The price of natural gas in Europe, which typically accounts for about one-fifth of the bloc’s electricity consumption, has nearly quadrupled since the start of the year. The root cause is not one single issue but rather a series of event that have tended to reinforce and amplify a problem of demand outrunning supply.
Natural gas is a flexible fuel that can be used to generate electricity, heat homes, and is an essential input to the chemicals and fertilizer industry. It can also be stored in very large volumes underground and transported around the world in either pipelines or special ships. Because of these diverse uses, the demand for natural gas can be influenced by weather and economic activity while its delivery through long pipelines can also be impacted by geopolitics.
In the current energy crunch, weather has had a central role, but other factors have exacerbated the issue. Earlier this year, Europe experienced a cold snap which increased the demand for natural gas. This was significant because it came at a time in the year when large volumes of gas are normally purchased for underground storage facilities to stock up and prepare for the following winter.
This annual practice of building up gas storage provides the necessary resilience to the European energy system by generating a buffer for the upcoming winter. However, last April’s cold snap diverted gas away from storage and more towards immediate consumption, with the result that today’s storage levels are only around 70 per cent full compared to the 93 per cent levels of a year ago period. Meanwhile, a warm summer in Asia increased the demand for air conditioning and electricity, resulting in cargoes of shipped natural gas which could have gone to Europe to meet growing demand to be redirected to higher bidders in Asia instead.
At the same time, lower output from Europe’s renewables, partly due to lower than average wind speeds, coincided with a strong rebound of the European economy. This meant that more gas was needed for businesses which overlapped with a time when imports from key pipelines were lower than expected due to outages and maintenance. Furthermore, carbon credits, which firms need to purchase in order to use coal-fired power generation, have almost tripled in price since the start of the year. The European Commission has been reducing the supply of carbon credits to the market, which has also contribued to higher gas prices.
On its part, Russia, which is a key energy exporter, limited pipeline exports to Europe, raising questions about whether this may be a deliberate move to bolster its case for starting flows via its Nord Stream 2 pipeline. The controversial pipeline, bringing natural gas to Europe from Russia, bypassing Ukraine and Poland, via the Baltic Sea, is soon expected to be fully operational and could potentially resolve some of the region’s supply problems.
Governments in a number of European countries have expressed alarm at the pace at which gas and electricity prices are rising and in some cases have already stepped in to deal with the issue. In Spain, the government announced a windfall tax that is planned to claim around €3 billion from the country’s utility groups while intoducing a cap on consumer bills. Similarly, Italian Prime Minister Draghi announced that his government is readying public funds to subsidise consumers’ energy bills due to the latest increase in prices. Finally, in France, the government is mulling whether to extend energy voucher benefits to more households to tackle soaring prices.
Disclaimer: This article was written by Stephen Borg, Head of Private Clients at Calamatta Cuschieri. The article is issued by Calamatta Cuschieri Investment Services Ltd and is licensed to conduct investment services business under the Investments Services Act by the MFSA and is also registered as a Tied Insurance Intermediary under the Insurance Distribution Act 2018.
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