Running Low on Gas

Jackie Doherty and Ed Yardeni

Corporate margins, while still at record highs, are facing a trifecta of pressures. US wages are on the rise as employers are having difficulties filling open jobs. Transportation costs are soaring, as more than 70 container ships bob outside of the Port of Los Angeles. And then there’s the latest problem: the soaring price of natural gas.

The price of natural gas futures has risen 89% ytd, from $2.54 as the year began to $4.81 as of Tuesday’s close, off a bit from this year’s high of $5.46 last Wednesday (Fig. 1 ). The price hasn’t been this high since a brief spike in 2013. The surge in the price of natural gas is particularly notable because it comes in advance of the winter heating season, when a price pop normally occurs. The natural gas price jump has caused the price of electric power and carbon credits in Europe to jump as well.

The potential problem is rooted in Europe, where we may be witnessing the unexpected consequences of the European Union’s push to cut greenhouse emissions. Less natural gas is being produced in Europe, and a greater dependency on wind power and imports is proving unreliable. The skyrocketing price of natural gas is affecting business operations in Europe and raising questions about the wisdom of the US exporting our natural gas supplies. Here’s a quick look at the situation:

(1) No wind in the sails. The UK has noble intentions of cutting its carbon footprint by turning to electricity generated by windmills and by closing all coal plants by late 2024. Wind power represented about a quarter of the power used by Great Britain last year. But the wind in the North Sea unexpectedly dropped dramatically in September, reducing related electricity production, a September 13 WSJ article reported. The shortfall of wind-generated electricity has forced a return to gas- and coal-fired electricity plants.

(2) Low gas inventories. The need for natural gas-generated electricity comes at an inauspicious time. Natural gas inventories are extremely low in Europe, which is unusual for this time of year because the heating season hasn’t begun. There has been lower production of natural gas in Europe due in part to EU taxes on carbon emissions meant to discourage the use of fossil fuels. Denmark committed to stop pumping oil and gas by 2050. And a Dutch gas company decided to close a huge gas field near Groningen due to public pressure after earthquakes hit nearby, a September 22 WSJ article reported.

Capital expenditures for upstream oil and gas projects worldwide fell more than 25% in 2020 to about $305 billion, down from $420 billion a year earlier, according to data from Statista. This year, capex is expected to increase by only 2% to $310 billion. That likely won’t be large enough to keep up with increasing demand for energy as the global economy rebounds from Covid.

As natural gas production has slowed, Europe has grown increasingly reliant on imports from the US and Russia. Russia supplies about 40% of Europe’s natural gas. While Kremlin-controlled Gazprom has fulfilled its long-term contracts, it has restricted additional sales and allowed its storage facilities in Europe to fall to low levels, a September 22 FT article ?noted.

A September 19 Bloomberg article attributed Russia’s lack of additional sales to Europe to an energy crunch that Russia is facing. However, the International Energy Agency has called on Russia to increase natural gas supplies to Europe, while the European parliament has launched an investigation into Gazprom’s actions, the FT article stated. The unanswered question is whether Russia is cutting off supplies in retaliation for the US opposition to the Nord Stream 2 pipeline, which would carry gas from Russia to Europe and, from the US perspective, make Europe even more dependent on Russia’s natural gas supplies.

Adding to the difficult situation, European buyers are competing against Brazilian and Asian buyers for liquid natural gas (LNG) supplies. “[C]ountries from Japan to India are panic-buying before the winter, heightening competition for the small fraction of the supply that trades freely in the spot market and isn’t tied to long-term contracts,” a September 20 Bloomberg article reported. Demand for LNG is also coming from Brazil, which has turned to the energy source because it is suffering from a drought that has reduced the hydropower that’s normally generated by dams.

(3) Ripple effects. European governments have started to plan how to provide emergency aid to households and utilities hurt by the high costs of natural gas and electricity. UK energy retailers are distressed because of the spike in gas and electric prices. PFP Energy and MoneyPlus Energy went out of business when electricity prices spiked earlier this month. Green Energy and Avro—a small energy retailer and a medium-sized energy retailer covering 1.5 million UK households—declared bankruptcy this week. More bankruptcies are expected.

Natural gas is used to make ammonia, which is used in the production of ammonium nitrate, a fertilizer. Two fertilizer factories in the UK owned by CF Industries Holdings shut down because of high gas prices, as did a Norwegian fertilizer manufacturer Yara International. The British government struck a deal with CF Industries to restart and run one of its plants.

If farmers don’t have access to fertilizer, food production could fall and prices could spike. Or farmers could pass on the higher cost of fertilizer and charge more for their crops. In addition, carbon dioxide is a byproduct of fertilizer production and is used by numerous industrial processes including the slaughter of animals and manufacture of vacuum packs, dry ice, and beer, a September 20 WSJ article reported.

(4) Impact at home. US and Russian gas exporters are making hay. US LNG exports have grown to record highs in the first half of 2021, and natural gas sales to Mexico through a pipeline increased 25% y/y in June, noted a September 20 article in Oilprice.com. In total, US natural gas exports rose to 5.4 trillion cubic feet in June, up from 3.4 trillion a year ago and 1.8 trillion five years ago. The shares of Cheniere Energy, a US LNG exporter, have climbed almost 50% ytd.

As a result, 16% of US natural gas production is now being exported, and US inventories are about 8% below their five-year average. A trade group representing chemical, food, and materials manufacturers, the Industrial Energy Consumers of America, has urged the Department of Energy (DOE) to order LNG producers to reduce exports due to the risk of price increases and shortages of natural gas in the US this winter, a September 17 Reuters article reported.

ICEA also has asked the DOE to freeze permitting for new LNG export plants and to order producers to reduce shipments until US inventories increase, the Reuters article stated. “Buyers of LNG who compete for natural gas with U.S. consumers are state-owned enterprises and foreign government-controlled utilities with automatic cost pass through,” said Paul Cicio, president of IECA. “U.S. manufacturers cannot compete with them on prices.”

The world needs a warm winter.

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