Interview, Podcast
The Impact of Rising Natural Gas Prices
- Natural gas prices in Europe have reached record highs due to a convergence of record-breaking power demand and global supply disruptions.
- Global power demand is at record levels, driven by an uneven post-COVID recovery where industrial activity and remote work have increased electricity consumption while service sector demand remains low.
- China alone is consuming 13% more power year-to-date compared to the previous year, significantly contributing to global demand pressures.
- Supply constraints are exacerbated by coal production disruptions in Colombia, a multi-year decline in China's coal capacity, and supply issues from Australia and Russia.
- Global natural gas inventories are at record lows ahead of the peak winter demand season.
- Supply cannot rapidly respond to current price signals because energy infrastructure projects, such as LNG terminals, require approximately five years to complete.
- China has announced plans to increase domestic coal output, and some market disruptions are normalizing, including increased gas flows from Norway.
- Russian natural gas exports to Europe have declined below expected volumes, with Russia signaling that exports will remain below normal levels through October.
- Russian export declines are attributed to unresolved regulatory hurdles for the Nord Stream 2 pipeline and a desire for consumers to commit to multi-year contracts.
- If Russian gas flows remain low, the risk of significant price increases and winter shortages in Europe rises substantially.
- Natural gas prices have reached levels that incentivize a substitution of oil for power generation, a measure currently being observed in Asia.
- Substituting oil for power could relieve approximately 2 BCFs per day in gas demand, though this is insufficient to fully resolve the global shortage.
- Burning oil for power is typically a "peaking solution" reserved for extreme conditions; the reliance on it so early in the season highlights the severity of the shortage.
- In a "one standard deviation colder than average" winter scenario, the risk of running out of gas for power generation by February or March becomes a realistic possibility.
- If gas prices rise further, the next demand adjustment will likely come from industrial sectors, rendering European industries uncompetitive globally; the fertilizer sector in the UK has already announced reduced output.
- Severe shortages could lead to power blackouts, similar to events already occurring in China, where fuel constraints are forcing economic slowdowns.
- Gasoline shortages in the UK are distinct from the natural gas crisis, stemming primarily from logistical constraints and a shortage of truck drivers exacerbated by Brexit.
- The global tightness in natural gas is symptomatic of broader commodity trends characterized by strong demand and chronic underinvestment in supply.
- Metals demand, including aluminum and copper, has already exceeded pre-COVID levels, supported by infrastructure spending and climate change policies.
- The energy supply gap was created by a period of capital destruction in the oil sector (2015–2019) and a shift in capital away from fossil fuels toward renewables due to ESG considerations.
- Investors remain reluctant to fund fossil fuel production even as prices rise because the required price threshold to incentivize new capital expenditure has not yet been met.
- Goldman Sachs economists estimate that a natural gas price increase to $25 per MMBTU would raise European headline inflation by 25 basis points next year.
- Wholesale energy price shocks have a slow pass-through to retail prices, meaning the inflationary impact is likely to persist into the first half of 2022.
- Fertilizer shortages caused by gas constraints are expected to impact planting seasons and drive up food prices throughout 2022.
- Goldman Sachs forecasts a potential reduction in GDP growth of roughly 0.2 percentage points for European economies if gas prices remain elevated at $25 per MMBTU.
- The more severe risk to economic growth comes from physical power shortages that force production cuts, as seen in China's reduced growth forecasts for late 2021 and early 2022.
- The current energy crisis highlights the dangers of prematurely abandoning fossil fuel production without sufficient renewable capacity to replace it.
- Internalizing carbon emissions is costly, and the transition to renewables is slow and intermittent, necessitating continued reliance on oil and gas at higher price points.
- Decarbonizing oil and gas will require increased investment in carbon capture and storage technologies to remain viable during the transition.
- Consumer power prices in Europe could rise by 10–20% next year, though government interventions like price caps in France and Spain may mitigate some of this pass-through.
- Oil prices are forecast to rise to $90 by the end of the year, driven by the same structural factors of underinvestment and strong demand seen in the gas market.
- Oil is entering a potential structural bull market that could compound inflationary pressures as a key input for various industries.
- Goldman Sachs recorded this episode on October 1, 2021, and all price references correspond to that date.