Natural gas markets under extreme duress

Ordinarily, rising oil and natural gas prices serve as positive signs of a recovering global economy. However, the rate and extent of price increases threatens to derail that very recovery. These increases, on top of rising interest rates, rapidly increasing inflation and constrained global supply chains, all continue despite more than a year into the recovery.
Energy markets are naturally price-inelastic and thus highly volatile. Nonetheless, an obsessive focus over the last year on the green agenda has led markets and authorities to dismiss the vital role fossil fuels play in global energy markets. Fossil fuels will continue to play a vital role for years to come as the energy market transitions gradually to a mix of more sustainable energy sources. Countries like Germany have shut nuclear power stations while at the same time watched natural gas reserves dwindle.  With the winter season, such madness has contributed to a quadrupling of European spot gas prices. It has also led to a corresponding surge in electricity costs and the curtailment of energy intensive industries like aluminium and zinc smelting, chemicals and fertilizers across the continent.
A perfect energy storm
Such perfect storm conditions always involve more than one dynamic. Low natural gas supplies from Russia and poor reserve management in Europe have played a role. So has OPEC’s unwillingness to increase output.  Finally a third dynamic, limited LNG supply coupled with limited LNG vessel carrying capacity has also led to the current storm. But as with all futures markets, investor positioning also plays a part. Record returns by oil traders points to the part financial markets serve, profiting from the market tightness. As reports, Brent prices surged past $90 per barrel last week for the first time in seven years. Markets have become increasingly nervous.
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Speculation over an embargo on Russian oil has now added a geopolitical premium to prices.  Markets have become ever more focussed on the Russia-Ukraine standoff and mull the potential outcomes should Russia gamble on an invasion. In the US, expectations of colder weather has spurred Henry Hub gas futures to their sharpest one-day climb last week, just as the February contract expired, surging from $4.50 to $7 per mmBtu at the peak of trading. A 72% increase marks the largest rise the US market has ever seen in a single day. Furthermore, it underlines that although the US has adequate shale gas reserves, the country remains susceptible to the volatility of the global natural gas market.
Response scenarios
According to the FT, the US and its European allies have drawn up a range of response scenarios dependent on Moscow’s next move. Sanctions would certainly play a role – from direct sanctions on individuals, to industry sectors like investment in oil and gas extraction, to action against the financial system such as SWIFT money movements and dollar clearing. Europe by far has the most exposure to Russian retaliation should its largest supplier so choose. Hopefully, Moscow will remain aware that with high inflation and a weak rouble, she needs European markets more than or at least as much as Europe needs Russian gas. After all, Russia supplies more than 40% of the European Union’s natural gas imports. But Russia depends on energy exports for nearly 60% of all the goods and services the country sells abroad.
A Mexican stand-off if ever there was one.

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