Demand destruction stalks Europe

What does the energy crunch teach us about the energy transition?

The unfolding global energy crisis has added urgency to the slow-burning debate on the role of reducing demand to achieve climate objectives. The trouble is, most people are looking through the wrong end of the telescope. When markets turn febrile, the first casualty is perspective.

In the energy and climate debate, the focus is skewed on the supply side. Commentators pore over upstream capital allocation, the reserves replacement ratio of big oil companies, or their climate strategies. (This newsletter is a little guilty of this too, albeit with one or two exceptions.)

Supply movements are lag indicators. Demand always drives the market. But when undersupply creates an extreme imbalance, the market screams out for demand destruction. Sentiment is everything in these moments, and Russian President Vladimir Putin sent prices whipsawing by laying bare his true intentions (as previously discussed in Energy Flux).

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More gas molecules are yet to arrive, either as LNG or via pipeline. Until that happens, the epic bull run in wholesale gas and power will continue towards price ceilings determined by the elasticity of each source of demand. We aren’t there yet, and prices have been barrelling up through some notable resistance levels to hit new all-time highs almost every day this week.

More supply would certainly help, but when price graphs go parabolic like this it is precisely because extra supply failed to materialise in time. Prices have now become unanchored and are searching for the ‘pain point’ where switches are physically turned off.

That can be either an orderly or disorderly process, one dictated by the cruel efficiency of markets or the squalid compromise at which politicians and regulators excel. Those that power down first either can’t afford to pay, or aren’t deemed important enough for state protection.

China has so far borne the brunt of what is shaping up to be a scary period of winter fuel price discovery. North-east China witnessed unplanned power cuts, disruption to water supply and even panic buying of candles.

Central and provincial governments sought to seize control of the situation by rationing electricity and imposing shorter factory working hours. Reports of people trapped in elevators and hospitalised by gas poisoning due to a lack of air conditioning make it hard to tell the difference between an organised power-down and a chaotic one in Xi Jinping’s China.

Where China leads, Europe follows. German ammonia producer SKW Piesteritz is throttling production by 20% as soaring costs erode economic viability, and warned of knock-on impacts on agriculture if governments don’t intervene. That could push up food prices and throw fuel on the fire of runaway post-lockdown inflation.

If critical supplies of basic products are at risk, intervention is guaranteed. The UK’s emergency subsidisation last month of carbon dioxide production at CF Industries to protect meat supplies won’t be the last – not least because it was supposed to last for only three weeks. Keep an eye out for an extension next week.

When any commodity supply tightens, protectionism and hoarding are kneejerk responses. Observe recent fisticuffs at the UK’s many depleted petrol stations, or panic buying of certain foodstuffs.

There are always winners and losers, so any protection offered to gas consumers will come at the expense of others. In the absence of a surprise and dramatic gas price correction, successive interventions will be needed to avoid crucial private industries from shutting down.

UK energy consumers are already protected by the retail price cap, at the expense of suppliers. Now heavy industries want special treatment to keep essential goods flowing and supply chains functioning.

The UK’s Energy Intensive Users Group is calling for the “immediate cessation” of policy costs such as the Carbon Price Support. Its European equivalent, IFIEC Europe, wants the European Commission to release more ETS allowances to bring down the carbon price.

Speaking to Energy Flux, IFIEC Europe president Peter Claes said industrial consumers are facing tough operational choices. These are individual decisions based on a company’s gas and power supply contracts (i.e. fixed or variable price) and its customer commitments.

Lost production from isolated plant shutdowns lasting a few days or weeks could be offset by reselling cheap energy on fixed-price contracts into overheated wholesale markets, Claes said. Those on variable tariffs don’t have this luxury and are more exposed, but temporary closures can still be managed in the hope that prices come down quickly.

“However, if my plant is down for three months I have to look for other solutions: start producing somewhere else in the world or see if I can find other producers, probably outside Europe, from whom I can buy my product to satisfy my customers rather than make it myself ”

Claes warned that without guaranteed access to competitive energy prices, “we might see some energy-intensive products not being produced in Europe anymore”.

Jobs mean votes, so ministers in the UK and across the EU might be swayed by these arguments. But protection can only go so far, and exacerbates the risk of actual physical shortages further down the line. If this worst-case scenario occurs, rationing cannot be avoided. This is when the really tough political choices must be made.

Once you have passed the point at which smelters stop smelting, bakers stop baking and boilers stop boiling, the government must decide which of these activities must continue at all costs, whom may do it, when and for how long.


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Fortunately, this remains a distant prospect. Yet the question of demand destruction remains critical to both balancing the market this winter, and to the decades-long energy transition. And the same question about whether it is left to market forces or political compromise must be answered in both cases.

When the dust settles on this winter crisis, might we have learned something about the scope for demand destruction to help bring climate-heating emissions onto a sustainable footing?

At the very least, when pressure groups call for fossil fuel supply cuts to precipitate elusive demand destruction, we will be able to give an answer to the question of ‘what might that look like in practice?’ In a word: ugly.

Despair not. There are encouraging signs that consumers *do* think about alternative choices when fuel crises hit. The UK’s petrol shortage seems to have prompted a surge of interest in electric vehicles. As eye-watering wholesale gas prices filter through to households via successive increases in the price cap, that might drive interest in heat pumps too.

At a political level, we are seeing bifurcated responses in Brussels: renewed zeal towards security of supply (which could translate into investment in strategic gas reserves), in tandem with strengthening resolve that reducing reliance on fossil fuels will insulate economies from future shocks.

The latter can be achieved by investing in renewables, subsidising energy efficiency measures, and reducing demand by changing lifestyles and behaviours. This boils down to ‘more fossil fuels in the short term, and less over the long term’. Which is probably the right general approach, because the world sadly needs both.

  • RELATED: If you’re curious about who the winners and losers are in all this, Scope Ratings has you covered.

  • RELATED (#2): ‘Net zero’ is all but unachievable in the UK without major reductions in energy demand, a new study finds. Existing policy instruments would reduce demand by only 5% by 2050 and require the electricity system to quadruple in size. But demand could be more than halved by 2050 without compromising quality of life to alleviate that burden. It would also bring numerous co-benefits that could actually improve lifestyles, the authors say. Here’s a quick overview:


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Also worth reading:

International

  • Hydrogen is too dirty and yet we should use more of it, says IEA – The energy transition can be tricky to navigate, even for experts. The International Energy Agency has highlighted the 900 mt of CO2 emissions generated from hydrogen production in 2020. In the same report, it called on governments to “scale up ambitions and support demand creation”. (Just a thought: Why not focus on decarbonising existing H2 supply first?) The IEA seems to have a more cogent message on tackling fossil fuel plant methane leaks, offering practical measures for a 75% cut by 2030. No head-spinning required there.

  • Global energy use and emissions set to soar by 2050, says EIA – Yet another reminder of the yawning gap between ‘net zero’ rhetoric and the reality of runaway emissions growth, this time from the US Energy Information Administration’s International Energy Outlook 2021.

  • Pledges, pledges and more pledges – The ‘net zero’ promises bandwagon is now a symphony orchestra on world tour. The International Air Transport Association has pledged climate neutrality by 2050, as did the United Arab Emirates – the first Gulf oil exporter to make this commitment and, as COP26 looms, maybe not the last.

  • Shell’s LNG volumes slump at worst possible moment –Liquefaction volumes from the world’s largest publicly traded LNG player will come in at 7-7.5 million tonnes in Q3’21 results, probably the company’s lowest in more than three years. This is due to “feedgas constraints and additional maintenance”, Shell said. With Brent at $82/barrel and JKM Asian spot LNG above $50/MMBtu, this is unfortunate timing both for Shell’s shareholders and the market in general.

Americas

  • No more cheap US gas this year, says S&PRatings agency raises its assumption for Henry Hub gas pricing to $4.50 per MMBtu for the rest of 2021, as HH futures surge above $6/MMBtu amid extreme Asian LNG spot surge. The US might have to choose between cheap domestic gas and its aspirations to be a global LNG heavyweight, argues Nikos Tsafos of the CSIS.

  • Phillips 66 sets precedent with modest Scope 3 emissions target – US independent targets 15% cut in 2019 product-related emissions by 2030, the first major American oil company to do so. Activists expect Chevron and ConocoPhillips to follow suit.

  • Hydrogen truck maker takes a jaunt upstream – Nikola signs pact with TC Energy to develop, build and own large-scale hydrogen production hubs to serve its Class 8 fuel cell electric vehicles (FCEVs) operating along busy trucking corridors in the US and Canada.

Europe

  • Uniper winds down engineering arm in decarbonisation re-think – German utility’s stand-alone engineering services unit will cease servicing external customers to focus exclusively on Uniper’s own fleet. An exception will be made for strategic growth areas: hydrogen, renewable energies, industrial customers and ‘net zero solutions’. Uniper says it is following its own decarbonisation strategy, which in this case means job losses.

  • Shell’s biofuels plan ‘increases deforestation risk’, says NGO – Using ‘waste’ cooking oil to produce aviation fuel puts pressure on limited supplies, leading to the increased production of virgin oils like palm to fill the gap, according to Transport and Environment

  • UK publishes eligibility criteria for industrial CCS support – The government’s proposed Industrial Carbon Capture (ICC) business model is “designed to incentivise the deployment of carbon capture technology for industrial users who often have no viable alternatives available to achieve deep decarbonisation” (more here)

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‘Carbon border tax spells trouble for non-EU oil and gas suppliers’ – Despite excellent leadership within its borders, Europe has 40% higher embedded flaring intensity in its imported oil than the global average, says Capterio. If the EU’s proposed Carbon Border Adjustment Mechanism (CBAM) is extended to energy imports, “border taxes of €3 billion per year could be levied on extra-EU oil and gas suppliers (equivalent to 1-2% of the underlying commodity price)”.

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🙃And finally...

The stakes in the energy transition couldn’t be higher. Choose very carefully…

That’s all for now. Energy Flux returns to the inboxes of premium members next Thursday.

Until then, please spread the word about the publication if you can. It always makes a huge difference.

Thanks for reading!

Seb


Main photo by Chris LeBoutillier from Pexels, edited by Seb Kennedy