Turmoil in the natural gas market spells trouble ahead

The outlook for inflation and the global economy hinges in large part on where energy prices head next—which makes recent turbulence in natural gas markets a worrying development.

What’s Happening: European natural gas prices finished at a record on Monday. They remain close to that level on Tuesday after Russia’s Gazprom said it would suspend flows to Germany via the Nord Stream 1 pipeline for three days starting at the end of the month.

Natural gas prices in Europe are almost 10 times where they stood this time last year.

Prices in the United States are significantly lower, but they’re rising, too. On Monday, they hit their highest level in 14 years. They’ve been pushed up by increased energy use during heat waves, demand from Europe as countries try to stock up for winter, and lagging production.

Salomon Fiedler, an economist at Berenberg Bank, told me that the sharp run-up in natural gas prices this week makes him confident that Europe is already entering a recession.

The Purchasing Managers’ Index from S&P Global released on Tuesday, which measures the services and manufacturing sectors of the economy, showed that business activity among the 19 countries that use the euro contracted for a second consecutive month.

There was one reason for optimism. S&P Global said ‘there were again signs that inflationary pressures at businesses have passed their peak, with rates of increase in both input costs and output prices softening across the board.’

But Fiedler expects this relief to be ‘short-lived.’

‘With the recent surge in energy prices—wholesale gas prices in particular—we will probably see quite a bit more inflation for the remainder of this year,’ he said.

This isn’t just bad news for Europe. Citi has said British consumer inflation could peak at 18% in 2023, or nine times the Bank of England’s target.

High demand for fuel and limited supply is also propping up natural gas prices for buyers in Asia, and to some extent in North America. Global businesses could take a hit as eye-popping bills weigh on demand for goods and drive up their own costs. And while central banks don’t have control over energy prices, they could be forced to keep hiking interest rates if the impact spreads across the economy and they need to fight a new wave of inflation.

One Caveat: Oil prices have been moving in the opposite direction. A barrel of Brent crude, the global benchmark, is down 16% since the beginning of July. US oil prices are 15% lower during the same period.

Other factors are driving that part of the energy market, as traders hone in on forecasts that slower global growth will reduce demand for fuel.

Crude prices could remain volatile in the coming months, however. Saudi Arabian Energy Minister Prince Abdulaziz bin Salman told Bloomberg this week that ‘extreme’ volatility in markets is disconnected from fundamentals, and that OPEC and its allies could be forced to cut production as a result.