Over the weekend, Morgan Stanley's global energy head Martijn Rats shared a comprehensive yet streamlined analysis of what happened in 2021 that has sent many commodity prices, including Europe's natural gas and electricity prices, surging to never before seen levels.
For those who missed it, Rats explained that a common set of factors has tied all these commodity rallies together. As often happens, the story starts in China.
The combination of a post-COVID-19 recovery and unusually hot weather has increased consumption of electricity sharply this year. Most of China’s electricity is produced from coal, but domestic coal production is increasingly struggling to keep up – the result of regulatory reforms, under-investment and more stringent HSE inspections. Another important source of electricity generation in China is hydropower, but because of droughts in key parts of the country, hydropower has failed to grow this year too.
Over the summer, this led to power crunches that forced regional governments to curtail consumption – street lights were even switched off at night in a number of regions. Another victim of these measures was aluminum smelting, which is a particularly electricity-intensive process. Normally, China supplies ~60% of the world’s aluminum. With its production curtailed and global demand continuing to grow, aluminum prices soared.
China’s domestic coal shortage compelled it to turn to the seaborne market. However, coal production elsewhere has also had its issues – e.g., heavy rains and staff shortages in Indonesia, railway disruptions in Russia and unrest in South Africa. As the seaborne coal market tightened, global coal prices rallied.
The same factors drove up China’s demand for LNG, but here China was not alone. For example, droughts in Brazil also curtailed its production of hydropower, driving up LNG demand as well. With a number of production outages at liquefaction terminals, the global LNG market has tightened severely in the last few months.
Europe is usually the end market for a substantial share of the world’s LNG. However, with other regions pulling harder, European LNG imports declined sharply this summer. At the same time, power generation from offshore wind disappointed – it has not been that windy in Europe recently – boosting demand for natural gas. Yet, with gas supply from Russia and other regions constrained, Europe was unable to build natural gas inventories as much as it normally does in the summer. European gas inventories are now unusually low for this time of the year, with winter yet to start. As natural gas prices largely set electricity prices, they have surged in tandem.
And while Europe, where electricity prices have hit stratospheric levels that have prompted street protests and forecasts of winter blackouts, has had lots of time to analyze all these factors, the continent which has been at the forefront of the "Green revolution" which is indirectly responsible for the collapse in legacy fossil fuel infrastructure and hence, for the surge in prices, decided to ignore everything else and focus on one single word: Russia.
So, as a result, on Tuesday the International Energy Agency demand that Russia send more gas to Europe "to help alleviate the energy crisis" the FT report, noting that in doing so the IEA becoming the first major international body to address claims by traders and foreign officials that Moscow has restricted supplies.
And so, once again, it's all Russia's fault.
The Paris-based body admitted that while Russia was fulfilling its long-term contracts to European customers - in other words it wasn't in breach of contract - it could always do more, and was supplying less gas to Europe than before the coronavirus pandemic.
“The IEA believes that Russia could do more to increase gas availability to Europe and ensure storage is filled to adequate levels in preparation for the coming winter heating season,” said the IEA, which is primarily funded by OECD members to advise on energy policy and security. “This is also an opportunity for Russia to underscore its credentials as a reliable supplier to the European market.”
This, coming from a continent that as recently as a few months ago was contemplating ending the Nord Stream 2 pipeline from Russia, is hypocrisy at its most astounding; it is also a clear example that beggars can indeed be choosers.
Taking a page out of the Hillary Clinton book where everything is Russia's fault, some industry participants have accused Gazprom, Russia’s state-backed monopoly exporter of pipeline gas, of limiting top-up sales in the spot market to Europe — that has led to a historic surge in prices which is raising household bills and threatening industries across the continent. As the FT adds, the company has also unsettled energy traders by keeping the underground storage facilities it controls in Europe stocked at low levels compared with previous years.
Translation: Europe's politicians are so desperate - only this time instead of explaining Hillary Clinton's stunning loss they have to explain why electricity hyperinflation is transitory - they have pulled the Russia bogeyman out of their sleeves again.
Of course, Gazprom is free to do as it wishes: after all in a world where higher prices lead to more supply, any Gazprom attempt to ramp up prices would lead to more output. Only, in the virtuously green Europe, the continent suddenly finds not only does it not have spare capacity, but global interconnections mean that foreign LNG deliveries are backlogged, making Europe Russia's bitch, just as Putin had intended all along. Related: Oil Prices Tick Lower After EIA Reports Crude Draw, Gasoline Build
Meanwhile, Gazprom’s chief executive Alexei Miller said last week that the company was meeting its supply obligations and was ready to increase production if needed, but warned that prices could rise further in the winter due to shortages in underground facilities. Gas prices rose even higher on Monday after Gazprom declined to book additional capacity for export via Ukraine for October and only reserved one-third of the available space on the Yamal gas pipeline via Poland.
To be sure, Europe has a simple solution: start using the Nord Stream 2 pipeline. The only downside is that this will destroy any leverage Ukraine - the site of the CIA-inspired 2014 presidential coup which meant to bring Ukraine closer to NATO but ended up going terrible wrong for Western countries - may have had. As the FT notes, Russia is looking to gain approval to start the Nord Stream 2 pipeline to Germany, which remains contentious because it will redirect some of the gas that flows through Ukraine.
Gazprom and Kremlin officials have said Russia could boost gas sales once Germany and the EU approve the start up of the pipeline. And even though its actions have added to suspicions that it has restricted sales in order to try to accelerate the decision, Russia has every right to lever its natural resources to achieve its geopolitical goals. And since the opportunity cost is half of Europe freezing this winter, Russia will get what it wants.
What is truly hilarious, is that while Europe politicians have generally refused to blame Russia for contributing to the fact that gas prices have more than tripled this year, some members of the European parliament have called for an investigation into Gazprom’s role in the crisis ever since European electricity prices exploded. Needless to say, doing so will only lead to even higher prices in a continent which clearly appears unaware that the global realpolitik has shifted dramatically in the past year.
The IEA’s call for more Russian gas comes as Russian president Vladimir Putin is considering allowing Rosneft, the Russian state-owned oil company, to supply gas to Europe via the pipeline. Russia's energy minister Alexander Novak recommended allowing Rosneft to export 10bn cubic metres to Europe a year via Gazprom’s export transit facilities in a recent report to Putin. The amount is small compared with the 139 bcm that Gazprom has exported outside the former Soviet Union so far this year. But it would spell a highly significant end to Gazprom’s monopoly on gas exports, which are more lucrative than the domestic Russian market.
Not that any of that would matter to Russia: both Rosneft and Gazprom are controlled by longtime allies of Putin.
Amos Hochstein, senior adviser for energy security at the US state department, told the Financial Times this month he was worried that “lives are at stake” in Europe in the event of a severe winter in part because Russia had “under supplied the market compared to its traditional supplies”. Now if only Europe had thought just a few months ahead, secured the highly valuable commodity in advance and not gutted its existing energy infrastructure in the name of the most expensive "green virtue signaling" campaign of all time...
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