Energy Prices – Why are they so high and what next?

The natural gas market has been hit by a perfect storm. A prolonged winter left European stocks depleted; lower supplies from Russia and strong demand for liquefied natural gas from Asia hampered summer stockpiling ahead of winter; and UK North Sea production has plunged as companies perform pandemic-delayed maintenance.  The below graph summarises how UK gas and electricity spot prices have developed over the last two years;

Soaring gas prices have influenced electricity prices, with Britain particularly reliant on gas for electricity generation and home heating. 2021 has also seen some of the lowest wind speeds for fifty years, it doesn’t matter how many turbines have been built, if there is no wind to turn them they will not produce electricity. This has created further demand and reliance on gas to generate electricity to balance the countries energy system.

Due to the potential tight supply issues for this winter gas prices have been very fragile to activity which could impact supply, for example a fire at Britain’s main subsea electricity cable with France caused prices to increase astronomically and suppliers to cease quoting for a period.

There is no single factor which has cause global energy prices to increase through 2020 and 2021, the below summarises the multiple factors which has created the Perfect Energy Storm and historic high prices which we are now seeing.

Global Economic Recovery

Natural gas, which is widely used in electricity generation as well as heating and industrial uses, has been in high demand globally through 2021as economies recover from the Pandemic. Last winter in Europe and Asia was prolonged, draining gas storage levels. European countries have still not re-filled on stocks ahead of this winter due to the high global gas demand as global economies have recovered.

Asian countries including Japan, South Korea and China have been increasing imports of liquefied natural gas (LNG), which can be moved on tankers and has helped globalise a market that previously more heavily relied on pipelines and links to oil for pricing.

But strong demand has continued through the summer thanks to high temperatures in Asia boosting air conditioning demand and with more countries under environmental pressure to reduce reliance on coal.

Gas Storage Capacity

Britain’s largest gas storage site, the ageing Rough facility off the Yorkshire coast, was closed to new injections in 2017 after owner Centrica said it was not economic to refurbish it. Gas storage owners had long called for incentives to encourage investment in storage in a country that only has capacity to cover about two per cent of annual demand — against 20-30 per cent in most other large gas importers.

The UK has the lowest amount of gas storage facilities when benchmarked against other major European countries.  Whilst the UK’s small amount of European storage facilities are now full, our European counterparts have not been able to fully replenish gas storage facilities ahead of Winter 2021 and are at their lowest levels going into Winter for more than a decade.  This has created huge risk in the market that if Europe has a cold, long winter and storage facilities are drained there could be a shortage of Gas across the continent.

A link providing live European Gas storage levels can be found here

Liquified Natural Gas (LNG)

Cargos of LNG, which provided almost a fifth of UK supplies in 2019 have been scarce throughout 2021 due to the high demand and high price being offered by Asia. Qatari LNG cargoes have primarily sailed to Asia this year. This is a stark comparison compared to summer 2020 when LNG supplies were consistent, and ships were floating in the Mediterranean Sea waiting for a buyer.

Pipeline supplies from the EU have also risen in recent years, leaving the UK potentially more exposed since Brexit, should European companies come under pressure not to export in the event of supply shortages on the continent.

Those lower gas stockpiles in storage mentioned earlier have been exacerbated by strained gas supplies, due to maintenance on gas infrastructure in Norway, which had been delayed due to the pandemic.

Russia

Gazprom’s lack of increased gas flows via Ukraine and Poland has adrawn suspicious accusations that Russia is holding back supplies of its own gas, to make a point about how much Europe needs the politically controversial Nord Stream 2 pipeline, which is awaiting approval by German regulators.

But Russia, too, is facing its own supply crunch: higher demand is coming not just from Europe but also from Asia, and that has been paired with the pre-winter need to replenish its own stockpiles.

Russia’s situation is just one of the global strains on gas markets. Because it can be transported, liquefied natural gas (LNG) operates as the “global” market for natural gas. Weather events have impacted LNG from USA which has seen several Plants taken off the market by Hurricane Ida, which hit the Gulf of Mexico and also Hurricane Nicholas, which has also shut down an LNG export terminal near Houston.

Here, Europe’s desperate demand for gas is further causing the price to surge. The fact that Europe is behind the LNG price surge is unusual. Making things worse, Asia is still a centre of LNG demand—and a growing one: a push by the Chinese government away from coal, paired with the general economic resurgence, is drawing gas from both the U.S. and Russia, while inventories are low globally ahead of winter.

That is raising the prospect that China, too, could see winter fuel price spikes so severe that industrial production that relies on gas-fired power will have to be restricted. Companies cannot cover the costs, like the CF Fertiliser Plant which requested financial support to keep producing essential carbon dioxide here in the UK.

Wind

There’s also another factor in the rise of energy prices, one that is particularly important in Europe. Wind power, which now makes up around 20% of the European energy mix on average and directly competes with gas for power generation, has long grappled with a huge question mark; what happens when the wind doesn’t blow?

This summer, this is exactly what has happened, we have seen the lowest wind speeds recorded since 1961.

This shortfall (and the solar equivalent: cloudy skies) hits at the problem of renewable intermittency, which forces those who rely on renewables to either store energy generated by those energy sources in batteries to shore up low periods or rely on traditionally stable sources of energy like nuclear power, gas, or coal to fill the gaps.

Because battery storage on a wide scale is expensive, Europe relies on highly interconnected systems of power, moving renewable energy around on the continent to try and balance out supply. But low renewable supplies, currently paired with tight gas supplies, which typically step into the gap, is momentarily re-carbonising the European power system, and doing so at a high cost.

Carbon Prices and No Coal

In the UK and Europe, a surge in carbon prices, which raises the cost for utilities and industry of using polluting fuels, has also at times boosted demand for gas. Carbon prices in the EU are treble the level of before the pandemic and the UK’s similar post-Brexit carbon contract is at similar levels.

Historically we would simply turn on coal power plants to help meet demand if Gas prices soared but this now not really an option given the high carbon price and the phaseout of coal generation in the UK.

A Temporary Glitch?

Though many of the current conditions pushing up gas prices are temporary, the wind will probably pick up again, for example, whilst others hint at a more fundamental shift and higher long-term prices. An increased reliance on renewable energy, higher carbon prices, weather disruptions from hurricanes and storms, and geopolitical wrangling with Russia are all long-term trends that could add to price volatility in the years to come.

Meanwhile, the argument that the energy transition itself could produce a supply crunch and high prices, by deterring medium-term fossil fuel investment is an argument that’s made frequently.

What does this mean for my Business Energy Contracts?

The last thing any business will want to be doing in the current energy climate is buying.  Unless your energy contracts are up for renewal imminently our recommendation is to wait and see how this winter pans out, there is much more downside potential in market prices than upside.

If your business does have a contract renewal this winter our recommendation is to move to a flexible contract, if possible, which eliminates the risk of purchasing a large amount of volume at the current high levels.  Long term fixed price contracts are currently slightly cheaper than short term prices but at some point, we expect the market to correct itself and prices to fall.  We recommend businesses do not secure long term fixed price rates at the current pricing levels, if prices fall you will be stuck on an extremely uncompetitive long term contract.

Our view is to always take a three-year rolling view of energy prices, you may not hit the market at the lowest point, but a three-year view protects your business from volatility, provides budget certainty and alleviates the risk of being exposed to energy markets when prices are trading as they are currently.

For more information on current energy market prices, how your future costs will be impacted and procurement strategies which provide control on long term energy costs please contact hello@gleg.co.uk.