Q&A: Could the energy crisis derail the green transformation agenda?
Summary: The energy crisis in Europe and the UK is increasing in impact and focus. But what are the ups and downs and how may it impact the long-term financial focus on e.g. the green energy transition? We have asked our Head of Commodity Strategy, Ole Hansen, to explain the crisis, its impact and what is generally important for investors to be aware of.
Ole, What’s going on - why are European and UK energy prices increasing as much as they are?
The past six months have been the perfect storm with low gas supplies, low gas storage levels due to a very cold winter in Europe last year and with a summer where the weather didn’t support the production of green energy.
Generally, the way the annual energy cycle works is that in summer we work towards filling the underground gas depots, so we can use those in winter times. Last winter was very cold, meaning that we used more of the stored energy than usual. That was followed by a summer, where wind, sun and other green energy sources have produced less than usual making it difficult for the gas producers to generate enough to both supply systems and fill up the storage units.
E.g. In Northern Europe, the wind hasn't blown as much as we’d normally see. The Danish offshore wind company, Ørsted, just reported one of the lowest energy production in a quarter for the last 22 years. Also, the European summer has been really warm, increasing the usage of energy for coolers. Finally, Russia, our main safety valve when green energy doesn’t produce, seems unable or unwilling to increase their gas output.
So the current increase in energy prices is because we lack energy?
Yes, it is basically a supply and demand imbalance. On one hand, you have global activity and growth increasing demand, but at the same time, there was a low supply to begin with coupled with a lower than normal production of energy.
Why do media speak of the current situation as a crisis?
Well, for starters, energy prices are trading around six times higher than a year ago and at least two or three times higher than the historical average for this time of year, so I think crisis is a fair tag for the current situation.
Adding to that, we are going to see second level effects for industries that are heavy energy consumers like e.g. cement, fertilizers and chemicals producers, which are basically forced to cut production. It is also a challenge for the agriculture sector, which is evident e.g. in the UK, where farmers have had a hard time to send their livestock to slaughterhouses because it’s become too expensive. This, in turn, leads to an increase food prices, which leads to increased inflation and so on. In the UK, this has forced the government to step in and subsidise the process.
Are any places in Europe harder hit than others?
Generally speaking it’s the areas with the lowest tax pressure that’s getting hit the worst. This is because the higher a percentage of your current electricity bill that’s taxes today, the smaller a part of the price you are used to paying will be affected by the increased prices.
More concretely, It is relevant to see how your house is being heated. Sadly this means that it is usually low income households as well as the elderly that will be hit the hardest, as they tend to live in the oldest houses with the worst insulation as well as the oldest heating systems or have the greatest need for heating, which they can’t afford. This is referred to as energy poverty.
Geographically, the UK in particular is being hit hard, because they don’t have district heating and a lot of their houses are heated by gas, which has seen the greatest price increase. And they are being punished quite severely. Right now, an average gas bill in the UK, according to the Financial Times, at current market prices, could go up by around £550 on an annual basis. That's an increase of nearly one third.
How is the European energy crisis affecting countries outside Europe?
The crisis is increasing the global competition for liquified natural gas (LNG). The summer has been really hot, especially Asia as well as in the US, which has meant that they have burned more energy for cooling systems than usual, meaning that – just like in Europe – their storage levels are lower than normal. E.g. China has been out stating that they are unsure whether they have enough gas stored to get through winter, meaning that they are also out willingly buying energy at elevated prices instead of using already-stored supplies. So while the supply crisis is primarily a European one, the global energy demand is likely to keep an upwards price pressure at least over the coming winter, which could very well lead to longer-lasting inflation.
What does this mean for me and my energy bills?
Well, it’s going to be more expensive to pay your bills. The individual purchasing power will go down, because people will have to spend more of their hard-earned cash on paying the electricity bill, heating up their house and refuelling their car. Even in a country like Denmark with very high taxes, where I’m from, it’s a sizeable increase in the electricity bill. So you will have less money for all the fun stuff.
Will the energy crisis hit my economy in other ways?
Yes, your purchasing power will also decrease and all the fun stuff will become more expensive as well. At least if it in any way consumes energy.
Is the increase in energy prices here to stay or is it a short-term thing?
I sure hope it isn’t something we have to get used to. But the thing is that during this green energy transformation we leave ourselves in UK and Europe vulnerable to events like this because we don’t have a so-called baseload of energy from a steady and reliable energy source and thus need to import it.
So is it fair to say that the green energy transition is causing the energy crisis?
It’s not the only reason, but we shouldn’t kid ourselves and say that it doesn’t play a part. Because it does. In energy management there’s a term called baseload, which is the permanent minimum load that a power system is required to meet fundamental demands by customers. In the past the that baseload was provided by baseload or conventional power plants such as coal and nuclear plants. With the green energy transformation, Europe, which is the most advanced in the transformation, is shutting down its conventional power plants as they are being replaced with renewable energy production. But the issue with this is that while it is easy to turn up and down for how much gas your pour into your power plant. We don't know what the wind is going to be doing in two weeks’ time and therefore it is very difficult for us to predict how much energy we can use. For instance in the UK we've seen days where sun and wind produced up towards 50 % of the entire power demand. And just recently some days it has been down to less than half of that. That’s an incredible volatility in energy supply.
So the transformation to a greener world is part of the reason, but it isn’t the only reason. The weather this past year is another part and the same is Russia, who have not added any additional supply because they state that they are unable to currently.
How do we create a sustainable and reliable baseload and at the same time go green?
It all comes down to scaling our green solutions. A sustainable, reliable and environmentally friendly baseload can be achieved by rolling out sun and wind power generation on an even greater scale, combined with a better network of interconnectors ensuring the flow and easy access between regions with too much and too little green energy production. Apart from that, the ability to store electricity in batteries and next-generation nuclear power technology, which, according to research, may prove to be safer than current technologies, while producing more power with the same amount of uranium.
Do you have any calculations on how much more expensive electricity can be in the process of going green?
I don’t have any concrete calculations, but until we are able to establish a reliable baseload, it will in theory be more expensive because in periods with lower supply than demand, we need to turn on some big back-up power generators to avoid blackouts and that isn’t cheap. But I mean, nothing in this world is free and neither is the green transition, but it is in the end a question of keeping our planet habitable.
How do we solve the energy crisis?
Well, first of all, we have to look at ourselves and see if we can decrease our individual energy consumption and do our part instead of just talking about it. That would be a good start.
Apart from that we’ll have to support our bright, well-educated army of young people who are interested in finding the technology, we are going to use tomorrow. It's a fascinating period we are entering into because there's so much focus, and so much government support to move to a greener world while ensuring our electrical stability.
Concretely there can happen a few different things, either we can “get lucky” and get a mild winter with great weather for renewables, which will decrease the demand for energy, Russia can decide to turn on the valve and provide Europe with more energy, which will increase the supply, or we can see governments go in and control the supply and thereby forcing the demand to decrease. This will be done by asking companies to scale down production, as it would be political suicide to accept blackouts for your population during winter.
Who should take responsibility for solving this crisis?
Governments will have to do their part and that will in the end mean that we all will have to pay for it through our taxes. That cannot be avoided it. But the government needs to do more than subsidise energy and – in worst case – control the energy output to companies. Governing bodies also need to look towards future energy sources like e.g. nuclear, which prominent people like Bill Gates are pouring billions into right now. Apart from that it’ll have to be a collaboration between us all – we need to funnel money through to innovation and development, e.g. through investing.
Do you think we can get through this crisis without bringing the green transformation into question?
I think we have to. There’s so much political will behind the green transformation that I cannot see how we can scale that back. But it’s an interesting discussion and last week there was actually some talk about whether politicians were more worried about blackouts than climate change. But even though the climate battle is global and you could argue that Europe’s development here doesn’t do a lot without the big polluters taking action, it seems very difficult, politically, to scale back on it.
Do you have any idea how high energy prices can go?
Well, we just saw last week that some companies began to curtail production, which could be a sign that prices have become so high that it is more valuable to shut down production than to increase it. But if we don’t see that behaviour across, and we end up with a cold winter, then the sky is the limit – then it’ll be parabolic until we get a very strong – probably governmental – response in terms of slashing demand. Then we could be talking about blackouts, but I sincerely hope we're not getting anywhere near that situation. We still have a few months left before winter really kicks in and then we can see if there should be any additional pressure on Russia to turn up the tabs.