The demand for gas had fallen off a cliff during the recession in 2007-08. In 2009, gas use was cut by 5%, or 27 bcm, down to levels last seen in 2004, making it the steepest contraction since 1970.
The contraction in demand is partly due to economic weakness, but the major reason as was noted by the Bank of America Merrill Lynch (BoAML) is the higher prices that continues burning the consumers’ pockets in the region.
The BoAML report notes that the European gas market faces some serious structural challenges. Even prior to the crisis, European gas demand growth was running at an average of just 1-2%, behind economic growth. Oil-indexed gas prices have rendered gas-intensive manufacturing highly uncompetitive for many years and some consumers have cut back on consumption.
On the power side, gas-fired generation recovered from the recession, but utilisation rates remain extremely low and the power sector is vastly oversupplied.
‘Our colleagues in the European Utilities equity team expect gas usage in power generation to continue to rise in the medium term, as 34 GW of CCGT capacity is scheduled to come on stream from now until 2015, a 21% increase,’ the report said.
The growth in natural gas demand has been sluggish and continues to remain the same. Moreover, competition from renewables is rising and nuclear output is generally more reliable, both of which add some downside risks.
In any event, European gas consumers are likely to remain over-contracted during the next 6-12 months.
For past several months, the demand seems to have improved, but the recovery has been slow and uneven and partly driven by weather.
‘We estimate that, under a normal winter in 1Q10, gas usage would have increased by just 10 bcm rather than the observed 17 bcm. Today, major gas buyers in Germany, Italy and Spain remain overcontracted in volume terms, as demand has not recovered to pre-crisis levels. Gas buyers are squeezed from both sides,’ it added.
The economy matters are holding back gas purchases in Europe, noted the BoAML report adding that high oil-indexed contract prices have clearly been curbing demand.
‘We find a very strong price elasticity of demand relative to oil prices lagged by 6-9 months, especially in Germany. Although the spread between contract and spot prices has declined lately on temporary gas supply issues, it is still very wide and we expect it to stay that way in a rising oil price environment. Overall, this supports our view of a slow recovery in EU gas demand in a high oil price environment,’ the repot noted.
The BoAML expects total OECD European gas demand recovering by 4.9% this year, but then declining by 1.2% next year under a normal winter.
Meanwhile, the demand from the industrial and the power sector is a key factor for fluctuations in gas consumption. As the economic recession set in, industrial gas demand collapsed, as factories shut in or reduced output.
Power demand also fell, indirectly reducing gas demand. ‘We find that the elasticity of European gas demand with respect to economic growth is positive and large, especially in Italy, the UK and France. The European gas market faces structural challenges…’ noted BoAML report.
Interestingly, in Germany, economic activity has no significant impact on gas demand, while the impact of oil prices is very strong.
Though gas demand has shown improvements this year, the economic recovery remains far below the expectations.
Even in Germany, where second quarter economic growth has been the strongest in 26 years, demand is only flat relative to two years ago, despite large power producers shifting heavily to spot gas.
German gas demand in June is down 19% YoY, the first contraction since November 2009. For the six core European countries, we find that demand in Q2 relative to 2008 is down 3%, or 2.6 bcm.
Stocks across Europe are high. As of the latest available data, storage capacity utilization for Europe sits at 93%, relative to about 91% last year.
‘We find that nat gas stocks in the larger markets Baumgarten and Germany are particularly high. Hence, we are heading into winter with high supplies, low prospects for demand and rising spot volumes of LNG.’
In our view, this suggests continued downside risks to Continental European natural gas prices at least for the current year, the BoAML noted.
