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Column: Global gas shortage helps lift prices in United States

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LONDON, Oct 19 (Reuters) – U.S. gas prices recently climbed to their highest in real terms for more than a decade, as energy shortages and spiking prices in Europe and Asia work their way back up the supply chain to the United States.

Front-month U.S. futures hit almost $5.90 per million British thermal units (Btu) at the end of September, more than double their level a year earlier, and the highest since April 2011, after adjusting for inflation.

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Prices are still far lower than in Europe and Asia because the United States is an exporter, while the other regions are importers, which ensures local prices will almost always be lower than elsewhere.

Futures prices for delivery in January 2002, the middle of next winter, are trading at just over $5 per million Btu in the United States, compared with $32 in Europe and $35 in Northeast Asia.

Prices for January 2022 have jumped by 75% over the last year in the United States but between 450% and 500% in the net consuming regions.

(Chartbook: gerom.org/3aQlmuq)

Nonetheless, price increases in the United States have correlated with those in the other regions, reflecting the global nature of the shortage and links between regional markets forged by exports of liquefied natural gas (LNG).

GLOBAL SHORTFALL

Similar to other parts of the world, U.S. gas production fell last year as a result of the coronavirus-driven recession and slump in gas prices to record lows.

Production has recovered more slowly than consumption, as gas drillers have remained cautious while the economy has bounced back vigorously from the recession.

The market-rebalancing process was accelerated by a long cold winter, especially a deep freeze over Texas in February.

As a result, gas inventories swung from a large surplus to the pre-pandemic five-year average in the second half of 2020 to a deficit by the end of the second quarter of 2021.

The same rebound in consumption, lagging recovery in production and rapid drawdown in stocks, accelerated by a long cold winter, has created fears about physical shortages in Europe and Asia.

The position is not nearly as bad in the United States, which is cushioned by its large domestic gas production base, but supply is nonetheless tight compared with recent years.

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U.S. futures prices have been climbing exponentially since May and the market has swung into an increasingly wide backwardation since July.

Earlier this month, the six-month calendar spread moved into its biggest backwardation for at least ten years, reflecting the relatively low level of inventories.

SLUGGISH PRODUCTION

Working gas inventories in underground storage are currently at their lowest level since 2018 and before that, 2014.

U.S. LNG exports have risen at a compound rate of almost 40% per year over the last two years, according to data from the U.S. Energy Information Administration (EIA).

Large volumes of U.S. LNG are now sent to markets in Asia (including South Korea, Japan, China and India) and Europe (Spain, United Kingdom, France and Turkey).

Gas shortages in Europe and Asia have therefore translated into higher prices and larger volumes of exports, helping pull up prices in the U.S. domestic market.

Higher prices will eventually result in increased gas drilling and production, but the process has been slow so far as gas producers concentrate on returning money to shareholders.

U.S. production has been slowly recovering from its cyclical low in mid-2020 but it had risen at a compound rate of less than 0.7% per year over the two years to July.

REVERSION TO COAL

While production catches up, prices have climbed to ration consumption, principally by encouraging electricity generators to run their gas-fired units for fewer hours and switch back to coal-fired generation instead.

On an energy-equivalent basis, the cost of gas for power generation climbed to an average of almost $5.30 per million Btu in September compared with just $2.00 for coal.

In practice, modern combined-cycle gas generators are about 30% more efficient than traditional coal-fired steam generators in converting the Btu of energy contained in fuel into megawatts of electricity.

Gas prices can therefore climb about 30% higher than coal before electricity generators have an incentive to reduce the hours of gas-fired units in favour of coal-fired units.

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But with gas now more than twice as expensive as coal, there is a strong financial incentive to minimise gas combustion and use the coal fleet whenever possible.

The EIA forecasts coal-fired generation will climb 22% this year compared with 2020, the first annual increase since 2014.

In recent weeks, there have been tentative signs that high gas prices and fuel switching have begun to help rebuild domestic gas inventories.

Working gas stocks increased slightly faster than the five-year seasonal average in each of the five weeks to Oct. 8, according to weekly estimates from the EIA.

Gas inventories are still around 5% below the pre-pandemic five-year average, but the deficit has narrowed from more than 7% in early September.

The slight improvement in the inventory position likely accounts for the recent retreat in both front-month futures prices and the calendar spreads from their recent highs.

But stocks remain relatively low, with the whole winter heating season ahead, and a continued strong draw on exports from Europe and Asia, which is likely to ensure prices remain elevated for some time.

John Kemp is a Reuters market analyst. The views expressed are his own.

Related columns:

– Worldwide energy shortage shows up in surging coal, gas and oil prices (Reuters, Sept. 24)

– Global gas prices soar as industry struggles to meet resurgent demand (Reuters, Sept. 8)

– U.S. gas prices at multi-year highs will protect stocks (Reuters, July 22)

– Rising U.S. gas prices will encourage more coal burning (Reuters, May 14)

Our Standards: The Thomson Reuters Trust Principles.

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