- A severe demand/supply imbalance has sent gas prices soaring
- High electricity prices are the result of high gas prices, which have risen stratospherically due to historic underinvestment in the sector, and recent outages
- Climate policies have had negligible impact on current energy prices
- Renewables helped shield customers from even greater volatility.
Record energy prices have caused a crisis in Europe
- Gas and electricity prices have risen dramatically. At its peak in December 2021, the European benchmark for gas prices had risen 850% from the start of the year, according to Bloomberg data. Since then, they have fallen dramatically, but they remain at elevated levels – over four times higher than this time last year. Electricity prices too have been surging, notably in France, Germany and the UK. Energy markets have buckled under the pressure. German electricity prices increased by over 500% over 2021. In the UK, 23 energy retailers have gone bust, impacting some 3.7 million customers, and taxpayers are potentially on the hook for billions of pounds.
- The crisis has sparked a fierce debate, with some blaming the energy transition. The oil and gas industry has pointed to climate policies and investment pressures that have forced a premature departure from fossil fuels. Others state that low wind speeds are to blame. On the surface, these explanations appear plausible, but they are not borne out by the data. While wind plays a crucial role in supplying electricity in Europe, gas sets the price for electricity in Europe’s power markets. Therefore, the complex dynamics of supply and demand in international gas markets are at the heart of Europe’s energy crisis today.
High electricity prices are the result of high gas prices
- Gas supply has not kept pace with demand. A rapid, if chaotic, recovery from the pandemic has increased demand for gas, but supply has struggled to keep up. For at least parts of 2021, supplies from Russia and Norway, which together account for 60% of exports to the EU, were at some of their lowest levels since 2015. In Norway’s case, extended maintenance and outages were to blame. Notably, a protracted outage at Norway’s Toll field, Europe’s biggest gas field, alone cut supply by 27 million cubic metres a day, almost 3% of the EU’s gas imports at the time. A marginal outage, but one that can move the dial on prices. Since then, more Norwegian facilities have come back onstream and supply has risen sharply. Prices, however, remain high. This is largely due to the low levels of Russian exports, prompting some to suspect that Putin is playing geopolitical games.
- Geopolitics has not helped Europe, but domestic factors in Russia are also at play. Russian gas flows to Europe have been lower than in previous years, despite Gazprom meeting its contractual obligations. The European benchmark price for gas has closely followed signals from Putin about whether or not Russia will increase supply. Some observers have surmised that Russia’s actions are motivated by the controversial Nord Stream 2 pipeline, whose approval German regulators have suspended. Indeed just this month, Fatih Birol, Executive Director of the International Energy Agency (IEA), accused Russia of creating “artificial tightness” in European gas markets to ratchet up prices. But domestic reasons also explain why supply from Russia was much lower in 2021. For one, the need to fill its own domestic storage facilities has kept much of Russia’s gas capacity out of the market. Russia’s storage was largely depleted following a bitterly cold winter early in 2021. Exacerbating this, its production of gas has struggled to increase in tandem with demand. Russia had to scale back its production after demand dropped dramatically during the height of the COVID-19 pandemic in 2020. Owing to the mechanical complexity of these facilities, bringing them back to full capacity takes time.
- Lower pipeline imports have sent demand for shipped liquefied natural gas (LNG) soaring, which has caused a dramatic increase in prices. Through LNG, gas markets have become more global. Europe pivoted towards LNG to reduce its dependence on piped gas, predominantly from Russia. In 2021, LNG represented approximately 25% of the EU’s gas imports. However, a global market is vulnerable to global shocks, and extreme weather events in 2021 helped fuel competition for scarce LNG. A cold snap in Northeast Asia in January sparked a buying spree from Japan and South Korea, while droughts in Latin America crippled hydro capacity, leading countries like Brazil to purchase more LNG. Again, suppliers could not meet demand. At least 10 LNG facilities were either offline, had planned maintenance or did not have enough gas in October, according to Rystad Energy. Norway, Nigeria and Trindad, which together supplied 10% of LNG in 2020, all faced severe supply constraints in the third quarter of 2021, pushing up prices further.
- High gas prices have pushed electricity prices higher. Gas supplied approximately 20% of Europe’s electricity in 2020 and it plays an important role in most EU member states’ power mix. As a result, higher gas prices have a direct impact on electricity prices. Once gas prices started to rise sharply, electricity prices followed (see chart below). Lower supplies from Russia led to the sharp spike in December, while an increase in LNG deliveries pushed prices down right at the year’s end.
Trends in European carbon, gas and electricity prices, 2021
Sources: Bloomberg, CSIS | NB: European gas refers to TTF prices, the European benchmark for gas prices. There is no such benchmark for electricity prices, so this briefing uses German electricity as a proxy.
Climate policies have not had a material impact
- Carbon taxes are not the reason for high energy prices. Some, such as Poland, have blamed Europe’s rising carbon price, but, as the chart above shows, this has not been the primary cause of rising electricity prices. For the first nine months of 2021, electricity prices moved more or less in tandem with fluctuations in the carbon market. However, around September, when gas prices began to surge, electricity prices were decoupled from the carbon market and were directly impacted by changing gas prices. A report from the EU’s Agency for the Cooperation of Energy Regulators (ACER) also unequivocally laid the blame on gas for the surge in electricity prices.
- A sharp decline in oil and gas prices in the 2010s led to a dramatic fall in investment in the sector. Fossil fuel investors are increasingly ESG-minded and are putting pressure on companies to tackle their emissions. But that pressure is not the reason there is a supply crisis today. The origins of the supply shortage lie in the collapse of energy prices in 2014. Increased production capacity from US shale producers and from OPEC, notably from Saudi Arabia and Russia, together with a decrease in demand due to an economic slowdown, particularly in Europe, led to a significant supply glut in the global oil market. Subsequently, US oil prices fell from a peak of USD 107 a barrel in June 2014 to USD 44 a barrel seven months later. Between 2014 and 2016, the broader energy price index collapsed 67%. This led to a precipitous decline in energy investments, which fell over those two years from about USD 1.1 trillion a year to around USD 800 billion and hovered at that level until the COVID-19 pandemic, according to the International Energy Agency (IEA). This under investment is the key cause of the supply shortage which has led to soaring energy prices.
- The crisis demonstrates that there needs to be more investment in the energy transition. The investment in clean energy and the infrastructure needed for the energy transition has hovered at or below USD 1 trillion since 2018. Dramatic price declines for technologies like solar (89%), onshore wind (62%) and batteries (82%) over the past decade have meant that this steady USD 1 trillion in investment has enabled more capacity for each dollar spent. Indeed, annual installations of renewables have increased each year since 2014. But it is not enough. In its net-zero emissions scenario, the IEA illustrates that investment in clean energy and infrastructure needs to more than triple to USD 3.3 trillion a year to replace fossil fuel supply and keep pace with growing demand.
- Renewables are a solution to the energy crisis. The IEA has stressed that a well-managed clean energy transition is a key component to shielding consumers from energy price volatility. As gas prices surged, solar, wind and other clean energy sources shielded consumers from a EUR 33 billion gas bill in the EU and EUR 2.3 billion in the UK, a recent CREA analysis reveals. Moreover, as gas prices rose stratospherically in the fourth quarter of 2021, wind and solar output actually rose 3% and 20% respectively year-on-year, helping protect customers from even higher prices.