Unloading prohibited! Off the European coast, LNG tankers are cruising at reduced speed on the orders of their owners. Two billion euros worth of liquefied gas are sailing, almost motionless, just a stone’s throw from the terminals that criss-cross the coastline from Greece to Poland.
Their temporary owners (traders, commodity arbitrageurs) are waiting for prices to rise before authorising the transfer to the regasification units, their eyes riveted on the structure of futures contracts in strong contango (the market is counting on a sharp rise in prices at the height of winter).
While waiting for the winter low, European gas tanks are full. The filling rate is 94%, 6 points above its average for the last 7 years. The reserves of France (99%) and Belgium (100%) are fully replenished.
Europe has diversified: its LNG imports are up by 70%, while Russian purchases now represent only 7% of the continent’s supply (compared with 40% in January).
In addition to the diversification of its supply, the adjustment of demand to prices and exceptional weather conditions is having an effect on spot prices, which have fallen by half since their last high point in September.
Domestic demand has thus fallen by 12% in recent months, driven primarily by the withdrawal of heavy industrial activity (steel, aluminium). Weather conditions that could not have been better for Europe this autumn are delaying heating needs (an estimated 7 billion cubic metres of gas are saved for each degree that mild temperatures are above their historical average), while the bad weather that followed the summer drought is allowing hydroelectric capacity to regain its place in the energy mix. The restart of the US Freeport export terminal and Japanese nuclear reactors also augur well for a less tight international LNG market.
However, for European investors, the consequences of the downturn in energy inflation are not easy to grasp. Theoretically, it should allow their currency to escape a catastrophic collapse of the parity with the dollar. In recent quarters, the exchange rate seems to have followed the spread between European and US gas prices, which peaked in early September. As European stocks have been replenished since the summer, this spread has converged towards its levels of the beginning of the year, which should have allowed the euro to return permanently to above parity.
In reality, the real interest rate differential, which is a fundamental determinant of exchange rates, continues to widen on both sides of the Atlantic, to the detriment of the single currency. It is suffering from a doubly unfavourable scissor effect. On the one hand, it is caused by consumer price inflation which continues to accelerate in Europe (10.7%) while the opposite is happening in the United States; on the other hand, since the press conference of a more hawkish Jerome Powell than expected last week, the Fed Funds futures are counting on a terminal rate of the FED now above 5%, weighing down the attractiveness of the interest rate in euros.
These are probably the reasons why the euro’s attempt to break out of parity last week was aborted. Its decline became more and more pronounced as Powell dashed hopes of an imminent Fed pivot. And it was probably in reaction to the aggressive tone of his American counterpart that Christine Lagarde intervened the next day, contradicting the more conciliatory intonation of the previous week, warning that a recession in Europe would not prevent the ECB from pursuing its rate hike programme.
As this recession (probably the most anticipated in history!) approaches, the euro remains under pressure against the historically expensive dollar, which is enjoying extreme speculative positioning. The prospects for an inflationary recession are bleak – but may it continue to escape the disaster scenarios predicted for it – Europe may hopefully regain favour with investors.
Thomas Planell, Portfolio manager – analyst at DNCA. This article was finalised in November 4th, 2022.
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