European gas markets: Too early to raise the alarm?

At the close of September, European natural gas prices ended the day near 27 USD per mmBtu, which was up almost 62.0% month-on-month and around 340% higher on a year-to-date basis. An array of factors have caused the inexorable rise in prices within Europe: relatively low stockpiles following a colder-than-normal winter at the start of the year; increased demand related to the ongoing recovery in economic activity and the easing of Covid-19 restrictions; government intervention in the form of higher carbon taxes across the Euro area; a lack of alternative power sources, particularly due to tepid wind power generation; and limited supply out of Russia due to disruptions at some of its gas facilities in recent months.  ​

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The rise in natural gas prices has worried markets in recent weeks, and this is being exacerbated by concerns over the potential for a colder-than-expected winter season ahead and a lack of LNG supply relief as strong Asian demand has LNG import prices trading at a premium in the far east. That being said, the potential economic turmoil caused by rising natural gas and electricity prices is likely to be limited in the Euro area. 

On the consumer price front, gas and electricity prices account for just over 4% of the Euro area HICP basket, thus limiting their impact on headline inflation. All being equal, the current level of futures prices would translate into around a 15% increase in consumer gas prices and a 7.5% increase in electricity prices on average. That being said, given the volatility in commodity prices, most power companies lock in contracts ranging from a month to a year ahead, which will limit the overall upturn in prices. Furthermore, in early September the European Commission announced that countries would be allowed to tweak levies and excise duties on energy products, as well as provide households with direct support to offset the rise in energy prices. 

 

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Taken together, although consumers and businesses will feel the pinch over the coming months, the brunt of the unprecedented jump in market prices witnessed this year will be taken by energy companies and governments, and the Eurozone economy should come out relatively unscathed. Consequently, our analysts are fairly sanguine regarding consumer prices, and see them averaging 2.1% in 2021, up just 0.1 percentage points from the previous month’s forecast. Moreover, our panel of analysts project the Euro area economy to expand 4.8% in 2021, which is up 0.2 percentage points from last month’s forecast.  

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Commenting on the short-term outlook for the European gas market, Warren Patterson and Wenyu Yao, commodity economists at ING, said:  

“The natural gas market continues to trade at elevated levels as concerns around tightness going into winter continue to linger. European gas storage is a little over 72% full, compared to the 5-year average of around 88% for this time of year. At times, it has appeared as though LNG supplies could offer some much-needed relief to the European gas market. However, spot Asian LNG prices have more than kept up with the strength in the European market. So, with the spot Asian market trading at a premium to Europe, spot LNG flows are likely to continue to make their way into Asia, rather than relieving some of the tightness in Europe.” 

Commenting on the impact of rising gas prices on the Euro area economy, analysts at JPMorgan noted: 

“At face value, the recent rise in market gas and electricity prices could increase headline inflation by 0.5 percentage points in the short run. We think this increase will not be reflected fully at the consumer price level and we forecast a 0.3 percentage-point boost to headline inflation in September. […] Regarding consumption, the link between prices and household spending is not very tight. The purchasing power hit coming from gas and electricity prices could be contained. On the production side, there is a risk of disruption in some industries reliant on gas and electricity. But so far, there is very limited evidence of such disruptions in the Euro area. As a result, we leave our near-term GDP forecast unchanged.”

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Disclaimer: The views and opinions expressed in this article are those of the authors and do not necessarily reflect the opinion of FocusEconomics S.L.U. Views, forecasts or estimates are as of the date of the publication and are subject to change without notice. This report may provide addresses of, or contain hyperlinks to, other internet websites. FocusEconomics S.L.U. takes no responsibility for the contents of third party internet websites.

Author: Steven Burke, Economist

Date: September 29, 2021

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