Europe's lucky warm winter

Benchmark Dutch Title Transfer Facility (TTF) gas prices have fallen from peaks above €340 per megawatt-hour to below €80, and European boardrooms have let out a large sigh of relief. Energy traders had billed the winter of 2022–2023 as a humanitarian and industrial disaster. Pundits forecast rolling blackouts, factory closures and rationing as the continent faced its first heating season without Russian pipeline gas. An unusually warm winter got in the way, with temperatures across central and western Europe breaking records.

The weather has changed Europe's short-term energy sums. Gas storage that was expected to be badly depleted by January is still about 83 per cent full, a remarkable cushion for mid-winter.

How Europe got here

The price spike of last summer had clear causes. Russia cut flows through the Nord Stream pipeline sharply in June and July and halted them entirely at the end of August, and explosions in September damaged the pipeline beyond quick repair. European buyers responded by bidding for every available cargo of liquefied natural gas to fill storage before winter, which is what drove prices to their peak.

The scramble worked, at a price. The European Union had set a target of filling storage to 80 per cent by November, and it passed that comfortably, reaching about 95 per cent. Member states also agreed in July to cut gas use voluntarily by 15 per cent over the winter, and high prices did much of the cutting on their own, as households turned down thermostats and factories reduced output.

Cheaper for treasuries

The fall in spot gas prices is an immediate windfall for public finances. Governments that set aside hundreds of billions for energy price caps and consumer subsidies will spend only a fraction of the money, which eases the pressure on their bond issuance.

Most support schemes cap the price that households and firms pay and let the state cover the gap to the market price. When the market price falls, the gap shrinks and so does the bill. Germany's €200 billion shield and Britain's Energy Price Guarantee, which limits a typical household's annual bill to £2,500, were both costed when forward prices were several times today's level.

Inflation turns, slowly

Wholesale electricity prices have also dropped sharply. That should pull down headline European inflation over the coming quarters and spare household incomes a painful squeeze. The turn has already begun: euro-area inflation fell to 9.2 per cent in December from a peak of 10.6 per cent in October, according to Eurostat's first estimate.

Core inflation tells a different story. Excluding energy and food, prices rose 5.2 per cent in the year to December, a record for the single currency, as earlier energy costs work through into services and manufactured goods. The European Central Bank raised its deposit rate to 2 per cent in December and signalled more increases of the same size, so cheaper gas eases the pain for households without yet changing the path of rates.

Who wins from cheaper gas

Energy-hungry industries are the clearest beneficiaries, though not all of them will restart. Chemical makers such as BASF cut output in Europe last year, and some of that capacity may never come back, since competitors in America pay far less for gas. Utilities that were caught buying replacement gas at peak prices, such as Uniper, which Germany agreed to nationalise in September, stop bleeding cash as spot prices fall.

The losers are those who locked in at the top. Households and companies that signed fixed-price contracts in the autumn will keep paying far above today's market for months. Sellers of LNG, from American exporters to Qatar, will see their extraordinary margins on European sales narrow as Europe's bids become less desperate.

Next winter is the test

Congratulating Europe on solving its energy crisis would be premature. The warm winter of 2023 was a stroke of luck with the weather, and luck does not fix the underlying shortage.

Europe will have to refill its storage for the winter of 2023–2024 with no Russian pipeline gas at all, while a reopening China competes hard for spot LNG cargoes. Last year's refill began with some Russian gas still flowing through the first half; this year's will start with almost none. The International Energy Agency warned in December that Europe could face a supply gap next year if Russian deliveries stop entirely and Chinese imports recover.

New import capacity helps at the margin. Germany opened its first floating LNG terminal at Wilhelmshaven in December, and more are planned, but terminals only matter if there is gas to fill them, and new global LNG supply is limited until large projects in Qatar and America come online later in the decade.

What would change the call

The indicators to watch are storage levels at the end of March, which set the starting point for the refill, the pace of Chinese LNG purchases as its economy reopens, and the summer forward price for TTF. The EU's new price cap of €180 per megawatt-hour, agreed in December, would only bite if prices spiked again, so it offers little protection against a steady climb. A cold end to the winter would erode today's cushion quickly.

The weather handed European policymakers a reprieve they did nothing to earn, and unless they line up more supply before next winter, gas prices will probably climb again as the tanks are refilled over the summer.