The extended and intense winter that Europe experienced, lasting from October 2012 to March 2013, gave rise to gas shortages across the continent. The unexpected weather conditions spurred a spike in demand for natural gas for heating purposes and caused the regional gas inventories to fall to historic lows.

Europe faces the brunt of harsh weather conditions

The experience of the previous year left the lesson that the European gas prices are highly sensitive to the weather conditions in the region. As gas inventories were worn down during this time, the weekly prices of natural gas were driven up. This price spike was aggravated by the pipeline outages from Norway, and prices climbed to an all-time high of EUR 38.7 per MWh.

Figure 1: LNG prices in Europe versus Asia

Gas Europe
Source: Bloomberg

The pipeline prices in the United Kingdom and Netherlands have historically maintained a discount to the North East Asian LNG prices of an average EUR 15.7. The first half of 2013 saw this discount shrink to less than EUR 5 at one point.

Norway – The primary supplier to Europe

The weather was not solely the perpetrator of this price spike. Europe is extremely dependent on the North Sea for its supply of fuels, especially natural gas. Usually, the North Sea is a reliable source and can be expected to supply uninterrupted gas. However, during this period, Norway suffered gas power outages and could not fulfill the European demand.

The North Sea supplies 44.5 percent of the European natural gas production and accounts for 55.8 percent of the European natural gas reserves. This share has multiplied considerably over the past two decades. Europe’s own natural gas reserves outside of Norway have deteriorated over the years and the production from these areas has also slowed down since 2005. This means that any changes in the Norwegian production are bound to have a direct and significant impact on the European gas prices.

Figure 2: Europe and Norway natural gas production (million tonnes of oil equivalent) and natural gas reserves (trillion cubic feet)

Source: BP Statistical Review of World Energy 2013
Source: BP Statistical Review of World Energy 2013

A bleak year for Natural Gas

Norway’s gas production has alarmingly declined 6 percent this year (production year-to-date August 2013). The number of drilling rigs in operation in Norway in August 2013 has also dropped, further decreasing the prospects of recovery in production numbers. This might prove to be the propeller for natural gas prices in Europe, driving them further upwards.

Figure 3: Norway natural gas production (million tonnes of oil equivalent) and number of gas drilling rigs

Source: Norwegian Petroleum Directorate, Baker Hughes
Source: Norwegian Petroleum Directorate, Baker Hughes

“Higher European production allows suppliers from Centrica PLC (LON:CNA) (OTCMKTS:CPYYY) to North Island Pasture Growth Index — gross index (NZE:PGNIG) to purchase less gas generally higher-priced gas from outside Europe,” analyzes Chris Rogers, a senior gas analyst. However, a decline in the major chunk of European production, i.e. Norway, will mean that the local suppliers will be forced to explore the option of LNG trade from Asia and pay the associated high prices for natural gas.