Gas Price Surge on New Russia Supply Threats
Bottom line: Concerns about a new 3-day shutdown of Nord Stream 1 have amplified the rush to secure LNG gas supplies and driven a further surge in European gas prices (Figure 1). The politically restrained gas supplies from Russia will likely last through the next few months in the run-up to the winter and as it tries to break the European consensus on Ukraine. However, into early 2023, Russia could change tactics and pick up exports to Europe, which would likely mean a substantive fall in European gas prices.
Figure 1: Europe and Japan/South Korea Gas Prices (Dec. 31, 2021 = 100)
Source: Datastream
Russia Supply Problems into the Autumn
Russia has announced a 3-day shutdown of Nord Stream 1 from Aug. 31, which has sent European gas prices surging as worries grow that the shutdown could be extended or that Russia could decide to cut off gas supplies permanently to Germany. A sense of crisis exists in Germany and Eastern European countries that gas inventories may not be sufficiently built up by October, when gas demand usually overtakes normal gas supply never mind the politically restrained gas supply of recent months.
This is all an attempt by President Vladimir Putin to break European support for Ukraine and either get Europe to reduce military support for Ukraine or for Europe to push Ukraine toward peace terms favorable to Russia. Russia could export via other pipelines, but has decided to restrain them as well. Retaliation for European sanctions is also a driving force behind Russia's restrained gas supplies. This stop-go policy could last for the next few months, both as European political support is currently strong for Ukraine and wary of Russia and as power cuts are a possibility rather than actually happening in Europe. Additionally, from September Russia will likely start holding referendums in territories it occupies in Ukraine to cede to Russia, and Putin loves a distraction at times such as these. Putin is also playing the long game with Europe and the U.S. on Ukraine to see whether the political landscape changes, especially if Donald Trump were to be re-elected president in 2024 (Ukraine War scenarios here). Russia and Putin can exert the maximum pressure on Europe in the autumn and early winter.
However, Russia cannot easily divert gas exports due to insufficient LNG capacity, while the second gas pipeline to China is not due to be completed until 2025. Russia needs to sell gas and Europe cannot diversify away completely from Russian gas for a couple of years. Russia at some stage in mid-winter will likely switch tactics and start selling more gas to Europe, as referendums are complete in parts of Ukraine and as Russia needs the foreign currency. Putin's pragmatism has already been seen on wheat, where the restart to exports from Russia and Ukraine has led to a noticeable decline in prices (Figure 2). Putin may also hope that in coming years that Russia could still supply gas to Europe and thus wants months of restrictions to be followed by less restraint to create an impression that Russia could still be a long-term gas supplier to Europe. The scale of any Russia gas export pickup from mid-winter is uncertain, however, as it would be made on political calculations. Even so, we could see enough extra exports for a 25% gas price reduction or even 40-50% in spot and future prices, which would have a big impact on the European growth picture. It is also important for parts of Asia, as Japan/South Korea gas prices have been driven up by European gas prices recently (Figure 1), but less so for the U.S. where plentiful domestic gas supplies and restrained LNG export capacity mean a much lower gas price than global LNG prices.
Figure 2: SRW Wheat Prices Decline with Russia/Ukraine Exports (USD)
Source: Datastream