Dead cat bounce
European industrial gas demand yet to reach rock bottom
European gas demand is showing the first signs of life since the energy crisis.
October saw the first year-on-year increase in gas demand since late 2021, driven by a rebound in industrial gas demand, and to a lesser extent by an uptick in residential & commercial consumption.
Is it just blip, or can the most meagre of green-shoots be sustained?
In the short term the answer has implications for European industrial emissions and hence demand for EUA’s. Longer term any sign of a recovery in industrial gas demand (~20% of Europe’s demand for natural gas) will be eagerly anticipated by EU governments and energy companies invested in bolstering the continents LNG infrastructure (see Europe's industrial slump: How bad will it get, and what does it mean for carbon?).
However, look back at October/November 2022 and you can see that gas demand was collapsing just as the energy price spike reached the peak of its parabolic ascent. Base effects are really what’s driven the apparent increase in natural gas demand.
Industrial gas consumption in Europe is concentrated in a handful of industries. Prior to the energy crisis just six sectors accounted for 87% of total industrial gas consumption: chemicals, non-metallic mineral products (cement and glass), food & beverages, basic metals (iron and steel), refining and coking, and pulp & paper.
European chemical production has been one of the most hardest hit sectors given its heavy reliance on natural gas (see Chemical reaction). Output during the first eight months of 2023 was down 11.2% versus the same period in 2022. Only the paper sector experienced a larger year-on-year decline, 11.6%.
The map below vividly highlights the scale of the ongoing disruption to European chemical and fertiliser production. Several facilities remain mothballed since October 2021, many have shutdown completely, while others continue to operate at reduced rates. Eurostat data shows that the decline in chemical production has been sharpest in Poland (⬇️18.3%), followed by Portugal (⬇️17%), the Netherlands (⬇️15.7%), Bulgaria (⬇️15%), and Germany (⬇️14.3%).1
Forward looking indicators continue to worsen. A continued slump in the order book combined with a pullback in business confidence across the sector in Europe suggest little prospect of an uptick in chemical production just yet. Natural gas prices may have come down, but that’s just one part of the equation. Operators are unwilling to restart production if they are not sure that demand is strong enough to justify the time and expense involved in restarting. Double-digit declines in selling prices for fertiliser, plastics and petrochemicals (Jan-Aug 2023 versus year earlier) point to a lack of impetus for a restart.
Other natural gas intensive industries are also now coming under pressure. Production of construction materials (cement, lime & glass) is starting to decline as construction activity across the continent begins to wane. EU construction volumes slowed from 2.7% in 2022 to a projected zero in 2023 and ING expects output to contract by 1% in 2024. Due to the long lead times involved with construction it can take many months before the impact from lower demand is felt across the supply chain. High prices for construction materials during 2022 helped insulate the sector from the turmoil affecting other energy intensive sectors, but slowing demand and downward price pressure is starting to force producers to cut production of building materials.
European steel production also has a big impact on overall natural gas demand given its use in the production of pig iron in blast furnaces (~60% of Europe’s production involves blast furnaces). According to The European Steel Association (Eurofer), overall European steel production growth declined from 3% in 2022 to 0.6% in 2023, and is projected to slow to a mere 0.4% in 2024. Over one-third of European production is tilted towards the construction sector, and so any further slowdown there will have an impact on the sectors demand for natural gas.
The outlook from those industrial sectors most dependent on natural gas isn’t exactly signalling an uptick in demand. What can we learn from past energy price shocks? Analysis published by two analysts from the Bank of Italy examined data from 2010 to 2022 to compare the impact of energy price shocks on European economies. In particular they looked at the typical length of time before the worst effects were observed in core inflation and industrial production.
Their modelling showed that it typically takes about 20 months for a gas price shock to completely filter through to core inflation. Given that European gas prices started their exponential rise in October 2021, this points to a peak impact in core inflation by the spring/summer of 2023 - pretty much what we have observed.
However, the full impact on industrial production takes around 35 months after the initial gas price shock. If correct this suggests that it won’t be until the middle of next summer before European industrial production is over the worst of the gas price shock.2
The question then becomes what shape the recovery in demand will look like: ‘U’, ‘V’, ‘W’, or even ‘L’. We can get some idea if we understand the reasons for the breakdown in industrial demand for gas since the beginning of the energy crisis, and what motivates those companies most affected by the downturn in demand.
The International Energy Agency (IEA) estimated that about 80% of the response was simple demand-supply dynamics. They estimated that around 50% of the decline in industrial gas demand in 2022 came from production curtailments, about 30% from fuel switching. The rest of the impact was the result of efficiency gains, import substitutions, and the effect of the weather. This analysis suggests that once input and output prices return to comfortable levels then we should expect industrial production rebound. However, it’s important to look at the underlying incentives affecting those industrial companies most exposed to the energy crisis.3
When looking at which industry was responsible for the decline in industrial demand for gas. One sector stands out. The chemical sector is estimated to account for around 40% of the decline in industrial gas demand. Despite this it’s incorrect to paint all chemical businesses in the same light. While some reported a significant downturn due to the energy crisis, others reported that the impact was negligible.
Analysis by OIES suggests that the ability of chemical companies to replace gas in their processes or raise sales prices was key to how the crisis affected them. Companies that produced a larger share of base products (such as BASF in particular), appeared to see a much larger adverse impact on output than those producing specialised chemicals for example.4
According to analysis by Goldman Sachs published in early 2023, up to 40% of the Europe’s chemical industry (primarily activities carried out by BASF) is at risk of permanent rationalisation unless natural gas prices fall to ~€70 per MWh or lower. BASF's European gas consumption fell by one third between 2021 and 2022 to 32TWh. Overall, the company accounts for almost 5% of total European industrial gas demand, the majority of which (24TWh) is centred on its Ludwigshafen site in Germany.
Gas prices have dropped significantly below that level (month-ahead prices are currently around €50 per MWh), and while chemical output prices remain mired in a downturn it’s becoming clearer that something more fundamental is going on. In February the chemical giant announced that it would close several production units at Ludwigshafen by 2026, permanently reducing its gas consumption at the site by 4.8 TWh per year.
The energy crisis may have sparked BASF into action, but its part of a longer term transition to reorientate the company towards locations elsewhere around the world where energy costs are lower, environmental regulations are less burdensome, and demand for their end products are still growing fast.
Whatever letter the eventual rebound in European industrial gas demand takes it’s likely to be a long and slow recovery, and will most likely never reach pre-energy crisis levels.
Note that in March this year the German chemical industry association Verband der Chemischen Industrie (VCI) were expecting Germany’s chemical industry to suffer an 8% decline in output between 2022 and 2023 https://www.vci.de/vci-online/presse/pressemitteilungen/brighter-mood-persistent-worries-business-situation-of-the-german-chemical-pharmaceutical-industry.jsp
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4549079
https://iea.blob.core.windows.net/assets/227fc286-a3a7-41ef-9843-1352a1b0c979/Naturalgassupply-demandbalanceoftheEuropeanUnionin2023.pdf
https://www.oxfordenergy.org/wpcms/wp-content/uploads/2023/11/Insight-137-German-industrial-gas.pdf
I would add that Cement companies have caught on to the fact that decarbonising their processes is not only technically easy, but that there is room for early movers to enjoy a significant arb, and enjoy the benefit of free allowances before phase out. Hocim just one of the players that are moving aggressively.