FEATURE: All eyes on Europe's tight gas market going into Q3

With prompt European gas prices having surged through the Eur30/MWh mark in June, the market is showing little sign of easing from the current period of extreme tightness into Q3 2021.

Three main factors have combined to trigger the fragile European gas supply-demand balance -- very low storage stocks, a reluctance on the part of Russia's Gazprom to increase supply via Ukraine, and competition with Asia for LNG cargoes.

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"Russian gas flows are a key uncertainty in Q3 as Gazprom's near-empty storage stocks within Europe leave them exposed to demand fluctuations and/or transport constraints," according to James Huckstepp from S&P Global Platts Analytics.

"Other key supply side uncertainties include continued LNG demand growth in China, risking less LNG available for Europe," Huckstepp said.

Platts Analytics expects gas demand in northwest Europe to soften in Q3, however, forecasting consumption at 428 million cu m/d, down by 27 million cu m/d consumed in the same period last year.

The sky-high gas price may have put a cap on more coal-to-gas switching in Europe, with gas demand in the power sector expected to fall compared with the same period last year.

But high prices are also disincentivizing injecting into European gas storages, especially given the non-existent spread between current prompt prices and Winter 21 prices.

According to data from Gas Infrastructure Europe, stocks were just 47% full as of June 27 -- compared with 80% this time last year.

Gazprom seems to be holding off upping its supply to Europe despite low storage levels, with stocks at its own sites such as Rehden in Germany and Haidach in Austria at very low levels.

It has so far opted not to increase volumes being sent via Ukraine, which could be in part due to its desire to show the need for the Nord Stream 2 pipeline to Germany, whose first string could begin commercial flows in October, according to Platts Analytics.

In Q3, the tight supply situation will also not be helped by the annual maintenance on the Nord Stream pipeline from July 13-23 and on the Yamal-Europe line on July 6-10.

LNG imports are, though, likely to be higher year on year, but that was from a very low base in Q3 2020 when the LNG spot price bottomed out, triggering the cancelation of cargoes across the globe, mostly in the US, but also in spot-exposed Egypt and elsewhere.

Platts Analytics forecasts northwest European LNG deliveries in Q3 at 129 million cu m/d, up on the 77 million cu m/d in the same quarter of 2020.

With the Platts benchmark JKM spot Asian LNG price back above $12/MMBtu on strong Chinese demand and a recovery in Indian demand, cargoes are still being pulled to Asia and away from Europe.

Power prices at 13-year highs

Rising gas, carbon and coal prices have also helped drive power prices to multi-year highs, even if recovering power demand looks set to be more than offset by improved French nuclear availability during the coming quarter.

"Our base case scenario assumes that year-on-year gains in nuclear and renewables output far outweigh the rebound for demand," Platts Analytics' head of European power analysis Glenn Rickson said.

Average Q3 demand across Europe's main markets was forecast just 1% higher year-on-year, with July potentially seeing the biggest on-year demand gain in a 10-market survey, according to Platts Analytics.

French nuclear output, meanwhile, was forecast some 7 GW higher, while combined solar and wind capacity has grown 7 GW year on year.

Upside risk remains in the form of an extended heatwave or low river levels impacting reactor cooling, which would add premiums of up to Eur5/MWh.

According to French grid operator RTE, a heatwave combined with a drought could reduce available capacity by up to 12 GW.

Plentiful nuclear has prompted Platts Analytics to forecast a 24 GW on-year decline for average gas generation this next quarter, while hard-coal generation could rebound 7 GW on average.

"Gas-fired generation comes under pressure compared to last summer's unprecedented fuel switch price signals in favor of gas. This lifts coal burn in Germany, the Netherlands and Italy and significantly limits cross-border switching," Platts Analytics analyst Sabrina Kernbichler said.

Average hydro generation across Continental Europe meanwhile was seen some 2 GW lower year on year, with Alpine reservoirs near the lower range.

Finally, while high Q3 power prices above Eur80/MWh have improved the outlook for low carbon generation, gas- and coal-fired margins remain constrained across most markets with German clean spark spreads the lowest since 2018.

Stable-to-bullish outlook for carbon

EU carbon allowances prices face moderate upside in the third quarter, with legislative proposals by the European Commission in mid-July expected to be supportive.

Following a dramatic Eur20/mt price surge in the first half of 2021, however, carbon prices may well make more modest gains in the period, according to Platts Analytics.

EU Allowance prices are expected to average at Eur54/mt in July, Eur56/mt in August and Eur57/mt in September, Platts Analytics said June 16.

That compared with a range of Eur49.26/mt to Eur56.20/mt in the period June 1-29.

"The physical EUA supply-demand outlook will weaken in the next few months, particularly with 2021 free allocations expected to arrive soon and the recovery in French nuclear generation," Platts Analytics said.

At the same time, continued gains in investor interest would support demand, while any larger dip in price would be treated as a buying opportunity.

Implied carbon prices are also supporting EUAs through the upcoming winter, and there is policy support from the EU's upcoming 2030 climate package to include proposed ETS reforms.

Carbon prices could move higher than expected if EU policymakers propose new parameters for the Market Stability Reserve, for instance. The MSR's current annual withdrawal rate is 24% and is set to revert to 12% per year after 2023.

A prolonged summer heatwave could also increase demand for EUAs by boosting air-conditioning demand while reducing thermal efficiency of power stations.

On the downside, if gas prices end up being weaker than expected, carbon's gains through the period could be limited, while changes in renewable energy and nuclear availability could also affect demand for fossil generation across Europe.