EU fires up plans to cap runaway power prices
Head of Commodity Strategy
Summary: EU gas and power prices trade lower today after rallying on Monday when markets responded to the Russia's latest strike against Europe by closing the Nord Stream 1 pipeline. A decision that according to Russian comments will not resume in full until the “collective west” lifts sanctions against Moscow over its invasion of Ukraine. However, the fact gas and power prices trade 35% and 52% respectively below the panic peaks seen in the aftermath of the Nord Stream 1 maintenance announcement on August 26, show the markets are looking to Friday's EU summit for solutions and answers to how Europe can mitigate the immediate threat to supplies
EU gas and power prices trades lower on Tuesday after rallying on Monday after Gazprom on Friday announced the Nord Stream 1 pipeline instead of opening following three days of maintenance would remain shut indefinitely. While an oil leak at the last compressor unit still in operation was used as explanation, the surprise decision came shortly after the G7 had announced a plan to cap prices on Russian oil. The energy war has therefore escalated further, and Europe look set to lose around 30 mcm/d or 4% of its gas supply.
While storage levels across the Euro area have grown rapidly in recent weeks due to surging imports of LNG, the prospect for rationing and further initiatives to curb demand for gas and power prices will attract an increased focus from politicians across the region. This in order to mitigate the destructive economic impact of surging prices ahead of peak winter demand season.
However, the fact gas and power prices trade 35% and 52% respectively below the panic peaks seen in the aftermath of the Nord Stream 1 maintenance announcement, show markets looking for policy makers to introduce measures to ease concerns within Europe.
EU leaders will meet this Friday to discuss a historic intervention in the energy market that may lead to price caps and other measures being introduced in order to limit the disruptions to consumers and industry from soaring and illiquid pricing markets. However, given the current limits on generation capacity, much of them due to Russia’s cutting off gas supplies, some sort of rationing plan may also be needed.
The draft that has been put forward by the Czech-led presidency of the EU and seen by several news outlets is focusing on five primary areas:
- Decoupling/limiting the impact of gas on the price of electricity
- Increasing liquidity in the market
- Coordinated demand reduction measures for electricity
- Limiting the revenues of non-gas electricity producers (ex. wind, solar and coal)
- Impact of the EU Emissions Trading System (EU ETS)
EU electricity pricing structure at the core of the problem.
Commodity markets tend to be priced at the margin, and so does electricity. This system basically means that gas-fired power stations often ends up dictating the wholesale electricity price for the rest of the market, even though renewable power and recently also coal, can be produced more cheaply. It is this market structure that in recent months with surging gas prices has helped drive power prices to previous unimaginable levels, peaking last Monday when German year ahead power briefly traded above €1,000/MWh, the equivalent of $1,700 dollars per barrel of crude oil equivalent.
Decoupling the price of power from surging gas prices has already been implemented in Spain and Portugal, two countries that benefit from having limited energy connections with the rest of Europe, as well as Greece. Across Europe such a system would work by charging non-gas power producers the difference between the agreed price limit and the actual market price - currently inflated due to high gas prices - that they receive for energy. The increased revenue from this surcharge should be shared among consumers while also support power generators forced to produce the marginal megawatt hour at a loss.
Between 1990 and up until 2019, the year before the global pandemic was followed by increased challenges with Russian gas supplies, Europe had seen the share of gas versus other energy sources rise from around 20% to 25%. With current high prices for gas this part of Europe’s energy mix sets the overall price for power, hence discussions to move towards an average or weighted average power price, the result of which would lead to lower consumer prices.
However, in this twitter thread my colleague Peter Garnry highlights the reasons why a change in the benchmark pricing of power will not reduce the overall cost, only redistribute it from consumers to utilities who then would need government support in order to avoid bankruptcy.
Latest Market Insights
Quarterly Outlook Q3 2022: The Runaway Train
- Winter is coming to the financial markets as central banks are tightening their grip. How spring will look is still a question.
European energy crisis: it will get worse before it gets betterThe winter in Europe will be tough, but whether the result is political chaos or sustainable, innovative solutions is still undecided.
A difficult and volatile quarter awaitsAs the year draws to an end, commodities continue to be at centre stage of the world with growth pockets political uncertainty.
The bright side: crises drive innovationThe positive spin on crises is that they come with solutions. It is worrisome that deglobalisation may be a response to this crisis.
Green transformation in China: renewable energy and beyondGoing green, China needs to span numerous energy sources to ensure stability, as every source comes with a challenge.
Asia: Intermittent solutions, but a faster renewable adoption curveAsian energy supply is being squeezed. This and the adoption of renewables may change the investment sentiment in the region.
FX: A Fed thaw needed to deliver a sustained USD turn lowerThe US Dollar can keep momentum when the Federal Reserve continues to tighten, leaving the rest to play to their drum.
Autumn can become ugly for equities and bond holders. Comfort for Dollar longsTechnical analysis suggests that equities could face a tough Q4 as could fixed income. US Dollar positions could provide some upside.
The next stock market sector to watch, with stocks going nuclearAs the world scrambles to find affordable, sustainable energy, nuclear is getting attention from politicians and investors alike.
The crypto space is getting cold when the hype disappearsCryptocurrencies face a winter of their own as retail investors and governments are asking tough questions.