Reasons behind the recent fall in European gas prices
Since the TTF price peaked in the last week of August, European natural gas prices have fallen sharply due to a combination of several factors.
The warmer-than-usual weather in Europe. The demand destruction in the industry due to the high prices and the increment in LNG imports (which received 70% of the US LNG exports in 3Q22 compared to 30% in 3Q21)
These factors have contributed to refilling the European natural gas inventories, reaching 95% capacity in early November. Because of the limited consumption and the elevated inventories, Day ahead prices (prices used to commercialise TTF which is not hedged) have plunged almost 90% from the August high (from €360/MWh to €45/MWh)
The most direct consequence of the fall in prices is that it is much less profitable for LNG Carriers to unload on European shores. As they get paid the price of that day. And predictably in a few days, the temperatures in Europe will be colder and natural gas prices will rise. In fact, the meteorologic forecast already is pointing out this). More than 30 LNG carriers are waiting in front of European beaches.
So… are high natural gas prices over in Europe?
Well… we as Europeans have been lucky with the warm weather we had in October and the first week of November. However, the situation changes from now on as colder weather arrives and the 95% capacity figure is a bit tricky.
It only covers 20% of yearly demand and is designed to receive natural gas from Russia during winter. Flex LNG’s CEO estimate that this storage will be enough only for ~7 weeks of winter
Moreover, we also need to point out that the French nuclear fleet is underperforming and reporting a lot of problems. So we do not expect them to provide the amount of energy expected when the winter calculations were made. It entails a bigger natural gas consumption in Europe.
Consequently, natural gas inventories are expected to fall more quickly than in the past. So Europe needs an extra effort to replenish them in 2023 as following the latest estimations of EIA, Europe faces a shortage of 30bcm which cannot be substituted by additional LNG.
And here is where the real problems arrive
The fact that 70% of LNG went to Europe in 2022 makes the rest of the world have low inventories and the urgent need to replenish them
We also need to highlight that the significant drop in Russian gas supply this year occurred only in June, meaning that Europe could still stock up on some Russian gas earlier this year. And this is not going to happen in 2023. The year-on-year increase is not sufficient to offset a total cut in Russian piped supply with under half of these volumes met by LNG increases
Another problem for next year is that domestic gas production in the European Union is set to decline. In the Netherlands, production at the Groningen field was capped at 2.8 Bcm for the 2022-23 gas year
But probably, the most important fact is the current China zero-Covid policy, which has restricted the amount of LNG imported by China, is expected to end in the coming months. Consequently, the demand from China is anticipated to bounce back strong diverting a considerable size of the LNG fleet. Specifically, China is expected to capture over 85% of the expected increase in the global LNG supply
Outlook for the medium term
Even taking into account that European natural demand is going to be reduced from normal levels. (Gas demand in the EU and the UK in the first 10 months of 2022 was down by an estimated 10% (40 Bcm)
There are going to be small liquefaction capacity increments in these 2 years but as commented before. We believe that China & Other Asia are going to absorb them. Consequently, the European natural gas situation is expected to remain tight at least until the new liquefaction capacity arrives in 2025.
Based on that and always conditional to the weather. We believe that European natural gas prices are going to recover soon and remain high for the next two years (including episodes of high volatility)
How are we playing this natural gas situation?
As you know if you have been following MORAM during the last two years, stocks operating in the natural gas industry have meant more than half of the portfolio in this period. We have changed a little the weights and added a new position in the last 2 months. But the names in the portfolio are largely known.
It remains the main position of the portfolio. We added exposure in the last weeks as the stock traded low due to the fall in natural gas prices plus uncertainty about new taxes in the UK & Netherlands. We made calculations about the retroactive taxes that they have to pay in the Netherlands and the impact (as we understand – no definitive) is not as high as we thought. Moreover, Kistos will have 17 months to pay the retroactive tax (draft presented – still to be confirmed).
We think that, despite the taxes, Kistos has enough money to cancel all the debt and potentially do some M&A and buybacks,…
Kistos took advantage of the situation in bond markets to buyback part of its €90MM bond. We think that it will have to wait until May 23 to complete its redemption. After that, it will be free to buyback shares (our best understanding of the situation)
Serica: It is going to be one of the most impacted by the increase in the UK windfall taxes (from 25% to 30%, 70% in total). If the North Eigg results are good (mid-December) they will be able to deduct the Capex and we expect the share price to rocket. However, if it is not like that. Serica will need to pay a considerable amount of taxes. Consequently, and based on our conversation with its CEO. We understand that they will look for opportunities in other jurisdictions.
IOG: We wrote an article about our views on the IOG situation two weeks ago and nothing has changed since then. We believe that is a leveraged bet on the natural gas prices (conditioned to its operational ability to connect Southwark in mid-December). If they are able to reach the mid-December target, we believe that it is the company that has the biggest potential. However, as we noted in the article, it is compulsory to understand the risks.
Golar LNG: TTF prices are hedged, so the impact of all of this in Golar is minimum. We expect that high European gas prices will allow them to announce new FLNGs in the coming weeks (at least 1). Based on our best understanding, there are two options currently on the table. Phase 2 of Tortue with BP & Kosmos. And the Fortuna project, partnering with NFE(30%), Kosmos (20%), government (20%). The difference between the two projects is significant. The Tortue project would be similar to Gimi. It means a toiling agreement where Golar put the FLNG and receives a toiling fee. However, in the Fortuna project, Golar would also be the off-taker of 30% of the production.
Vermilion Energy: It will report on Tuesday this week and we will publish our comments and views about its results. We published a detailed analysis of Vermilion last month
Note: Every week, we publish several articles about the companies in our portfolio (analysis of quarterly results, the impact of events,…), macroeconomy, new investment thesis and quarterly letters about the evolution of the portfolio. You can subscribe for free to receive these emails on Sunday & Follow us on Twitter. Moreover, we would appreciate it a lot if you help us by sharing the content of Moram
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