Winter is coming

Well, winter is not coming just yet, but round about this time last year, natural gas prices started to explode as speculators bet on a cold winter and insufficient gas supplies to Europe due to the sanctions against Russia. Nothing much has changed since then, and I would expect that this “winter trade” will again be played in coming months. But while nothing much has changed, some things did and these changes matter.

If you had bought Dutch natural gas in early June last year and somehow managed to time the market perfectly and sell at its peak, you could have made a more than 300% return in about two months. That is the kind of return crypto traders may have been used to before the Cryptowinter started but are generally unknown to serious investors.

Dutch natural gas prices

Source: Bloomberg

The reason for this massive rally was the fear that Russia would shut down its gas deliveries to Europe while a cold winter would lead to insufficient gas supplies. Today, Russia still does not supply any gas to Europe and winter is coming, as it tends to every year.

But while these two facts are undeniably the same as last year, the key difference is that unlike last year, Europe, and in particular Germany has better access to liquified natural gas (LNG) that can be imported from Qatar, the US, and other countries. All European gas importers have to do is pay more for LNG than other countries and supplies that have not been contractually committed to specific countries will re-rout and ship to Europe. So, gas prices are still likely to rise in coming months but probably less so than last year.

How much less and what the economic impact of these rising gas prices will be has been estimated by a group of economists from the IMF. They modelled the impact of a complete Russian gas boycott to Europe like we have seen last year under two scenarios.

First a scenario where the affected countries (Germany, Poland, Hungary, etc.) have no access to LNG and have to find alternatives in other commodities or face energy supply shortages. Second a scenario where these countries have access to LNG in the global market through the ports that have been built and opened over the last 12 months.

The chart below shows that even with the access to global LNG markets, gas prices are expected to rise by some 110% compared to prices before the Russian boycott but that is still substantially less than the 360% price increase Europe faced in the absence of access to the LNG market.

Estimated impact of gas supply shock

Source: Albrizio et al. (2023)

And because the gas price spikes less and European countries can replace Russian gas with gas imported from other countries, the costs to the economy would be a lot lower as well. The researchers estimate that in the scenario of no European access to LNG, the cost to the EU economy were some $225bn. With access to the LNG market, these costs are about a third at $69bn. But for other importers of natural gas, the costs increase. Because Europe is now competing for gas supplies in the LNG market, countries like China, Japan or South Korea that rely heavily on these supplies as well have to pay more for gas. The estimated costs for countries outside the EU are some $54bn. What happens is that the EU ‘exports’ some if its pain from the previous dependency on Russian gas to other countries around the globe. You may not like that if you sit in Seoul or Tokyo and see your gas bill increase, but on a global scale that is still preferable because the increased flexibility and the smaller shock to gas prices mean that global costs (EU + non-EU) decline from $225bn to $124bn. And that is not the worst news I can think of.