Goldman Sachs: What will happen to Nord Stream 1 flows, how will natural gas prices move, what are the risks for Europe

By Eleftherias Kourtalis

With attention focused on whether Russian gas supplies via the Nord Stream 1 (NS1) pipeline will resume as maintenance is completed on Thursday, Goldman Sachs looks at the biggest concerns clients have expressed about this issue for the last two weeks.

According to GS’s assessment, the most likely scenario is for NS1 to return to operation at 40% capacity, the level of flows i.e. before the maintenance works. In terms of prices, in this scenario he believes Q3 will remain around EUR 170/MWh (TTF), in line with the EUR 160-180 range seen over the past two weeks. Conversely, if Russian export flows do not resume, natural gas prices will move significantly higher.

Specifically, he estimates that the prices (TTF) will exceed 210 euros/MWh, as the storage must be replenished next year in the event of a complete interruption of flows.

Why Russia won’t cut Nord Stream flows to zero

Most of the clients Goldman spoke to last week are split between the scenario of 40% and zero post-maintenance flows, with many market participants, particularly in Germany, expecting the pipeline to actually remain to zero.

However, Goldman still does not see NS1 flows remaining at zero as a likely scenario, as (1) it would remove flexibility from Russia’s supply decisions (when at zero, there is only one option going forward: increase flows), (2) would significantly reduce Russia’s gas revenues, especially in view of a possible rise in gas prices in Europe that would mean more revenues for its economy, and (3) would necessarily lead to a even faster pace of gas production shutdowns in Russia.

The outages are effectively delaying a growing share of Gazprom’s gas revenue. The fact that many expect the pipeline to remain at zero after maintenance suggests a sell-off in European gas prices from current levels is likely should NS1 return to at least 40% capacity from July 21 .

This is in line with yesterday’s TTF move, with its price falling €5 to €154/MWh, following media reports that NS1 will restart as planned. “To be clear, in a 40% flow rate scenario, we do not believe that prices this low would be sustainable, with prices returning to near €170 more likely in our view to create enough demand destruction to contribute to Europe’s 90% storage target by the end of October.”

What is the risk to European gas markets if NS1 flows remain at zero?

Under this more unfavorable outcome, even taking into account compensations for supply losses, the average TTF price will exceed €210/MWh in Q3. This is based on Goldman’s expectation that markets (and governments) will act to fill NW European gas storage to 90% before winter. This scenario will also push the Eurozone into a clear recession.

Can Russian gas go elsewhere if it is not flowing to Europe?

No, says Goldman Sachs. There is a lack of pipeline connectivity between the specific production area and alternative buyers. Gazprom’s published figures suggest its output is down 10% year-on-year compared to July 2021, and more than 35% year-on-year for the first half of July this year.

However, this is not expected to create a geological issue, given Gazprom’s proven ability to historically shift production down or up. The most recent example was the 50 Bcm production swing in 2020 during the peak of the pandemic. GS also notes that Gazprom’s gas cutoff process has not affected Russia’s oil production.

Has European gas demand fallen further due to today’s high prices?

There has been an accelerated fall in gas demand this month year-on-year compared with June in Germany, the Netherlands and Belgium, but not yet in the UK or France, where storage levels were higher than average term and natural gas prices lower than TTF. Natural gas demand from NW European consumers remains more resilient than expected, 11% above Goldman’s expectations for July.

This relative strength of demand despite extremely high gas prices has been exacerbated by the heat wave Europe is currently experiencing. While air conditioning is typically much less present in homes in NW Europe than in Southern Europe, the heat affects the ability of nuclear reactors to discharge water used for cooling into rivers that are already too hot for wildlife, thus increasing combustion natural gas.

In addition, the low water level in the Rhine River adversely affects shipping, including the transport of coal to power generators in Germany.

Can Europe’s LNG imports stay high?

The resilience seen so far in gas demand across NW Europe relative to Goldman’s expectations has been offset by higher-than-expected supply, driven by LNG imports into the region. NW European LNG imports averaged 28% above expectations for the month of July, helped by weak LNG imports in China as well as some more price-sensitive buyers.

A slow recovery in Chinese natural gas demand from April lows helped keep Chinese gas storage well-stocked, reducing the country’s demand for LNG imports, thereby leaving additional cargoes available for Europe.

But as Chinese economic activity continues to recover, its competition for LNG cargoes puts European LNG supplies at risk. In addition, recent declines in Japan’s natural gas inventories due to a heat wave, as well as low inventories also in South Korea, reinforce Goldman Sachs’ view that LNG demand in Asia will increase further, reducing available LNG supply for Europe in the coming months.

Can European gas demand shift to other fuels?

Since European natural gas prices have been much higher than coal and oil prices since last autumn, fuel substitution has already occurred to a large extent, particularly in the burning of coal in electricity generation.

Measures such as the lifting of the cap on coal burning in the Netherlands and the restart of coal generation capacity that had been put in reserve in Germany may add to this, although its impact on natural gas demand will remain satisfactory under the continued shortage of Russian supplies. It is also noted that fuel substitution in industrial operations is also possible, although so far it has been considered as a possible response to gas rationing, as opposed to a substitution due to current gas prices.

If implemented, such substitution measures would help sustain economic activity while managing gas storage levels. Substitution from fuels such as oil or coal for industry will not come without challenges, however, with European coal supplies becoming increasingly difficult from August, when the European ban on Russian coal imports comes into effect.

And while oil prices have retreated from their highs earlier this year, they are expected to rally significantly from current levels, especially when the refinery maintenance period returns in the fall.