Head of Commodity Strategy
Summary: European consumers, both private households and industry, have witnessed surging electricity and fuel bills during the past six months. While part of the increase is driven by a strong post-Covid growth recovery, the bad news relates to supply which especially for natural gas has been in short supply during this period.
European consumers, both private households and industry, have witnessed surging electricity and fuel bills during the past six months. The good news is that part of the rally has been triggered by increased demand, with Europe witnessing a growth sprint just like other regions of the world following last year’s pandemic-led shutdowns. The bad news relates to supply, which especially for natural gas has been in short supply during this period.
European power or electricity is derived from four major sources: combustible energy such as crude oil, gas and coal; nuclear power; hydroelectric power; and renewable energy such as wind and solar. As per the 2019 graph from Eurostat, Europe remains highly dependent on combustible fuels, which depending on the source requires the user to offset the generated pollution through the purchase of carbon emissions.
So far this year, Europe has been hit by an almost perfect storm of developments which have helped drive gas, coal, emissions and power prices to or near record levels. The biggest single contributor has been reduced flow of gas following a very cold winter which has helped deplete stock levels. During the second and third quarter in any year, excess gas imports from Norway and Russia, and to a lesser extent through shipments of LNG, are pumped into storage facilities across the continent to be used during the peak autumn and winter period.
Due to lower-than-expected gas imports from the three mentioned sources, especially from Russia, gas prices in Europe earlier this month hit a record with the Dutch TTF benchmark hitting €48/MWh, or more than double the ten-year average. Reduced flows and a scorching hot summer in Southern Europe has driven gas in storage some 20% below the five-year average to a ten-year low for this time of year, and with time to restock before winter running out, the risk of a supply crunch and elevated prices remains.
Russia’s Gazprom, the national gas producer, is just weeks away from completing the controversial Nord Stream 2 pipeline, and once completed, gas could flow directly from Russia to Germany, thereby reducing flows on the main pipeline via Ukraine. This is a line that for years has provided Ukraine with a major source of revenues, and one of the reasons why the U.S. has been against the pipeline. Just recently, the US applied sanctions on two Russian entities involved in the gas link while German Chancellor Angela Merkel has offered reassurances that Ukraine would not suffer from the construction of the Nord Stream 2 pipeline. The German energy minister has chipped in by saying Germany would not create obstacles while Ukraine said talks about its future as a transit country had been vague.
The latest twist in this saga has come today from Dusseldorf Higher Regional Court. It ruled that the Nord Stream 2 pipeline is not exempt from European rules that require the owners of pipelines to be different from the suppliers of gas to ensure fair competition. This ruling may further delay the starting time for when gas will flow
With gas prices in Asia also surging, arrivals of LNG shipments to Europe has slowed, thereby increasing further the continent’s reliance on Russian supplies. As a result of the reduced gas flows, European power producers have been forced to buy more coal and due the higher level of carbon emission, the cost of buying pollution offsets via the European Emissions Trading Systems (ETS) has risen to record levels near €60/tons.
The ETS started back in 2005, and today, it is by far the largest and most successful market. It’s a very liquid cap and trade system where the authorities set a cap for the maximum amount of carbon emissions that can be produced within an economy or region. The ETS is by now very well-established and carries a high degree of transparency. It covers roughly 40% of the greenhouse gas emissions (GHG) in Europe through sectors like utilities and industrials. Other sectors like agriculture, construction and transportation (including shipping) are currently not included, while some are expected to be included over the coming years.
In summary, the result of surging gas, coal and emissions prices this year has been surging electricity prices across Europe with record levels seen in Germany this past month. Several electricity intensive industries have seen their electricity bills rise by a factor two or even three. Given the political will to cut emissions through stealth is likely to propel emission prices even higher over the coming years, not least considering the prospect for additional industries being included.
In order to achieve such a massive emissions reduction, utilities, industry and other heavy polluters will increasingly be looking towards alternative low emission sources of energy. With this in mind there is little doubt that demand for power derived from renewable sources, which has yet to include nuclear, will only continue to rise.
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