Why are natural gas and oil prices spiking? | Calamatta Cuschieri

Energy prices have made an immense turn in Europe and around the world in the past year, following a torrid 2020 conditioned by the pandemic. The current spot price for TTF – a virtual natural gas trading platform in the Netherlands – currently trades around €75 – 80/MWH (Megawatts per Hour). The same quote was around €5/MWH in May 2020 and from there increased continuously to current levels. Since 2003, when TTF was created, prices above €30-35/MWH did not exist for extended periods. The current price of oil around $ 80/barrel also trades above its long-term average of cca. $ 50/barrel – that is if historical prices get adjusted for inflation.

There are a number of reasons that have brought about the current situation. From the demand side, as economies are recovering from the pandemic, travel is picking up and lockdowns are easing, demand has increased for oil and gas.

From a supply standpoint, oil and natural gas production are cyclical industries with having lower prices for typically 5-7 years followed by years of elevated price levels. The year 2015 brought about more depressed prices which resulted in industry participants investing less in new production capacities, creating a supply bottleneck hence pushing energy prices upwards.

Shale oil and gas production, mostly in the US, has also been influencing prices worldwide in the past decade. Shale is a porous rock that holds oil and natural gas. Major technological developments made the extraction of these oil reserves profitable with much lower global oil prices. In 2010, cca. $ 100/barrel was required to make it profitable, while nowadays it can turn a profit from as little as $ 30/barrel. This factor helped keep the oil prices lower in the past years however shale oil companies had piled up huge amounts of debt in the first half of the 2010s and they concentrated on normalizing their balance sheets instead of starting new projects and thereby ramping up production.

When it comes to shale gas, the above-mentioned technological developments have made the US one of the biggest natural gas exporters in the world, in the form of Liquified Natural Gas (LNG), transported on maritime carriers. Europe has been a reliable customer for these LNG exports however around the end of 2020 demand suddenly and unexpectedly spiked up in Asia so US export quickly reacted and turned away from Europe where demand was momentarily lower. Earlier in 2021, European market participants possibly waited for prices to return to lower levels and scaled back gas buying during Q1 and Q2. However, demand in Asia did not taper down as they had expected and Europeans were forced to start buying at higher levels, stretching prices even further.

Furthermore, current social trends are also a factor affecting energy prices globally. There is more and more awareness about the negative impacts of global climate change. The extraction of fossil fuels and scaling up production are looked at increasingly negatively. This process is represented by the ever-growing interest in ESG (Environmental, Social, and Governance) investments that consider such factors when making investment decisions. Major investment managers have created ESG funds and they are rapidly growing in size, creating a reduction in the demand for the stocks of energy companies. As energy company leaders are in part compensated in the company's shares, there is an incentive on C-level to adhere to the changing stock market trends, scale back on investments in production capacity and attempt to serve the investor base with ‘greener’ projects.

All the above factors have contributed to the current energy prices. Some of them have short to medium-term effects however, the case for longer-term impacts is also well positioned. “This is the first innings of a multiyear, potentially decade-long commodity supercycle,” said Jeff Currie, global head of commodities research at Goldman Sachs Group Inc. Energy prices being input prices into practically all manufacturing and transportation activities, inflation could see a significant upward pressure in the following years from this sector. Undoubtedly, the long-term trend of support levels might be conditioned by a variety of unknowns. Nonetheless, the ESG trend seems to be the most plausible long-term trend going forward.

Disclaimer: This article was issued by Tamas Jozsa, Research Analyst at Calamatta Cuschieri. For more information visit, www.cc.com.mt. The information, view, and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.