Why supply issues could keep natural gas prices higher for longer


The price of natural gas could remain at higher levels due to concerns over future supply, especially as Russia cuts off gas pipeline flow to Europe. Anthony Okolie speaks with Hussein Allidina, Head of Commodities at TD Asset Management, about the outlook for goods


Anthony Okolie: Natural gas has recently traded around levels last seen in 2008. And according to our guest today, higher prices may be here to stay amid tight supply and growing concerns a cold winter ahead. Hussein Allidina, Head of Commodities at TD Asset Management, joins us now to learn more. Hussein, let’s start with the dynamics of supply right now. Why is the offer so tight?

Hussein Allidina: Yes, Anthony, thank you for inviting me. I think with regard to the gas market in Europe in particular, Europe is quite significantly dependent on supply imports from Russia. The situation in Russia, particularly with regard to Nord Stream 1, which is the gas pipeline that supplies us, the volumes have been quite low.

Europe started the summer with a relatively tight level of supply following a cold winter last year. For years, Europe has been withdrawing from national production of natural gas, which is highly dependent on imports from Russia. And those volumes have been lower. And all of that is, of course, exacerbated now by materially warmer than normal weather in Europe, which is fueling demand for natural gas at a time when, frankly, it’s horrendous. The timing is awful.

Anthony Okolie: Yes, we have certainly seen the news about heatwaves in England and the rest of the country. Tell us how integral natural gas prices are to the European economy and energy markets.

Hussein Allidina: Yes, so natural gas is important globally. It is very important in Europe, mainly because it is a cleaner fuel than oil, than coal. Europe has therefore moved away from oil, coal, etc., which are more polluting, to turn towards gas. But the gas obviously does or does not come from Russia today.

You’ve seen over the past few months announced industrial closures, whether it’s fertilizers, smelters, aluminum smelters, etc., because the cost of inputs is so high. And finally, at today’s prices, I think you’re going to continue to see European industry under pressure because the math just doesn’t work at this high level. Its very important.

Anthony Okolie: It’s just more expensive for a lot of these producers to produce these products.

Hussein Allidina: Of course it’s expensive for producers or for the industry to operate. And it is also quite painful and difficult for the consumer, because remember that natural gas is a raw material for the production of electricity. And part of the reason you have record, never-seen-before electricity prices in Germany and France is because of what’s happening to input natural gas.

Anthony Okolie: Now you said that the risk of a shortage of natural gas as winter approaches is definitely a potential. Why do you think this might play?

Hussein Allidina: Yes, so the highest demand period for natural gas is winter due to increased heating loads, increased demand for electricity generation. And we are always worried about not having enough supply in winter. Today, if I take the example of the United States, if the weather is normal, everything should be fine.

But the risk is – and if you’re a utility, if you’re PowerStream, providing power to my house, they have to be able to provide power when I call, so obviously they are very concerned about the cold weather. And when they model how much they need for the winter, they assume the weather is not normal. They assume the weather will be colder than normal.

Anthony Okolie: Much colder than, yeah.

Hussein Allidina: And depending on how many colder than normal standard deviations we have, you may miss. That’s why I think you’re seeing prices not just in Europe but also in the United States going up in an effort to ration demand to avoid that kind of outcome.

Anthony Okolie: And what does the situation in Europe mean for us here in Canada in the United States?

Hussein Allidina: Yes, so today we are exporting – the United States exports about 12 billion cubic feet a day. So the US market is, production is about 95 billion cubic feet a day right now. Just to put into context, today we send between 12 and 15 billion cubic feet per day when Freeport is back in operation to Europe.

If Europe ends up being cold enough or if Europe is unable to source supplies from Russia or elsewhere, they will call. Now we can’t do much more than 12. But the challenge we have is if we have colder weather and we’re still exporting 12, 13, 14 billion cubic feet a day to Europe, we run into problems with our balance.

So I think what the market is trying to figure out is where do I send the price in order to limit domestic demand? If we end up in a position, Anthony, where we have to stop LNG from going to Europe, we’re talking about pricing well over $20 an MMBtu, because Europe is already trading above those levels in this moment. If I close, if I want to close this arb, I have to deter shipments from going there. And it’s not $8 per MMBtu that does it. That’s well north of $20.

Anthony Okolie: So all of this suggests that natural gas prices will remain high for some time. What needs to happen to make it go away?

Hussein Allidina: Yes, so I think prices will stay high because the underlying stocks in North America and Europe are tight. If we end up having a mild start to winter or production – we wait for US production to respond.

I think a lot of people thought that production in the United States today would be 97 or 96 and a half Bcf a day. We are only at 95. It is still expected that as the number of rigs increases and companies seek to increase production, that production will increase.

Anthony Okolie: Will increase, yes.

Hussein Allidina: So your biggest risk of lower gas prices here is a milder than normal start to winter. And the onset of winter is especially important, because the longer the winter passes, the lower the risk of running out.

Alright, so a mild start to winter in November, December would be bearish for natural gas, as would an improvement in production and/or if that disconnected Freeport LNG facility stays disconnected longer than expected. He should come back in October, November. If it stays off longer, more supply is left in the country.

So those are the bearish factors that I see in the short term. But the medium term is still the one that I think is contested because we have to invest. The demand for this stuff just keeps growing. We have already talked about that. Especially as people move away from oil and coal, gas…

Anthony Okolie: All fossil fuels, exactly. We are looking for… Hussein Allidina: …gas needs to see investments.

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Editor’s note: The summary bullet points for this article were chosen by the Seeking Alpha editors.

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