Gas crunch hits government bond markets as energy prices surge


European natural gas prices shot to unprecedented heights on Tuesday, dragging down bond markets, particularly in the UK, in a sign that investors are anticipating wider economic damage.

European gas contracts for delivery in November jumped by 23 per cent to €117.50 a megawatt hour, up from just €18 six months ago on the prospect of supply shortages over the winter months. UK prices also soared, breaching £3 a therm for the first time, with prices tripling in just the past two months.

The latest price gains mean gas in the UK and Europe is now trading at more than $200 a barrel of oil equivalent or almost three times the price of crude, with inflationary effects threatening to ripple through economies reliant on gas for heating and power generation. Traders are now pricing in a peak in the UK consumer price inflation rate at nearly 6 per cent in April next year.

Tuesday’s gas price surge added fuel to a recent drop in bond prices, particularly in the UK where concerns about rising prices have been felt most acutely. UK 10-year government bond yields surged to 1.09 per cent, the highest since May 2019.

Government debt in the eurozone and the US also weakened, with 10-year US Treasury yields climbing close to last week’s three-month high, as investors become increasingly concerned about inflation.

“Bond markets are trading off gas prices,” said Mike Riddell, a portfolio manager at Allianz Global Investors. “The rise is so dramatic that it’s feeding these concerns about stagflation.”

Longer-term inflation expectations have also shifted higher, extending a gilt sell-off that began last month when the Bank of England indicated it could raise interest rates as soon as this year.

But investors have questioned whether central banks can curb inflation driven by tight supplies in energy markets, which have rippled out from Europe to the wider world. The largest economies in Asia are also increasingly feeling the hit of record prices, including in coal markets, with both China and India experiencing short supplies.

The tightness in energy markets stems, in part, from the rapid rebound in economic activity and energy demand from the depths of the pandemic. But gas demand has also risen in Asia, where governments are trying to reduce reliance on highly polluting coal. Europe’s domestic production has also fallen.

Russia, the largest supplier of natural gas to Europe, has also restricted pipeline exports to long-term contracts only, despite clear signs traders want more spot market sales to help fill storage facilities.

Russian president Vladimir Putin on Tuesday described the situation in Europe as one of “hysteria and confusion”, blaming tight supplies on under-investment in fossil fuels as economies try to pivot towards renewable energy.

Ukraine and other eastern European countries have accused the Kremlin of attempting to “weaponise” natural gas supplies to try secure quick approval to start up the Nord Stream 2 pipeline and as part of a backlash against the push towards renewable energy.

Nord Stream 2 will carry Russian natural gas to Germany through the Baltic Sea, bypassing Ukraine, and was targeted by US sanctions until a deal between Angela Merkel and President Joe Biden earlier this year.

Surging energy prices are also putting pressure on governments and policymakers in Europe. Ursula von der Leyen, head of the European Commission, said on Tuesday that Brussels would explore setting up common strategic storage facilities for gas, warning about Europe’s heavy dependence on Russia for imports, while praising Norway for taking steps to increase gas production.

“We are very grateful Norway is stepping up but this does not seem to be the case for Russia,” von der Leyen said.

Brussels is under pressure to act in the face of record natural gas prices that have forced governments in Spain, Italy, France and Greece to agree subsidies to protect households from higher costs.

Record wholesale prices have also led to the collapse of 10 retail energy providers in the UK since the start of August, requiring millions of customers to be transferred to other companies.

The cost of supplying the average household in the UK with gas and electricity for a year has soared to more than £1,800, far above the £1,277 price cap.