An already structural problem in Gas Precios
Since January 2021, natural gas prices have climbed more than 170% in Europe, raising concerns about possible macroeconomic consequences. Both demand and supply factors have contributed to straining the European gas market.
European demand for gas is increasing in home heating, industry and power generation. The increase in residential heating demand due to a cold winter and widespread teleworking led to a 7.6% increase in global gas demand in Europe in the first quarter of 2021. In addition, the combination of a continued rebound of industrial production, summer heat waves with increased use of air conditioning and rebounding carbon prices in the EU, which are encouraging the switch from coal to gas in power generation, have maintained European demand for gas at a low level. high in the second quarter of the year.
Supply problems also arose. Russia has limited gas pipeline exports to Europe due to strong domestic demand, production interruptions and high liquefied natural gas (LNG) prices linked to the economic recovery in Asia. Russia is also potentially limiting the supply of natural gas to Europe and the start of flows through the Nord Stream 2 pipeline will not begin until 2022.
European gas reserves are scarce and what was used during the winter could not be replenished during the summer months. The need to replenish these reserves implies an increase in European imports of LNG and gas in the coming months, which encourages competition between Europe and Asia for the supply of LNG and, consequently, a further increase in gas prices.
The advanced structure of the European gas market, ironically, makes matters worse. Since 2005, gas pricing in Europe has moved from the classic oil indexation formula to gas-gas competition, similar to that of the US market. About 80% of the natural gas consumed in Europe in 2020 was priced according to this competition, and only the remaining 20% was still indexed to oil.
By way of comparison, the price of gas in East Asia is still mainly based on the indexation of oil. This characteristic makes the European gas market more flexible, but exposes Europe to strong fluctuations in the international market.
Although natural gas supplies only about a fifth of electricity in Europe, rising gas prices are putting disproportionate upward pressure on electricity prices. Gas-fired power plants have become pricing units due to increased demand for electricity (through recovery and declining renewable energy production due to heat and low wind speeds during the summer), the rise in world coal prices and the unprecedented rise in carbon prices in the EU. Therefore, wholesale electricity prices are increasing rapidly.
Rising energy prices have become a problem with macroeconomic effects in Europe. On an annual basis, a doubling of wholesale electricity prices from around € 50 / megawatt hour to € 100 / MWh would mean that EU consumers would pay up to € 150 billion (€ 50 / MWh for 3 billion MWh) more for its electricity. High gas and electricity prices affect supply chains and cause inflationary pressures. Drastic increases in energy expenditure will reduce the disposable income of the poorest households with their high propensity to consume.
Fuel poverty in Europe is a major problem: the percentage of people who say they cannot afford to keep their homes warm enough is high in many EU countries, such as Bulgaria (30.1%), Lithuania (26.7%), Cyprus (21.0%), Portugal (18.9%), Greece (17.9%) and Italy (11.1%). This price increase will have socio-economic implications.
If poorly managed by governments, low levels of gas storage and a cold winter could even lead to a shortage of supply. The current high prices are therefore an economic signal that demand must be brought under control to prevent the situation from worsening during the winter.
The key question for policymakers is whether this price move is a one-time shock resulting from a rapid recovery and bad weather. This would imply that letting the market run in the short term is the best way to get back to “normal” prices. Temporary government intervention could help protect the most vulnerable households from rising energy prices. For example, additional revenue from the EU carbon price and energy VAT could be returned to citizens in the form of fixed amounts per capita.
In our view, however, there are more fundamental reasons for the high volatility and excessive price spikes. The industry knows that the energy system is undergoing a profound and rapid transformation. Investments in fossil fuels are not sustainable in the long term. But governments have yet to make a sufficiently clear commitment to a low-carbon future. Therefore, the balance between energy supply and demand in the EU will be unstable depending on how quickly fossil fuels are phased out and green energy is introduced.
Clearer government commitments to introduce low-carbon energy sources, for example by financing the necessary infrastructure and committing to substantial carbon prices in all sectors, could help remove this precarious balance. Since the shift to net zero-emission energy will imply an ever-increasing demand for electricity, investors will not have to worry about over-investing in low-carbon energy systems.
At EU level, the early approval and implementation of the “Fit for 55” package would thus represent a more structural solution to avoid future energy price hikes and ensure an orderly transition from brown to green.