European hub gas prices, especially those in the UK, have continued to rise quite sharply over the last couple of weeks with NBP now a whisker below the USD 400/kcm (USD 11.3/mmbtu) mark. As a result, the discount to our estimate for the generic oil-linked gas contract price has shrunk to just 15%, having been as wide as 40% in the summer.
The UK is clearly short of gas, as demonstrated by the unusual reverse flow of gas into the UK through the Interconnector and at record levels. That is also likely to be the cause of the widening spread with prices at Zeebrugge, we expect. However, although the spread is widening, it is also serving to pull hub prices up in Continental Europe.
The reasons for the shortage of gas in the UK are straightforward. Although underlying demand is sharply weaker, indigenous production is also down significantly. More importantly, LNG flows into the UK have dropped precipitously and are down over 40% YoY (to August), reflecting the broader trend for Europe. In our view, that is because much of the LNG which comes to Europe is delivered at the commercial whim of the sellers and increasingly they have been finding stronger markets elsewhere. Moreover, while underlying demand has been weak, gas demand is now subject to the vagaries of the winter, to which demand is extremely sensitive. The weather has already been unusually cold in the UK and is set to get colder still, not just in the UK but more broadly across Northern Europe.
Although storage remains ample in Europe, the earlier colder-than-average weather starts, the greater the perceived risk that the winter will be colder than average overall and the sooner inventory concerns will start to build.
The Far East has also been suffering colder than normal temperatures and prices for ‘spot’ LNG into the region have jumped 18% since the end of October to USD 560/kcm (USD 15.85/mmbtu). As a result, LNG availability to Europe is likely to remain under pressure.
It remains our view that we would not be surprised to see European spot gas trade up to and even above the oil-linked price this winter. Current circumstances are only increasing the likelihood of that eventuality, in our opinion.