While oil and gas prices are falling, things remain grim on the energy front

Just make it chocolate. Not so long ago, the western world was groaning under sky-high energy prices. Oil hit $125 a barrel last summer, not far off the mark all time record of 150 dollars from 2008. Gas cost ten, eleven times as much as normal. Companies went bankrupt, consumers sometimes had to set the thermostat to 15 degrees in winter out of sheer necessity. All this as a result of the energy war that broke out between Russia and the West after the Russian invasion of Ukraine last year.

But if you look at the prices now, you may wonder whether there is still an energy crisis. Oil and gas prices have been falling for months. The most important European gas price (TTF) dipped below for the first time this week below forty euros. Still twice as high as before the war, but compared to last year’s extreme levels, it almost feels ‘familiar’ again.

The main oil price for Europe (Brent) has hovered around USD 70-75 this week – a level last seen well before the war. After the outbreak of the unrest surrounding US banks, the oil price in particular took another hit. In the days immediately after, almost 20 percent went off.

And that while things are still grim on the energy front. Russian President Putin cut off supplies of gas to Europe last year, but the Kremlin is also threatening to cut off the last supply. Four months ago, European countries themselves started boycotting Russian oil. And since the beginning of last month they no longer buy Russian diesel.

There are concerns about new attacks on crucial energy infrastructure, on which Europe now depends, such as last year on the Nord Stream pipeline. The boss of the Norwegian energy company Equinor, Europe’s new main supplier, said two weeks ago that his company “in full” is working on tightening the security of the gas pipes.

In such a tense climate, a ‘normalization’ of prices seems a bit strange. What is going on? And most importantly: where is this going?

Falling energy prices are not necessarily good news for consumers

First of all, this is not necessarily good news for consumers. Fuel prices in the Netherlands are only partly determined by the price of crude oil, partly because (heavy) excise duties are also included in the price. Large drops in the oil price therefore translate into (considerably) less sharp drops in the price of petrol and diesel.

And consumer prices for gas often lag behind fluctuations in the wholesale market, even if people have a variable contract (currently more than 90 percent). In practice, prices are often fixed for two or three months. They therefore only notice price drops after a while.

Disaster scenario

As for the price of oil: it is now falling simply as a result of the fact that the scarcity is now a lot less. In the run-up to last year’s extreme price spike, there were fears that there would be major shortages worldwide as one of its main suppliers – Russia is the third largest oil producer after Saudi Arabia and the United States – could disappear. .

That’s right. At first Western countries feared that Russia would also use oil as a ‘weapon’ to put pressure on the West, just like its gas, so that the total amount of oil on the world market would decrease (and competition for it would therefore become fiercer). Later they themselves started working on a boycott and a ban on insuring Russian oil by ship, which threatened to have the same effect. The latter would also make it more difficult for countries such as China and India to buy the oil, because such insurance policies are mainly taken out in western financial centers (London).

But the loss of Russian oil flows ultimately did not happen, so the pressure was off. Russia did not stop its exports and Western countries, in particular the US, were themselves so afraid of shortages that they devised a goat path to prevent them. In addition to their insurance ban, they introduced an ‘international’ maximum price for Russian oil, and those who adhered to it could still obtain insurance.

You could see that as undermining their own sanction, but it did keep Russian oil flowing. Russia would still be hit, by the way, because it has to sell its oil at that lower price, the proponents claimed.

There are now developments that can actually lead to a surplus on the market. In the US, and to a lesser extent in Europe, central banks are gradually raising interest rates in an attempt to combat skyrocketing inflation (partly caused by high energy prices). But that also puts a brake on economic growth because borrowing becomes more expensive and investment therefore less attractive.

This in turn weakens the demand for energy. Four in ten Americans are now taking into account a recession, according to a recent poll by news channel CNBC. The hopes of oil traders are pinned on China, which is ‘open’ again after two years of stifling corona policy. But Chinese economic growth in the first two months of this year (slightly) lagged expectations.

The sharp price drops after the fall of the American Silicon Valley Bank two weeks ago can be explained by the same ‘recession fear’. Yes, there were smart traders who tried to capitalize on the panic by speculating on a fall in prices, causing extra strong price fluctuations. But the decline also had to do with real concerns. A further escalating banking crisis will put a heavy burden on the economy, just as happened in 2008. After the banking crisis in that year, Europe and the US entered a deep recession, partly because banks became extremely reluctant to lend money.

Analyst Hans van Cleef of the Public Affairs consultancy: “If the unrest in the banking world continues, the fence will be over. Then you get a repeat of 2008.” After the banking crisis, the oil price collapsed from USD 150 per barrel to less than USD 30 in a few months.

Blind panic

When it comes to the price of gas, there are many parallels. Last summer’s peak was mainly due to serious concerns about impending shortages, especially during last winter. Those concerns arose after Russia started to turn off the gas tap in April last year. EU countries started hoarding alternative (liquefied) gas to prevent shortages, but they all did so at the same time, causing prices to skyrocket. “Germany went out to bid against the Netherlands. Netherlands against Italy. Italy against Belgium,” says Ben Woldring, founder of the website gaslicht.com, which maps energy rates for consumers. “That could have been more coordinated.”

But now prices are falling again because there is much less scarcity. This is partly due to the efforts of European countries – households and companies have made huge savings on their consumption (25 percent in the Netherlands compared to 2021). But the ‘luck’ factor should not be underestimated either. European countries were lucky that the Chinese economy was still largely locked up last year, as a result of which Chinese demand for energy was considerably lower than usual and there was therefore much less competition. The winter was also relatively mild, which meant that less gas was needed.

Where it goes now remains to be seen. If there is indeed a recession, driven by an escalating banking crisis (Finance Minister Kaag warned this week that Europe must remain ‘vigilant’) or by further interest rate hikes, it is quite conceivable that oil and gas prices will fall further. This may also cast a shadow over the energy transition, which has gained momentum in recent months due to the high oil and gas prices.

But there are also plenty of analysts who think that energy prices will rise again. Especially since China will really come out of its corona shell later this year, they believe. China itself expects an economic growth of 5 percent in 2023. If that does indeed happen, fierce competition can be expected for next winter. Because, just like last year, Europe will have to replenish its winter stocks in the coming months.

Less is needed than last summer, because the storages are less empty thanks to the mild winter. The Ministry of Economic Affairs announced this week that the Dutch storage facilities are now 59.2 percent full, compared to 20 percent around this time last year. However, there is still a substantial amount to be added. Gas is not up for grabs. Large energy companies have invested relatively little in extra extraction in recent years, because this is becoming increasingly controversial due to climate change. As a result, it is not left to the ‘supply side’.

The pressure may now be a little less, according to analyst Van Cleef. However, he says new ‘price risks’ are looming on the horizon.