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The Impact of Rising Natural Gas Prices

2021-10-05

As natural gas prices hit record highs in Europe and Asia, what does that mean for the broader commodity complex? Goldman Sachs Research’s Damien Courvalin explains the impact of rising prices on energy costs, inflation and economic growth. 

This is an unofficial transcript meant for reference. Accuracy is not guaranteed.
Exchanges at Goldman Sachs, and I now the Nathan, a senior strategist in Goldman Sachs Research, natural gas crisis, are hitting record highs across Europe with supply shocks, gathering steam globally for This week's episode, I'm speaking with my colleague, Damien Equivalent, who leave energy research and are commodities team to discuss the outlook for natural gas and other commodities and the potential impact on inflation and economic growth. Damien welcome the programme. Jonathan for hurry. So again, we are seeing these soaring prices for natural gas. There now record high levels in Europe give us some kind how did we get here? We got here both because of demand and supply when you think about the covert recovery, it uneven, and when you think about oil demand, we ve seen fear under performance with people not flying, but
I see the opposite in terms of power demand the record power demand levels, China alone, Fraser Boys, Creed, swimming thirteen percent, more power here today than last year, and as because, when you think about this, economic recovery, less services, more industry, more people working from home, that's on more demand for electricity. Of course, supply has contributed as well. We seen disruptions in coal production in countries like yeah a declining called capacity in China, yours in making and also destruction, on the gas side coming from countries like Australia or Russia. So a treaty, the confluence of demand, forces and supply of forces which have left to global gas landscape facing record low inventories ahead of it. Peak season on the man in the winter. Let's dig into this. I demand driver should drop more. Why
we now seeing a greater supply response, given how high prices are right now, there's an important question: and the key here really that when you think about coal or gas supply These are very long cycle investments. It takes five years to build analogy terminal, and so, despite this price signals What we are actually trying to solve for is substitution on the demand side, rather than a supply response. Now there will be some new China today, for example, just announced that it wanted to see a higher cooperating from domestic minors, some disruptions that we ve seen in all our normalizing, knowing setting a bit more gas thee issue, however, remains the mismatch that we have today between inventories ahead of peak demand heading into the winter, and what about Russia? Is there any ability to increase supplies, which is a major natural gas supplies to Europe? Did they have potential to ramp up capacity? Here? You are right to point out.
shut. Your russia provided through the summer expected volumes of gas into Europe, but those volumes have declined me Turkey and Russia has also signal that, through October, exports to Europe will be below nor level meter. Initially, they were actual disruptions. It is Here now, what is driving this under performance? Russia has been vocal about wanting to see nor trim too new pipeline, approved by regulators, wanting consumers to commit to multi year contracts, and so this may be contributing to those lower flows important because, as the largest supplier to Europe continued, lower russian flows, actually create another significant significantly higher in prices, as it would make the outlook for shortages much more realistic by the end of winter. Now again, your Russia does have that capacity to produce more. It has been missing
mental pipeline. So there could be a resolution eventually much higher russian flows. A pie does take, however, a few deals to come through and leaves the gas outlook into Europe. Highly volatile uncertain in the neck several months and then you mentioned the potential to see substitution way from natural gas and into oil in response to supply constraints and that could believe some pressure. So to what extent is that capacity there? How much do you think that could improve the situation? So energy markets is first important, emphasise raw substitute by new concrete power from gas power from coal power oil. You're doing he call is the cheapest solution than you move to gas. Surely we use oil, but this is not very expensive solution, but when you think about the shortage that we have today, both coal and gas, we actually do need to burn some oil and, if you think about where gas prices today they reach a level where that should happen.
so we see that they are. We see evidence of it, in particular, in Asia, and that can help. Nor can help relieve about to be chefs per day, which would be Finally, less than a standard deviation, cold winter in Europe and Asia, but it's not a smooth process. Right burning oil for power is typically what we call a peeking solution. It's a few days Typically at the end of winter, we ve never seen outcome were already in September and October were having to turn to that solution. So emphasizes is yes were reaching for the last possible substitution, but its potential to solve. The issue is just not that large meaning. The real risk going forward would be blackouts and outright shortages, and everything well, there's gonna have a lot to do with that. So give us a sense of the scenarios here. If you have a colder than expected when situation, then what that mean for this outlook and for the potential for power, outages you're. So, first of all, that's your just me.
We reiterate we're not in winter. Yet right said the fact that prices are so high today should reflect the potential whether risks through the upcoming winter, if winders average we get by right. We have enough gas in inventory. Today you are absent. Russia really reducing frozen sustained basis, but because whether its volatility on the market has to date today that risk, if we do have that one standard deviation quarter winter and were calling, as I mentioned upon, the oil market, but whereby, at that point really testing the lack of gas that just means running out of gas for power by the end of winter, your February and March, should that's a real risk that we cannot rule out yet weather forecasts, only God two weeks and your for winter weather risk is still ahead of us, so how much Would there be for natural gas prices and that scenario, and how much outside would there be for oil prices? So we have no precedents for this situation. We are record high gas
Prices I mentioned here the rational last substitution is to oil and weave clear that threshold. And so the last lay higher, is the one that actually destroys demur right. That's classically the casing: commodities. When you don't have the supply, you can't have the demand that can t two shapes. The first one is on industrial activity. I gasped This is in Europe would be sufficient. hi that european industries are left and competitive on a global landscape. You briefly saw that with the fertilizer sector in the UK, announcing reduced rates recently other sector that couldn't be impact, it would be steel phrase ample paper, high gas. swimming sectors that outweigh the first raised, that you see in terms of the next demand adjustment and affords us When is what we are seeing in China this week, which our blackouts right turning off power, because there is no fuel
So the case today, right we're heading into winter, were at the seasonal Pekin inventories they're just re low, but as we go through winter does to want to keep an eye out for and then were also hearing headlines about gasoline shortages, so distinct from natural gas. Gasoline shortages in the UK is that related to what we're seeing going our natural gas or is that something entirely different though entirely different right, you're oil, husband deficit, but we are not at historically low inventory levels we could be, but not yet what this briefly. Eggs in said is a phenomenon we see elsewhere, which is logistical constrains, especially around truck driver So the UK issue is moving sure from the dish in terminals to the retail palms and that reflection of a global tightness in trouble, rivers and probably in the case of the UK, was exacerbated by breaks it with sure available truck drivers, but again
it is not related to gas and that structural aid is what all to reduce, treating the global logistical stress that our economies are going through. So it's kind of bad luck, power. having this shortage and gasoline. At the same time, there were having the shortage in natural gas. Absolutely it's not related. maybe there's a confusion on gas prices being that gas were gasolene, but in the end that oil gasoline shortage should normalize incoming weeks. Given the UK government responses, Listen some good news, but we'll leave. to the natural gas taken? As that we are saying we are seeing other tightness across the commodity, complex, an aluminum and copper, so work environment. That is related to the natural gas, tightness and ill. did we see that heading saw thing? What is noteworthy here is the gas shortage is fertile symptomatic of broader trends in commodities.
a strong demand and supply under investment, and then second lack of gas can indeed have impacts on other commodity markets. Sorry, the structural component Corbett was ahead on economic activity, enhance commodity consumption. The recovery outside of oil has actually been spectre right. Metals demand is already above pre covert level, so is electricity demand you ve had strong concern. more spending on the back of government support, We are also seeing a focus on infrastructure spending so that, damn inside has strong and, in our view, is here to stay right. Policies on fighting climate change all require a lot of infrastructure and policies on Reducing income inequality also tend to support higher consumption
on the supply side predates covered. I did you looked at the oil market, for example, what you saw between two thousand fifteen and two thousand nineteen was just perpetual capital destruction by producers, focus on growing production at all costs. Instead, of generating corporate returns, and so that has left investors reluctant to invest in natural resources the view that as a much higher cost of capital to action spend money on production and the shift to hear she has exacerbated that right. Think about oil, it is a source of carbon pollution, and so capital has naturally migrated to renewables, for example, though, leaves us today, which is just a lack of investment in recent years and We need that investment, the realisation that it takes a much higher commodity price to actually is send two eyes spending and case in point
Oil prices are treating at their highest levels since twenty eighteen, but the stock price of oil, producers is still lingering at low levels so don't have that signal to actually do more. now on the more short term item of natural gas availability that you mentioned, rights, an input to tee industries as a source of power in China. So we will see localize constraints. Fertilizer phrase ample too, that keep in mind for mixtures, food prices, aluminium and steel as well- and that's gonna happen now, but you Those markets were just the same facing those structural dynamics already, and I should look across the commodity com. We ve actually been in deficit for pretty much every single commodity since the middle of last year. we're already seeing very high inflation in the major economies so
Well, this commodity outlook a fact that narrative bad. This is all temporary. I mean do you think this could be a prolonged boost to inflation? going forward, There are many moving parts. Radio, the shock from natural gas prices feeding through power prices, will have an impact on headline inflation. or economists estimated that the move to twenty five dollars per annum be to you would increase european inflation by twenty five basis. Points next year now preserve another thirty burst, since then, so you can see how those upside risks are building import. Although you see it today in gas, keep in mind It has a slow pass through from wholesale to retail prices. Should I got friends still be a cap on power prices. Tell April Germany, as is still pass through Germany, only a couple countries like Spain and ITALY will you'll see it now so already know that
shark is here for at least the first half of twenty twenty two I mention food prices. Like the fertilizer will impact planting next spring, so that impacts. prices for all of twenty twenty two and because Of course, this is seasonal. The effect and our forecasts point two. Shooting energy prices next year, but because it also structural and persistent those rich? of another short his next winter are quite real and in fact, in a weaker if winter is called end up next summer, I saw historically high energy prices, so, I think that's the key here is your. The shock is significant and scale does have allowed pass through so transitory, yes, but still we're talking six month to twelve months. impact and in second, because we really not resolving any of those structural issues. The risk of that returning is actually quite high, going forward, What about the implications for economic growth?
No, the economic impact will be first of all from the reduction in consumer income due to hire electricity bills, are economies for the move, as I mentioned to twenty five. dollar gas prices. Estonia, about to ten percent of GDP growth for one year not lay mentioned, gas prices have rallied further and ultimate The real risk is the one we are now seeing in China, where, because of energy shortages, are economies had to reduce their yonder grow afraid a forecast by eight percent, the end of twenty one in the beginning of twenty twenty two, that's the real risk to it. I'm a girl, not so much price themselves, but really the point. You are just unable to generate electricity and you are forcing much lower economic not there. Yet again, I emphasise in Europe, but it surveys that cannot be dismissed going for so big.
sure to some extent, the broader pushed to de carbon eyes were hearing so much focus on the shift towards renewable energy sources. That's all As I have heard you say you know the production of fossil fuels no such as coal, How will this current energy crunch really effect that energy transition? There are two components: the first one and call is the example shows that abandoning too quickly the production of what we consume today, whether it be coal gas oil, is quite dangerous. As we still consume those commodities right. So the energy transition has to be much more about sir being the demand side then impacting already today the supply side. cause an example. Everybody knew called the man would decline that led to a precipitous decline in at stream mining cutbacks and today call prices are treating at record highs now. The second key point here is that
internalizing or carbon emission, is costly right. We have operated for centuries without that in mind and today, as we have to reflect the carbon content and an emissions of what we do. It is proving to be quite expensive and renewables help, but it takes time to scare them their intermittent and that further illustrates that we will need in this energy transition, still a lot of oil and out of gas and that those will have to come at a higher price, given their inherent. Missions, so we are seeing a greater focus of society into fixing those issues, but I think this energy winter crisis is showing is the cost of making that transition and their implications of that for investors are there going to be winners versus lizards. You mentioned the low returns that traditional oil producers are facing. An important question. So from an oil market and gas producer perspective, it means probably,
coming back in to the forefront of investors, have to consider in their portfolio as the output of those industries is still essential to global economic growth. It means likely. Further investment needed on the energy side had that's a long cycle of investment and clearly now we need more capacity. It also means, as the incumbent source of power de Carbonizing Oil and gas will be important, not I could come from carbon capture and ultimately, needs a solution and then, finally, as illustrated in Europe recently, Relying on renewables does create challenges such as when there's no wind, no sun or not enough hydro and rain, and so storage is all the key to enabling the energy transition to much higher usage of renewables, So if you look at ahead, it seems like you are expecting higher.
Gee prices and that ultimately will translate into higher gas needs? but he does this winter said. The question is how high so give us a sense. Your forecasts and how you think that will translate to consumers. The risk here really is the inherent high volatility that we expect going for right and then every country has on the power side, various pass through mechanism, but you were talking ten twenty percent attention impact next year for consumer power. Prices to the extent that is passed on to consumers is less clear given the potential intervention by governments instead power prices, as I said, We were seeing right now. It has started right, so you he didn't Spain, you seen it in France and that further exacerbates the concerns of policymakers on this additional innovation shock. There is one market that we didn't discuss as much as the oil market right. It's not expose yet significantly to this,
energy crisis. There is some, but not too much substitution. but we actually believe that oil prices are said to significantly appreciate going forward are forecast for the end of this year. Ninety dollars and as a key and pay, too many other industries here that we should contribute also further to the rise in headline inflation and again as the gas market it illustrated the DRC Ivory of that higher oil price, for a task which is under investment and strong man. We're only get a compound going forward, citing that's the one market to keeping I'm sure, maybe a mild winter this year Maybe everything will be resolved quickly. Oil Whoever is setting up to very much start a structural bull market, one that I think better, policymakers need to be aware of what, let's hope from Ireland this year, Damien Jason. He thinks for joining us thanks for having me Alison. That concludes this episode of exciting
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Transcript generated on 2021-10-16.