Energy market: Europe faces its anxieties
Natural gas prices are surging on both sides of the Atlantic due to winter weather concerns. While North America prepares for the first proper cold spell of the winter season, Europe is wary of another so-called ‘Dunkelflaute’ episode appearing later this week. The shift in the forecast for Europe over the past days towards cold weather and soft wind conditions added fuel to the price rally.
Europe seems to be very anxious about winter energy supplies. The pre-pandemic natural gas price response to similar weather events was less pronounced, even under tighter supply conditions. Indeed, over the past two weeks, storage levels swiftly dropped back to average as cold weather and weak wind conditions raised demand. However, this season’s storage offers a sufficient buffer to absorb such demand spikes.
Europe’s gas demand trends lower for structural and cyclical reasons. Overseas imports have fully replaced Russian inflows, and there is no visible gap. On top, strong growth in solar capacity means that gas demand from power plants begins to drop off ever earlier in spring. The winter window for storage to buffer demand gets ever shorter. Nevertheless, Europe is fearful about supply and reveals an unnecessarily high willingness to pay for imports. Prices paid for liquefied natural gas trade considerably above production/logistics costs, without meaningful signs of scarcity in the market.
In North America, the episode of depressed prices is likely ending. Liquefied natural gas exports are about to grow strongly over the coming years as new terminals enter service, the first of which should come online this winter. To meet demand growth, prices must settle around USD 3 per million British thermal units to set the incentive for gas-specific drilling and production. This view already underpinned our longer-term forecasts. In consequence of the recent price moves and seasonality, we lower our view to Neutral from Constructive and raise our near-term forecasts.
Equity strategy: Consumer cyclicals up, utilities down
Going into 2025, we see potential tailwinds for consumer cyclicals (stocks that are highly influenced by the economy such as airlines and luxury items) sector. Particularly in the US, where improving consumer confidence and higher real disposable incomes provide a supportive backdrop. That said, selectivity is essential, as various subsegments face structural disruptions: autos from electric and autonomous vehicle trends, media from internet-based platforms, and retail from the rise of e-commerce – just to name a few.
Regionally, we favour US consumer cyclicals, which are less exposed to these challenges and stand to benefit from stronger economic prospects, while remaining cautious on European counterparts, where luxury goods and automobile manufacturers dominate. The luxury segment continues to struggle with weak Chinese demand, while automakers face structural challenges and additional tariff exposure. Arguably, a large part of those risks is already priced in for those segments, and our analysts see value in selective quality names, but the case will likely take some time to play out.
With regard to utilities, which have performed in line with the market so far this year, we expect headwinds in 2025, as rising long-term yields and stronger economic activity typically weighs on this defensive, bond-proxy sector. Within utilities, we have a preference for European names due to the lower upside risk for bond yields in Europe, underappreciated solid earnings momentum, and the recent share price overreaction to the US election.
What does this mean for investors?
Natural gas prices are surging due to the cold winter outlook. Europe’s supply fears are overdone. Storage is sufficiently filled to absorb any demand spikes. Meanwhile, the episode of depressed prices in North America is likely concluding, as exports are picking up with new terminals becoming operational.
On the equity side, while US cyclicals are well positioned to benefit from stronger economic prospects, European cyclicals face ongoing challenges from weak Chinese demand and structural industry disruptions. We have upgraded consumer cyclicals to Neutral. Conversely, we have downgraded utilities to Underweight, as rising yields and accelerating economic activity create headwinds for this traditionally defensive sector.