EU gas and power prices traded mostly sideways following the early October spike, but at five times the seasonal average gas prices are still well above levels that will cause economic hardship across the region while at the same time hurting growth as heavy energy-consuming industries scale back their production. As temperatures continue to cool across the northern hemisphere, the market remains exposed to price spikes in the event of a colder winter. A 25% tumble in coal prices following intervention from several branches of the Chinese government helped, at least temporary, to alleviate some of the fears of runaway prices.
With the power crunch in China showing signs of easing as coal powered plants are incentivized to produce more power, the prospect for more LNG shipments reaching Europe has also received some attention. Overall, however, Europe is still facing a grim winter unless high prices kill demand, the winter turns out to be mild and windy, and most importantly Russia decides to ship more gas. Unfortunately, such a decision increasingly looks like it's being linked to a swift approval by Germany of the controversial Nord Stream 2 pipeline. With this in mind, global energy prices look set to remain elevated with gas-to-oil substitution adding an additional layer of support for several fuel products from heating oil and diesel to propane.
Crude oil’s six-week rally showed signs of running out of steam in response to lower US gas prices and the slump in coal prices. From a technical perspective, the combination of Brent and WTI crude oil both reaching overbought territory and hedge funds turning net sellers into the rally helped trigger some long overdue profit taking. According to the latest Commitments of Traders report covering the week to October 12, hedge funds cut their exposure in Brent crude oil, the global benchmark, by 10% to 300 million barrels, less than half the record 632 million barrels recorded back in 2018, the last time the price traded above $80/b.
WTI crude oil meanwhile rallied to the highest level since 2014 with stocks at Cushing, the important delivery hub for WTI crude oil futures, rapidly draining to a 2018 low and well below average levels. As a result, the futures curve has moved deeper into backwardation, a formation where market tightness drives the spot price higher than the deferred prices. An example being the $10.4/b spread between the two nearest December futures contracts, a level that was last seen in 2013.
In our Q4-2021 outlook published on October 5, we raised our target range for Brent crude oil by 10 dollars to a $75 to $85 range. Having reached the upper end of this range already, and well before winter developments and a lack of additional OPEC+ action potentially tightens the market further, the risk to our forecast remains clearly skewed to the upside. Continued selling by hedge funds, however, needs to be watched as it removes a key source of demand in the “paper” market.