Natural Gas Prices Look To Be Peaking For The Near Term

Mainstream media is starting to pick up the situation surrounding Europe's ballooning electricity prices. While they make for great headlines because it induces panic, it is not good for investors to get caught up in the hype or the frenzy. Instead, we have to take a step back and ask ourselves a few important questions:

• What do European gas fundamentals actually look like?

• What do US gas fundamentals look like?

• Is the recent surge in European gas prices sustainable?

• How will a drop in Europe impact the US gas market?

The reality is that Europe's gas storage situation is far from dire. We have already written about this in the past, but here's an updated chart:

Source: Giovanni Staunovo

As you can see from the chart above, despite the lower exports from Russia, European gas storage has managed to match the 5-year average for this time of the year. For some readers, you may question the logic here. How is it possible that Europe's gas storage is filling faster than the 5-year average despite lower supplies? It's because of demand destruction. We are already seeing EU businesses being massively impacted by the surging prices, and so the demand destruction has resulted in the injection rate being higher than average.

So why are European gas prices and electricity prices surging? As we wrote before, the obvious answer is that the market is doing what it needs to balance the market. In this case, since supply is inelastic, demand is the only way we can balance the equation. In addition, traders view Europe as a one-way bet since supply is fixed/moving lower and the possibility of a colder than normal winter on the horizon could still result in a material deficit. This means that traders could push the boundaries to the extreme without any near-term ramifications. The problem, however, and as illustrated in the chart above, is that the rise in price has in effect accomplished the near-term goal. With the winter heating demand season still 3 months away, the market will have ample time to bet on the possibility of a colder than normal winter later on.

In the meantime, we think the recent frenzy is coming to an end. The reality is that Europe is ok from now to November, which at some point during this 3 month period will see European gas prices pull back severely. This means US gas prices will also be materially impacted since the recent uplift came as a result of European gas prices going parabolic.

In addition, today's sudden reversal in TTF is another cause for alarm, and such large declines usually signal trend exhaustion. 

Now moving over to the US gas fundamentals, things have really loosened.