Unless you’ve been hiding in a cave for the past few months, you’ll be well aware of the rising energy prices. Particularly natural gas and particularly in Europe. Last year the annual heating cost for an average home in Europe was about €119. At current natural gas prices, that figure will be a whopping €738.
There is a myriad of reasons for this recent hike in energy prices.
SUPPLY & DEMAND
- On the demand side, we had a cold spring in Europe, followed by a hot summer in Asia, as well as the post-covid rebound in industrial production
- On the supply side, there were various production disruptions such as the Siberian forest fires
- Some also argue that Russia is holding back to force the Europeans to speed up the approval of Nord Stream 2
- Global LNG supply is roughly 5% below what it was last year
- In Europe, the situation is a lot worse because a good deal of that supply ended up in Asia (particularly in China as its economy picked up after the initial shock of the pandemic)
- LNG imports in Europe were lower by about 20%
But probably the most significant factor on the supply side is the fact that natural gas is now expected to play a bigger role as the world is transitioning from carbon to renewables. There is a lot less investment in coal, as it’s the most environmentally harmful. But the gap left by less power from coal is not fully filled by renewable sources. Add to that the fact that last summer, European winds were significantly lighter (so, less wind-generated power), and there were droughts all over the world (meaning less hydropower).
Hence, the skyrocketing prices at breakneck speed.
NEW KIDS ON THE BLOCK
One of the interesting things about the energy markets is that demand can be largely price-inelastic. It takes really big price movements to curb demand. Not only do consumers of energy just have to keep on buying, but also retail prices don’t always reflect the real price of energy thanks to regulatory control and other types of government intervention, such as the UK’s recent price caps or the subsidies in Italy.
That ‘missing money’ has to come from somewhere, which explains the failing energy retailers in the UK. Since the liberalization of the markets, there has been a glut of newcomers who have been offering fixed-priced contracts to consumers. And yet, they buy energy at floating rates without any sensible risk management programs.
SHORT CUTS CAN MAKE LONG DELAYS
Energy markets have always been volatile. That volatility will rocket over the coming years as the world works to transition from carbon to renewable sources and the markets try to navigate this transition. Intermittency of renewable power, the fact that grid level battery storage is only in its infancy, and the continuously evolving regulatory environment all contribute to higher volatility of energy prices. Market participants who ignore this and do not manage their risk are basically gambling.
About the title of this blog
A lot of people in European energy markets are trying to predict if this winter will be a mild or a harsh one, as that will determine the direction of energy prices.
Doing a back of the envelope calculation, the difference between the cost of natural gas used in Europe last winter versus what it would be this winter at prevailing prices is about €140 billion.
If my sources and unit-of-measure conversions between exajoules and million cubic meters and MMBtu and MWh are correct, then: Europe consumes about 2 billion MWh of natural gas in an average winter. Last year’s prices were hovering around €15 per MWh of natural gas, while they are at about €85 these days. Hence, the €140 billion prize for whoever can guess the winter weather in Europe.
If you don’t want to gamble and wish to monitor and manage your risk, let’s talk.
It could be the safest decision you make this winter.