EU fires up plans to cap runaway power prices EU fires up plans to cap runaway power prices EU fires up plans to cap runaway power prices

EU fires up plans to cap runaway power prices

Ole Hansen

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. 

Disclaimer

The Saxo Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website is not intended to and does not change or expand on this. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/en-sg/legal/disclaimer/saxo-disclaimer)

None of the information contained here constitutes an offer to purchase or sell a financial instrument, or to make any investments. Saxo Markets does not take into account your personal investment objectives or financial situation and makes no representation and assumes no liability as to the accuracy or completeness of the information nor for any loss arising from any investment made in reliance of this presentation. Any opinions made are subject to change and may be personal to the author. These may not necessarily reflect the opinion of Saxo Capital Markets or its affiliates.

Saxo Markets
88 Market Street
CapitaSpring #31-01
Singapore 048948

Contact Saxo

Select region

Singapore
Singapore

Saxo Capital Markets Pte Ltd ('Saxo Markets') is a company authorised and regulated by the Monetary Authority of Singapore (MAS) [Co. Reg. No.: 200601141M ] and is a wholly owned subsidiary of Saxo Bank A/S, headquartered in Denmark. Please refer to our General Business Terms & Risk Warning to consider whether acquiring or continuing to hold financial products is suitable for you, prior to opening an account and investing in a financial product.

Trading in financial instruments carries various risks, and is not suitable for all investors. Please seek expert advice, and always ensure that you fully understand these risks before trading. Trading in leveraged products such as Margin FX products may result in your losses exceeding your initial deposits. Saxo Markets does not provide financial advice, any information available on this website is ‘general’ in nature and for informational purposes only. Saxo Markets does not take into account an individual’s needs, objectives or financial situation.

The Saxo trading platform has received numerous awards and recognition. For details of these awards and information on awards visit www.home.saxo/en-sg/about-us/awards.

The information or the products and services referred to on this website may be accessed worldwide, however is only intended for distribution to and use by recipients located in countries where such use does not constitute a violation of applicable legislation or regulations. Products and Services offered on this website are not intended for residents of the United States, Malaysia and Japan. Please click here to view our full disclaimer.

This advertisement has not been reviewed by the Monetary Authority of Singapore.