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Energy Spike in Europe – Why, How Long, Impact

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by Kamalakannan N , Senior Research Analyst, Energy and Sustainability
28 October 2021

Natural Gas Prices

All energy prices are witnessing an increase in Europe since the start of the year. The prices of all key energy commodities, including natural gas, electricity, and coal, are in multi-year highs. The reason for the spike is multifold, some of them are the critical changes in the market that happened recently, while some already exist and have been building gradually.

natural gas price

The Reason for the Price Spikes

There is no one specific reason, but there are multiple interlinked events and changes that are now playing out in the energy markets. Some of the major reasons are increased frequency of summer heatwaves, reduced Russian gas export, renewables scaling problem, and increased carbon price.

High Demand

  • The increasing frequency of heatwaves and the related increase in power & gas demand is a relatively new phenomenon that is being added to the typical energy price spikes. The key spike is generally during winter, due to high demand for heating across regions. However, the western hemisphere has been facing more frequent, stronger heatwaves than in the past few years
  • The western hemisphere heatwave in 2021 has set off the increased demand during June–July 2021, where the prices were high, due to the demand-pull from the residential and commercial heating requirements. Europe imports about 35–40 percent of its gas from Russia, which has been increasing the exports to cover the demand spikes

Supply Crunch

  • The typical demand during summer has reduced the ability of European suppliers to increase their inventory. As the summer demand eased from Europe and western hemisphere countries, the demand from Asia and the large consumers in Asia, such as China, Japan, Korea, and India, had led to the increased demand. India, after its disruptive COVID-19 waves, has started to recover and demand has increased. This sustained demand has kept the global supply tight as well
  • The high impact was felt when the gas supply from Russia became uncertain. Russia, which supplies most of the gas to Europe, reduced its export from August 2021, on the account of two major reasons:
    • An accident in a Siberian gas processing plant reduced the export to Europe by 3 percent in the second week of August 2021

    • Russia will need to increase its domestic gas inventory, in order to meet strong domestic demand and also export to Europe

  • On top of these, Hurricane Ida has impacted the US’ ability to export more LNG and reduced the country’s inventory

Carbon Prices

  • Carbon prices are another major factor that has impacted the power prices across Europe. In Europe, the price of carbon emission allowance is determined by the EU Emission Trading Systems (ETS). The EU ETS was being implemented in phases, its most advanced phase IV began in January 2021 and will be effective until 2030

  • This latest phase of the EU ETS has tightened the supply of carbon allowances in the form of free allocation to entities. This means that more carbon emissions will need to be priced using lesser allowances, creating a strong increase in carbon prices. The cap of the carbon market is also expected to reduce annually, in order to support sustainable pricing of carbon. This directly translates to more cost for some of the largest power generation companies in the region, which is then reflected on electricity prices.

natural gas

How Long?

  • The current energy price spikes in the region are expected to continue for the next two quarters. Traditionally, Q4 of every year is the highest demand phase for gas and electricity. This is due to winter and its related heating demand from residential and commercial enterprises. Hence, the prices may start to ease from February 2022 onwards

  • Russia has announced its completion of the Nord Stream 2 pipelines construction, which can increase gas supply to Europe. However, the pipelines remained one of the controversial constructions, due to the geopolitical impact of Europe’s dependency on Russian gas. The gas project had constant criticism from the US. However, Russia has applied and is waiting for the approval of the German Energy Ministry to use the new pipeline. However, Russia will not be able to increase its production in the short term even if the pipeline comes online

  • The demand from other regions for coal and gas is not expected to slow down during the period, as they both are connected to power demand, which is strong.

Future Impact

  • As of early October 2021, the gas inventory in Europe was 74.7 percent full against the five-year seasonal average, from 2014 to 2019, at 87.4 percent. This shortage in inventory, along with high global demand, peak production, and lack of gas supply, is expected to disrupt both supply and price in the coming winter 

  • In the UK, 12 small to medium-sized energy suppliers have ceased their retail operations, due to the impact of high wholesale prices of gas and electricity. Ofgem has reallocated its customers to different suppliers 

  • The most significant impact, due to the gas price hike, is felt on gas utilities, as well as energy-intensive industries, such as Ammonia, Fertilizer, Glass, CO2, and other industries. Due to high prices and strong demand, few smaller suppliers are expected to collapse. Few small suppliers in the UK gas solicited government support, in order to supply to their customers. In Spain, the government has introduced a levy on clean energy generation companies, in order to support smaller gas suppliers

  • In the long term, if the new gas field capital expense (CAPEX) is not increased to find and tap new sources of natural gas, the existing ones will remain more sensitive to global demand drivers, such as heatwaves or natural disasters

  • The governments have not interrupted the market with regulatory support so far, except for short-term relieves. This could be because the governments expect the market to return to normal post the short-term supply scenarios play out.

  • Regulatory actions can also give a long-term relief for energy prices. For example, the EU ETS carbon markets contain a Market Stability Reserve that can be tapped to increase the allocation of emission allowances in the market, thus reducing the price of carbon emission allowance unit.

 

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