importantly, at a EU ministers meeting in Brussels last week Berlin dropped its objections to a gas price cap, although the details of the mechanism have not been agreed on and will be worked out in the coming weeks.

Silver lining

In the meantime, the fall in energy prices is good news for many European countries. It reduces the pressure on budgets and allows governments to pass on smaller price increases to households, thus reducing the size of the political backlash that there would have been if power and heating bills were to decuple in the course of a few months.

There are three key channels through which this fall in gas prices will benefit economies across Central and Eastern Europe (CEE), according to Capital Economics.

“First, it will reduce upward pressure on inflation by limiting the extent to which household and business energy bills rise. Second, it will (therefore) support economic activity by limiting the squeeze on household real incomes and business profitability,” says Nicholas Farr, an emerging Europe economist with Capital Economics. “Third, by reversing some of the deterioration in countries’ terms of trade and reducing how much government support is needed to soften the blow of high prices, it should restrict any further deterioration of external and fiscal positions.”

The relief will be largest in the countries with the biggest current account deficits, especially Hungary and Turkey.

“Hungary is one of the most dependent in Europe on gas for its energy needs and Hungarian assets have come under significant pressure this year as energy prices have surged,” says Farr.

Hungary’s central bank has scrambled to prop up the sinking forint with a series of emergency intra-meeting extreme rate hikes in an effort to cap soaring inflation. But more recently at the end of September the Hungarian national bank (MNB) decided to pause the hikes at the end of September, but put through fresh emergency rate hikes in the middle of October, after it realised it had not done enough to stop the rot. The regulator also said it would start providing foreign exchange reserves to finance energy imports.

“Hungary’s central bank, as well as others in the region, will take some comfort from the fall in gas prices for improving the inflation outlook and reducing pressure on their currencies,” says Farr.

But the recent tumble in gas prices provides only temporary relief, argues Capital Economics. Even after their tumble in the last few weeks, the prices for gas and power remain very high at record levels. At the same time, the inflation caused by ballooning energy prices are being kept high by various “second round” effects that will be a lot more persistent.

Finally, even if the drop in prices and 100% full tanks at the start of the heating season will mitigate the energy crisis this year, the fact that Nord Stream pipelines are now permanently offline means that refilling the tanks next year will be an even bigger challenge. The energy crisis is unlikely to go away.

New front in economic war will open soon

The gas price cap, together with a mooted oil price cap scheme that is due to go into effect in December, could both well bring fresh supply and price shocks, say analysts. For its part, the Kremlin has said it will simply cut off supplies to anyone that attempts to cap prices. The assumption in the West is the Kremlin won’t be able to forego the revenues, which make up the largest part of the government’s income. However, the latest Central Bank of Russia (CBR) macroeconomic survey found that the Russian economy is in surprisingly good health and Putin seems confident that he can sell enough hydrocarbons to his friends in India and China to cover the costs of running the country.

In preparation for the coming clash, shipbrokers report seeing large numbers of tankers being booked by undisclosed customers in the last six months, leading to speculation that a large fleet is being amassed, ready to reroute Russian crude and products from Europe to Asia once the European oil embargo goes into effect on December 5.

“There’s been a sharp rise in the tanker trading” since the start of the Ukraine crisis and ahead of the start of the European crude embargo on December 5, with many or most purchases being conducted by undisclosed entities “based in countries such as Dubai, Hong Kong, Singapore and Cyprus”, according to Anoop Singh, head of tanker research at shipbroker Braemar, as cited by BCS GM. “Will there be enough ships? Perhaps... Braemar estimates that, to reroute c4mn barrels per day (bpd) of Russian crude and products from Europe to the Pacific Region, many of the recently purchased vessels will be required to join the “102 Aframaxes, 58 Suezmaxes and 80 very-large crude carriers” that have been transporting Venezuelan and Iranian crude in the recent past.”

BCS GM speculates that part of the Russian plan is to make substantial at-sea ship-to-ship transfers to disguise the origin of the oil and gas, as bne IntelliNews reported was likely to happen in an article on oil and gas leakage to the sanctions regime.

“Reporting in recent months has indicated this practice has already become commonplace, with smaller ships often travelling to international waters in the Atlantic Ocean to transfer Russian crude to larger, more efficient ships to onward shipments to Asia,” BCS GM reports.

Analysts remain very sceptical that either the oil or gas price caps can be made to work thanks to the already existent leakages in the sanctions regime.

“We think both policies – blocking insurance and the price cap – are very unlikely to succeed. The first can be gotten around by determined buyers, and the current c$20 per barrel Urals discount provides a significant $80mn per day of such incentive,” says BCS GM.

Analysts also speculate that any attempt to impose the price caps will lead to a retaliation by the Kremlin, which would make good on its threat to simply cut buyers off from supplies and that will lead to both a supply and price shock.

“The second will simply not be adhered to by Russia and attempts to enforce price caps will see Russian exports drop and, most likely, international oil prices rise materially,” BCS GM added.