Can the world be powered without nuclear?

The nuclear disaster in Fukushima is still far from over. I am not a nuclear scientist or a radiation specialist, so it’s as hard for me to judge how much harm has been done exactly to the environment and human health. As an energy market specialist however, I am pretty sure that this event will influence energy and environmental commodity markets in the coming years. I was surprised to find this report by the WHO, the UN outfit for worldwide healthcare. It states that the deaths caused by the Tsjernobyl disaster are actually much lower that often presumed. Again, I am not scientist enough to judge the truth of this statement or the solidity of the analysis that led to it. But it could be that nuclear disasters are a little bit less apocalyptic then we mostly presume.

However, such scientific evidence will never win from the popular perception. As of now, the world’s population has these images in their memory of men in radiation suits and with masks on scanning little babies with spooky devices to check whether they are contaminated. This has already become an important political reality. Last Sunday the German Green party made a historic victory in elections for the regional parliament of Baden-Würtemberg. The region is home to six of Germany’s seventeen nuclear power plants. The Greens have pledged to shut them down. Italy has delayed its plans to build its first nuclear power station by two years.

 

Politicians across Europe that have previously decided to turn back nuclear phase-out schemes try to save their skins by promising their voters a thorough stress-test of the nuclear power plants. I am afraid that these tests might lead to further shut-downs. The stress tests will undoubtedly unveil security failures. A few years ago, a Belgian activist managed to get on the premises of the Doel nuclear power station. According to her, it was very easy to get in. Electrabel, the operator of the Doel plant claimed that she never made it to the nuclear part of the plant. However, the Fukushima disaster has shown us that the non-nuclear part is vulnerable as well. If somebody gets in and seriously damages the pumps that are to supply the cooling water, what happens? Are nuclear facilities really capable of surviving a plane crashing on top of them? And again, as Fukushima has shown us, will the non-nuclear facilities on the sites pass the stress-tests?

If security issues arise in the stress tests, I believe that politicians will most likely copy Angela Merkel and shut down plants. In the post-Fukushima era, no politician will want to take the risk of keeping open a power plant that is not declared 200% safe. Any small issue with safety will lead to temporary or even definitive closures. Therefore, these stress-test swill also be a period of stress for the energy markets.

In the past weeks we have clearly seen how the markets react to the shutting down of nuclear power plants:

1. Power prices obviously rise as less supply of electricity is available and extra, gas-fired power plants with higher marginal costs need to be fired up.
2. This causes increases in gas prices as well, as gas demand goes up.
3. Less nuclear and more gas-fired power means that more carbon dioxide is emitted, which results in rising emission rights prices.
4. The higher prices for gas and emission rights feed back into the power price.

So far, these effects have mostly been observed in the forward markets. In Germany, the Netherlands, Belgium and France, Cal 12 electricity now trades at almost 60 euro per MWh. The spot price has continued at a reasonable level. This clearly signifies that the forward price increases signal a fear of supply shortage, but in the real world, no shortages have occurred yet, even if 7% of Germany’s power capacity is down. Spare capacity and cross-border trading explain why no supply crunch has occurred yet. However, we should watch very carefully at what happens in Q2. This is traditionally maintenance season and a lot of nuclear power stations across Europe are up for planned maintenance. If some unexpected shutdowns due to stress-test issues would be added to that, we could see a supply crunch materializing.

For the longer term, it is highly probable that in many countries the plans for building new nuclear power plants or for keeping existing plants open for a longer period will be ditched. This obviously raises the question whether the world is capable of powering itself without using the nuclear option. According to this article in the Economist we can. They point out that nuclear power plants produce only 14% of the world’s energy. In recent years we have seen several countries grow to 20% shares of power production for wind and solar, countries such as Germany, Denmark or Spain. If the whole world would follow that lead, we could replace nuclear power plants by renewable power plants, without pumping extra CO2 in the air. (Pro-nuclear proponents often make the argument that without nuclear power plants we cannot reach the Kyoto targets). Of course, if our electricity consumption continues to grow, or starts to grow even more rapidly, e.g. because we all start driving electrical cars, the 14% target will become ever more challenging.

Buyers of energy need to be aware that this transition will come with a high bill. German power consumers currently pay 35 euro per MWh for green energy, money that goes to the producers of green energy in the shape of a feed-in tariff. This makes Germany one of the most expensive countries in Europe for industrial power consumption.

Even if we can transfer to a non-nuclear power production in the world as a whole, in Europe, this will be significantly more difficult. The proportion of electricity produced in nuclear facilities in Europe is twice as high as in the rest of the world, almost 28%. Face it as it is, Europe is the must nuclearized zone of the world. France for example, produces as good as all its electricity with its 58 nuclear plants. This can’t simply be replaced by renewable energy, which due to its intermittent character cannot provide all the energy. When the sun doesn’t shine and the wind doesn’t blow, you need another technology to make the power. That technology is likely going to be natural gas-fired power plants due to a variety of reasons:

• Gas-fired power plants have a lot of flexibility for firing up and scaling down the production. This makes them very suitable as stand-in power stations.
• The economics of gas-fired power plants also fit perfectly well with the economics of renewable power stations. With their low investment costs and high fuel costs, they are the marginal power stations of choice.
• Recent developments in the gas markets, such as the development of Qatari LNG business or the shale gas development have inspired optimism that we might have a lot of the stuff left.
• Natural gas burns cleaner than coal, which emits roughly twice as much CO2.

A combination of renewable and gas-fired power plants seems to be the most likely option for a non-nuclear power market. Switching over to this market will demand huge investments. Part of those investments will be passed through to the end consumer in the form of feed-in tariff financing or green certificates to support the construction of windmills and solar panels. The gas transport infrastructure in a country like France will need to be expanded. And the increased demand for gas will put pressure on the gas markets. The volatility that we have recently witnessed in power and gas markets is therefore likely to continue.

Nuclear power enthusiast minted the term nuclear renaissance a few years ago to describe the trend that they saw of a return to more nuclear power production. However, if you look at the graph below, you will notice that in Europe the share of electricity produced in nuclear power stations has systematically decreased in the past ten years. The situation in Fukushima could speed up this decline.

Filed under: Climate change, Energy history, Energy policy, Energy technology, The market today

Earthquake shakes energy markets

German Cal 12 power ended above 58 euro per MWh today. The disastrous events in Japan have sent ripples across the worldwide energy markets. A brief résumé of the consequences of the earthquake that we currently observe:

1. Oil prices have declined. The Brent traded below 110 dollar per barrel today. Oil traders fear that the economic disruptions due to the earthquake will reduce oil demand in Japan, the world’s third largest consumer of oil. For the moment, it looks like the earthquake has (temporarily?) stopped the bull run in the oil markets.
2. Gas prices increased rapidly. TTF Cal 12 traded above 27 euro per MWh today. Nuclear power production in Japan is out due to the earthquake. It is assumed that the MWh’s not produced by the nuclear facilities will be produced in gas-fired power plants. The extra MWh’s of gas will probably come with LNG shipments from (mostly) Qatar. This sparks fears that the LNG supply to Europe, so important in keeping European gas prices at a reasonable price level, will be reduced.
3. Power prices rallied. This was not only due to the rising gas price. The problems with Japan’s nuclear facility could mean the end of plans to keep nuclear power plants in Europe open for longer than originally planned. Today, German Chancellor Merkel even announced that seven nuclear power plants in Germany would be shut down immediately for safety controls. If other countries would adopt similar measures, we would see a severe shortage of electricity in Europe.

The energy markets have changed completely in less than two months time. Revolution and war in the Middle east and an earthquake in Japan have severely shaken the supply / demand balance. The short term price movements might just be speculation or panic reactions. They could also be the start of a further bull trend. But then the question is: can the recovering economy stand this combination of: 1. Commodity price inflation, 2. Severe disruption of one of the world’s most important economies, 3. A massive switch of insurance money towards the Japanese reconstruction? Is the current crash of stock exchanges the precursor of a new economic crisis looming? Or is it just a panic reaction?

No better illustration of the unpredictable character of energy markets than the past two months. Keep counting on that lack of predictability and spread your buying decisions is the best that we can advise in such circumstances. We have to watch carefully in the next days whether the spot gas prices continue to rise. Because that would clearly indicate that increased Japanese LNG buying is affecting supply to Europe.

For the longer term, it is clear that the Japanese disaster will affect the nuclear power sector. It was the Tsjernobyl disaster in 1986 that inspired European governments to decide to phase out nuclear power production. The 25 years that followed without nuclear incidents inspired those governments to turn back those plans of shutting down nuclear power plants. But what politician will dare to defend expanded lifetimes for nuclear power plants after what has happened in Japan? Let alone decide whether to build a new nuclear power plant. If the nuclear phase-out plans would be resumed, this would inevitably have consequences for power pricing in Europe. But that’s the longer term. No idea what it will bring, as every morning we get up in surprise over a new explosion or fire in the Japanese nuclear power plant.

Filed under: Energy history, Energy policy, Energy technology, Germany, Market analysis, The economy, The market today

Deutsche Börse – NYSE merger and the German energy market

“Erfolgsgeschichte”, that’s the beautiful German word for success story. And that is clearly what the recent German economic history reads like. The German economy has recovered more rapidly from the 2008 crisis than any other traditional economy. The whole country seems to be vibrating with a newly found self-confident entrepreneurial spirit. This economic success is not without political consequences. At the latest EU Summit, statesmen from other European countries saw an unprecedented German assertiveness. Miss Merkel’s argument seemed to be: “since Germany is the best-performing economy of Europe, all other countries should adopt our economic policy”.

Today, a next chapter in the success story of the German economy is written. The Belgian business newspaper ran as its headline today “Deutsche Börse takes over the New York Stock Exchange”. The headline is exaggerated as headlines should be. Deutsche Börse is not taking over, it is merging with the world’s most famous trading place on Wall Street. But as 10 of the 17 top jobs in the new company will be held by Germans, it is clear that Frankfurt is the leading dancing partner. So, to continue in hyperbolic language, who would have thought that Germans would once run Wall Street?

I guess that in the next years we will be able to buy many books that explain in detail for what reason the German economy recovered at such a rapid pace. I don’t have the arrogance to share more than an observation with you on this topic. In recent years, I have done a lot of business in Germany. What I have come to appreciate especially in the way Germans do business is their ability to balance discipline and creativity. This can also be observed in the policy adopted by the German government to recover from the crisis, a policy which they would like other European countries to copy. It is a cocktail of budgetary discipline and increased entrepreneurial flexibility, e.g. by relaxing rigid employment conditions.

The question is of course, whether we can see a similar positive, vibrating development in the German energy market. Many would argue that this is not the case. In my opinion, the German energy market is still facing two major issues:

1. The non-commodity part of the energy bill is higher in Germany than in any other country. As I have written earlier in this blog, Germany has developed its green power production remarkably fast. But it comes at a massive cost of now 35 euro per MWh. On top of that, grid fees are the highest of any Western-European country. The reason for that is very simple. There are more than a thousand different grid companies, all of which have fixed costs. Michèle Bellon, the CEO of ERDF, the French electricity distribution grid operator, probably has a decent salary. But the French pay just one CEO salary for having electricity distributed in 95% of their country. The Germans pay a thousand CEO salaries for that same service.
2. To some extent the German energy market remains stuck in archaic structures. There are not only a multitude of local grid companies, the Stadtwerke, most of them also continued to run a supply business after liberalization. What is the future of such companies? If they don’t develop a commercial approach to attract customers outside their traditional supply area, they are sitting ducks, waiting for new suppliers to steal away clients from them. As the Stadtwerke are run by local politicians, they often lack the willingness to expand the business beyond their locality.

In many cases we observe negative consequences of the archaic market structure with buyers of energy. I have already praised the unique German cocktail of discipline and creativity. However, sometimes the discipline takes over and becomes conservatism. This is nurtured by the local supply companies that rely heavily on the decades long relationship that they have with a client to convince him to continue working with him. But when these local companies are small, they often lack the ability or willingness to develop the new energy buying solutions to face today’s energy market challenges and grasp the opportunities. German energy buyers then continue to sign fix price contracts for electricity and oil-indexed gas contracts, out of habit, and not based on a genuine analysis of their risk exposure in the energy markets.

I am not too negative about the German energy market however. We do see the discipline – creativity cocktail manifest itself in many – surprisingly rapid – evolutions:

1. The German gas market is developing at light speed. We now find gas contracts based on Hub prices available for almost every client. Prices can be spot based with good possibilities for forward hedging. We can see most suppliers still struggling to develop the right approach, but such contracts are almost as good as anything you can find in for example the UK or the Netherlands.
2. Especially as I come from Belgium, I’m surprised to find in Germany a country with a government that takes decisions and implements them relatively efficiently. This is probably why German politics succeeded in coming out of the crisis the way they did. We also observe it in the energy markets. One of the main issues with deregulating the German market is having free access to grids arranged in a country with such a massive amount of grid companies. Even the transportation grid is split up in a multitude of different grids. In the past four years, the German authorities have worked very hard on assuring free third party access and with great success. In the electricity market, any supplier can now supply to any client anywhere in the country if he wants. For gas, some restrictions remain, but they are removed at an extremely rapid pace.
3. Thanks to the multitude of energy companies in the country, the supply market is very vivid and competitive. The German power market, for example, is not dominated by a single large supplier such as EdF in France or Electrabel in Belgium, there are four big players in the power market: E-On, RWE, Vattenfall and EnBW. Next to that there are several local suppliers or conglomerates of local suppliers that have developed a nation-wide business, players such as EWE, MVV, Trianel, N-Ergie, etc. And then there are new players, newly created companies such as Natgas or Gasag in the gas market. One of the consequences of this vivid competition is that new products such as a tranche model contract for buying gas on the TTF or NCG have been developed very rapidly.
4. Leipzig-based EEX is the most liquid of all continental European energy exchanges. I remain skeptical whether the energy markets will develop as exchange-traded or as OTC markets. But if the exchange-traded model prevails, the EEX will be the big name in Europe. A little bit like Deutsche Börse in the stock markets?

The German energy market is full of opportunities. And I am confident that the newly-found economic self-confidence will inspire the creativity in German companies to grasp these opportunities.

Filed under: Energy history, Energy policy, Energy suppliers, Germany, The economy, The market today

100 dollar oil: back where it all started?

Yesterday the Brent has traded above 100 dollar again. This is its highest level in 28 months. The first time that the oil price broke above 100 dollar was on the 28th of February 2008. It was then followed by a speculative craze that pushed the Brent price all the way up to 146,08 dollar per barrel. By that time oil demand in the US, the key oil consuming region, was going down. More and more US citizens defaulted on their mortgages and one of the reasons for this was the derailing fuel budgets. It is clear that rising fuel prices and their consequences for other commodities such as food was one of the reasons for the 2008 financial crisis.

This time, the consequences for European consumers of oil products and oil-indexed natural gas are even more severe than in 2008. Back then, the euro was worth 1,5121 dollars whereas now its value has declined to 1,3692 dollars. This means that in euro, a barrel of crude oil is now more than 10% more expensive than in February 2008.

There are parallels to be found with the situation in 2008:

• The underlying fundamental is similar: the 10% growth rates of emerging economies, foremost China, sucking up commodities faster than production can grow.
• It’s not only oil that is rising, metals, coal and soft commodities are also contributing to general inflationary pressure.
• Analysts’ hysteria is contributing to the bull run. This morning already you can read plenty of articles of enlightened minds that “forecast” even higher levels.
• Opec claims to have spare capacity but refuses to bring it to the market, saying that there is more than enough oil in the market.
• The contango in the market has almost disappeared and turned into backwardation, meaning that the further you go into the future, the cheaper the price at which you can buy oil. To some, this is proof that the bullish sentiment is unsupported.

However, we also see two important differences:

• In February 2008, we crossed the hundred dollar barrier at a moment of solid economic growth in all parts of the world. This time, we cross it at a moment of fragile economic recovery in the Western world. The traditional medicine for curbing inflation is raising interest rates. Governments hope that this will inspire citizens to save more and spend less and companies to invest less. This would obviously reduce demand for commodities and can stop the bull run. But on the other hand, it would also kill off the beginning of a recovery that we have seen in recent months. Moreover, it’s not only governments in the West that fear inflation. Authoritarian regimes across the globe know that many revolutions have started with a middle class that reacts to a rising cost of life. It is therefore not surprising that the Chinese government is taking steps to reduce inflation. But it is clear that these steps will reduce growth in China, the growth that has been the engine of recovery in many other parts of the world, as far as Germany. The Chinese government can see good examples of the danger for the regime of inflation happening before their eyes in the Arab world. The people on the streets of Cairo quote rising food prices as one of the reasons for their anger.
• This brings us to the second danger. Geopolitical tensions have always been cited as a reason for oil price increases. But if you look back in history, you can find only two occasions of serious oil price inflation due to political conflict. The first one was in 1973 with the Yom Kippoer war and the ensuing blockade of the Suez Canal. The second one was in 1979 with the Islamic revolution in Iran. The Gulf Wars for example, had only a limited effect on oil prices as Saudi-Arabia stopped initial price increases by pumping up more oil. Opec is now claiming again that it will open the valves if the Egyptian crisis would cause restraints to the world’s oil supplies. However, the current situation bears some very uncomfortable analogies to the two previous occasions of politics leading to oil supply crunches. There is a danger that if Hosni Mubarak is ousted, he will be replaced with a regime that is much less friendly with Israel. It might even be an Islamic government. War between Egypt and Israel would disrupt supplies through the Suez Canal. Fear of this scenario was the reason most cited for yesterday’s push above 100 dollar.

Overall, and as always, the picture for the next months is complicated and unpredictable. Mister Mubarak might survive the crisis. He might be replaced by mister El Barradei who seems to be a peaceful figure (he has a Nobel prize on his desk to remind him of that). I have read in many books and articles that the Egyptian Muslim Brotherhood has developed more in the direction of Turkey’s moderate Islamic party than in the direction of radical Islamism. It is clear that no one can predict what will happen in Egypt. And even if Egypt becomes a broader conflict with ramifications for oil supplies, it is not clear whether oil prices can continue to rise. My best guess is that it will cause a new recession as governments raise interest rates and middle classes see higher commodity prices cutting into their buying power.

The economic picture of the past decade looks really bleak. A large part of this planet is growing towards a better future by growing their economies rapidly. This leads to spectacular boom phases. But the planet is unable to support that growth with sufficient commodities. The consequence is high inflation cutting into buying power which leads to spectacular busts. There is a shimmer of hope however and it lies in the third difference with the situation in February 2008. This time, many gas consumers in the West are not affected by the rising oil price. They buy gas in the Hub markets. In Europe, these prices haven’t risen much higher than 20 euro per MWh even in the coldest winter in decades. In the US, prices are half that thanks to the shale gas boom. The developments in the gas market show the way out of the boom and bust cycle. We have to reduce our dependence on scarce commodities such as oil.

Filed under: Energy history, Market analysis, Oil, The economy, The market today

Fuel for the dragon

Last month, figures were published that made clear that China has surpassed the US as the world’s largest consumer of energy.  Economic pessimists will probably interpret this as another sign that the Western economies are being surpassed by the Asian economies. It is true that for many years now, the economies of the east have grown faster than our economies. However, you are only surpassed when your competitor is becoming bigger than yours. And if we are discussing economic performance, you should watch for per capita figures rather than absolute figures. If you only watch absolute figures, the tiny country of Belgium that I live in, would never be good in anything. If you look at the energy consumption figures in that perspective, it still means that US energy consumption per capita is four times bigger than the Chinese. So, once again, we should remark that China is catching up rather than surpassing. In the past decades, this economic miracle has lifted 400 million Chinese out of poverty. Who can be against that?

The dragon economy of China has recovered more swiftly than that of any other country from the perils of the 2008 financial crisis. Moreover, it looks like they are managing to reduce the dependency on export (and American credit-based consumption) by stimulating inland demand. As the Chinese become richer (and wages are rising fastly), they buy more and more consumer goods. They also move into higher added value goods, which is a logic step. Being the world’s cheap labor workshop is not a source of sustainable economic growth. The counterside of that economic growth is of course the rise in energy consumption. And this gives rise to some important reflections:

1. Since hitting their lowest point in the beginning of 2009, oil prices have more than doubled again, fueled by the rapid recovery of Chinese oil demand growth. Coal prices didn’t grow as much, as increasing demand was matched by increasing supplies.  However, the evolution of oil prices shows that increasing Chinese demand has an important impact on commodities that are traded on a worldwide scale. This is also obvious in other commodity markets with tight supply such as copper.  What does this mean for natural gas markets, now that they are becoming more and more worldwide markets due to the LNG boom? Will China dash for gas and tap into the reserves of Russia, Southeast Asia and the worldwide LNG markets? And will the newly tapped reserves of shale gas be able to fuel an increase in worldwide gas demand? Will China itself be able to increase its production of gas due to the shale gas evolution?

2. Chinese energy demand growth has a big impact on the global carbon dioxide balance. China is growing fastly in renewable energy and for wind and solar power, it is a key market. But this renewable energy is unable to compensate for the even larger growth of coal-fired power plants. With its newly won status of being the world’s largest consumer of energy, the pressure on China for taking more responsibility in terms of reducing carbon dioxide emissions will be bigger than ever.

3. Even if China is obviously the most important factor in determining oil prices, the market is still looking mostly at the US for its analysis of prices. See this previous entry for more on that. This is due to the lack of good quality data on Chinese oil consumption. In the past two years we have seen the market surprised again and again by unexpected growth in Chinese oil demand. It is clear that an improvement in Chinese energy statistics would make the markets a lot more transparent.

We will have to see in the next years if the Chinese economy can continue its economic success story. Anyhow, it is clear that we will have to look East for information about the energy markets.

Filed under: Climate change, Energy demand, Energy history, Natural gas, Oil, The economy

German Court deals a (small?) blow to oil-indexed gas pricing

It was a long ride yesterday from Berlin back to Frankfurt, and my German colleague Arne and I threatened to run out of conversation topics. But then the radio news gave us a topic that kept us busy for the remaining two hours. A courthouse in Karlsruhe has decided against oil-indexed gas pricing practices by two German suppliers, Rheinergie from Cologne and Stadtwerke Dreieich from Hessen. I’ve heard about this court case in Karlsruhe a month ago and was watching anxiously for its results. The court ruling isn’t the definitive blow to oil-indexed gas pricing that some had hoped for. The judge hasn’t outright forbidden oil-price indexation for gas. That’s probably for the better. Where do we go when judges decide upon micro-economic realities such as gas price indexation? The ruling, to my opinion, will not be without consequences, like some German papers imply this morning.

Before we go into the details of the ruling some background. When we started consuming natural gas in large quantities in the 1960′s, two different market models developed:

1. In the United States and the United Kingdom, pricing systems were created that we call ‘Hub markets’ or gas-to-gas pricing today. The principle is simple and economically wise. Supply and demand of the natural gas itself determine the price. Such pricing obviously calls for a competitive gas market on the supply side to avoid misuse of market power to push up prices. It is therefore not surprising that the first liberalized gas markets developed in the US and the UK. Such a market model demands a fundamental (Anglo-Saxon?) believe in the powerful force of markets. Security of supply is guaranteed by open access to markets in this model and not by political protection of energy rights. (Although the role of the UK and the US in the Iraq war shows that they are not always such firm believers of this principle either.)

2. In continental Europe, belief in the power of open markets has always been much less. Therefore, a different model was developed, that of the long-term oil-indexed pipeline gas deals (what a mouthful). European politicians of the consuming countries, such as Germany, France, Belgium, Austria, Spain, Italy, etc., negotiated long term supply contracts with the producing countries such as Russia, Norway, the Netherlands or Algeria in the South. Large pipelines were constructed to which only the companies that had invested in them had access rights. Long term contracts were made, guaranteeing the off-take of certain minimum (take-or-pay) quantities of natural gas for up to 30 – 40 years. If you make such long term contracts, you obviously don’t want to go for a fixed price. And as no liquid market with gas prices was available, the habit grew of linking the price of gas to the ‘first nearby’ energy product: oil. There was even some economic logic for doing this. At that time, natural gas was still fighting for its place as a substitute for heating oil. By linking the gas price to heating oil prices, the producers and resellers in the countries of consumption could ensure that the gas price was developing unfavorably compared to the competing heating oil.

In the then regulated markets, the official tariffs reflected the underlying costs of the monopolistic suppliers, i.e. of the prices going up and down with the oil prices. So we have all grown accustomed to the fact that our gas prices rise, not because of supply and demand dynamics of the gas itself, but because of what is happening in the oil markets. But if you think about it, it isn’t exactly logic. It’s a little bit like selling potatoes for the price of tomatoes. They are both vegetables, but if the growing season for tomatoes goes wrong, this doesn’t necessarily mean that the growing season for potatoes was also a failure. So if you have linked your potato price to the tomato price, you will inevitably find yourself sooner or later in a situation where you find yourself paying a high price for a product that is in abundant supply (i.e. when the tomato and not the potato growing season went wrong).

Since the middle of 2008, we find ourselves in exactly that situation in the gas markets, which brings oil-indexed gas pricing in an increasingly difficult situation. Whereas the oil prices have doubled after hitting their lowest point in February 2008, the gas prices on the Hubs have fallen since the middle of 2009. The gaspool Hub price for German gas published by www.eex.de has fallen by 63% compared to June 2009. This falling gas-to-gas price reflects fundamentals, namely the increasing inflow of LNG into the UK and the increasing supply of gas to the world markets due to the shale gas developments in the US. Many observers cite decreasing demand due to the economic crisis as a main reason, although that isn’t completely correct. We come out of a winter with record high demand due to the cold weather, and in that winter the spot price for gas never was much higher than 17 euro per MWh. This clearly shows that increased supply is an important gas price driver at the moment.

Now let’s go back to the Karlsruhe court case. This is a clear case of consumers complaining that they get potatoes sold at the price of tomatoes. And of course, a judge cannot outright forbid the practice. But the ruling does say that oil-indexation cannot be used as a justification of price rises if the underlying costs for the suppliers haven’t risen equally as much. This could have some important ramifications. Gas suppliers currently win a lot of money on oil-indexed vs Hub-indexed gas arbitrage. For example. If the Hub price is low, as it currently is, they only buy their minimum obligation (take-or-pay volume) from the gas producer. If the total sum of consumption of their clients is larger than that take-or-pay level, they buy the extra gas on the Hub and sell it against oil-indexed prices to their clients. The Karlsruhe court ruling puts such money spinning based on oil-indexed end contracts in question.

Moreover, the big German gas suppliers seem to have understood that the current decoupling of gas and oil prices could continue. They have therefore renegotiated their Gazprom contracts and the Russian gas giant is now indexing part of its gas prices to the Hub prices. However, in the retail market, the big suppliers continue to encourage clients to buy gas at oil-indexed prices. Isn’t that another example of what the Karlsruhe court ruling calls a price rise based on oil-indexation that is not supported by the real cost structure of the suppliers?

It remains to be seen whether the court ruling could have any short term practical consequences for industrial consumers that are frustrated with their oil-indexed gas contracts.  But I am convinced however that it could have some longer term consequences:

1/ As large European gas resellers try to renegotiate terms with Russians and Norwegians to include Hub components in the gas price indexations, the court ruling will help them in stating their case,

2/ It draws consumers attention to the ambiguity of oil-indexed gas pricing, which many large industrial consumers, especially in Germany, take for granted. They are easily convinced by suppliers’ arguments that oil-indexation is ‘safer’. Many think that the Hub market is a spot market. IT IS NOT ! You can buy gas for 2013 today based on Hub pricing. That’s not exactly my idea of a spot market. Still, today, in almost every German newspaper I read, I find that the Hub markets are described as spot markets and spot markets are more risky. The raw facts, however, are there. If you have chosen an oil-indexed gas contract 12 months ago, you pay a lot more than if you have chosen that ‘risky’ Hub price. Moreover, if you had chosen a Hub contract five years ago, you would have suffered spikes that never went much higher than oil-indexed price spikes and your average gas price over those five years would have been substantially lower. The Karlsruhe court ruling might help consumers to have a fairer assessment of hub prices. I found out at least one German client today where the articles on the court ruling were being mailed around.

3/ It will draw politicians attention to the problems of continuing with oil-indexed gas prices if Hub gas prices stay where they are. The papers cited several German politicians that pleaded for ending the oil indexation, the long term contracts along with it and go for a fully liberalized gas market. That is very remarkable in a country where a former chancellor hammered out the North Stream pipeline deal (all very long term and very oil-indexed contracts) and was rewarded with a top job at the company constructing it.

The decoupling of gas and oil prices is an extremely interesting event. We are not predicting that it will continue. However, if you look at reserves of natural gas and oil, you cannot deny the potential of it continuing. If it doesn’t, it is because somebody blocked the import of extra quantities of gas into Europe. Long term oil-indexed pipeline gas deals are an excellent instrument for doing so. The Karlsruhe court ruling could be an important milestone in fighting such blocking of the markets by oligopolies. Let’s hope it will turn out to be so.

Filed under: Energy history, Energy suppliers, Germany, Natural gas

Shale gas: mankind’s second chance?

In the past five years, it looked like we were coming very close to the point where we would have to say, “We’ve done it, we’ve spoiled the earth’s riches”. As a larger share of mankind took its part in the global wealth, the consumption of energy rose steadily. Production of energy was unable to keep pace. The oil price peaked to almost 150 dollar per barrel. Peak oil seemed to move from theory to fact. On top of that, scientific consensus grew that burning all that fossil fuel was destroying a fundamental characteristic of life on earth: the climate. The end of fossil fuel burning seemed near. Oil, gas and coal would become increasingly scarce and unwanted because of their environmental impact. Many industrial consumers of energy told me in those past five years: “In the long term energy prices can only rise”, and adopted an energy buying strategy with such long term bullishness in mind.

It looks like the earth is prepared to give mankind a second chance, or at least a few extra decades to look for a good energy solution without burning hydrocarbons. Recent technological developments have opened up a vast reserve of those fossil fuels that have the lowest impact on climate change: natural gas. Engineers have found out ways to tap into unconventional gas sources such as shale gas, tight gas and coal-bed methane. It’s not that we have discovered a new reserve of energy wealth, it’s just that we have developed technologically so that we can extract more from the soil than we previously could. And this is not some technology which lies ahead of us in the future. Thanks to shale gas production, it looks like the US surpassed Russian production in 2009 !

This sudden glut of natural gas is not without consequences for energy prices. Since the middle of 2009, natural gas prices in Europe have decoupled from the oil prices. Whereas the oil price was rising, gas just kept falling lower and lower and lower. In the past winter, the coldest in 25 years in North-Western Europe, the spot price for natural gas (on the British NBP, Belgian Zeebrugge, Dutch TTF and German Gaspool market), never went much higher than 15 euro per MWh, to be compared with prices above 40 at the beginning of 2008.

Now, many will say that these lower gas prices are due to the decline in industrial and power production demand in the wake of to the economic downturn. But that is not exactly true. As I have said, the past winter was exceptionally cold. This has caused gas consumption to rise to record highs. Of course, these highs would have been even higher if the industrial demand was at its 2008 level. But they were record high, and despite that, no price spikes occurred. The reason for that? Every week LNG ships unloaded their cargo in one of the UK’s new LNG terminals or in the recently expanded terminal in Zeebrugge. All this LNG gas was available, not only because of investment in LNG production in e.g. Qatar, but also because of the lack of LNG demand in the US, where the shale gas was supplying the extra winter gas.

We should be very careful about shouting ‘bonanza’ in the energy market. Conventional gas producers and resellers will be quick to point out the risks of some backlash. This could for example be the environmental impact of the horizontal drilling and rock shattering necessary to produce shale gas. But with every article that I read about this shale gas thing, it looks more and more like this could be the big game changer. An illustration of this could be the situation at the Kitimat LNG terminal in Canada. Originally designed to be an LNG import terminal, it is now being refitted to become an export facility of LNG coming from shale gas sources. Instead of becoming a major importer, Northern America is preparing to become a major exporter of natural gas. This clearly illustrates that if this shale gas is becoming a reality, how deeply it changes the rules of worldwide natural gas economics. The massive flow of gas from Russia and the Middle-East to the US and Europe might not materialize. For Europe, it looks like there are vast reserves in Poland and maybe also Germany. China is hopeful about its underground holding shale gas as well.

I think that the world will gladly adopt natural gas as its main source of energy, for three reasons:

1. Natural gas is cleaner that coal and oil. So, if we replace coal and oil consumption at a faster pace than we use extra energy, the net result for the environment will be positive.

2. Gas-fired power plants and CHP’s are proven technology. Moreover, for a utility, building a gas-fired power plant is currently the cheapest option.

3. Gas-fired power plants are easy to fire up and scale down. Therefore, they are excellent peak-load producers. We need more such peak-load capacity as a back-up for the renewable power that we increasingly use.

If we continue to invest in wind, solar and other renewable energies like we do now, if we build gas-fired power plants as back-up facilities, if we don’t massively pull out of nuclear power production, if we keep improving the energy efficiency of our appliances, we could even switch to electricity for driving our cars and still reduce the overall greenhouse gas emissions. It is maybe my optimistic nature that makes me say this, but it looks like the doomsayers got it wrong (once more). More pessimistic natures will point out that the availability of cheap gas will slow down the development of renewable power production. I partly agree, we will need continued political will to support renewable. I even partly cheer that prospect, in as far as cheap gas will keep us from investing in those sometimes insane biomass projects that are currently running.

To me, the shale gas development looks like the most important event in the energy markets in decades. But as I’ve said, we should carefully watch out for any unsuspected backlashes that shatters the optimism to pieces. E&C will carefully watch this for you and inform you what it means for your energy buying.

Filed under: Climate change, Energy history, Energy technology, Natural gas, US

7 questions that will determine energy prices in the next decade

I am not in the forecasting business, so futurology is even less my cup of tea. Still, last week, in the margin of the E-World fair in Essen, I had a very interesting conversation with a client. Over dinner, we discussed the current outlook for the energy markets and some interesting ideas popped up. We are today facing some evolutions which will very probably have an important influence on worldwide prices for oil, coal, gas and electricity. Asking these questions is interesting in itself. Anyone with a good sense of reality will acknowledge that making a forecast about the outcome of any single one of them is impossible. The energy prices of the future will be determined by the combination of outcomes of all of these questions, which makes it even more difficult to forecast them. So, according to me, these are the issues:

1. Will we all drive an electrical car in ten years? Car companies, and even governments, are betting heavily on this. Today, oil is mainly consumed for transportation. If we all (or most of us) drive an electrical car, the consumption of oil will fall in favor of electricity. Where will that electricity come from (see questions 4 and 5)? Will this cause prices of oil to fall and prices of coal and natural gas to rise?

2. Will the peak oil theory materialize? According to some we are already witnessing the peak. According to some dissidents from the International Energy Agency, oil producers are not able to produce more than 90 million barrels per day. They claim that they were forced by their organization not to tell the world about this fact.

3. Will there be a post-Kyoto climate change policy? And how stringent will that be? Will Europe continue to try to be the best of the class? Or will it be joined by the other countries? And if Europe is that lonely front-runner, how enthusiastic will it continue to be? Or will it rather scale down its efforts? Or is the drive towards greenery unstoppable, even without a world agreement on climate change efforts? This will obviously have impact on the outcome of other questions such as 1 or 4 or even 6.

4. Will renewable energy technologies such as wind or (large-scale) solar become competitive with traditional methods of power production? Or will these technologies continue to need state aid to become widespread? The outcome of this question obviously depends on what the outcome of all the other questions is on the energy price. The higher the energy prices, the more competitive the renewable energy technologies will become. But then, because of their low variable cost, renewable power production pulls down the electricity prices.

5. Will shale gas cause a glut of natural gas in the United States, Europe or China? Shale gas is now being produced and all big energy companies (even Exxonmobil) are investing in it. If it is really recoverable in the quantities such as announced, even with a huge increase in gas consumption, we are not facing a gas supply shortage in the next decades. With abundant gas around the corner (Germany and Poland are said to have big prospects in shale gas), the fundamentals of energy shortages change completely.

6. Are we really at the brink of a nuclear renaissance? In Asia, many new nuclear power plants are being started up. In the US, Mr. Obama is betting on nuclear also. In Europe, governments are more hesitant. As with renewables, the low variable cost of nuclear tends to pull down electricity prices (which again, makes investment in nuclear less interesting).

7. Will Europe continue to be a liberalized energy market? It’s hard to see a way of turning it back. Is it possible in democratic, open market countries to create new monopolies without a cavalcade of court cases from the heavily disadvantaged competitors? But on the other hand, consumers (voters) and their governments are growing increasingly frustrated with the results and – logical – consequences of energy market liberalization. But maybe, the market will take some hybrid shape, something in the line of what France is currently trying to create.

None of these questions is hypothetical. I am not speculating about some undeveloped question, such as the possibility of nuclear fission. Electric car technology is being developed, peak oil theory discussed as a real possibility, Copenhagen was a failure to reach a post-Kyoto agreement, prices per kWh of renewable electricity are falling, the gas market is massively investing in shale gas, nuclear power stations are being built in Asia and the discussion on liberalization was opened even in ultra-liberal Britain last week. These are all factors that will determine the price we will pay for energy in the next decade. And moreover, new questions and issues will pop up.

Filed under: Energy history, Energy technology, Forecasting, Market analysis

Iraq: the next oil bonanza?

The oil market is buzzing with whispers over the future oil supply from Iraq. The Iraqi government is granting licenses for the giant Iraqi oil fields. The numbers are impressive: Zubair: 4 billion barrels, Majnoon: 12,8 billion barrels, West Qurna 12,9, Halfaya: another 4 billion barrels. As a comparison, Ghawar in Saudi-Arabia, the world’s largest oilfield, is said to have already produced 60 billion barrels. Still, the Iraqi government hopes that the production in these oilfields will allow the country to surpass Saudi-Arabia as the world’s largest producer of oil. They project Iraqi oil production to grow to 11 million barrels per day, five times its current production. Western analysts are more prudent and say that they would be happy if Iraq could grow to 5 million barrels per day.

The most important feature of these oilfields is that they are giant, conventional on-land oilfields at a normal depth and with satisfying pressure and water levels and that they are close to existing oil export infrastructure. This means that production from these oilfields will be cheap. Occidental Petroleum (US), Eni (Italy) and Korea Gas Corp, the three companies that team up for production at Zubair are happy to earn 2 dollars per barrel. They will invest 20 billion dollars in Zubair over the 20 years for which they have won a license. This is a completely different story than the tar sand or deep-sea off-shore oil fields of Canada, Venezuela or Brazil. Oil can be economically produced from these fields only at oil prices far over 50 dollars per barrel.

If the Western oil companies that have now been invited into Iraq manage to produce the oil bonanza for which the Iraqi government is yearning so much, this could mean a huge glut of cheap oil in the markets. The combination of increasing demand and diminishing supply from traditional cheap oil fields like Ghawar or China’s Daqing has produced the peak in oil prices of recent years. The fact that these large cheap oil fields were being replaced by much smaller and more expensive oil fields also caused the extreme volatility of oil prices which made oil prices double again in 2009. Will a glut of cheap Iraqi oil produce more stability and lower prices in the oil market?

The first question is of course whether they are indeed the bonanza that both the Iraqi government and Western oil companies clearly believe they are. After all, these are not newly discovered oilfields. Was it just the crookedness of the Saddam regime that made large-scale oil production from these fields impossible? Or are unexpected technical difficulties awaiting? And if oil production is technically possible, will the political climate in Iraq finally find the stability necessary to allow a stable flow of the oil out and the money in? Will the Sunnis, Shiites and Kurds find peaceful agreement over how to share the booty? Today, the US Marines are leaving Iraq. Is this signaling a final step for the country into a peaceful, prosperous future?

If Iraq could finally come to peace with itself and its oil riches, the question is of course what happens in the rest of the world. The combination of growing oil demand (in China) and declining oil production in other parts of the world like Saudi-Arabia could outstrip the increase in production in Iraq. This is what James DiGeorgia, author of “The global war for oil” believes. If that would happen, that would be excellent news for the Iraqi government. They would cash in the extra dollars between the low price paid to the producers and the much higher price that they would get in a world market characterized by tightness. It’s cynical, but it would be a huge payback for Iraq for all the blood and tears of the past decades. That is, if the oil bonanza doesn’t cause another period of war and terror.

Impossible to see who will prove right, skeptics like mr. DiGeorgia or the Iraqi government. Anyway, with the Iraqi oil bounty looking for its way to the market, a future of rising oil prices looks less certain. In your energy buying strategy, you shouldn’t neglect the possibility of a future of cheaper oil.

Filed under: Energy demand, Energy history, Oil

No nuclear phase-out for Belgium

Belgium produces approximately 60% of its electricity in the nuclear power plants situated in Doel and Tihange. A decade ago it was decided that these would be phased out. That decision has now been reversed. The oldest plants will keep on running beyond 2015, the date put forward for their shutdown.

In 1999, Belgium lived through a political earthquake. Right before the elections, a food scandal broke out, with chickens polluted with dioxin coming from industrial oil that got mixed up in chicken food. The result was a landslide electoral victory for the Green parties in both Flanders and the Walloon Region. The Greens made a government together with liberals and socialists.

The green parties in Belgium, like in most European countries, have their roots in the anti-nuclear movement, the mass protests against nuclear arms of the late seventies and eighties. To them, the triple danger of nuclear accidents, storage of nuclear waste and proliferation of nuclear technology, makes nuclear the worst possible technology for producing electricity. It was therefore not surprising that the green parties enforced legislation for a nuclear phase-out. As of 2015, when the oldest nuclear power plants reach the end of their lifetime, the law asked for them to be shut down. As such, the share of electricity produced by nuclear power, currently approximately 60%, would start to fall.

One would suspect that politicians that have just voted to close nuclear power plants would draw up a plan for investing in the transition towards a new power production. Not so in Belgium. Since 1999, no new large scale power plants have opened. Admitted, renewable energy is developing remarkably swift, thanks to strong incentives. But the small scale of renewable energy plants make it an unlikely replacement for the massive amounts of energy currently produced by nuclear power plants. The result is undeniable. In the past decade, Belgium has switched from being an exporter into becoming an importer of electricity.

Most of that electricity is coming from France, where it is produced in … nuclear power plants. Proponents of keeping Belgian nuclear power plants therefore have a valid argument when they point out that shutting them down is hypocrisy. The Belgians won’t stop consuming nuclear energy, they will just bring it in from abroad instead of producing it inside their own borders. Therefore, the decision to keep the Belgian nuclear plants open for longer than 2015 looks like sound policy. Moreover, it was probably inevitable. The initial phase-out law included a passage that said that the phase-out would be turned back if it could be proven that it would cause problems for the power supply of the country. As such, the current decision was already embedded in the initial decision to shut down.

Still, I am disappointed by the way our politicians treat this important issue regarding the energy supply of our country for several reasons:

1. Nobody ever seriously studied how a non-nuclear power supply for Belgium could have looked like. Greens naively held on to the doctrine that the combination of more renewable production and reducing consumption would be able to replace 60% of current power production. Socialists did the same, although they admitted that it would also mean extra import of French electricity. Other parties simply waited for the moment to reverse the phase-out decision.
2. That moment is now, because of budgetary concerns. It is unacceptable that important long term decisions regarding our energy supply are taken to ease short term concerns such as the current budgetary situation only. The cabinet seems to be mostly concerned about how much money they can get from Electrabel in exchange for the phase-out reversal, much more than with the safety questions or what this decision means for the Belgian energy market. Some politicians openly plead to pocket a lot of Electrabel money in a short time, saving the budget during their constituencies, rather than getting the compensation money over a longer period and investing it in the long term energy future of the country.
3. Some politicians show a clear lack of understanding of how electricity markets work. They proclaim that keeping open the nuclear power plants will lower the cost of electricity in Belgium. That is not true. The price of electricity in Belgium is set by fossil fuel fired power plants. It is therefore determined by the cost of gas and coal, and nuclear power plants do nothing to lower it. Open power markets work with a mechanism called ‘marginal cost pricing’, but in the past days I have heard only one politician, Bruno Tobback, that seems to understand how that works.

The political bickering of the past days makes me pessimistic. I fear that Electrabel compensation will take the shape of a tax that will be passed through to the consumers of power. And I also fear that another good opportunity of negotiating measures to improve the situation of the Belgian power market will get lost.

Filed under: Belgium, Energy history, Energy policy, Energy technology, France