Goldman Sees Europe’s Return to Gas Use in Power as Short-Lived

Jul 23, 2014 6:06 am ET

July 23 (Bloomberg) -- Europe’s return to favoring natural gas for power generation for the first time in almost three years will be short-lived as Russian and Norwegian gas imports will be needed for winter, according to Goldman Sachs Group Inc.

An excess of gas in storage is driving “efficient” power plants in the U.K. to use more of the fuel at the expense of coal, the bank said in a report dated yesterday. Power plants in the U.K., Europe’s biggest gas market, can consume supplementary inventories before the winter if prices for the fuel are at an average discount of 5 pence a therm (9 cents a million British thermal units) to coal, it said.

Price-induced coal to gas switching is “likely to only be a summer phenomenon in Europe,” analysts including London-based Daniel Quigley said in the report. “Beyond the summer, we continue to expect European gas to return to a 2013-like dynamic, requiring relatively high imports from Russia and Norway to compensate for 11 billion cubic meters a year of production cuts from the Dutch Groningen gas field.”

Front-month gas on the U.K.’s National Balancing Point fell 46 percent this year to 37.15 pence a therm as Europe’s mildest winter in seven years left high inventories, according to broker data compiled by Bloomberg. Prices may fall to average 33 pence in the next three months in order for coal to gas switching to balance the market, Goldman forecasts.

Prices may decline further if balancing the market requires power plants in northwest Europe to also switch to gas, the bank said. That could happen if U.K. generators don’t switch to using gas quickly enough or due to “strong” growth in renewables. Prices would need to drop below 30 pence a therm before gas- fired units in northwest Europe could compete with coal on a large scale.

Price Forecasts

U.K. gas prices will probably average 34.2 pence in the third quarter, which will be “sufficient to correct its storage overhang,” Goldman said. While the usage of gas at the expense of coal in Germany starts to be profitable at 32 pence, prices need to fall further to “kick-start this demand in the short run,” according to the report.

Northwest European inventories have an excess of 4 billion cubic meters (142 billion cubic feet) of gas over 2012 levels, the bank said. Without coal-to-gas switching or an escalation in tensions between Russia and Ukraine the surplus will be 2.7 billion cubic meters above 2012 levels at the end of October, it said. It would take 24 million cubic meters a day of incremental demand through October to alleviate the glut.

The U.K. has spare gas-fired power capacity to increase demand for the fuel by 40 million cubic meters a day, according to the report. Switching to gas for European power generation to deplete excess gas inventories would result in thermal coal demand loss of about 5 million metric tons, which could add further pressure on prices already trading “near a multiyear low,” the bank said.