Gas and coal surge spreads to oil with substitution in focus

Gas and coal surge spreads to oil with substitution in focus

Ole Hansen

Head of Commodity Strategy

Summary:  The global energy market remains on fire, with surging gas and coal prices now increasingly impacting crude oil as well, with consumers looking for alternative fuels to substitute punitively high and increasingly growth impairing prices for gas and coal across the world. Under normal circumstances, a surge of this magnitude would trigger increased CAPEX spend by producers looking to benefit, but the green transformation drive has potentially reduced this reaction function, leaving consumers exposed until prices reach levels that forces demand destruction.


The global energy market remains on fire, with surging gas and coal prices now increasingly impacting crude oil as well, with consumers looking for alternative fuels to substitute punitively high and increasingly growth impairing prices for gas across the world. The rally which started in Europe several months ago has during the past months been spreading like a wildfire to the rest of the world. The combination of gas in short supply, and lower-than-expected power generation from solar and wind has forced utilities to buy coal in order to maintain the required baseload across the electrical grid.

In energy management the term baseload, is the permanent minimum load that a power system is required to produce in order to meet fundamental electricity demands by customers. In the past that baseload was provided by conventional power plants such as coal and nuclear plants, but with the green energy transformation in Europe, many of these conventional power plants has been shut down and replaced with renewable energy production, and with gas being the go-to fuel when production from renewables drop.

To put the current elevated prices in Europe into perspective, the price of Dutch TTF first month gas has risen to near €85/MWh or $29/MMBtu or more than five times higher than the average seen during the previous five years. German power prices for 2022 delivery have risen to €120/MWh and more than 3X the five-year average. Tight supply of gas has forced power generators to turn to coal, thereby not only driving the price of coal delivered at Rotterdam to a multi-year high at $155/tons (2X the average) but also increasing the price for emission allowances under the European Union’s Emissions Trading System to €65/tons (4X the average).

Source: Saxo Group

Low stockpiles of most fuels, and limited time left to replenish stocks before the peak demand season, has left consumers around the world increasingly exposed to a supply crunch should we end up with a colder than normal winter. With gas and coal trading at very elevated levels we are now seeing the next stage of this energy crunch with crude oil prices rising as well. Brent crude oil trades above $80 for the first time in three years on the rising prospect for increased substitution demand for oil powered generation.

That additional increase in demand for crude oil and fuel products occurring at a time when global stock levels of crude oil are falling amid a continued post-pandemic recovery in demand and after hurricane Ida supply disruptions more than offset the ramp-up in OPEC+ production since July.

The latest market to surge higher is US traded natural gas prices which during the past four days has surged by 30% to a seven-year high at $6.25/MMBtu. The global supply crunch will drive increased demand for US LNG exports, thereby also raising concerns about tightening inventory levels in the US. The March-April 2022 spread, also called the Widowmaker given its unpredictable and volatile behavior has surged to $1.54, the highest for this time of year since 2005. The spread reflects the market view on how tight supply will be at the end of winter, before spring arrives and injections into storage resumes.

Source: Saxo Group

In conclusion, the old saying that the best cure for a high price is a high price may not work this time round. The focus on ESG and green transformation has reduced producers' normal long-cycle capex response to surging prices and rising demand. Without a response from producers, the only other option is for prices to reach levels that triggers demand destruction. A development that may come at a heavy price given the risk to global growth, inflation and stock price valuations.

The best we can hope for is a milder than expected winter lowering demand. If, however, prices continue higher, the much-needed green transformation push could suffer a temporary setback with worries about blackouts exceeding worries about climate change.

Disclaimer

Saxo Capital Markets (Australia) Limited prepares and distributes information/research produced within the Saxo Bank Group for informational purposes only. In addition to the disclaimer below, if any general advice is provided, such advice does not take into account your individual objectives, financial situation or needs. You should consider the appropriateness of trading any financial instrument as trading can result in losses that exceed your initial investment. Please refer to our Analysis Disclaimer, and our Financial Services Guide and Product Disclosure Statement. All legal documentation and disclaimers can be found at https://www.home.saxo/en-au/legal/.

The Saxo Bank Group entities each provide execution-only service. Access and use of Saxo News & Research and any Saxo Bank Group website are subject to (i) the Terms of Use; (ii) the full Disclaimer; and (iii) the Risk Warning in addition (where relevant) to the terms governing the use of the website of a member of the Saxo Bank Group.

Saxo News & Research is provided for informational purposes, does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. No representation or warranty is given as to the accuracy or completeness of this information. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. No Saxo Bank Group entity shall be liable for any losses that you may sustain as a result of any investment decision made in reliance on information on Saxo News & Research.

To the extent that any content is construed as investment research, such content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication.

None of the information contained here constitutes an offer to purchase or sell a financial instrument, or to make any investments.Saxo Capital Markets does not take into account your personal investment objectives or financial situation and makes no representation and assumes no liability as to the accuracy or completeness of the information nor for any loss arising from any investment made in reliance of this presentation. Any opinions made are subject to change and may be personal to the author. These may not necessarily reflect the opinion of Saxo Capital Markets or its affiliates.

Please read our disclaimers:
- Full Disclaimer (https://www.home.saxo/en-au/legal/disclaimer/saxo-disclaimer)
- Analysis Disclaimer (https://www.home.saxo/en-au/legal/analysis-disclaimer/saxo-analysis-disclaimer)
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)

Saxo Capital Markets (Australia) Limited
Suite 1, Level 14, 9 Castlereagh St
Sydney NSW 2000
Australia

Contact Saxo

Select region

Australia
Australia

The Saxo trading platform has received numerous awards and recognition. For details of these awards and information on awards visit www.home.saxo/en-au/about-us/awards

Saxo Capital Markets (Australia) Limited ABN 32 110 128 286 AFSL 280372 (‘Saxo’ or ‘Saxo Capital Markets’) is a wholly owned subsidiary of Saxo Bank A/S, headquartered in Denmark. Please refer to our General Business Terms, Financial Services Guide, Product Disclosure Statement and Target Market Determination to consider whether acquiring or continuing to hold financial products is suitable for you, prior to opening an account and investing in a financial product.

Trading in financial instruments carries various risks, and is not suitable for all investors. Please seek expert advice, and always ensure that you fully understand these risks before trading. Saxo Capital Markets does not provide ‘personal’ financial product advice, any information available on this website is ‘general’ in nature and for informational purposes only. Saxo Capital Markets does not take into account an individual’s needs, objectives or financial situation. The Target Market Determination should assist you in determining whether any of the products or services we offer are likely to be consistent with your objectives, financial situation and needs.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the US and other countries. AppStore is a service mark of Apple Inc.

The information or the products and services referred to on this website may be accessed worldwide, however is only intended for distribution to and use by recipients located in countries where such use does not constitute a violation of applicable legislation or regulations. Products and Services offered on this website is not intended for residents of the United States and Japan.

Please click here to view our full disclaimer.