By Alex Kimani of OilPrice.com
Last week, oil prices finished the week in the green, gaining 3.5% after tumbling nearly 10% a week earlier thanks to a weakening dollar after better-than-expected inflation data altered interest rate expectations from the Fed. Unfortunately, the oil price rally has been snuffed out in a dramatic fashion. WTI and Brent crude have both declined more than 5% in Monday’s morning session to trade at $87.31/bbl and 93.16/bbl on demand fears as disappointing Chinese economic data renewed global recession concerns. China's central bank cut key lending rates in a bid to revive demand as the latest data showed the economy unexpectedly slowing in July–and the market wasn’t expecting it.
China’s industrial output grew 3.8% in July from a year earlier, well below the 4.6% consensus on Wall Street. The grim set of figures is an indication that the world’s largest importer of crude is struggling to shake off the effects of Beijing’s Covid restrictions months earlier.
Coupled with high oil price volatility, this is taking a heavy toll on oil prices, with Brent crude open interest this month down 20% compared to a year ago levels.
"Open interest is still falling, with some (market players) not interested in touching it because of volatility. That is, in my view, the reason resulting in higher volumes to the downside," UBS oil analyst Giovanni Staunovo has said, adding that the trigger for Monday’s drop was weak Chinese data.
But a slowing Chinese economy might be just one of a host of bearish catalysts that might conspire to keep oil prices grounded if Europe’s natural gas stockpiles are any indication.
Gas to Oil Switching
Shortly after Russia invaded Ukraine in late February, dozens of Eurozone countries pledged to heavily cut Russian natural gas imports or halt them completely as soon as they can afford to. These countries took several aggressive measures to replenish their natural gas stockpiles ahead of the winter season, including reaching a political agreement to cut gas use by 15% through next winter.
And now there's a growing sense that Europe might not only meet its gas targets but also exceed them. European governments had been worried that Russia's cut in supplies through its main gas pipeline to Germany would leave many of them with less than sufficient supplies for the winter season. However, many European nations have managed to build up ample gas storage by switching from gas to coal for some power plants, steadily curbing gas demand, and increasing imports of liquefied natural gas (LNG).
According to a report by the Observer Research Foundation, energy supply disruptions triggered by Russia’s war on Ukraine took LNG prices even higher leaving coal as the only option for dispatchable and affordable power in much of Europe, including the tough markets of Western Europe and North America that have explicit policies to phase out coal.
Coal mines and power plants that closed shop 10 years ago have begun to be repaired in Germany. Now, Germany looks set to burn at least 100,000 tons of coal per month by winter. That’s a big U-turn considering that Germany's goal had been to phase out all coal-generated electricity by 2038.
Nor is Germany alone: Austria, Poland, the Netherlands and Greece are also gearing up for coal plant restarts, while China’s coal imports have been surging, increasing 24% month-to-month in July as power generators increased purchases to provide for peak summer electricity demand. China has the largest number of operational coal power plants with 3,037 while Germany, the largest economy in the EU has 63.
As a result, thermal coal, which is the variety used to generate power, has seen a 170% rise in price since the end of 2021--most of those gains made following Russia’s invasion of Ukraine.
Ramped-up LNG imports have also helped, with the EU importing 21.36 million tonnes of LNG in the first half of 2022, up from just 8.21 million tonnes during last year’s comparable period. In a historical precedent, Europe is now taking in more American LNG than piped Russian gas.
The result: injections to Europe’s gas storage are running about nine weeks ahead of last year, an impressive feat even after flows from Russia have been severely curtailed. European gas storage levels are above 70%, and have even surpassed the 5-year average, according to data from Gas Infrastructure Europe (GIE).
By November 1st, the EU will likely hit 80% natural gas storage capacity–just in time for peak winter demand. Germany is even aiming for 95% capacity, and is already at 75%.
This is set to curb oil demand since some operators have begun switching from gas to oil generation due to high natural gas prices. "The EU already surpassed its September 1 interim filling target in early July and is still on pace to reach the November 1 target," Jacob Mandel, senior associate for commodities at Aurora Energy Research, has told Reuters.
Indeed, analysts at Standard Chartered Plc are saying that President Vladimir Putin’s gas weapon will be effectively blunted by the inventory build, with Europe set to go through winter “comfortably” without Russian gas.
More than enough natural gas available will, unfortunately, lower oil demand as an alternative. That said, Europe will have to pay a heavy price: the cost of replenishing natural gas stocks is estimated at over 50 billion euros ($51 billion), 10 times more than the historical average for filling up tanks ahead of winter.