Europe's natural-gas crisis is worse than it looks

European natural gas prices are still well below the all-time high set in March. Dig a bit deeper, however, and they are signaling a more protracted disruption than markets anticipated in the immediate aftermath of  Vladimir Putin's invasion of Ukraine.

While the gas market then priced in a short-lived crisis, lasting perhaps a couple of months, it's now flashing extreme danger for next winter, through 2023 and, increasingly, into 2024. Over the last few days, the whole European gas price curve has repriced at a much higher level.

The shift in the forward curve has been the most notable development of the gas market in the past month – one that's not gathering enough attention in European capitals. But industry is keenly aware, as it's bearing the cost. Back in March, a German manufacturer could lock in gas prices for all of 2023 at about 80 euros per megawatt hour; now, it has to pay a record high 145 euros to hedge the same price risk.

Gas Prices Higher for Longer

The whole European gas-price curve has repriced at a much higher level compared with the level it traded in March

It's not just companies paying the price. Cornwall Insights, a consultant, forecasts that UK households will pay as much as £3,244 ($3886) per year for their gas and electricity bills, starting in October, up nearly 65% from £1,971. Before the curve re-priced higher over the last few weeks, UK energy consultants were anticipating a smaller increase.

Last week, the closely watched Dutch TTF contract, a European spot benchmark, rose to about 175 euros, doubling in a month, after Russia cut supplies via the Nord Stream 1 pipeline into Germany. Even so, spot gas prices remain 30% below the record high settlement of 227 euros set during the early days of the war — worrying, but not alarming; prices are high, but not that high. After what the market weathered in March, one can understand why policy makers aren't panicking.

Russian Squeeze

Despite a big rally so far in July, spot European gas prices remain 30% below the record high set during the early days of the Russian invasion of Ukraine

But that's if you ignore the action on the back end of the curve. On March 5 — when spot gas prices surged to about 185 euros — the contract for delivery in December 2022 rose only to about 155 euros; last week, when the spot price was slightly lower, the December contract traded at nearly 195 euros.

A year into Russia manipulating European gas supplies, the market is finally convinced that Moscow will continue to do so, and perhaps with greater intensity.

The first test comes in the next two weeks. The Nord Stream 1 pipeline, the most important gas link between Russia and the European Union, undergoes annual maintenance from July 11 to July 21. Berlin fears that Moscow will find an excuse to keep it closed for good, cutting gas supplies to Germany completely. After all that Moscow has done, the German government is right to be concerned.

Yet, Russia may want to keep some gas flowing to preserve its long-term leverage. From a game-theory point of view, that makes sense. Once Russia stops shipments completely, it can no longer apply pressure. Tactically, Moscow is likely to keep some gas moving, retaining the option of cutting or slowing flows whenever it chooses.

Moreover, Nord Stream 1 is the main route for Russian gas into Europe indexed against the TTF contract, according to Goldman Sachs. Not reopening the pipeline after the maintenance shutdown will limit the profit that Gazprom, the Russian state-owned gas giant, enjoys from sky-high gas prices.

Russia has clearly written off its gas relationship with Europe. For now, however, the Kremlin will continue to enjoy the best of both worlds: high revenue and compelling leverage. To achieve its objectives, Russia needs to continue selling some gas into Germany, but at reduced rates, as it's currently doing.

The market is right to reprice the gas curve; the only question is why it took so long. There's further risk ahead: At some point, Moscow will completely turn off the tap, probably just before the winter, to try to bring the German economy to its knees. That's an outcome the market hasn't priced yet. 

Javier Blas is a Bloomberg Opinion columnist covering energy and commodities. A former reporter for Bloomberg News and commodities editor at the Financial Times, he is coauthor of "The World for Sale: Money, Power and the Traders Who Barter the Earth's Resources." @JavierBlas

Disclaimer: This article first appeared on Bloomberg, and is published by special syndication arrangement.