Europe’s energy ambitions are clear: to shift to a low-carbon future by remaking its power generating and distribution systems. But the present situation is an expensive mess. A global supply crunch for natural gas, combined with low inventories, military tension on the Russia-Ukraine border and bottlenecks for renewable energy, have contributed to soaring prices for everything from electricity to coal. Governments are prepared to intervene if needed in volatile energy markets to keep homes warm and factories running.
1. What’s the problem here?
Natural gas prices in mid-December climbed back to October’s peak levels as economies started to emerge from the pandemic -- boosting demand just as supplies were falling short. While the omicron virus variant was damping some demand, there was still pressure on supplies. Coal plants had been shuttered, gas stockpiles were lower than normal and the continent’s increasing reliance on renewable sources of energy was becoming a vulnerability. Benchmark European gas settled at a record 128.30 euros a megawatt-hour Dec. 14, compared with about 20 euros at the start of the year. Power prices have also surged, with German year-ahead electricity and futures for the first quarter of 2022 in the Nordics reaching record levels.
2. What do gas prices have to do with electricity?
Some 23% of European Union electricity was generated from gas in 2019, just behind the 26% that came from nuclear plants. Electricity is very hard to store, which means that big swings in fuel costs translate quickly into price volatility. Large batteries exist, of course, and that technology is developing quickly, but it will be many years before they can offer serious storage capacity for renewable energy. Some European countries have become increasingly dependent on electricity exports from others with an abundance of power.
3. Why is there a supply shortfall?
Gas inventories in Europe in December were the lowest on record for the time of year. China, which is by far the biggest consumer of energy and commodities in the world, has ordered state-owned companies to secure supplies at all costs. Prices in Europe would need to stay high to attract cargoes of liquefied natural gas away from Asia, where China is stockpiling to power its economy and build reserves for winter. Earlier in 2021 Norwegian gas flows were lower than average during maintenance work at its giant fields and processing stations, and supplies from Russia were limited while it was rebuilding its own inventories. Russian President Vladimir Putin calmed the gas market in October by offering to help stabilize the situation, saying Russia could potentially export record volumes of the vital fuel to Europe this year. More recently, though, a key new avenue for Russian exports to Europe has become complicated by geopolitics.
4. What is that avenue?
Delays in certifying the controversial, newly completed Nord Stream 2 natural gas pipeline under the Baltic Sea between Russia and Germany have combined with market concerns about potential disruption of gas flows through Ukraine to drive natural gas prices higher. Nord Stream 2, opposed by the U.S. government because of concerns over Europe’s energy dependency on Russia, must clear political hurdles before it starts operating, but is also entangled in bureaucracy and will need to wait several more months to gain regulatory approval. At the same time a geopolitical crisis has been brewing as Russia has built up troops at the border with Ukraine. A potential invasion could come at the height of the European winter, according to U.S. and Ukrainian intelligence, although Putin has denied any such intention. The U.S. was pushing Germany to agree to stop Nord Stream 2 should Putin invade Ukraine, according to documents seen by Bloomberg and people familiar with the plans.
5. How are power prices set in Europe?
Utilities and big companies buy and sell power years in advance, relying heavily on forecasts about the economy and long-term fuel costs. The broader European power market has traditionally been focused on the price for the following day, with auctions supplying a day-ahead price functioning as the benchmark. Traders submit bids and offers for each hour based on their calculations of supply and demand, and then an average price is calculated by the exchange handling that market. Consumer prices are set by state regulators after utilities request rate changes based on how much they’ve paid for wholesale power, transmission investments and overall upkeep of their grids.
6. What’s new in the system?
The explosion of renewable energy, which is more intermittent than fossil- or nuclear-fuel generators. Because weather patterns can create big price shifts, markets for shorter time periods later the same day have also become vital.
7. How reliant is Europe on wind?
Northern coastal countries including the U.K., Germany and Scandinavian nations have become leaders in wind generation and technology. In Spain, the growth in wind and solar plants helped send its share of renewable energy to a record 44% of total power in 2020. France also is producing more power from wind, but its electricity generation is still dominated by nuclear plants.
8. Which countries are most at risk of running out of power?
Those with limited cable links to their neighbors. In a crisis, they are less able to benefit from Europe’s interconnected market, which enables power to flow to where it’s needed the most and where it fetches the highest price. Ireland’s grid operator warned in September that there was a risk of blackouts due to lack of wind. Many U.K. plants are old and break down from time to time. If big outages coincide with little wind or sun, the nation could be close to running out of electricity.
9. What does this mean for Europe’s climate goals?
Renewable energy brings volatility, and that’s going to make it very costly for the continent to reach its targets. EU climate chief Frans Timmermans has said higher prices must not undermine the bloc’s resolve to expand renewable power and that the industry should speed up instead to make more cheap green energy available. In October, EU energy chief Kadri Simson said the EU was reviewing recommendations for member states on the measures they can take to alleviate the crisis without undermining EU rules, including compensation for the most vulnerable households, tax cuts and state aid for companies.
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