Thread by @PZeniewski

Everybody is staring in disbelief at European #gasprices. If the gas market is broken as many have been saying, it would most visibly be seen in the TTF benchmark. Here are my two cents (warning, lots of correlations ahead!)

The main explanation for the much higher level of TTF is the fear premium brought about by Russia’s withholding of supply (pre-invasion), tight LNG markets and very low EU storage. But TTF really is off the charts. Fundamentally, is gas really worth the equivalent of $200/bbl?

The model I use to assess European gas prices says no. It’s a simple model that back-casts EU prices based on an US LNG export margins and a 6-9 month lag on Brent. The rationale is that gas prices in Europe should reflect a bit of oil indexation and the cost of spot LNG.

Everything tracks reasonably well until October 2021, after which there is a decisive break in trend. US LNG export margins would have gone up by 2-3$/MBtu, and the 6-9 month lagged oil price averaged $70/bbl in the second half of 2021.

This would suggest EU gas prices peaking at $16/MBtu, but easing global supply bottlenecks would have brought this down to around $10/MBtu by December.

And yes, Europe is in competition for LNG with Asia, and many are looking to the spread between TTF and the Japan-Korea Marker, a spot LNG benchmark, as a key indicator of LNG market tightness. But this relationship has also been looking wobbly since October 2021:

Demand inelasticity and market design could explain the premium. After you max all other sources (incl. coal), you need gas to generate power. If you don’t use it, the lights go out. Because of marginal cost pricing, even using 1 MW of gas-fired power links gas/electricity prices

Natural gas also keeps buildings warm, and the weather is a stronger predictor of natural gas consumption in buildings than the TTF. Higher gas prices take time to feed through to higher household bills, and the strength of the effect is less than for oil changing pump prices.

Trading activity may also be culpable. @OIES has some interesting insights about the shift from OTC to exchange trading + speculative trading on volatility. But the conclusion is still: from a supply point of view, TTF is at levels difficult to justify based on the fundamentals.