Weak fundamentals curb oil/gas correlation at Dutch TTF hub

The correlation between key forward gas contracts at the Dutch TTF and front-month Brent crude prices has sunk to a 2016 low in August according to ICIS analysis, as weak gas fundamentals have gripped European hubs.

Based on ICIS closing price assessments of the third quarter ahead at the TTF and ICE front-month Brent crude futures, the ten-session rolling correlation coefficient between the two commodities sank to a low of -0.7 on 12 August – indicating no discernible correlation. This was fractionally below the previous 2016 low recorded early in January and in stark contrast to the +0.74 correlation coefficient that was observed between April and the end of July.

European gas prices often take their lead from the direction of oil as hub contracts are traded by some companies to hedge and optimise the offtake of gas delivered under oil-indexed supply contracts, which include a lag of around six-to-nine months on average within their formulae.

Despite the rapidly declining incidence of oil-indexation within European supply contracts, the historical prevalence of oil-indexation in Europe means that oil remains a significant sentimental driver in the minds of many traders, particularly when gas fundamentals appear to be balanced.

However, since the start of August front-month Brent crude futures have arrested the gentle downward trend that was in evidence through June and July, rising again towards the $50/bbl mark, while European gas contracts have not followed suit.

The third quarter ahead at the TTF – for delivery around the time that current oil prices are likely to feed into some companies’ oil-indexed supply agreements – has shed more than 3% of its value since the start of August, according to ICIS closing price assessments. Oil by contrast, has gained nearly 15% in value across the same period.

Fundamentals

An increasingly weak fundamental outlook for the European gas market has helped the TTF curve resist rising oil prices early in August, with global LNG export capacity gradually increasing, sustained pipeline supply to Europe and a bearish short-term gas storage scenario.

The second train at US LNG terminal Sabine Pass is scheduled for completion by late September, although trading sources have indicated that the first commissioning cargo could load as early as August. Only two US LNG cargoes have so far made their way from Sabine Pass to Europe, but the new train will boost LNG supply to the Atlantic basin which may indirectly maintain downward pressure on European hub prices, even if few cargoes reach the continent.

On the storage front, total European gas stocks were 13 percentage points ahead of the previous year according to data collated by ICIS on 16 August, at nearly 58 billion cubic metres. Lower demand to inject gas into storage also typically weighs on gas prices.

In Britain, an outage at the long-range Rough facility has fully restricted injections for the rest of the summer while uncertainty about the site’s capability for withdrawals in the winter means there is some risk that the site may be unusually full ahead of the next injection cycle.

On 4 August, Centrica Storage gave an indication as to how far withdrawal capacity at Rough could be restricted through the winter (see ESGM 8 August 2016). A minimum of 6 million cubic metres (mcm)/day of withdrawal capacity is expected to be available, rising to as much as 37mcm/day in the best-case scenario. This would be down from the 42mcm/day rate that Rough typically supplies gas to the British market.

Russian and Norwegian pipeline supply to Europe has also shown little sign of slowing throughout 2016 (see ESGM 3 August 2016), except for maintenance restrictions, feeding bearish short-term sentiment even further.

Support for gas prices appears to be in short supply, but the potential for coal-to-gas fuel switching to lift European demand as prices fall is one possible scenario which may help to balance the fundamental outlook. jake.horslen@icis.com