EUROPEAN GAS OUTLOOK: RELIEF FROM A LATE-STARTING WINTER

For Europe's late-arriving winter 2006/07, price relief from last year's record-high levels seems in sight. Absent extreme weather, both spot and oil-linked gas prices are expected to slowly decline. Investment in new supply remains a high priority for companies in and around Europe, as the gas industry continues to be in an expansion mode.

* Demand-only a modest check to growth. Although European natural gas demand growth rate is slowing, demand is still increasing, in spite of high wholesale and retail prices, mainly driven by the power generation sector with a healthy pipeline of gas-fired plants.
* Tomorrow's supply-certain capacity, uncertain surplus. The European gas market in the next two years will go from tight supply in certain markets-notably the United Kingdom, Italy, and the Iberian Peninsula-to surplus delivery capacity. Given the surplus, Iberia's worries are fading; but new UK infrastructure may not have sufficient supply to comfortably meet peak winter demand in case of extreme cold weather.
* Prices-a sea change in the offing. Longer term Europe's gas price environment will likely change substantially. Prices are shifting from a dual (UK spot and oil-linked contract prices) to a triple price dynamic adding global gas prices through LNG arbitrage and supply. As the United Kingdom comes to depend on large, new infrastructure that provides lumpy new supply, its spot prices, although lower, will likely be more volatile. The relationship between National Balancing Point (NBP) gas prices and Continental oil-linked gas prices will evolve from a NBP premium to a discount against oil-linked prices-reverting to their pre-2003 pattern.

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