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Too much politics, not enough gas
Dissecting the European energy crunch
European energy prices are going ballistic. Barely a day has gone by this month without wholesale gas and power prices breaking the previous day’s new all-time high. But what is really driving the bull run, what does it mean for decarbonisation, and how is this playing out in the political arena? Energy Flux breaks it all down.
European gas traders have never known anything like it. The Dutch Title Transfer Facility (TTF), the benchmark for north-west European wholesale gas prices, went stratospheric this week.
The Chicago Mercantile Exchange’s October-dated TTF futures contract on NYMEX exploded above €72 per MWh on Wednesday (~$25/MMBtu), having risen almost 10% since the market opened that morning. Month-ahead TTF typically averages ~€15 to €25 per MWh in September.
The TTF forward curve looks bleak over winter. You can’t buy gas for less than €60/MWh until April 2021, when the price drops precipitously to €36/MWh – still well above seasonal highs of recent years.
Expensive wholesale gas is pushing power prices up across Europe. German baseload power futures dated September are trading above €143/MWh, rising to €171/MWh for delivery in February 2022. Just like TTF, the April power contract is trading much lower. The Italian power forward curve looks similar.
At these prices, gas-fired power generation is being pushed out of the money. To the detriment of the climate, coal-to-gas fuel switching is being reversed – even though coal in Rotterdam has more than tripled in price over the last 12 months.
(We are now hearing the first calls for the UK government to postpone the looming 2025 target to end coal-fired power generation. No matter what happens at the COP26 climate talks in November, this would be politically untenable.)
Flipping the merit order
Coal burn is up across much of the continent, driving demand for carbon allowances (EUAs), which have shot up to ~€60 per tonne. This, in turn, is driving power prices ever higher.
It is now much more profitable to run a 40%-efficient coal-fired power station and buy more EUAs on the Emissions Trading System (ETS) than it is to run a 60% efficient ultra-modern combined cycle gas turbine (CCGT) and buy fewer EUAs.
In fact, all but the most efficient CCGTs are now loss-making if generating at German baseload power futures prices:
The situation is so dire for gas that it would require the carbon price to more than triple, to €200 per tonne, to put gas-fired power ahead of coal in the merit order – as illustrated in this theoretical graph:
This would be a pyrrhic victory for gas. EUAs at €200, which is not unthinkable, would push gas-fired generators even further into loss-making territory, regardless of their efficiency. Without thermal backup, renewables, biomass and nuclear alone would have to keep the grid running around the clock.
This is not a realistic situation for most of Europe this side of 2030. In Germany, power prices would have to rise to €220 per MWh to offset the €200 carbon cost and allow CCGTs to run, according to calculations by Energy Flux.
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The political fallout
These prices would ultimately fall on European consumers. Smelters, cement factories and other heavy industries would dial down output in peak hours or even shut down altogether, with implications for jobs – always a political flashpoint.
This is not a distant possibility. Only yesterday, a large manufacturer of nitrogen and hydrogen halted operations indefinitely at two UK facilities “due to high natural gas prices”.
Political ramifications are already being felt with carbon at the comparatively benign €60 mark. European Commission technocrats who usually steer clear of sending market messages are now calling for market participants to “keep calm” as these inflated CO2 prices are, apparently, only “temporary”.
ETS prices will soften when the extremely tight global gas market loosens up and power sector demand for carbon allowances falls away. But longer-term, the cost of emitting carbon must rise – and significantly so – if Europe is to deliver its ‘Fit for 55’ climate package.
That’s the whole point of carbon pricing – it is supposed to make existing business practices less affordable than cleaner alternatives, and drive investment into decarbonisation. There is a widespread expectation that EUAs will breach €100 per tonne in the latter half of this decade, and hedge funds are positioning themselves accordingly.
The populists pounce
In the meantime, there are more pressing issues to attend to. Parabolic power prices in the UK are pushing unhedged smaller suppliers into insolvency. This is not *yet* a political crisis in Westminster, but it has potential. Wait for more suppliers to go bust.
Just look at Spain, where wholesale prices tend to filter through to residential bills more quickly. The government has cut retail energy taxes and is rolling out legislation for a windfall tax on energy firms. Funds raised will be redistributed to consumers to offset soaring bills.
Quite how the government intends to claw back profits is not entirely clear, but it makes for a good headline and Spain’s ruling Socialist Party (PSOE) could do with some of those. PSOE is taking a bludgeoning in the polls over ballooning energy prices, with the right-leaning opposition Popular Party (PP) seizing the opportunity to score political points.
Meanwhile, the spectre of the gilets jaunes haunts officials in France, Greece and Italy, where moves are afoot to rein in wayward power prices and alleviate impacts on the fuel poor. If these measures fail, governments expose themselves to scathing attacks from populist opponents eager to exploit the genuine anguish of those most vulnerable to price shocks.
The European Commission can expect more populist-flavoured blowback the longer this goes on – which is probably why the European Commission’s arch Green Deal evangelist Frans Timmermans told the EU Parliament:
“The one thing we cannot afford is for the social side to be opposed to the climate side... Only about one-fifth of the [electricity] price increase can be attributed to CO2 prices rising.”
This claim was corroborated by clean energy think-tank Ember. Whether the message gets through to voters is another matter entirely.
Putin’s gas-fired power play
All of this begs the question, why exactly is gas rallying in the first place? Financial chicanery and prudent risk management are certainly at play in the face of deteriorating liquidity and ballooning volatility. But that’s a late cycle anomaly. Let’s take a step back.
Don’t believe the narrative that strong gas demand is the primary driver. European gas demand is, surprisingly, currently very average. There’s an argument to be made that this is an opportunistic supply-side power play. Here’s how it goes.
Gas prices were high in the second quarter of 2021 due to the long end to the winter, and the 2021-22 winter contango failed to materialise due to the expectation of imminent new flows from the newly complete Nord Stream 2 gas pipeline under the Baltic Sea.
This meant there was no incentive to refill gas stocks, which are still well below the five-year average – leaving Europe more exposed than usual to gas supply constraints. Might Russia have spied an opportunity to engineer a supply crunch?
Well, by coincidence, Russian flows of Arctic gas into Europe along the Yamal pipeline have been severely curtailed since a fire took out a Gazprom facility over the summer. Some observers have speculated that this has taken deliberately longer than necessary to fix, as a means of pressuring German institutions to give NS2 the green light to start operations.
The German regulator is now saying certification of NS2 could take four months. At issue is the question of whether NS2 complies with EU competition rules that require the owner of the pipeline to be separate from the owner of the gas molecules flowing through it at the point of entry into Germany.
Lo and behold, the Kremlin is now talking about breaking up Gazprom’s gas export monopoly and allowing Russian semi-state oil giant Rosneft to export gas along NS2 as well. BP, which owns 19.75% of Rosneft, saw its shares rise 4.5% on that news.
Dude, where’s my freedom gas?
Other market factors are at play. Russia is said to be facing its own domestic winter gas supply challenges, while rampaging Asian LNG demand is pulling cargoes eastwards and leaving European regasification terminals underutilised.
US LNG exports are at record levels, but not much of it is arriving in Europe. Officials in Brussels might be puzzled that ex-president Donald Trump’s beloved “molecules of freedom” are not flowing to their rescue.
Total US LNG exports in June 2021 (the latest available dataset) were up 149% year-on-year, at 271.2 billion cubic feet (Bcf). Official data show the US shipped 70% of this to non-European destinations: South Korea (55.9 Bcf), China (42.3 Bcf), Japan (39.8 Bcf), Brazil (32.3 Bcf), and Argentina (19.3 Bcf).
Therein lies another harsh market reality: Europe is, and always will be, the market of last resort for global LNG suppliers. LNG cargoes follow the money and Asia pays a premium. Latin America is also prepared to pay, as a prolonged drought has curtailed regional hydro-electric power generation.
This market dynamic, whether cynically exploited by Vladimir Putin or not, is inconvenient for die-hard proponents of “freedom gas”. Like so much that came out of the Trump administration, the description of US LNG as “giving America’s allies a diverse and affordable source of clean energy” feels like an absurd memory.
There is one last irony to observe. European utilities “went on arbitrage against Gazprom in the 2010s to change their [long-term] gas supply index from Brent to TTF which was deemed at the time more affordable,” a gas industry source tells Energy Flux.
Today, Brent is at $72/barrel and TTF is at the equivalent of almost $150/barrel. Or to put it another way, gas at 13% Brent slope today costs $9.36/MMBtu, while TTF is almost three times more expensive at $25/MMBtu. Again, Putin never misses an opportunity to gloat:
Infuriatingly calm weather
One thing that definitely can’t be laid at Putin’s door is the becalmed state of the North Sea, where wind speeds dropped to seasonal multi-decade lows just as the shortage of gas set European power markets alight.
Wind power was generating as much as 40% of the UK’s power and 12% of the EU mix as recently as mid-August. Those figures dropped into the low single digit percentages for much of September. Inevitably, this was seized upon by anti-wind zealots.
What goes unmentioned here is the gas industry’s claim to be a partner of the wind industry, ready to back up variable output renewables with flexible, affordable, cleaner-burning thermal generation.
Seb Kennedy | Energy Flux | 16th September 2021