European spot gas is showing signs of life as winter looms, and remains at multiples of the US gas price. Since the end of August, the European spot price has risen from USD 349/kcm (USD 9.88/mmbtu) to USD 370/kcm (USD 10.49/mmbtu) for a total increase of USD 21/kcm (USD 0.61/mmbtu) or 6% (Figure 1). Over the same period, the US gas price has eased slightly to USD 122/kcm (USD 3.47/mmbtu), or a third of the European spot price, confirming that these markets continue to price completely independently, in our view. Meanwhile, our calculations indicate that the price of oil-linked term gas has been weakening (Figure 1) and this is also reflected in the data reported for European border prices by WGI.
The effect of these movements is to reduce the discount of European spot gas to oil-linked contract gas to 11%, halving the summer dip (Figure 2). YTD, the discount has averaged 15%, almost half the level of the 28% discount which prevailed over the equivalent period in 2012. Given the further 20% YoY reduction in LNG imports to Europe, we believe this confirms our view that the increasing European dependence on pipeline imports is forcing the spot price closer to the oil-linked contract price, which represents the marginal supply molecule to Europe (see European Gas Market Outlook, of 2 July).
Current indicative spot prices for LNG for delivery in 4-8 weeks suggest a 10% increase in the Asian premium over Europe to USD 145/kcm (USD 4.10/mmbtu) with Asian spot LNG priced at USD 554/kcm (USD 15.7/mmbtu). That is more than adequate to continue to pull cargoes away from Europe, in our view, and is also supported by reported trade flows.
Given the price dynamics, it seems likely to us that LNG will continue to be bid away from Europe to higher priced markets. That means that as European gas demand begins its normal seasonal increase, the dependency on pipeline imports could well increase further, making it likely that the spot discount to the oil-linked price will compress further, even in the absence of any supply disruptions which could cause the spot price to spike upwards.
Storage levels in Europe remain 10-20% below recent seasonal norms for this time of the year and while there is still time for inventory to build, the economic incentive to do so is not strong. That could result in Europe entering the winter heating season even more dependent on reliable pipeline deliveries than it is now.