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The oil-gas (dis)connection

By Emma Slawinski on 28-Mar-2016

Oil and other commodity markets rallied in early March, but a key support factor behind the rise was speculative trade, rather than reliable supply and demand indicators.

Although the bullish trend abated towards the end of the month, Brent crude has been sustained at levels around $40/bbl, well above its January nadir of around $28/bbl.

As ICIS oil and chemicals expert Paul Hodges has pointed out, low central bank rates in major economies including the US, UK and Japan are fuelling forward buying by financial institutions.

But European gas hubs have resisted the trend, as natural gas traders have questioned the sustainability of price rises that do not appear to reflect concrete, underlying fundamentals.

First of all, it’s worth stating that although wholesale gas in Europe is increasingly priced on the commodity’s own fundamentals, a strong connection to oil remains. This is due to ongoing, though diminishing, oil indexation in long-term gas supply contracts.

The opportunity to arbitrage between hub purchases and long-term contract offtake is one way in which oil influences gas; hedging of oil-indexed contracts is another.

Longer-dated hub contracts have shown a strong correlation to Brent crude movements in the past year. But since late February, gas prices have been fairly stable even as the oil benchmark, Brent crude, has gained value.

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Click to enlarge

There appear to be two factors behind this, with a mutually reinforcing tendency.

Firstly, Europe is in a situation of oversupply after a relatively mild winter that has left gas stocks underused.

The launch of the 4.05billion cubic metre (bcm) Bergermeer storage facility in the Netherlands also means the total amount in store in Europe has been much higher this year than last.

On top of this, the continent is being used as a sink for surplus LNG in the global market amid mounting new production capacity.

But despite all the supply-side pressure, low gas prices have not stimulated consumption sufficiently to boost demand significantly.

The second factor is to do with the market’s perception of oil price trends. In the past weeks, European gas traders appeared increasingly reluctant to react to news about potential OPEC production cuts.

“Gas is decoupling from oil price rises as people no longer believe that [oil] spikes will last longer than a session or two,” one European gas trader said recently.

Today, it would take more concrete developments in oil fundamentals to persuade gas traders that commodities bulls have got it right.

If these do not materialise, and oil does not see further significant gains, we may continue to see forward gas prices sticking to gas fundamentals for direction. emma.slawinski@icis.com