Global gas prices have climbed to their highest level for seven years in real terms, as traders anticipate a shortage this winter, with consumption rebounding more quickly than production from the pandemic slump last year.
The global market is experiencing a classic but violent price cycle, with an unprecedented downturn in 2020, caused by the coronavirus epidemic and lockdowns, creating the conditions for a boom in 2021/22.
Last year, volume-weighted global prices fell to their lowest annual level since 1995, after adjusting for inflation, according to the World Bank. ("Commodities price data (the pink sheet)", World Bank, Sept. 2021).
The result was a sharp cutback in drilling and capital investment across the industry, leading to an unprecedented decline in worldwide output, which has remained depressed even as global economic activity has surged back.
In an inevitable reaction, monthly prices have now climbed to their highest in real terms since mid-2014, as traders anticipate there will not be enough production to meet all the demand from consumers by the end of the year.
By August, real prices had risen to the 68th percentile for all months since 1980, up from the 1st percentile in June 2020, with further sharp increases so far this month.
Rising prices are sending a strong signal to the industry of the need to boost production and are providing the cash flow to finance a major increase in output, which should support strong growth in 2022 and 2023.
Before the pandemic, both global production and consumption had increased at a compound rate of roughly 3% per year between 2009 to 2019 ("Statistical review of world energy", BP, 2021).
But the pandemic caused consumption to drop by 2.1% last year (the largest decline since the financial crisis in 2009), while production plunged even more sharply by 3.1% (the largest decline since at least the 1970s).
As a result of the aggressive supply response, the emerging oversupply of gas had largely been brought under control by the end of 2020.
A colder-than-normal winter, including the big freeze in Texas in February, then eliminated excess inventories, with stocks falling below the five-year average by March and April 2021.
The first indications that oversupply was being replaced by undersupply emerged at the start of 2021 when LNG prices spiked in Northeast Asia.
Price increases have subsequently become more persistent, spreading first to Europe, then back into the United States as the potential production shortfall has worsened.
In the next few months, with production largely fixed, high prices will have to choke back consumption through conservation, fuel switching (mostly to coal in power generation) and reduced use (mostly by industrial shutdowns).
But over the next year, higher prices will progressively incentivise more drilling and production, which should return the market to balance by the end of 2022, with prices retreating closer to long-term average levels.
In the same way gas production fell much more quickly than consumption in 2020 to whittle down excess inventories, it will have to grow faster than consumption in 2022 to rebuild stocks to a more comfortable level.
Rebalancing the market will therefore require a period of unusually high prices in the short term before they revert closer to long-term average levels late in the second half of 2022 and into 2023.