Germanovich
The price of natural gas could remain at higher levels because of worries about future supply, especially as Russia cuts the pipeline flow to Europe. Anthony Okolie speaks with Hussein Allidina, Head of Commodities at TD Asset Management, about the outlook for commodities
Transcript
Anthony Okolie: Natural gas has recently been trading around levels last seen in 2008. And according to our featured guest today, higher prices may be here to stay amid tight supply and increasing concerns about a cold winter ahead. Joining us now for more is Hussein Allidina, head of commodities at TD Asset Management. Hussein, let’s start with the supply dynamics right now. Why is supply so tight?
Hussein Allidina: Yeah, Anthony, thanks for having me. I think looking at the gas market in Europe in particular, Europe depends pretty meaningfully on supply imports from Russia. The situation in Russia, particularly as it relates to Nord Stream 1, which is the pipeline that brings our supply, volumes have been quite low.
Europe started the summer with a relatively tight level of supply on the heels of a cold winter last year. Europe for years has been divesting from producing natural gas domestically, very dependent on imports from Russia. And those volumes have been lower. And all of that is, obviously, being exacerbated now by materially warmer-than-normal weather in Europe, which is stoking demand for natural gas at a time when, frankly, it’s horrible. The timing is horrible.
Anthony Okolie: Yeah, we’ve certainly seen the news about the heat waves in England and the rest of the country. Walk us through just how integral natural gas prices are to the European economy and energy markets.
Hussein Allidina: Yeah, so natural gas is important globally. It’s very important in Europe, primarily because it is a cleaner fuel relative to oil, relative to coal. So Europe has moved away from those dirtier oil, coal, et cetera, towards gas. But the gas is, obviously, coming, or not coming from Russia today.
You’ve seen over the course of the last several months industrial shutdowns announced, whether it’s fertilizer, smelters, aluminum smelters and the likes because the input cost is so high. And ultimately at today’s prices, I think you’re going to continue to see European industry come under pressure because the math simply doesn’t work with this elevated level. It’s very important.
Anthony Okolie: It’s just more costly for a lot of these producers to produce these commodities.
Hussein Allidina: It’s costly for the producers or for industry to operate, for sure. And it’s also quite painful and challenging for the consumer as well, because remember, natural gas is a feedstock for power generation. And part of the reason why you have record-high, never-before-seen prices for power in Germany and France is because of what’s happening to the input natural gas.
Anthony Okolie: Now, you said that the risk of natural gas running out as we head into the winter is certainly a potential. Why do you think that might play out?
Hussein Allidina: Yeah, so the highest period of demand for natural gas is the winter because of increased heating loads, increased power generation demand. And we always worry that we’re not going to have sufficient supply entering the winter. Today, if I look at the US as an example, if we have normal weather, we should be fine.
But the risk is – and if you’re a utility, if you’re PowerStream, who provides power to my house, they have to be able to deliver power when I call for it, so, obviously, are very concerned about cold weather. And when they do their modeling on how much they need to have for the winter, they assume weather is not normal. They assume weather is going to be colder than normal.
Anthony Okolie: Much colder than, yeah.
Hussein Allidina: And depending on how many standard deviations colder than normal we have, there is potential that you run out. So this is why I think you’re seeing prices not only in Europe, but in the US move higher in an effort to ration demand to avoid that sort of outcome.
Anthony Okolie: And what does the situation in Europe mean for us here in Canada in the United States?
Hussein Allidina: Yeah, so today we’re exporting – the US is exporting about 12 Bcf a day. So the US market is, production is about 95 Bcf a day right now. Just to put into context, today we’re sending somewhere between 12 and as much as 15 Bcf a day when Freeport is back up and running to Europe.
If Europe ends up being quite cold or if Europe is not able to get the supply from Russia or elsewhere, they’re going to call. Now, we can’t do much more than 12. But the challenge that we have is if we get colder weather and we’re still exporting 12, 13, 14 Bcf a day to Europe, we run into issues with our balance.
So I think what the market is trying to figure out is where do I need to send price in order to limit demand domestically? If we end up in a position, Anthony, where we need to stop LNG from going to Europe, we’re talking about prices well north of $20 an MMBtu, because Europe is already trading north of those levels right now. If I close, if I want to close that arb, I have to disincentivize the cargoes from going. And it’s not $8 an MMBtu that does it. It’s well north of $20.
Anthony Okolie: So this all suggests that natural gas prices will remain elevated for some time. What has to happen for it to ease?
Hussein Allidina: Yeah, so I think prices will remain elevated because underlying inventories in North America and in Europe are tight. If we end up having a mild start to the winter or if production – we’ve been waiting for US production to respond.
I think a lot of folks thought production in the US today would be at 97 or 96 and a half Bcf a day. We’re only at 95. There’s still an expectation that as the rig count increases and as companies look to expand their production that production will grow.
Anthony Okolie: Will increase, yeah.
Hussein Allidina: So your biggest risk to gas price on the downside here is a milder than normal start to the winter. And the start of the winter is particularly important, because as the winter passes, the risk of running out decreases.
Right, so a mild start to the winter in November, December would be bearish for natural gas, as would an improvement in production and/or if this Freeport LNG facility, which went offline, stays offline for longer than expected. It’s expected to come back October, November. If it stays off longer, then that’s more supply that stays domestically.
So those are the bearish factors that I see in the near term. But the medium term is still one which I think is challenged because we have to invest. The demand for this stuff continues to grow. We’ve talked about this before. Particularly as people are moving away from oil and coal, gas…
Anthony Okolie: All the fossil fuels, exactly. We’re looking…Hussein Allidina: … gas needs to see investment.
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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