We characterized the behaviour of the oil market as defiant in yesterday’s note as it performed rather convincingly last week despite adversity in the financial markets. Yesterday, however, it could not defy gravity any longer. Some put the exodus partially down to the gradual resumption of oil production in the Gulf of Mexico after Hurricane Ida, but those views are probably misplaced. If analysts surveyed by Reuters are to be believed US inventories in the main categories fell further last week. The impact of the tempest will be felt for weeks and months to come. Shell, for example, does not see its oil production fully recover this year. Brace yourself for further downward revisions in non-OPEC supply.

China, the US and the resultant dollar strength were responsible for the massive sell-off in oil. Safe havens were in fashion yesterday: the dollar index rallied (albeit it came off the peak), gold also edged higher and Treasury bond yields fell as inventors decided to look for shelter. The S&P 500 index finished the day 1.70% lower and Nasdaq lost 2.17% of its value.

As said above the main driving force behind the dump was the dollar. Its strength was directly related to concerns about economic growth. The liquidity crisis of Chinese property developer, Evergrande and its potential default on its debts has raised fears of contagion, which put inventors on the defensive. The outcome of Wednesday’s policy meeting of the Federal Reserve also made them cautious. The US debt ceiling is another sword of Damocles that hangs over the equity markets. Yesterday was one of those days when oil had nothing to do with the performance of oil. The power of the financialization of our market was on full display.

Inauspicious signs as winter approaches

The natural gas market has been on a roller coaster ride lately. Fears of falling supplies and rising demand ahead of the winter coupled with already low inventory levels have sent natural gas prices to highs not seen for a long time. Concerns are growing that an unusually cold winter or even cold spells that only last a week or two will lead to a supply crunch in the natural gas market, which will have an adverse impact on electricity supply putting financial burden on energy suppliers and households. The consequences could be and already are far-reaching. Producers of fertilisers, the product which is derived from natural gas have been forced to cut output. CF Industries closed two fertiliser factories in the UK and Norway’s Yara International also operates at reduced capacity at its UK and EU factories. The UK government held an emergency meeting over the weekend with meat suppliers about how to mitigate the impact of rising gas prices. Smaller energy suppliers have already thrown in the towel and those who managed to stay solvent are also asking the government for emergency support.

There are voices that put the blame on Russia, the biggest natural gas supplier to Europe. Some countries have called for an investigation into the actions of the country’s gas exporter Gazprom. They suspect that the company’s reluctance to supply discretionary volume of gas in order to gain leverage over the opening of the Nord Stream 2 pipeline has led to the spike in prices. Whilst this could have played part in the unforeseen rally tight natural gas markets appear to be a worldwide phenomenon.

The US is the least effected part of the world, yet CME natural gas prices rallied to a multi-year high before retreating from $5.65/mmBtu. Volatility in the front-month futures contract has peaked above 50%. Last week’s natural gas stock data put inventories just above 3 bcf. It is 16% lower than during the comparable period of 2020 and 7% below the 5-year average. A trade group called the Industrial Energy Consumers of America estimates that prices would need to double to $10/mmBtu to incentivise producers to increase production and build up inventories. It also called on the DoE to order the reduction of US LNG exports ahead of the winter months to help replenish depleted stocks, Reuters reported on Sunday.

In Europe and in the UK the situation is more dire. On ICE the day-ahead natural gas price peaked just below £2/therm last week before easing back to £1.5/therm. Prices, however, resumed their upward trajectory yesterday and broke above the £1.8/therm level again. This contract has tripled in price this year. The situation is so serious that in addition to the crisis talk in the UK, Europe’s second largest gas supplier, Equinor has won permission to up its pipeline gas exports to Europe from its Oseberg and Troll fields. It is intriguing to note that in the nine years preceding 2021 the average front-month ICE Brent-natgas price ratio was 1.59. At the current next-day natgas price of $1.80/therm it equates to an implied Brent price of around $110/bbl. In the Far East the Japan-Korea Marker has increased more than fourfold since the beginning of March. On top of lower stocks and healthy demand, unplanned outages at LNG export facilities in Australia and Malaysia, amongst other countries, are contributing to the shortage. The two continents are competing for scarcely available LNG cargoes.

One can only wonder if or when the tightness currently seen in the gas market permeates through to oil. Whether industrial consumers would find switching from natural gas to refined products economic depends on the price differential. Our light-end desk sees the price of naphtha reaching parity with gasoline prices, a very rare occurrence. Goldman Sachs reckons that rising gas prices due to a prolonged winter could add an extra $5/bbl upside risk to the price of crude oil and potentially create an additional 900,000 bpd of oil demand. In the light of recent developments in the natural gas market and given the relentless price rally in Europe and Asia yesterday’s price action in oil was somewhat of a head-scratcher. Or was it just the lull before the storm?