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Energy: What Condition Our Condition is In

Author: Brynne Kelly 10/03/2021

There is a mania across energy markets being fueled by natural gas, coal and electricity shortages in Europe and Asia. The conditions in both regions are not the same conditions that exist in the US. Specifically, the US is not currently experiencing power curtailments due to lack of fuel supply. Rather it is experiencing price increases as a result of conditions elsewhere in the world.

Last week, China’s central government officials ordered the country’s top state-owned energy companies -- from coal to electricity and oil -- to secure supplies for this winter at all costs, according to people familiar with the matter. It's important to note, however, that when China talks about energy security, it's basically talking about coal. China’s power system is structured around coal plants with the expectation that they can operate 24/7 and provide stability.

As a result, coal futures continued to break fresh records and hit $231 per metric ton for the November 2021 Rotterdam contract in Europe (after gaining 27% in September, and adding 171% so far on the year). Several factors have been pushing coal prices up, including tight supply in China as the country vows to achieve emissions standards and reach carbon neutrality by 2060; a lack of mine investment reflecting pressure from socially conscious investors; import constraints due to coronavirus restrictions and a surge in natural gas prices amid prospects of a shortage in inventories, specifically in Europe. Meanwhile, the Chinese National Development and Reform Commission formally urged local economic planners, energy administrations and railway companies to increase coal transportation to meet citizens' heating demand during the winter season.

China uses more coal than the rest of the world combined, according to a guide on Chinese climate policy produced by Columbia University’s SIPA Center on Global Energy Policy. It is also the world’s leading coal producer, but the supply crunch has forced it to ration power and curb factory output.

As a result, China essentially sets the price for the marginal unit of coal consumed and we can see this impact on European coal futures prices.

Energy shortages in China, the United Kingdom and Europe are causing significant disruptions. Goldman Sachs Group Inc. almost doubled its outlook for Asian coal prices as a global recovery in power demand and production issues in key mining countries combine to make supply scarce. Benchmark Newcastle thermal coal will average $190 a ton in the fourth quarter, up from a previous forecast of $100, to meet demand in the northern hemisphere winter and taking account of a global rally in natural gas, Goldman analysts Paul Young and Hugo Nicolaci said Tuesday in a research note. The bank lifted its 2022 forecast to $120 a ton from $85.

Combined, coal and natural gas accounted for 51.9% of the world's primary energy consumption in 2020 (according to BP's Statistical Review of World Energy 2021).

For some perspective, here is a look at where European coal, natural gas and Brent crude oil futures settled as of October 1, 2021 (heat content adjusted US$ per Mmbtu). The comparison uses Rotterdam coal futures which is the most actively traded contract

Each region has their own set of issues that are first driving local prices and then spilling over to global markets. Here are some of the forces at play in each:


As the world starts to reopen after the pandemic, demand for Chinese goods is surging and the factories making them need a lot more power. The problem is particularly serious in China's north eastern industrial hubs as winter approaches - and is something that could have implications for the rest of the world. Blackouts are not that unusual in the country but this year a number of factors have contributed to a perfect storm for electricity suppliers.

As Bloomberg has reported, the country has struggled in the past to balance electricity supplies with demand, which has often left many of China's provinces at risk of power outages. During times of peak power consumption in the summer and winter the problem becomes particularly acute. But this year a number of factors have come together to make the issue especially serious.

Rules imposed by Beijing as it attempts to make the country carbon neutral by 2060 have seen coal production slow, even as the country still relies on coal for more than half of its power. And as electricity demand has risen, the price of coal has been pushed up.

But with the government strictly controlling electricity prices, coal-fired power plants are unwilling to operate at a loss, with many drastically reducing their output instead. The problem is compounded by a structural problem in China’s energy sector: Power plants buy coal at market price but are not allowed to raise electricity rates on customers beyond small margins set by national planners. When coal is expensive, many plants report “maintenance outages” and reduce or stop operation rather than suffer losses. Energy-intensive industries such as steel-making, aluminum smelting, cement manufacturing and fertilizer production are among the businesses hardest hit by the outages.

Last Wednesday, China’s National Development and Reform Commission announced it would let firms increase prices to “reasonably reflect changes in demand, supply and costs,” Bloomberg News reported, but it’s unclear how high those prices will be allowed to go. The Chinese government is also said to be considering hiking electricity prices for factories, people familiar with details of the plan told Bloomberg News.

Goldman Sachs has estimated that as much as 44% of the country's industrial activity has been affected by power shortages. It now expects the world's second largest economy to expand by 7.8% this year, down from its previous prediction of 8.2%.

In China, the demand for current coal-fired electricity continues to come up against emissions cuts that the Chinese government has laid out as part of its ambitious goal of going carbon neutral by 2060.


The U.K. is more vulnerable than most other advanced economies to a surge in demand for natural gas, analysts say. A lack of natural-gas storage facilities in the U.K., where capacity has been allowed to dwindle in recent years, has amplified the risks of a global shortage of the fuel and raised concerns that energy supplies won’t hold up if there is a cold winter.

Energy prices across Europe are breaking records, too. Supply shortages in coal, gas and water have all driven energy prices sky-high in Europe. Meanwhile, United States gas and coal producers are struggling to keep pace with demand even before the Northern Hemisphere hits its winter period and heating demand skyrockets.


The push-pull — between meeting energy demands now and investing in renewable energy sources that help the planet long-term — is a big part of the current crisis worldwide. We are now in a situation where we are having to pay short term premium for long term mismanagement.

It's not only coal prices that are moving up. Oil and natural gas futures have also been impacted. By the end of last week, WTI calendar strip futures had reached yearly highs.

The oil price rally to three-year highs is exacerbated by an even bigger increase in natural gas prices, which have spiked 150% in the US since the beginning of the year.

US natural gas futures have been propelled higher by the astronomical rise in LNG futures. However, keep in mind that US liquefaction capacity is not unlimited. Currently, it stands around 10.8 Bcf/d. As of October 2, combined natural gas feed to LNG facilities at Sabine Pass, Cameron, Elba Island, Cove Point, Freeport & Corpus Christi was 10.31 Bcf. All of the facilities have recently been operating at or near full capacity. This means that the US has reached it's limit for the time being in its ability to participate in global LNG markets. Furthermore, most US LNG is sold via long-term contracts and therefore already spoken for (most contract terms do not allow the buyer to resell the LNG into the open market).

A sixth train at Cheniere's Sabine Pass terminal in Louisiana is expected to start up in the first half of 2022 (according to the company's earnings report), while two new US LNG export terminals – one in Louisiana and one in Texas – are scheduled to begin production between 2022 and 2024. The addition of Cheniere's train 6 will bring the U.S. LNG potential to 11.9 billion cubic feet daily in 2022.

This fixed amount of US liquefaction capacity and long term contract structure is why the spread between global LNG prices and US natural gas can continue to widen.

So, what are some domestic factors that underpin US natural gas prices? The largest is residential winter heating demand. As we saw earlier this year with winter storm Uri, winter weather can wreak havoc on supply and distribution systems and drive prices towards scarcity pricing in a matter of days. This alone has led market participants to include more risk premium in winter natural gas prices. The potential for $100+ prices for a few days is certainly now being factored in to the month futures price. For example, if spot prices for just one day of the month spikes and clears at $150, that can add up to $5 to the monthly average spot price. Since this was proven out in recent history, US natural gas futures are much more willing to go along for the ride being fueled by global circumstances in China and Europe.

The other major demand for US natural gas is power generation. In the US, generating units fueled primarily with natural gas account for the largest share of utility-scale electricity generating capacity in the United States at 40% of the total while reliance on coal as a source of electricity production has been declining and currently stands at around 19%. At the bottom of the pile is petroleum, which was the source of less than 1% of U.S. electricity generation in 2020

With coal and petroleum combined making up 20% of the total, there is limited ability to fuel switch between them and natural gas. Given the current prices of US natural gas versus coal, it's fair to assume that to the extent natural gas can be used, it will be used.

The circumstances in China and European natural gas and coal markets are certainly having an impact on US markets. But the conditions driving them aren't necessarily the same. US inventories are on the lower end of their 5-year averages, but they are not in shortage. Electricity is not being curtailed to factories or homes like they are in China at the moment. At best, the conditions we are seeing overseas merely point out what could happen domestically if we do not increase, or at least maintain current inventory levels going in to the winter season or if production is unable to return to pre-pandemic levels.

Of Note:

OPEC and its allies meet on Monday to debate how much oil to release into the market. The nearest month any increase could occur is November since OPEC+'s last meeting decided the October volumes.


EIA Inventory Statistics Recap

Weekly Changes

The EIA reported a total petroleum inventory BUILD of 4.30 for the week ending September 24, 2021 (vs a net DRAW of 3.80 last week).

YTD Changes

Year-to-date cumulative changes in inventory for 2021 are DOWN by 134.30 million barrels (vs down 138.60 million last week).

Inventory Levels

Commercial Inventory levels of Crude Oil (ex-SPR) compared to prior years are have gone from way above historical levels to surprisingly below historical levels and should continue to draw as long as backwardation in the market persists.


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