The bank believes that European gas prices will fall sharply this winter
Earlier this week there were a slew of headlines claiming that the energy crisis had been solved and that prices were expected to come down imminently. The stories cited a report released by Goldman Sachs entitled ‘Natural Gas: The End of an Era’, which attempts to model the complex dynamics of the natural gas market amid the backdrop of major changes since Russia brought gas deliveries to Europe to a halt.
Note two of those words: ‘complex’ and ‘model’. The paper is not one built on facts but rather on assumptions. We all remember those models during the early pandemic warning of 250,000 Brits dying by Spring 2020 or 2.2 million Americans gone within months, which turned out to be fanciful (to put it kindly). Those too were attempts at modelling a highly complex phenomenon and used assumptions to do so.
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The truth is that models are just stories told using mathematics and data. The assumptions plugged into the models are like fictitious characters in a novel. Ultimately the assumptions — like the characters — do what the writer tells them to do. By changing the assumptions in the model, it can be determined whether the outcome of the story is tragic or not.
Immediately then, the headlines claiming that the energy crisis was resolved were far-fetched. A more honest headline would have run something like: “Goldman Sachs analysts model scenario in which energy crisis is resolved”.
At that point the question becomes: based on what assumptions? If we dig into the model a few immediately catch our eye. First, the analysts assume a substantial drop in energy consumption. ‘Consumer demand assumptions through the end of winter embed an 11% drop,’ the authors write, ‘with most of this reduction impacting industrial and generation demand for gas (-18% vs average, a deeper decline vs what we have observed recently).’
To my eyes, an 11% drop in energy usage and an 18% drop in industrial energy usage is not a resolution of the energy crisis, it is the energy crisis. The analysts are assuming that industrial capacity in Europe drops by around one fifth, which in turn means shortages and potentially runaway inflation.
In addition, the authors appear to make a number of rather rosy assumptions about Liquid Natural Gas (LNG) supply. These include: ‘higher LNG supply from new projects in the US and Mozambique vs last winter, the restart of the Hammerfest facility in Norway, and a recovery in feedgas in Trinidad allowing for higher exports’.
But it is important to remember that these have not actually happened yet. The authors admit as much, writing: ‘Alternatively, LNG supply could disappoint… a sustained drop in LNG into Europe would likely trigger a surge in gas prices’. Well, quite.
It doesn’t stop there. The authors go on to list yet more assumptions about a ‘cold spike during winter’; Russian gas imported by Italy being curtailed; ‘a colder-than-average winter in Asia’; and ‘a stronger-than-expected rebound in China’s economic activity’. The list goes on and on.
Contrary to the headlines, if this report shows anything, it is how difficult it will be to resolve the energy crisis. As much as we may be comforted by reports like those produced by Goldman Sachs, it is wishful thinking to believe that there is an easy way out of this situation we find ourselves in.