Good Value Briefing | Moscow compounds gas woes as winter power crunch looms

25 October, 2021

Europe’s gas prices surged again over the last week after it was confirmed that Russia would not be increasing gas supplies to continental Europe.

Gas supply in Europe remains incredibly tight as the continent heads into winter. Already low inventory levels are being further depleted. 

Now, sitting at over $30/mmbtu, Europe’s gas price is at a record high, having risen over 300% year to date.

What has caused Europe’s gas shortage?

It’s a combination of the strong rebound in economic activity, supply issues and an underinvestment in power infrastructure. Today, grids are growing more and more unstable due to the higher penetration of renewables, and so they are burning more gas.

Even if Russia does decide to supply some additional gas in the foreseeable future, Europe is unlikely to find enough volume from traditional suppliers to fill the deficit quickly – making for an expensive and strained winter period.

The best hopes now lie with a mild northern hemisphere winter.

Flow-on effects in the US

The US gas price has more than doubled over the past year.

Until recently, low gas prices and weak balance sheets have left little incentive to invest in LNG export capacity. So, the US has been a relatively small supplier into the global market.

This is despite the US being home to an abundance of gas resources.

We think US gas production and exports will increase over time due to greater global demand for gas as a transition fuel until grid investment catches up to cope with the increase in renewable generation.

What about consumers?

There is valid argument that this recent gas rally is fuelling the oil rally.

How?

LNG and European gas prices are currently equivalent to over $150 per barrel of oil – versus an oil price of closer to $80 per barrel.

This has led to an uncomfortable shift to burning oil in Asia. This move is unpalatable in Europe. And yet it brings another conundrum in energy markets.

Time will tell if OPEC steps in to increase oil output, but regardless consumers are going to start to feel this.

Using the US as an example of what is going on around the world, half its power is derived from gas. The move in today’s gas and oil prices implies a 40% increase in the cost of filling the tank and a doubling of direct fuel costs for gas power generators and household heating.

All else equal, this equates to a headwind of around $1,600 per household, if passed through to the consumer.

For global equity investors there’s much to consider, and we haven’t even touched on China, where power shortages have seen high energy intensive sectors like steel, aluminium and chemicals experience shutdowns. This is leading to pressure on raw material prices. If shutdowns in China’s industrial sector accelerate, or if power prices continue to rise for industrial users, there will likely be implications for domestic and global economic growth.

So, we have a very real risk of a power crunch across major economies and higher power prices through winter months.

As well as the impact to economic activity, this could have meaningful implications for inflation. Meanwhile, we think there’s many great energy businesses that continue to trade at attractive valuations. Some of these were discussed in a recent podcast episode.

A stock in focus | Coterra Energy

Antipodes global portfolios are overweight Oil and Natural gas in the global portfolios, led by holdings in Exxon Mobil and Coterra Energy.

Coterra, a company formed from the recent merger of Cimarex and Cabot, is the second largest gas focused independent producer in the US, with operations in the prolific Marcellus and Permian basins. The company has a low cash cost, strong balance sheet, and will benefit from the strong prevailing gas prices. It’s also indicated a shareholder friendly dividend model – promising a minimum payout of 50% of free cash flow. Coterra stands in sharp contrast to the rest of the sector which sits with high debt and weak shareholder return programs.


Disclaimer
Antipodes Partners Limited (ABN 29 602 042 035, AFSL 481 580) (‘Antipodes’) is the investment manager of Antipodes Global Investment Company Limited ABN 38 612 843 517 (‘APL’). Any opinions reflect the judgment and assumptions of Antipodes and its representatives on the basis of information at the date of publication and may later change without notice. Disclosure contained in this communication is for general information only and has been prepared without taking account of any person’s objectives, financial situation or needs. Persons considering action on the basis of information in this communication are to contact their financial adviser for individual advice in the light of their particular circumstances.
31 October 2021
Antipodes