Euro Boosted by Sharp Drop in Natural Gas Prices

File image of Ursula von der Leyen. Photographer: Etienne Ansotte. © European Union, 2020. Source: EC - Audiovisual Service.

Plummeting natural gas prices are seen supporting Euro exchange rates as the end of August draws close.

European and UK Gas prices for future delivery are down in the region of 20% at the time of writing, aiding the Euro back above parity against the Dollar and extending a multi week run of gains against the Pound.

"A retreat in European natural gas futures after the Commission promised emergency intervention and reform in the power market came as a breath of fresh air for the euro," says Marios Hadjikyriacos, Senior Investment Analyst at XM.com.

Gas prices are in retreat on a combination of two factors: 1) data shows European storage levels are rising rapidly, lowering chances that rationing will be required. 2) European leaders are looking to reform the pricing structure of the electricity market, which should bring prices down.

1) Storage success

Gas Infrastructure Europe reports Europe had by Sunday met the EU's target to replenish storage to 80% of capacity by November.

"These stores of gas are being filled at absolute peak prices, ordinarily you’d hope to have filled them when the price is very low. In Germany, was driven by Government backed loans to utilities essentially buying at any price," says Faisal Islam, Economics Editor at BBC.

This hints at declining physical demand going forward as gas companies can opt to be more price responsive when meeting the remaining storage needs.

Above: The EU gas price benchmark has fallen sharply. Image courtesy of @ChrisGiles_

Above: The UK benchmark has also fallen amidst lower demand in Europe. Image courtesy of @ChrisGiles_

2) Energy pricing reform

European Union Commission President Ursula von der Leyen said Monday the EU intends to introduce notable reform to European energy markets. The UK has already said it is also looking at taking similar measures.

The current market structure means even electricity that is relatively cheap to produce, such as wind and solar power, is expensive to buy if gas prices are high, pushing up costs for utilities and households.

It is hoped the final price of wholesale electricity can be disentangled from the price of its most expensive component, in this case that generated from gas.

It is this link that governments in both the UK and Europe want to break, possibly by creating separate markets for power produced by wind and solar or gas and coal.

von der Leyen said the worsening energy crisis besieging Europe has laid bare the "limitations" of the electricity market and requires an "emergency intervention".

This has been a torrid month for the Eurozone and its single currency as gas and electricity prices soared to new records amidst tightening supply from Russia and surging demand as countries raced to fill storage facilities ahead of a difficult winter.

"The skyrocketing electricity prices are now exposing, for different reasons, the limitations of our current electricity market design," von der Leyen said on Monday, at the Bled Strategic Forum in Slovenia.

"We, the Commission, are now working on an emergency intervention and a structural reform of the electricity market. We need a new market model for electricity that really functions and brings us back into balance," she added.

Should investors sense the worst of Europe's energy crisis is near, they might start backing the Euro again.

We have noted in regular reports that the Euro has been particularly prone to weakness amidst surging Eurozone energy prices, given the energy-intensive nature of the German economy.

The EU also sources more gas from Russia than, for instance, the UK which depends on its own North Sea reserves and imports from Norway.

Falling gas prices are therefore more likely to impact the Euro in a positive manner than the Pound: the Pound to Euro exchange rate is down below 1.17 at 1.1688 at the time of writing, its lowest level since July 21.

The Pound has now fallen against the Euro for four of the past five weeks, (last week saw the pair end flat).

The Euro is now building up a head of steam against the Pound and a test of 1.16 and the June lows of 1.1462 are now likely.

The Euro to Dollar exchange rate is meanwhile up a third of a percent at 1.0041 with recent price action confirming the market is not entirely comfortable with levels below 1.0.