If you are concerned about the rising prices, you are not alone.
As the world reels from the biggest price rise in electricity and gas in over a decade, our expert analysts take a look at some of the reasons behind the sudden surge and what the future could hold in store.
European storage inventories are well below average
European storage
There were strong withdrawals in Q1 2021, as colder temperatures settled over Europe. At the same time, Asia was experiencing similar conditions. Japan had a very cold January along with several outages, which led to an immediate need for LNG to boost gas power generation.
As a result, LNG deliveries to Europe slowed down and the region had to rely on more stored gas. The early part of Q2 2021 saw persistent colder temperatures, low wind and maintenance, leaving little surplus to make its way into storage.
By the time injections started there was already a shortfall and the pace of injections has not been enough to shut down this deficit.
European storage is vital to ensure some security of supply over winter, especially if there are supply issues from other sources. Storage is also needed to top-up supply, when demand is high.
Reduced gas supplies this summer
UK LNG imports
Part of the reason for the lacklustre injections is the heavy maintenance in many gas-producing regions during this summer. Covid restrictions hampered maintenance schedules last summer and many sites were running strong through the colder winter that followed.
In addition to the shortfall in supply, LNG deliveries to the UK and Europe were drastically reduced, particularly during this quarter. This fall in import volume is due to a marked increase in demand for LNG in Asia this year. This demand growth is largely due to China ramping up its economy post-Covid, as well as other regions replenishing their depleted stock levels.
Weak renewable generation this summer
Power output comparison table
In recent years, the UK has increased its wind capacity to about 25% of the generation capacity. This summer has seen some of the lowest wind speeds, with the likes of Orsted – who have invested heavily in wind generation – reporting lacklustre returns this summer.
The graph above highlights the drop in wind output, especially in Q3 2021, and the increased need for gas generation. As a result, the need for gas to generate power has been elevated at a time of tighter gas supply.
Supply margins in the UK were extremely tight last week, and as a result, we saw some unprecedented price levels – as shown below in the UK day-ahead power price. System prices were as high as £4,000/MWh at peak times.
UK day-ahead power price forecastIncreased cost of substitute sources of power generation
In parts of Europe, there has been an increased reliance on coal and lignite power generation. On the back of various policy moves, the price of carbon allowances in Europe has also surged. This year alone, prices have doubled. As a consequence, it has become increasingly expensive for fossil-fuelled power generation. Gas prices have risen so strongly that it has become more profitable for coal and lignite power generation in Europe (which are more polluting) instead of gas.
The UK and European governments manage the supply of carbon allowances. With a current policy of zero carbon, it is difficult to see governments increasing the availability of allowances.
Carbon allowancesRussian gas supply
Despite the surge in gas prices across Europe, Russian supply volumes have not responded to demand. In July and August, there was maintenance on both Nordstream 1 and Yamal pipelines that saw substantial declines in Russian volumes, exacerbating the tight gas market.
The domestic Russian gas market is also under relatively tight conditions. Russian domestic storage was heavily drawn last winter and there has been some delay in replenishing them, due to heavy summer maintenance.
There has also been a reluctance to increase flows across the Ukrainian and Polish routes. In the meantime, with the completion of Nordstream 2, a preferred alternative route is ready. But there are some legal hurdles that need to be overcome, denting market hopes for the start of the fourth quarter.
What’s next?
There is a substantial risk premium priced into this winter, given all these factors so far. There is also an underlying uncertainty of how and when these will resolve, in the face of an unknown winter demand.
A mild and windy winter will allow for more wind generation and reduce some of the demand for heating. However, periods of cold and still conditions will see supply margins drop and system prices record high prices once more.
Gas could start to flow through Nordstream 2 this winter. But will this merely displace gas that is currently moving through one of the other routes to Europe? Or will supply increase significantly, once domestic reserves are met?
It is likely that this winter will see an increase in price volatility, with price swings in either direction.
For advice on how your business can respond to changing energy prices, contact EIC today.
