A year on from the war in Ukraine, energy markets have proven to be remarkably resilient
Did luck play a decisive factor?
For global energy markets it seems as if 2022 never even happened. As President Vladimir Putin ordered his troops into Ukraine a year ago, a dazed world watched footage of tanks and troops cross over the border, with dire predictions that Kyiv would fall in a matter of days. Russia was building up troop and artillery deployment along the border in the weeks and months ahead, but expectations that he would order an invasion were low. Many had seen those maneuvers perhaps more as a negotiating tool, with the Kremlin pushing back against growing Western presence and influence in countries that were once part of the Soviet Union. It perhaps demanded concrete assurances from the US and its allies in matters such as permanently blocking Ukraine from joining NATO.
Policymakers scrambled to assess the impact of the war declared by one of the world’s most powerful nations on a much smaller neighbor that was surely going to draw in the West. The uncertainty and confusion were not limited to geopolitics alone. After all, the war involved one of the biggest global producers of oil and gas, and a top supplier to Europe. As the conflict unfolded, the viability of supply lines and trade routes in place for decades that handled sizable portions of global flows was called into question. Policymakers, energy traders and industry participants were actively gauging the aftermath of a market that looked like it was heading into a tailspin. Much as most of the world was shocked by the invasion in February 2022, oil and gas markets have been springing everyday surprises to the downside one year in. Another one of the many predictions that did not come to bear was Moscow’s assessment of a prompt collapse of Ukraine. The nation with a nascent military and limited firepower displayed remarkable smarts and resistance, pushing back the Russian military through large parts of the country, with solid weapon and equipment assistance from the West. The exact rationale that drove President Putin to order the invasion may never be known, besides the well-publicized view about restoring his nation to its glory. Still, it may have been driven partly by the confidence Moscow had garnered from its annexation of Crimea in 2014, given the muted reactions from the West and the war in Syria in support of the Assad regime. His presence in Crimea this weekend to mark the ninth anniversary of annexing Crimea from Ukraine perhaps helps drive home the point. Hence, of the many, these surprises have perhaps stood out the most – the invasion itself, Ukraine’s resistance and its ability to hold its ground, and energy markets caught in the crossfire. While geopolitics and energy markets are inextricable interlinked, we dedicate this issue of REview to study the many factors that have resulted in bringing energy prices to their current state. And we stay within our wheelhouse to evaluate the key drivers that may weigh on markets in coming months.
The energy system has been greatly altered on a short- and long-term basis. From new and evolving trade flows, policy changes, renegotiations and the re-evaluation of investment strategies – the list goes on. But very few markets experienced the gyrations seen in the gas sector. Through 2022, gas markets experienced a steadily worsening supply disruption scenario, which led to price volatility that, in turn, triggered demand destruction. The recipe was for an all-out doom amid heightened fears that reverberated and resonated across the European borders, weighing across all energy markets. Natural gas took center stage, as a critical source of energy in Europe and global trade turned into one of the hottest commodities last year amid heightened uncertainty of shortages on the back of acute market imbalances. Throughout last year’s commotion was the all too common magnetic and compulsive reaction to crises – turning to the worst-case scenario as the focal point. Media pundits highlighted shortages, with markets playing on the feelings and emotions of all-compassing doom.
To be sure, some of those fears were warranted. Russian gas supply to Europe via pipeline remains down some 70% year to date. The only Russian gas supply reaching Europe include volumes transiting from Ukraine and the Turk Stream pipeline supplies. As a result, energy security in Europe became the No. 1 priority and the pressure intensified, as governments grappled with fears of blackouts and rationing, terms that had been relegated to the region’s history books. And the fear was real – all countries in the EU are energy importers: only Norway, besides Russia, are exporters.
Clearly some enormous market damages played out last year. Even so, the energy system overall remained resilient. Markets have managed to rebalance and now, one year later, based on the current price board – it is as if 2022 never even happened. The Dutch TTF price is back to trending below the Asia spot price in a more comfortable $20 per MMBtu range. Meanwhile, the US Henry Hub gas price nearly dipped its toes into the sub-$2 MMBtu waters in late-February. A multitude of factors – in what many have argued was the ‘perfect storm for markets’ – have contributed to the recent collapse. Not until last year, when Russian piped gas supplies fell off a cliff, did Europe begin bringing in such high levels of liquefied natural gas (LNG) imports to help offset those losses. Europe managed to secure enough LNG to support very healthy balances ahead of winter. The peak demand season, however, turned out to be anything but impressive and Europe had more than enough gas to survive the winter.
Even so, demand destruction, particularly in the industrial sector, played a crucial role in lowering total European gas consumption last year. Thanks to warmer weather trends, the EU was able to lower its gas demand for heating. That was followed by demand destruction in the industrial sector that came as a result of incredibly high prices during summer, which disincentivized consumption of the fuel. As a result, the EU was able to reduce its demand by 14%. Some improvements from domestic production were also realized, but that did not swing the needle much. LNG had a significant role in strengthening European markets in 2022 and this will have to continue going forward.
And gas was certainly not alone. The oil market arguably saw just as significant an impact from the war. The European benchmark lost Russian barrels and new trade flows emerged. After more than a year, it is clear that the war failed to isolate Russia like it was originally envisioned – the outcome seems to have been quite the opposite. It brought Russia into a closer embrace with China, with experts predicting ties between the two nations deepening further. China has maintained a neutral stance on the war, with President Xi Jinping’s visit to Russia underscoring a strong show support from the world’s second-biggest economy. And what about the countries that have continued to receive Russian oil supplies, taking advantage of the deep discounts being offered on the barrels? Many have criticized India for its purchase of oil from Russia. Sanctions on Russian oil, and on the country in general, have helped cut their revenues – money that would have otherwise gone to fund the war. Even so, Russia is still managing to find markets for its oil – and it is very possible that Russia isn’t losing any barrels. According to some estimates, it may in fact be getting more money out of selling its oil and gas. Speculations are that discounts to Urals delivered to India, for instance, may not be as deep as the $20-$40 per barrel that have been reported by pricing agencies. Russia’s GDP growth over the year has been more than what many had forecast, pointing to the success the nation has had in weathering the storm.
On a different note, one of the outcomes of the war was Europe’s drive to accelerate its energy transition. Energy security remains the top priority in the short term, but it has fueled Europe’s ambition to speed up the adoption and implementation of renewables in an effort to rid itself of fossil fuels. This is obviously going to be very challenging as many market participants see 2022 as an example of how things can go wrong if the timing is not right. All eyes will be on Europe’s targets and energy strategy going forward, but first Europe has to take care of the current crisis in order to prevent or mitigate future ones.
How critical was a mild winter? Was Europe just lucky? The chips fell where they needed to last year. So yes, in many ways, Europe lucked out. The region was fortunate to have minimal competition from Asian LNG buyers and the mild winter was considered a saving grace. Now the question has turned to next winter. Considering the short term, Europe is expected to manage the rest of this winter, but questions are now being raised over the 2023/24, and more importantly, the 2024/25 winter. We anticipate that Europe can manage through this year and next on firm LNG imports and domestic production, in combination with reduced demand of at least 10%. But it is important to remember that in 2022 Europe reduced total gas demand by 14%. A large portion of this decline was in the industrial sector which saw demand destruction given the high price environment. If Europe is able to sustain lowered demand like last year, it should have more than enough gas supply. However, this scenario could change for the worse if Russia cuts off all supplies, which is still not off the table. There is certainly still some downside risk if all Russian flows stop, but that will likely not push inventories outside of this 5-year range until mid-2023.
Hence, 2023 is now the bigger concern and LNG will continue to play a critical role in supporting Europe’s gas demand needs. And that gas will come mostly from the spot market.
A key concern is the increased likelihood of a structural uptick in LNG demand from China. If that happens and competition for LNG increases, it could limit the amount Europe can take in – and we would once again see prices rebound, with perhaps even bidding wars between the two markets. Of course, the EU price cap that was introduced could help. The proposal of a price cap was introduced early last year, which did eventually go through, really had little to do with the collapse in gas prices. With the price cap, the goal was not to crimp supply, but rather it was to keep supply up. This is what the EU and US administrations wanted to achieve, and they did. Yet, it is worth bearing in mind that the price cap is not binding, and its impact may be limited and could cause more harm than good if Europe does have to vie for LNG volumes this year.
Looking back on 2022, Europe increased LNG imports by about 70% to nearly 120 million tonnes (MT), with over half from the uncontracted spot market. Europe wasn’t expecting the huge loss in pipeline imports, so LNG helped offset the gap. This positive trend in LNG demand is expected to continue for both Europe and Asia over the coming years, creating market tightness along the way. European demand is forecast to grow 7 MT in 2023; not as strong as the 48 MT growth last year but still meaningful – because that growth is on top of the gain seen last year. LNG demand is expected to pick up in Asia with China's reopening, though it is already well covered by LNG contracts this year. However, there is still the chance that south and southeast Asian buyers may also return to the market. With 15MT of new demand expected this year, LNG markets will remain tight.
Against that backdrop, an analysis of US LNG exports is crucial. The global LNG market will depend on increased imports from the US. With US LNG capacity holding flat at 95 MT this year, the LNG production potential growth of 9 MT could be a challenge. All facilities will need to continue to run close to max capacity throughout the year. Plus, the recent restart of Freeport LNG – and most importantly, a swift ramp up and steady performance – will be necessary to achieve LNG growth from US facilities this year.
The collapse in gas prices in the US was brought about by improvements in key market fundamentals. Supply grew enough last year to support increased LNG exports and domestic demand, while Freeport LNG helped to boost storage inventories ahead of winter, which never really emerged. As a result, the US is saddled with stocks that are over 22% above the 5-year average, with gas prices plummeting to 2021 levels. However, the US is not entirely in the clear. The risk of a recession has kept many markets, including commodities, on edge. While the recent strain on the banking system may somewhat temper the pace, the Federal Reserve is still expected to tighten its monetary policy as it seeks to curb inflation. Market signals are pointing to an inverted yield curve, and though this trend could be self-induced by starving credit, it suggests the US could be heading toward an economic slowdown.
Consumers are already having to adjust to inflation, spending more time these days budgeting to decrease spending where they can. Market data suggests consumers in the US are already starting to pull back on spending as the increase in savings through the pandemic are beginning to evaporate. Higher housing, food and energy costs are forcing consumers to rethink absolute necessities. And at the center of all of this is demand and the prospect of reduced gas consumption. In this scenario, lowered demand will lead to healthy storage levels all year, and prices will fall on low demand and strong storage.
Even with LNG exports increasing this year, it won’t be enough to support a strong uptick in gas prices if demand remains low at home, amid the high inventories. Bear in mind that a drop in prices could trigger an uptick in gas demand since low prices lead to increased competitiveness in the power mix so some rebalancing would happen in this scenario. Furthermore, if gas prices slide low enough to trigger a decline in operator activity or shut ins, the question remains on whether supply will manage to keep pace with demand. In addition, supply chain issues and labor shortages continue to transpire and could have negative effects on supply. This scenario could be reversed as well. If supply lags this year and there is another strong demand season this summer, and a perhaps decline from other sources of energy like hydropower in the West, a possible undersupply situation could develop, pushing prices higher. This is the name of the game with gas balances. It is a delicate balance and the outcome this year in the US will absolutely affect the global gas and LNG markets.
Looking ahead, incremental gains in liquefaction capacity through the addition of Fast LNG, Golden Pass, and Plaquemines Phase 1 facilities will boost US LNG production but not until 2024, so the added volumes are not likely to support global markets this year. We will simply have to wait until next year for strengthened US and global LNG supplies. US natural gas supply is well positioned for growth and capable of providing the gas and LNG required for global market needs this year, but gas infrastructure must continue to be built to accommodate this growth and support domestic and global balances. Without any newly built LNG facilities in 2023, a tight global market is inevitable for this year, given the under-supply situation. Hence, we fully expect Europe and Asia will continue to compete for available LNG supplies.
Due to the LNG market tightness in 2023, global gas prices will be set by levels curbing demand. Europe wasn’t expecting the huge loss in pipeline imports, but LNG shipments have been able to help offset this so far. However, this trend is expected to continue and will create market tightness over the coming years. Luck and hope – for another mild winter and no major supply disruptions – will play a big factor this coming winter and next.
In any analysis of this war, it is impossible not to recognize and mourn the catastrophic humanitarian toll it has taken, with hundreds of thousands of casualties and millions of displacements with buildings and cities razed to the ground. The rebuilding of cities and infrastructure will cost billions of dollars with many families torn apart and suffering injuries and fatalities. The suffering should and must stop immediately. Eventually, despite the many moving parts highlighted above, secure energy and reliable supply will again play a central role whenever the rebuilding phase gets fully underway.
Sign up to be the first to read REview every month.
Senior Vice President, Oil Markets, Head of Americas Research
Vice President, Gas Markets
Vice President, Analytics
(The data and forecasts contained in this column are Rystad Energy’s and the opinions are of the authors.)