A decade of low energy prices?

Written by Benedict De Meulemeester

In March / April of this year, energy prices across the globe hit historical lows. The Brent oil price dropped to 27,88 dollar per barrel, WTI to 26,21. The price of coal for the world markets dropped to 36,55 dollar per ton. Natural gas in the US (Henry Hub 12-month forward strip) traded down to 2,11 dollar per MMBTU, European gas for next year (TTF) dropped to 13,02 euro per MWh. With fuel prices that low, it’s not surprising that power prices hit historical lows as well. The German baseload electricity price for next year dropped to 20,85 euro per MWh. Pricing in the US is very scattered, but the price for Northern Illinois as an example, traded as low as 25,30 dollar per MWh. Since then, prices have rebounded, but they remain at very low levels. Oil is currently trading just below 50 dollar per barrel, less than 11,8 % of the prices seen in the last ten years were better than that.

For buyers of energy this opens up important questions of course. Should you take this historical chance and make long-term fixings? Or are the supply and demand fundamentals supporting this bearishness so strong that we are heading for a decade of low energy prices, so it’s better to stay in the spot market? Some insight into what has been driving prices in the past decade, will teach us that giving a definitive answer to this question is impossible. Hence, the best bet is to prepare for both scenarios.

What on earth happened to peak oil? In the period 2000 – 2008, prices of energy and other commodities increased steadily to reach peaks in the first six months of 2008. An old theory that was popular in the 1970’s was revived. It assumes that production of energy resources follows the path of a bell-shaped curve whereas demand just continues to increase. Once the right-hand side of the bell-shaped curve has been reached, there is an inevitable supply crunch (peak oil). The maker of this theory, M. King Hubbert, was relatively successful in predicting the moment of the crunch in US oil supplies, giving him some credibility. An increasing number of energy market analysts interpreted the energy price bullishness as proof that peaks were occurring (Peak oil! Peak gas! Peak coal!). 8 years later, with prices at these historical lows, the declarations of the peak theorists seem ridiculous. A quick visit to the website of their association http://peak-oil.org/ will make most of us smile, or worse, get annoyed at the lack of empirical backing of what is said, e.g. that the production of oil has been almost flat since 2005, whereas in reality we’ve seen an increase of almost 12%.

Nevertheless, way back in 2008, the peak oil idea had a huge following. Goldman Sachs forecasted an increase of the oil price to 200 dollar per barrel. Many energy buyers fixed prices at the high levels of the first six months of 2008 as they believed the scary stories of ever increasing energy prices. I remember a meeting with the CEO of a big company that said: “we all agree that energy prices can only increase, don’t we”. Why were business people so easily scared into thinking that energy prices could know only one direction: up? First of all, I think that most of us have a hard time not to think in trends. It takes a lot of guts to believe in a decline when for months and months, even years and years, prices have continuously increased. Secondly, when it comes to energy pricing, many of us tend to be pessimist, energy is always too expensive, never cheap. Thirdly, the idea of scarcity was nurtured by environmentalists. When you can’t motivate people to reduce energy consumption for the sake of the environment only, fear of higher prices might be quite helpful. Eight years down the road, and on the other side of the price ranges, it might be tempting to think the other way around, to believe that the decline can only continue. Thinking back about 2008 can be a powerful reminder always to expect the unexpected, to run an energy buying strategy that is ready for the changes in the trends.

If we look at the long term developments in energy markets, we see a pattern of continuously low prices, temporarily interrupted by sharp upticks. This is caused by the way elasticity, the adaptation of supply and demand to price evolutions, works in energy markets. On both sides there is elasticity, but it works slowly, with significant delays. And the delays tend to be longer on the supply than on the demand side.

On the demand side, short term reactions to prices can occur in the shape of fuel switches, e.g. an industrial using fuel oil instead of gas for producing steam. Mid-term, consumers can lower their consumption when prices increase with behavioral efficiency gains, e.g. driving less kilometers with the car or decrease the temperature in one’s house. On the other hand, if prices are low, consumers will become more profligate. Long-term changes in energy demand due to periods of high or low prices can be caused by investments in structural energy efficiency improvements and by the effects of high or low energy prices on the economy. It would be far-fetched to say that the economic crisis that started in 2008 was caused by high energy prices, but it is clear that there was a link. Another example of this can be found in the 1980’s when the high prices of the 1970’s resulted in a sharp economic crisis resulting in much lower energy demand and two decades of low prices.

On the supply side, short term reactions occur in the shape of marginal cost decisions not to produce when prices have dropped below production costs. These reactions cause a continuous rebalancing but no structural price movements, as the capacities come back online as soon as prices increase above the production costs. More structural adaptations can be found on the mid-long term when installations are shut down when prices are too low. However, due to the high stranded costs of energy production installations, this shutdown is often rather temporary (the installation is “moth-balled”) and can be undone as soon as prices increase again. In the same fashion, we often see a supply side correction when prices are very high in the shape of bringing very old installations back online. The real structural adaptations of supply to price occur in the shape of production capacity adaptations by investments or lack of it in new production facilities. And the terms can be very long. The construction of a new power station, an LNG export terminal, ships for transporting coal, the development of an oil or gas field, etc., they can take more than a decade before the first energy is available to the market.

Having these elasticities in mind, we can perfectly understand what has happened in the energy markets in the last two decades. The strong global economic growth of the late 1990’s and early 2000’s with the exponential growth of emerging economies and China caused a voracious growth of demand for energy and other commodities. As of the mid 2000s this started to result in supply shortages causing prices to increase rapidly. Many decisions to invest in new production capacities were taken, but most of them only hit the market as of 2010. In the meantime, mid-term demand adaptations started to occur, we saw e.g. Americans choosing more fuel-efficient cars, causing a slow-down in demand growth. As of the second half of 2008, demand was slashed by the economic crisis which, as I’ve said before, was partly linked to the higher energy prices. This resulted in a sharp reduction of prices. When as of 2010 demand started to pick up again, supply extended more rapidly, resulting in a new supply glut that ended in the historically low prices of the beginning of this year. The recent bullish correction can be explained by higher demand and the mothballing of older production capacities.

It is however too early to say whether this is the definitive turnaround. It is clear that investments in new energy production capacities are slowing down, as we can see in this graph from the IEA with figures until 2013:

fig1

Source: Special Report: World Energy Investment Outlook, International Energy Agency, 2014, p. 20.

At some point, this slowdown in investment will result in a supply crunch such as the one that we have seen in 2005 – 2008. Whether that will be next year or whether we will see a decade of low energy prices is impossible to say. A lot will depend on how demand evolves in the meantime. Will we see another period of rapid economic growth or not? Moreover, we are seeing an increasing drive towards higher energy efficiency on a worldwide basis, meaning that more economic growth means less energy demand growth. This efficiency drive in the framework of climate policy started in Europe that has seen its primary energy demand drop by more than 10% since 2006 (although in 2015 it increased again for the first time in nine years). It is now being copied in more and more parts of the world. Will this keep down demand growth sufficiently for prices to remain low?

Slow elasticity sometimes leads some observers to the reasoning that the normal laws of economics (Adam Smith’s invisible hand) don’t work in the energy markets. They are wrong. Trends such as the sharp decrease of energy prices seen in the last five years do end at some point. Whether the recent turnaround is just temporary or the beginning of a longer period is impossible to forecast. Therefore, as an energy buyer you better prepare for all scenarios.

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Mercado energético español: ¿qué nos ha dejado el 2014?

By Maria Martinez de Ubago

Durante el 2014 han tenido lugar cambios regulatorios en el sistema eléctrico español que han afectado profundamente la estructura del mismo. Entre otros destacan el nuevo y polémico sistema de subasta del servicio de interrumpbilidad, el establecimiento del fondo de eficiencia, el inminente cambio en la definición del sistema de periodos, las medidas para hacer frente a la sobrecapacidad, el nuevo impuesto de hidrocarburos con el que se pretender incentivar la exploración de pozos de petróleo marinos y el decreciente precio del petróleo que impacta directamente en el precio del gas en España. Este 2014 se ha caracterizado, al igual que el 2013, por la incertidumbre regulatoria. Incertidumbre que se trasladará al 2015, más aún teniendo en cuenta las elecciones generales de final de año.

El ministerio de Industria y Energía publicó en Agosto de 2014 un nuevo y polémico mecanismo para la asignación del servicio de interrumpibilidad durante 2015, según el cual los grandes consumidores reciben subvenciones por desconectarse de la red en momentos de saturación. Este mecanismo consiste en una subasta descendente en la que solo los pujantes más competitivos adquirirían ‘bloques interrumpibles’. La primera subasta celebrada, le costó al sistema 352 millones de euros, 325 millones de euros menos que en 2014 y casi 200 millones de euros menos que la previsión inicial para el 2015 realizada por el gobierno. Pero algunas industrias muy intensivas como Alcoa, muy descontentas con el resultado de la primera subasta, amenazaron con el cierre de dos de sus plantas y despidos colectivos. Tras un tira y afloja entre el gobierno y Alcoa, finalmente se llevó a cabo una segunda subasta para cubrir los MW que restaban hasta llegar a los 550 millones previamente previstos por el gobierno. Cabe destacar que este servicio no se ha usado desde 2009 y que España posee una capacidad instalada mucho mayor de la necesaria. A día de hoy queda pendiente la publicación de cuál será el coste de este servicio para los consumidores en 2015.

En Noviembre se publicó la liquidación del sistema Eléctrico así como la previsión del déficit de tarifa para 2015. Según esta circular, el déficit para 2015 sería cercano a cero. De esta manera, el gobierno justifica la congelación de los peajes en 2015. Esta medida tiene lugar un año antes de las elecciones generales y algunos tachan la medida de electoralista. Cabe destacar que, el servicio de interrumpibilidad que hasta ahora ha estado incluido en los peajes de acceso, va a pasar a devengarse como parte del precio de la energía. En parte por este hecho, el gobierno puede justificar la reducción del déficit de tarifa en la liquidación del sistema eléctrico.

En 2014, se ha creado un Fondo de Eficiencia Energética con el objetivo de cumplir con los objetivos de ahorro energético fijados por la UE para España. Este fondo será financiado por el fondo FEDER así como las distribuidoras y comercializadoras de gas y electricidad. Las comercializadoras se verán obligadas a aportar al fondo con carácter retroactivo. En diciembre de 2014, algunas comercializadoras ya han hecho pública su intención de trasladar el coste al consumidor.

El año termina sin claridad respecto a si se modificará o no el actual sistema de periodos así como si esto supondrá un incremento en la commodity para 2015. Algunos comercializadores han declarado que el nuevo calendario impactará en los precios. Sin lugar a dudas, este nuevo sistema de periodos hará que los peajes en Agosto se incrementen.

En Enero de 2015 se renovará el actual mecanismo de apoyo a las centrales de carbón nacional, tras la fuerte presión ejercida por dicha industria. Por otra parte, la UE obliga al gobierno español a reducir progresivamente las ayudas hasta que acaben en el 2018. A partir del 2018 solo podrán quedar en actividad las empresas mineras que sean económicamente rentables sin ayuda pública alguna.

El pasado mes de diciembre, el Ministerio de Industria publicó un informe de sostenibilidad ambiental para 2015-2020 en el que se prevé un fuerte crecimiento de las renovables y un retroceso en las centrales de gas y carbón con el objetivo de cumplir los objetivos europeos de eficiencia, renovables y emisiones para 2020 fijados el pasado 23 y 24 de Octubre en la cumbre europea sobre energía celebrada en Bruselas. Para cumplir con los objetivos marcados por Europa sería necesaria la instalación de aproximadamente 7000 MW de energía renovables, y un recorte en las energías convencionales de 7300 MW, principalmente en centrales de ciclo combinado. El sector está a la espera de la publicación de un real decreto que regule los mecanismos para hacer frente a la sobrecapacidad actual, cifrada en más de un 40%. Cabe recordar que el mecanismo de respaldo del sistema eléctrico se financia a través de los pagos por capacidad. Sería de esperar que una reducción de este backup, supusiese un ahorro para los consumidores finales.

En diciembre, el gobierno también aprobó un anteproyecto de ley en el que se incorpora un nuevo impuesto de hidrocarburos destinado a incentivar la exploración petrolífera en aguas profundas. Parte de esa recaudación irá destinada a las comunidades autónomas y ayuntamientos donde se localicen las prospecciones. Con esta medida el gobierno pretende ganarse la simpatía de los ejecutivos regionales que alegan daños medioambientales.

El precio del Brent tiene un impacto directo en el precio que pagamos en España por el gas, ya que la mayor parte de los contratos de gas están indexados al Brent y tipo de cambio. El panorama de continuo decremento en el precio del petróleo observado desde Agosto 2014, ha permitido que se hayan podido negociar contratos a 24 €/MWh frente a los 32 €/MWh observados en verano.

Como resumen, todos estos cambios regulatorios muestran los problemas a los que se enfrenta España a la hora de regular el mercado eléctrico. Los mecanismos que se crean son, con frecuencia, innecesariamente complicados y producen efectos secundarios que deben ser reparados mediante nuevas adaptaciones lo que al final no hace más que complicar las cosas. Para el consumidor final, las consecuencias de esta complejidad se traducen en un incremento del coste de la energía. Es por tanto esperable, que algunos de los cambios que hemos comentado en este artículo, se traduzcan en un incremento del precio. Desde E&C, haremos este seguimiento por ti.

Declining oil price: geopolitics or just plain economics?

The main event in 2014’s energy market has been the sharp decline in oil prices in the second half of the year. In the first six months, geopolitical tensions regarding Ukraine & Russia still caused hick-ups in the oil markets, with Brent prices reaching 115,06 dollars per barrel on the 19th of June. But then the barrel started a bear correction that even brought it below 60 dollars per barrel on the 16th and 18th of December. Even if oil pricing has lost much of its importance for European industrial energy consumers, due to the decoupling of natural gas from oil prices, I obviously want to share some thoughts on this sharp bear trend.

“It’s the economy, stupid”

 In general, the press is always quick in looking for geopolitical explanations of oil price trends. Even seasoned oil traders often have one eye on CNN and the other on their trading screen. However, a look at supply and demand dynamics of 2014’s oil markets is telling much more than the images of war and political leaders that color the many ‘the world in 2014’ retrospectives that we currently see on television. First of all, demand is not growing as fast as before. Economic growth in Europe and Asia is sluggish, and the one economy which is doing well, the US, is switching towards other fuels and higher efficiencies. Moreover, the US is producing more and more of their petroleum needs themselves. According to the International Energy Agency, the US have grown their oil production in the first nine months of 2014 by 3,5% compared to the same period in 2013. The US is now solidifying its position as the world’s biggest producer of oil. And they’re not there yet, but they could be heading for the enviable position of net crude exporter.

The increase of oil production in the US is caused by the rapid development of shale oil production, the petroleum equivalent of shale gas. This boom is obviously attracting much attention. But we shouldn’t forget that oil production booms are happening in other countries as well. Still according to the International Energy Agency, Canada has grown its oil production in the first nine months of 2014 by 6,5% compared to 2013, thanks to the development of oil sands. And the deep sea oil production of Brazil, causes that country to report an 11,5% increase of oil production in October compared to one year earlier (source: Forbes).

Is Opec waging a price war?

All that increasing production in non-OPEC countries should obviously provoke a reaction from OPEC countries. Traditionally, we expect OPEC to cut supplies when prices hit historical lows. But that’s not what it is doing. On Monday the 22nd of December, the Saudi oil minister, Saudi-Arabia still being the most important OPEC-member, announced that OPEC would not cut supplies, however low the oil price would drop. This strongly confirms the decision at the latest OPEC summit at the end of November not to cut.

A hawkish interpretation of OPEC’s policy of not cutting supplies sees it as a price war. OPEC is consciously dragging down prices, hoping that it will undercut the economics of that new oil production in the US, Canada and Brazil. We’ve seen OPEC (and Saudi-Arabia) attempting similar price wars in the 1980’s, then mostly hoping to stop the development of North Sea and Gulf of Mexico offshore oil production. It failed spectacularly, with the competitors continuing their development and the Saudi budget fatally hurt by low oil prices. Price wars are a tough game. Mostly because of the way that supply and demand dynamics or price elasticity work. For understanding them, you need to make a firm distinction between fixed or investment costs and variable or operating costs.

Short term price elasticity is mostly influenced by operating costs. If the price of a product drops below the operating costs, producers will stop producing the product. In terms of crude oil, if the price of crude drops below the variable costs of operating a well, the producers will shut down production from that well. Now, as far as oil production is concerned, we need to make an important remark here. Operating costs of oil wells are often quite low. Wells are often quite expensive to drill, causing a high investment cost. This is especially the case for the US shale oil and Brazilian deep sea offshore wells. But once drilled, the costs of letting the oil flow out are not very high. To understand this, look at the situation of Brazilian oil producer Petrobras. They have just invested hundreds of billions of dollars to develop their deep sea offshore oilfields. Why on earth would they stop producing from those wells now? Of course, they and their American shale oil colleagues would prefer getting the 110 dollar plus prices for their oil of a few months ago. But the less than 60 dollars that they get at this moment is still giving them some return on their massive investments. Stopping production and getting 0 dollars per 0 barrel is not paying back anything.

With its combination of high investment and low operational costs, the oil market is not a good place to see short term effect in a price war. Price warlords should therefore aim for the long term effects of lower oil prices. Investors in the US, Brazil and Canada could be frustrated and stop investing in the oil developments in those countries. Lower stock prices of oil companies seem to point in that direction. This could have only limited effect on large scale developments like those that we’ve seen in Brazil. However, it could be more effective in hurting the US shale oil development. Shale oil wells typically have steep production decline curves, meaning that most of the oil is produced in the first years after drilling the well and then the production volumes per well drop rapidly. So, you need to maintain investment in drilling new wells to keep up the overall production rate. If lower prices would cause a decline in investment, the expansion of US shale oil production could be slowed down or even reversed. However, experience in the shale gas industry has shown that investment has been more resilient to lower prices than initially thought, especially since a fall in natural gas prices coincided with a drop in the investment costs due to the falling cost of the newly developed horizontal fracking technology. Therefore, it’s all but certain that a conscious price war by OPEC (and/or the Saudis) against further investment in new oil production could produce results.

Maybe, what we are seeing is far from a conscious attempt by OPEC to wage a price war, but a simple struggle for market share. OPEC cannot idly sit by and watch the US, Brazil and Canada steal away its market share. Oil supply growth is currently outstripping oil demand growth, meaning that the oil market is currently a buyers’ market and not a sellers’ market. In such a market, price wars are usually not fought in an offensive attempt at hurting competitors, they are fought as a defensive strategy for keeping market share. In the end, at the sellers’ side everybody is hurt and only the strongest survive. The Saudis could be hopeful that they will prevail with their low cost oil production.

Are Opec and the US working together?

Amateurs of geopolitical explanations of the events in oil markets are pushing an opposite theory. Saudi-Arabia and the US are not fighting each other, they are collaborating. Flanked by the economic sanctions of the EU, they work together to lower the oil price down to levels that really hurt the Russian enemy. Early in November, Vladimir Putin himself put forward this theory by stating that he believed that politics were the cause of the lower energy price. Whether this global conspiracy theory is true or not, it is indeed effective, if you see the turmoil of the Russian economy and currency in the last weeks.

 

All in all, these events are showing once again how utterly unpredictable energy markets are. Six months ago, Russia, an important oil producing country was engaged in a deep geopolitical conflict, with concerns over the impact on supply causing oil prices to increase. Anyone that would have said then that by the end of 2014 the oil price would drop below 60 dollars per barrel would have been declared a nutcase. But it happened. We can make educated guesses about its causes: simple supply and demand dynamics, a conscious commercial policy by OPEC or a complicated geopolitical intrigue? Or a combination of two or even all three of these options? Which explanation we choose, probably depends more on our own personal convictions than on empirical reality. Which obviously shows that we shouldn’t attribute any predictive quality to our theories. What has happened has happened. The oil price is historically low, benefit from it. And prepare for the next move which will come just as unexpected as this decline.

The gap between Belgian and German electricity prices

Belgian year ahead baseload power in the wholesale market is now more than 14 euro per MWh more expensive than German power. In the spot markets, prices since the beginning of this year have on average been 6,72 euro per MWh more expensive in Belgium compared to Germany. Two years ago the German price was still more expensive than power in Belgium. But then German power started to drop more rapidly. I see two main reasons for these cheap wholesale prices in Germany. First of all, the rapid expansion of renewable electricity in Germany has had an undisputed bearish effect on prices. On top of that, Germany is producing much more electricity from coal than Belgium. And as coal prices have declined, this has helped to push down wholesale power prices in Germany even further.

 

In the last three years, wholesale electricity prices across Europe (UK being the most notable exception) have generally been falling. Simple supply and demand economics are responsible for that. With pockets full of cash due to the windfall profits of high wholesale prices in the 2005 – 2008 period and inspired by reports of a looming supply shortage, European energy companies engaged in an intensive investment campaign in new production capacity. The Netherlands, for example, has expanded its power production capacity by 8.846 MW in the 2009 to 2014 period, and most of that is conventional gas-fired and even coal-fired capacity (Source: Tennet). The supply capacity boom was further enhanced by the fact that renewable energy expanded much more rapidly than anyone had ever expected, specifically in Germany. This unexpectedly rapid expansion was provoked by generous subsidies and solidified by rapidly dropping technology costs. At the same time, the economic crisis and successful climate policies caused an electricity demand decline rather than the expected increase. The result is a global European market of overcapacity for power production.

 

The stupefying thing, as far as Belgium is concerned, is that amid all this excess supply it has managed to put itself in the position of a country with a supply shortage. This and only this is the explanation for the price rift between Belgium and its surrounding countries. The spread between Belgian and German wholesale prices widened recently due to the outage of two nuclear power stations in Belgium on security concerns. But this might just give policymakers a too easy excuse for the current situation. In the past years, Belgian power production capacity has dropped. It is clear that Belgian energy policy has failed to create the conditions for attracting investments in capacity expansion. Germany has not failed in achieving that. And that’s why the wholesale prices in Germany are lower.

 

The main reason for this failure of Belgian energy policymaking has an institutional character. I don’t want to tire foreign readers of this article with the quagmires of Belgian politics, but still, the complexity of its institutions has contributed a lot to this policy failure. In the last decade, Belgium has had many different energy ministers from many different parties. Energy policy tends to be a heavily colored by ideology, so all these changes in ministers have caused multiple turnarounds and flip-flops. On top of that, in Belgium with its complicated structure, the responsibility for energy policy is spread over the federal and regional decision-making level. Even if the federal minister seems to have most impact on security of supply issues, important aspects such as renewable support mechanisms or authorization procedures are decided by their Flemish, Walloon and Brussels counterparts (yes, city-region Brussels has a separate energy policy). This institutional framework isn’t exactly beneficial for the creation of the consistent policy that you need to attract investments in energy infrastructure which are typically high capital cost investments with extended realization periods. Examples of these policy failures are:

 

  1. Belgian energy policymakers have often focused on fighting highly symbolic battles with incumbent supplier and producer Electrabel (now part of the GdF-Suez group). Despite the rhetoric, it took them a very long time to really do something about Electrabel’s dominant position, discouraging alternative suppliers to invest in Belgium.
  2. Belgium launched a nuclear phase-out policy and then renegotiated it, and renegotiated it and renegotiated it. This obviously created a lot of uncertainty and refrained energy companies from investing in large-scale fossil fuel-fired power production in Belgium.
  3. Belgium (i.e. the Flemish, Walloon and Brussels’ regions) launched ambitious, generous support schemes for renewable but then rapidly withdrew them as the cost of this for the end consumer became clear.
  4. Politicians kept dreaming about energy independence and only realized the importance of increasing cross-border capacity when the security problems with the two plants surfaced. For example, there still is no cross-border capacity with Germany, it is only planned to be operational in 2019. This is obviously especially painful at this moment when German wholesale power is so much cheaper.

 

At the end of this month, the Belgians go to cast votes not only for their European representatives but also for their federal and regional parliaments. Many are hopeful that after these elections, having a few years in a row without new elections will create the sort of stable political climate necessary to put en route necessary reforms. Let’s hope we can also see the sort of reforms of energy policy necessary to normalize energy pricing. Now that investment costs in renewable energy have dropped a lot, it should be carefully considered whether some extra support for renewable couldn’t be a cheap and climate-friendly part of the solution. And there is no doubt that in a context of supply shortage with excess supply capacities in neighboring countries, rapid investment in cross-border capacity is an inevitable option. With the current price differential between Belgian and German power in view, we highly recommend to speed up the Alegro project that connects both markets. Do we really need five more years to build that line? Supporting gas-fired power stations with capacity payments is a bad idea. It will cause extra cost as these subsidies find their way to the end consumers’ bills. And with their high marginal costs, I can’t see how these gas-fired MWh’s will reduce the commodity price.

 

With the price rift peaking, industry representatives were very rapid to complain about the disadvantage it creates for Belgian companies competing with German companies. We obviously have to highlight here that the wholesale power price is only part of the overall electricity bills. On top of that, a consumer pays a retail margin to its supplier, but these margins are minimal in both countries, so they are not creating much difference. The main difference can be found in the grid fees and taxes. These are much higher in Germany than in Belgium, but energy-intensive consumers can benefit from large reductions on these high grid fees and taxes. The situation is therefore as follows. If you’re a German company for whom electricity cost is more than 14% of its added value and with more than 7.000 hours of load duration, you will pay almost nothing for grid fees and taxes. But many German companies that don’t meet only one or none of these criteria pay a lot more for consuming power than any Belgian company. Nevertheless, coming on top of important differences in grid fees and taxes, large price differentials in wholesale prices are creating unnecessary competitive disadvantages within Europe. However, we have to consider that today’s winners may be tomorrow’s winners. Belgian industry representatives pleaded for a long time to increase cross-border capacity on the French border and not on the Dutch and/or German borders. This wrong choice of border is now contributing to the competitiveness problem.

My best wishes for 2014 (wishes, not forecasts!)

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In my home country Belgium, we have the nice tradition of ‘New Years letters’. Children write letters full of semi-philosophic observations and wishes which they read to their parents and grand-parents on New Year’s Day. In this tradition, I also want to write a few words in which I look back on trends observed in the past months and try to look forward on what could happen in the new year. As I have remarked before, I am not in the forecasting business. So don’t expect any forecasts on prices or events. I will try to think about what might happen to guide the reader as to what she/he should look out for in the next months in the news on energy markets.

1. Will the European gas prices move? Up? Down?

The gas markets in Europe have traded flat in the past two and a half years. Impossibly flat. The main concern of analysts in this market was trying not to fall asleep. Prices traded towards a level of 26 – 28 euro per MWh in the wake of the Fukushima disaster. Upward pressure continued as Asian demand remained high. And this was / is not just more demand in Japan due to nuclear shutdowns. New LNG import terminals in China, South-Korea and other Asian countries have also put pressure on the demand side. At the same time, expected LNG export projects in Australia were delayed. Without further delays, the first of the Aussie new LNG will start flowing in 2014. As of 2015, they are expected to hit the market in full strength and US LNG export projects add extra volumes. Can this (anticipated) increase in supply cause a downtrend in 2014? Or will, on the contrary, prices increase as supply projects suffer further delays, Asian demand continues to soar and European demand picks up in the wake of an economic recovery?

A downtrend in gas markets would be a welcome relief to Europe’s energy markets. In the last three years, consumers haven’t had any chances of securing some good prices for future gas budgets. The same would be true for power consumers in the UK, where power prices are closely linked to gas prices. A dip in the gas price would be even more welcome for the power production sector. With relatively high gas prices, low coal prices and large amounts of renewable power on the grid, the owners of gas-fired power stations have been butchered in the last two years. This became clear in the last days as Germany had to announce that its lignite consumption peaked in 2013. A drop in gas prices that improves gas power plant economics would therefore also be good news for our climate policy.

2. Will low wholesale prices for electricity persist?

 

Certainly in Germany and Central Europe, the wholesale electricity prices hit historically low levels in 2013. Causes have been: low coal prices, increasing renewable energy production, low prices for emission rights and declining power demand. This has obviously enabled end consumers to fix some really low budgets for power (commodity) for the next years. But we might see some dark clouds on the horizon:

  • The low prices have slashed the profitability of power production. Therefore, we should expect a normal economic reaction: i.e. shutdowns of power plants that lead to a decline in supply and increasing prices. This trend has started already, certainly as far as the unprofitable gas power stations are concerned. Governments are trying to stop this by denying plants the right to shut down or by considering capacity payments to gas-fired power plants (see below). Moreover, it is highly likely that other than economic reasons will also influence our power supply situation.
  • Seeing that their climate and other environmental policy efforts are undone by increasing coal and lignite consumption, governments might decide to shut down coal and lignite-fired power stations, a phenomenon we have seen already in the UK.
  • In many countries, governments are also turning back or rather reducing their programs for supporting renewable energy. They might take that a step too far and slow down the development of renewables too much.
  • And what if in 2014 measures are taken regarding the emission trading system (ETS) that go further than the cosmetics of the back-loading proposal? What if a real shortage of emission rights prices is created? Buyers (and policymakers) have to take into account that theoretically every 1 euro per ton increase in emission rights prices leads to a 0,5 euro per MWh increase in wholesale electricity prices. This theory was empirically proven in 2005 – 2006. And the impact might even be larger this time as more marginal MWh’s are produced from coal, which has higher emissions per MWh factors.
  • Many economists are quite upbeat about Europe’s economy in 2014. It would be very interesting to find ourselves in that situation, not just from a socio-economic point of view. A period of economic growth would show us whether the decline in power (and natural gas) demand observed in the last years can be purely attributed to the economic crisis or whether it was also caused by a more fundamental trend: the effect of climate policy. But a recovering power demand could have a price increasing effect.

As you can see, there are many reasons to observe power markets carefully this year and watch out for signs of a reversal of the current downtrend. However, in the first week of the year, the market was rather pointing in the other direction. It could therefore very well be that the combined forces of low coal prices, unstoppable renewable energy development and declining demand continue to push down prices. And – who knows – if we would see a downtrend in gas prices (see above), we might find even lower prices. If the past years have learned us anything about energy markets, it is ‘Never say never’.

3. Will the non-commodity part of the power bill continue to increase?

Even if commodity prices for electricity have reached historical lows, for many consumers across Europe the total price of electricity has increased sharply. This is due to the increase of the non-commodity part, the grid fees and taxes. Europe’s power supply system is being rapidly transformed from a centralized system with large-scale power stations to a locally distributed system with many small-scale power stations. It is logic that such a systemic transformation causes cost increases. Also, we have to consider that the market system in itself has been redesigned. In the past, markets were regulated and its operators were state-held and/or heavily politicized monopolists. Systemic transformations such as the construction of nuclear power plants or the continuing use of coal when it was no longer economic to produce it, have been and continue to be heavily subsidized. However, these subsidies were often paid from other sources than the power consumers’ bills. Therefore, they were less visible. In today’s liberal markets, every cost of the power market transformation is passed through in the bills of end consumers. This makes the cost of the transformation much more visible than what we have seen in the past.

This obviously doesn’t mean that the cost increases should be neglected. In those countries that have pushed for more renewables hardest, we now see impressive add-ons for renewable energy on the electricity bills. Germany is the most obvious example, with the contribution to support renewables now almost twice as high as the wholesale value of the electricity. In other countries such as Spain, Italy, Belgium (especially the Southern part) or (increasingly) the UK, we see a similarly high renewable energy bill for the end consumers. Even if price increases were perfectly predictable when politicians introduced the renewable support schemes, politicians have reacted to them with surprise and have announced reforms of the renewable support schemes. They might take this too far and stop the further development of renewables. I personally think that this would be a sorry thing. The efforts of the past decade have brought down the cost of renewable energy technology. It’s never been cheaper to invest in more renewables than at this moment. It would therefore be very disappointing if we stop the efforts right now. It would be like stopping while the finishing line is in sight. However, maybe countries that have so far been laggards, such as the Netherlands or many Central European countries, should take over the efforts. That would also be a good thing for the balance of both the grids and the internal market for electricity in itself.

The high add-ons for renewable in countries such as Germany, are largely caused by ‘stranded costs’, compensation for high subsidies that were guaranteed to investors in renewable energy when the technology cost was still much higher than it currently is. It should therefore be carefully considered how this cost is distributed in time and across the different actors. Protection of Europe’s electro-intensive industry should be an important consideration. And should we really pay back these costs in the next five to fifteen years or shouldn’t we rather finance them from a long term credit? The next generations will profit (from an environmental but also from an economic point of view) from our current efforts to develop renewable energy. Is it therefore a case of inter-generational injustice when we pass on part of the renewable energy bills to these future generations? In the North of Belgium (Flanders) reforms of the renewable energy support mechanisms seem to have succeeded in keeping the costs at bay without completely stopping the development of renewable energy. Germany has also started its reforms and is discussing the distribution questions actively at this moment. This week, we saw a rather disappointing ‘stopping in the bud’ of the intergenerational discussion by the President of Bayern and of government party CSU Ernst Seehofer. But I would be surprised if this ‘spreading the cost in time’ isn’t discussed again in Berlin.

I am not entirely confident that politicians will manage to make these reforms of Europe’s renewable energy policy a success. I have seen too many cases that prove that politicians’ interventions in the energy market always cause unwanted side effects and price increases. This lack of economic prudence shows itself again as the effects of more renewable are being discussed. Policymakers are loudly protesting the current cost increases caused by renewable energy development. However, at the same time they want to hand out money (capacity payments) to gas-fired power stations to solve a problem (power plant shortage) that hasn’t manifested itself yet, against all forecasts. Who will pay for such capacity payments? Yes, the end consumers in the shape of another add-on on the electricity bill. Worst case, we will see reforms that stop the development of renewable energy but because of the stranded costs issue that doesn’t lead to any cost improvements and capacity payments to gas-fired power stations continue to increase the power bill.

As in every ‘New Year’s letter’, I want to end this blog article with some good-hearted- if slightly naïve wishes. I wish all of you energy buyers out there for 2014:

–        A good dip in the gas markets,

–        Continuing low wholesale power prices (and, if possible, a little bit lower still?),

–        Politicians that manage to reform renewable energy support mechanisms in a cost-efficient and rationally distributed manner.

Geopolitics and energy markets

One of the more exciting aspects of a job as energy procurement consultant is that you get deeply involved in geopolitics. Elections in Iran, Russian post-Soviet policy or Arabian Spring Revolutions, we eagerly try to assess their impact on energy markets. What a nice job we have. Some conflict escalates on the other side of the planet, and the next day we are discussing the (possible) impact of that event on energy budgets with a client. It isn’t surprising that two of E&C’s consultants have studied political sciences. No, we are not just eating megabytes and megabytes of consumption data. Our life is more than just reading through the dull passages of energy contracts. Analyzing the impact of geopolitics on energy markets is the fun part. What makes for a better bedtime read than the books of Daniel Yergin, who dissects links between the world’s history and energy markets all the way back to the world wars. It wouldn’t be the first time that I make quite an impression during a reception when I explain how different the world would have looked if Hitler had reached Baku!

However, maybe because of the excitement involved, I’m convinced that geopolitics’ impact on energy markets is often exaggerated. This is certainly the case in the press, as journalists tend to be among the most passionate followers of geopolitics. They interpret any conflict anywhere in the world as having a price-increasing effect. I remember a spectacular example of that somewhere in the period before June 2008 when oil prices made their spectacular rally towards almost 150 dollars. Tensions in the Middle East, Nigeria or Venezuela were broadly cited every day as causes for this price escalation. On one day, North-Korea fired a missile and military conflict in Eastern Asia loomed. In the oil market comments of that day, the North-Korean tensions were broadly cited as a reason for rising oil prices … Hello? North-Korea is in an oil-consuming and not oil-producing part of the world. So, military conflict in Eastern Asia and its impact on the economy would most probably cause a decline in oil prices.

If we look at the oil and natural gas reserves versus energy consumption of our planet, we touch the fundamentals of this continuous linking of energy market analysis with geopolitical analysis.

Gen_130815_Oilreserves

Source: BP Statistical Review of 2012 – all data are for 2012

Consumption of oil and natural gas is highest in Europe, North-America and Asia, reserves are concentrated in the Middle East and the former Soviet Union. Add to these data four broad geopolitical conflicts:

  •  The rise of China and other emerging economies as superpowers as their economies grow and the (suspected?) competition in this regard with traditional superpowers, the USA in the first place.
  • The broad cultural conflict between the West and the Islamic World.
  • The particular way in which Russia is redefining its role as a geopolitical and economic powerhouse under President Putin.
  • The ideological struggles of the Americas where left-wing South-American countries agitate against the USA, a struggle symbolized by the former Venezuelan president Chavez.

The geopolitical connection becomes clear. Middle-Eastern countries, Russia or a country like Venezuela can exert political power that exceeds their pure political weight, thanks to their large reserves of oil and natural gas. Therefore, they don’t hesitate and distort the markets if it fits within their broader political goals. This is particularly worrying for Europe. Even if Europe consumes less than its North-American allies, it is extremely poor in resources. Its proximity and historical ties to mostly Russia and to a lesser extent the Middle East emphasize its vulnerability. This situation feeds worries over security of supply. In particular, it is feared that the producing countries will ‘wield the oil sword’, meaning that they cut oil and/or gas supplies in an attempt to support their geopolitical agenda’s. Every geopolitical conflict is then interpreted in the framework of this fear of the oil sword. Oil and gas traders have one eye on the Brent, NBP or TTF curve and another one on CNN or Al-Jazeera. They push up (forward) prices at the slightest sign of trouble.

However, a totally different picture is drawn if you look at oil and gas reserves versus production figures:

Gen_130815_Gasreserves

Source: BP Statistical Review of 2012 – all data are for 2012

What we see in these data is that the regions with the largest reserves are not necessarily the largest producers. This is most clear in the so-called R/P ratio where total reserves are divided by annual production. These ratios are very low for natural gas in both Europe and North-America and to a lesser extent Asia-Pacific. They are also extremely low for oil in Europe and Asia-Pacific. Some will read these data as a sign of a looming energy crisis. But it can also be interpreted as a graph of missed opportunity.  The Middle-East for example, is not exploiting the potential of its massive gas reserves. The situation is even worse for the gas under the soil in Kazakhstan, Turkmenistan, Uzbekistan and Azerbaijan.

The largest producer of natural gas in the world is the USA. In the last years, they have developed their shale gas reserves. Rather than tapping into the massive and easy-to-produce reserves in the Middle-East, they produce the more expensive shale gas at home. So, if the producing countries are indeed wielding the oil sword, the economic effect is a loss of market share and hence income. Hardly an effective policy, I would say. The Arab countries have experienced this when they cut oil supplies in the 1970’s. In the next decade, the US and Europe rapidly developed their off-shore reserves, leading to the rapid decline in oil R/P ratio that we see in the table above. This caused severe budget troubles in Saudi-Arabia in the 1980’s and 1990’s.

The same is true for recent Russian gas policy. The cutting of supplies through Ukraine during two winters in the last decade can be interpreted as an example of wielding the oil sword. Russians will – probably rightfully – respond that it was a justified attempt to sanction gas theft, but however you wish to interpret it, the effects are clear. European consumers grew anxious about Russia’s reliability as a supplier and this spurred alternative imports, mainly from Norway and Qatar. Compared to 2011, gas exports in Russia declined by 20,5 billion cubic meters in 2012. In Qatar they increased by 5,1 billion cubic meters and in Norway by 11,9. Russia is rapidly losing market share in its key exporting market, Europe.

The biggest story of missed opportunity definitely is Iran. The Islamic Republic has an R/P ratio for oil of almost 117 years, which is much higher than the Middle-East average of 78,1, with only war-ridden Iraq having a higher ratio. Iranian oil reserves are just 40% lower than those of its big regional rival Saudi-Arabia. Nevertheless, the Saudis produce more than three times more oil. And if you look at Iran’s situation in natural gas, the situation is even more disappointing. The R/P ratio for natural gas is a staggering 209 years. And, despite having the world’s largest reserves of natural gas for a single country, Iran is a net-importer of (Caspian) gas! Iran has been threatening the shutdown of the crucial Strait of Hormuz in the conflict over its nuclear projects. And it has always been a hawkish member of Opec. Well, this willingness to wield the oil sword hasn’t brought much benefit, on the contrary. If only Iran’s politicians had focused a bit more on developing its oil and gas industry instead of trying to use its massive reserves to get some political leverage.

The supporters of the Iranian regime will scream that this missed opportunity is due to Western sabotage policies. And the funny thing is that they are (partly) right. The Iran case is clearly showing that if geopolitics is effective, it is mostly when consuming countries are ‘attacking’. Cutting supplies has proven to be ineffective. But cutting consumption by imposing trade sanctions can be highly effective, as Iran’s case is clearly proving. The oil sword of the consuming countries seems to be stronger than the one wielded by the producing countries. Therefore, all this anxiousness in the markets about the countries with large reserves in the Middle East and Russia shutting down supplies is exaggerated. The oil sword hasn’t been wielded so very often and when it happened, it produced adverse effects.

Therefore, rather than looking at producing countries’ foreign policies, it would be much wiser to look at their internal policies. Are they, like Qatar or to a lesser extent Saudi-Arabia, creating an environment in which the oil and gas industry can prosper and develop the potential? Will the newly elected Iranian president Hassan Rouhani focus on that? And if we look at foreign policy, the question mainly is whether there is a willingness to soften the tone so that Western countries are less likely to apply trade sanctions.

This week, a client asked me whether the political showdown among Russia and the USA over Edward Snowden might not have a price-increasing effect on gas markets. In other words: will Russia wield the oil sword because of this conflict? Well, if they have the slightest apprehension of the real impact of geopolitics, they better not. And (warning: I tend to be slightly over-optimistic on such issues) there are some signals that this might be the case. The Kremlin seems to realize that its recent energy policies have caused loss of opportunity and apparently isn’t blind for Russia’s loss of market share (and highly needed export revenues) in Europe. The internal market for natural gas in Russia has been liberalized. I have no experience with buying gas in Russia, so I can’t really judge how effective this liberalization has been. However, in theory it could create the right conditions for gas reserves to be developed more effectively. And even more importantly, president Putin has indicated that he is willing to end Gazprom’s monopoly over Russian gas exports. He has approved a project by Novatek to export (liquefied) gas to China. A more liberal gas policy in Russia would be excellent news for the world’s gas markets, creating benefits for both Europe and Russia itself.

Are we approaching an age of energy abundance?

Do you remember the first months of 2008? Every week, prices increased. Oil prices rose near an all-time high of 150 dollar per barrel and some analysts “predicted” that they would soon reach 300. That was obviously a disaster every time you had to fill the car. But European buyers of natural gas were also affected as back then almost all the gas contracts were pegged to oil prices. Natural gas prices rose above 40 euro per MWh. And if you were impressed by the tripling of oil prices, what to say of coal that rose from a level around 50 dollar per ton to more than 200. Electricity prices were obviously affected by these increases in combustible prices and in many countries baseload prices rose to a level near 100 euro per MWh. For buyers of energy these were terrifying times. Every delay in price fixing decisions caused a frightening increase in energy costs. We had several emergency meetings with companies in those days that were desperately looking for ways to avoid dramatic increases of their energy budgets.

Most analysts agreed on the root cause of this unprecedented bull-run. As countries like China and other emerging economies grew at exponential rates, the planet just wasn’t capable of producing enough commodities to fuel that growth. The developed economies had already depleted the world’s geological reserves so much, that there wasn’t enough left now that the developing economies joined the race. We were just plainly running out of oil, coal and natural gas. That was the simple logic behind the 300 dollar per barrel prediction of a Goldman Sachs analyst that forced many buyers of energy into panic decisions. And the fact that other commodities such as copper were also rising to historical highs proved the point. The peak oil theory became wildly popular. This was a calculus introduced decades ago by a Shell geologist called M. King Hubbert. According to Mr. Hubbert, production of oil reserves followed the elegant path of a bell-shaped curve. At some point the peak was reached and after that ever declining production rates were inevitable. Mr. Hubbert had applied his bell-shaped calculus to the US oil production and produced a reasonably accurate forecast of the peaking moment. As oil prices increased exponentially, more and more observers became convinced that we had reached or were at least near the peak of the curve of worldwide oil production. Some were even convinced that we were on the right side of the bell shaped curves of coal and natural gas production as well …

Open-minded people will acknowledge that reality is in most cases way too complicated to fit elegantly bell-shaped curves. But I have to admit, that as prices just kept on rising, even I was tempted into some Hubbert-style thinking. What explains the attractiveness of the peak theory? I believe it is our instinctive scarcity scare. Most of the people reading this blog article can satisfy their basic needs without much trouble, just like me. Just consider the most essential needs, warmth and food. Heating myself and my family means the occasional phone call to the plumber to fix my gas-fired boiler and checking gas bills and contracts from time to time. And the struggle for daily food means phone calls with my wife in which we discuss food variety and who will take the ten minutes to stop by a shop on the way back home. However, thinking about it, I have to return just two generations to find ancestors for whom the struggle for essentials was much harder. I remember a story told by my grandfather in which he scattered white flower on his coal reserves in the shed to check whether his suspicions of a coal-stealing neighbor were true. Less than a century ago, people still had to fight daily to get their share of the scarce energy and food. Unless you are born in some old aristocratic family, you carry in yourself the genes of people that survived due to their scarcity scare. This explains why perfectly civilized societies start the completely irrational hoarding behavior or even worse, looting, as soon as the first signs of scarcity are on the horizon. Slightly ashamed of our luxurious contemporary life styles, the idea of increasingly scarce energy supplies fascinates as well as scares us. The horror picture of 300 dollar oil fascinated us, because we are silently scared of having to return to the harsh daily struggle for the scarce commodities for keeping your family warm.

Some economists kept their cool and displayed a ‘what goes up must come down’ mentality. They remarked that this wasn’t the first peak in oil prices, and that previous peaks had been followed by deep decreases. They argued that high prices would put the laws of supply and demand at work, leading to corrections. Only, as the lead times for adaptation in energy are very long, this takes some time. As the bull-run extended in time, some renegade economists started to declare that energy was a basic good and hence not price-elastic. Whatever its price, consumers would continue to consume ever more energy. And accepting the ‘inevitable’ truth of M. King Hubbert’s peak theory, even if producers wanted to increase supply, they couldn’t. The cooler economists responded that energy supply and demand are price-elastic, but it is slow elasticity. Investing in more energy-efficient equipment and in new production isn’t done overnight. These delays explain the ‘boom-and-bust’ cycle of energy prices. Cool-headed economics has proven to be right again. In the second half of 2008, the energy prices corrected sharply and dropped back to their pre-peak levels. Peak oil (and other energy) theorists used the economic crisis as an excuse. As soon as that crisis would pass, the plain logic of the bell curves would kick in again. But isn’t the economic crisis in itself a sign of the elasticity of energy demand? If energy prices rise too high, this pushes the world into a recession, causing demand to drop sharply. The 2008 crisis (which still isn’t over, at least not in Europe) has a complicated web of causes. But high energy prices are definitely part of that. The increasing impact on their budgets of high fuel prices was one of the reasons why so many Americans couldn’t pay back their mortgages. So, even if 300 dollar oil prices and equivalent prices of other energies are possible, they would very probably be extremely short-lived, as they would push the world in a deep recession. That draws a bleak picture of life in a perpetual economic crisis on the other side of Hubbert’s peak. The last five years have learned that economic stagnation isn’t fun, so we all have a moral duty to avoid ever ending up there.

As the economy has recovered, specifically in the commodity-devouring developing economies, energy prices on the world markets have increased again, but they haven’t hit the previous highs (yet?). Electricity in many countries of Europe is currently even trading at its lowest level since 2005. And we are clearly seeing that energy demand and supply are impacted by more fundamental phenomena than just the economic crisis:

DEMAND SIDE:

– Combined with climate policy measures, the high prices of 2008 have caused renewed enthusiasm for energy efficiency improvements. This seems to have caused a sustainable downtrend in energy consumption in the developed world (both the EU and the USA). However, the effect of this is largely undone by continuing growth in energy demand in the developing world.

SUPPLY SIDE:

– Oil production in 2011 was 1,5% higher than in 2008. So, we are not on the right side of the bell-shaped curve yet. It should be remarked that these extra barrels are increasingly expensive to produce, causing oil prices to remain high. But it looks like we still have enough oil left. Thanks to shale oil, US oil production was 16,44% higher in 2011 than in 2008 and some are optimistic that these unconventional resources could ultimately mean an end of oil imports in the US. So, Mr. King Hubbert, the tail end of the US oil production curve is not bell-shaped …

– Peak theorists that simplistically extended the peak oil theory to coal and natural gas, were ignoring the fact that undeveloped reserves of those fossil fuels were much higher than those of oil. As oil prices remain high, the world has tapped into its coal and gas reserves. Coal production in 2011 was 12,8% higher than in 2008, gas consumption grew 7,5%. This clearly shows that the peaks in coal and natural gas were nothing more than an expression of slow elasticity. Natural gas production has been boosted by conventional and unconventional gas production. I have extensively written about the shale gas revolution on this blog. If it can spread across the globe, gas abundance could become a reality.

– The prices of wind and solar power production have dropped to a level that necessitates only limited subsidies to stimulate their growth. Therefore, the growth of the share of energy produced from these renewable sources seems unstoppable.

The previous energy crisis (the 1970’s) was followed by a long period of energy abundance and historically low prices. Are the trends above sufficient for the world to be entering an age of energy abundance again? The hunger for energy of the developing economies is continuing to put pressure on the world’s energy markets. But if shale gas becomes a worldwide reality, energy abundance could become a fact, especially if it is combined with an adoption of more energy-efficient and more renewable technology by the developing economies.

There are many obstacles on the road to energy abundance. And the legendary unpredictability of energy markets makes it impossible to say if we are heading for it or not. So please don’t interpret this blog as a forecast of low energy prices. The important message is that abundance is not unthinkable. Still, we see many energy buyers that continue to be driven by scarcity scare in their price fixing decision. This is partly due to the fact that abundance stories don’t get much political and press attention. Many conservative politicians prefer the peak energy theories because they fit within their energy independence policies that are supportive of their hawkish geopolitical position. Do you really think that the American public would have allowed the sacrifice of American blood and money in the Iraq War if back in 2003 they would have known that they were heading for the abundance of homegrown shale gas and oil? On the liberal side, the scarcity scare fits within the anxiousness to do something about climate change. This seems to be the predominant policy of Europe. We need to be very careful as we are approaching a possible age of energy abundance. If Europe unilaterally choses for more efficiency and renewable rather than more (unconventional) oil and gas, we might end up with a much higher bill than the rest of the world. Can we really afford that?

Benedict is giving a presentation on this topic on our (Central) European Energy Procurement Conference on the 16th of May in Warsaw. Send an e-mail to info@eecc.eu if you want to attend or click here.

Time for action on Belgian industrial power prices

Febeliec, the Organization of large Belgian energy consumers published an alarming report this week on the prices that Belgian industrial consumers pay for electricity compared to their competitors in the Netherlands, Germany and France. For both parts of the country and for all types of consumers, Belgian power prices are clearly more expensive than in any of the surrounding countries. Industrial consumers pay 6,5 to 10 EUR/MWh more on the total electricity price in Flanders and 7 to 25 EUR/MWh more in the Walloon region. And that is compared to the average price similar consumers pay in surrounding countries. More than these figures, the relative differences are telling. Large industrial consumers face a 12% (1 TWh consumer in Flanders) up to 45% (100 GWh consumer in Wallonia) price handicap for electricity compared to their Dutch, French and German competitors. Recently, several large Belgian industrial companies have announced that they will close down plants in Belgian, with the loss of many jobs as a result: Ford, ArcelorMittal, Caterpillar, Duferco, Saint-Gobain. Not all of them are energy-intensive, but it is clear that such an energy price handicap is not keeping these companies here. Febeliec is more than right in calling for action.

First of all, my compliments to Deloitte, that made this study for Febeliec. Often, studies comparing energy prices fail to produce relevant results, especially when they are based on empirical data such as traditional surveys. What individual companies pay is the result of a large number of parameters. It is hard to find much line in such diversified empirical data. Deloitte has chosen a more theoretical approach. Studying baseload prices, they avoid the trap of drawing conclusions from incomplete and/or unrepresentative data. Deloitte has studied baseload prices for the commodity part of the bill and the official tariff structures for grid fees and taxes. Doing so, it can draw pertinent conclusions on structural differences. These have been checked by the expertise of Febeliec, but I can’t imagine anything else than a broad confirmation.

In the conclusions, we can see a few big lines:

1. The bad position for Belgium can be explained by: lower exemptions for Belgian large consumers compared to Germany, lower reduction on wholesale commodity compared to France and higher overall tax levels compared to the Netherlands and France.

2. Inside Belgium, there is a structural difference between the Walloon Region and Flanders, which is completely due to the difference in taxes on power consumption.

3. The competitive disadvantage is biggest for the ‘smaller’ large consumers, the consumers of ‘hundreds of GWh’s rather than those of TWh’s’. But obviously, the larger consumption of a TWh consumer leads to a larger disadvantage in total euros per year.

Having an insight into the energy bills of more than 200 mid-sized and large energy consumers in all of the countries in the study, we can only confirm these conclusions. They are the logical consequence of the power market policy in the different countries. We can summarize that policy as follows:

France has never fully embraced electricity market liberalization. It wants to continue to give the price advantage of its nuclear power production to its consumers, both industrial and residential. The loi NOME introduced an element of competition, but the mechanism still causes prices to be lower than those in the liberalized surrounding markets, although recently, the drop in prices in Germany has caused the French power price advantage to disappear.

The Netherlands manages to keep its industrial power prices reasonable by keeping grid fees and taxes at bay. Contrary to popular belief, the Netherlands is not the Walhalla of renewable power. Yes, there are many windmills, but if you look at them closely, you will see how old most of them are. In the last decade, the Netherlands hasn’t had the programs of massive subsidies for renewable energy like we have seen in Germany and Belgium.

Germany has very high grid fees and taxes. But it has also adopted a policy of conscious protection of large consumers of energy. With the Härtefall regulation, an German energy-intensive company can get massive exemption of the extremely high EEG-entgelte, the tax for paying renewable power subsidies. And it gets even better if your load duration exceeds 7000 hours, which means that you have an extremely stable off-take of power, which is only possible if you use the power for stable, around-the-clock and electro-intensive processes. Such companies pay 0 euros for using the grid in Germany. This might give the impression that Germany is a power consumer’s paradise. But that is not the case. The Febeliec study is focusing on those very energy-intensive companies only. For many others, the cost of power in Germany is extremely prohibitive, much more expensive than in Belgium.

Belgium has a power market policy that is … typically Belgian. And I’m not just referring to the difference between the regions. Belgian energy policy fails to make firm choices, such as the deliberate measures for protecting large consumers in Germany. Belgian energy policymakers try to protect small consumers (especially residential) which waters down the potential for protecting large industrial consumers. Moreover, politicians don’t always take their responsibility. They broadly smile before the camera’s when they open another renewable energy production site. But when it becomes clear that the subsidies for renewable have caused a derailing of the tax part of the power bill, they look the other side. They blame the suppliers and the lack of competition and refuse to take responsibility over the cost-increasing effect of renewable energy policy. Well, the Febeliec study is clearly showing that the main problem are the taxes, and not the market. Energy producers in Belgium are not selling their product at a structurally higher price than producers in neighboring fully liberalized markets such as Germany and the Netherlands (although there is quite a big gap with Germany at this moment, but it is explicable).

The problem is clearly larger in Wallonia. The Green Certificates system in the Southern Region of Belgium has continued to pay out much larger subsidies to owner of solar panels for a much longer time than the system in Flanders. The Walloon Government is currently reviewing the green certificates system, but the high subsidies have caused an investment boom, meaning that a lot of owners will continue to benefit from these high subsidies, causing further inflation of the cost to be reflected in energy taxes on consumers’ bills. The Febeliec study is confirming what we are seeing in the power bills of our Belgian clients: there is a big problem with the cost of green power in Wallonia. If you know how much investment costs in solar panels have decreased in the last four years, this problem of over-subsidizing is shocking. It might have caused the creation of jobs in the solar panel sector. Subsidized jobs, I should clearly say. If that causes the loss of industrial companies and non-(or less-) subsidized jobs, this is a very painful evolution. We hope that it is not too late to cure this, and that the Walloon government will increase the exemption of green certificates costs to industrial consumers, just like the Flemish government has done earlier. And we hope that the Febeliec study will inspire both governments to make even bigger efforts to protect the energy-competitiveness of our economy. And they should not just think about the large single-site companies. There are many companies that use a lot of electricity scattered over different sites. As exemptions are calculated on a site-by-site basis, they often pay an extremely high power bill. This should be considered when reviewing exemption systems. Finally, we hope ministers think about the Febeliec study before they air unnecessary and cost-increasing ideas such as the creation of a capacity subsidy for gas-fired power stations, or the construction of a doughnut artificial island to store renewable energy at sea.

German Cal 14 baseload power drops below 42 euro per MWh

It was the summer of 2005 and we had just created E&C, a brand new energy procurement consultancy focused on servicing clients in taking energy price fixing decisions. The price of year ahead electricity in Belgium rose above 50 euro per MWh. Our phone was red hot with clients in panic. Such price levels were unsupportable! Little did we know then that this was just the beginning of an uptrend that would culminate in baseload prices near 100 euro per MWh in the spring of 2008. Then came the crisis and a sharp correction of the energy markets. As soon as the price dropped below 50 euro per MWh, every client wanted to fix. What seemed like a nightmare price level three years before was now generally described as “an opportunity we don’t want to miss”. And when in the spring of 2011 and in the wake of the Fukushima disaster baseload power prices in North-Western-Europe jumped back above 60 euro per MWh, everybody was so sad for not having fixed more at levels around 50 euro per MWh.

Today, the Belgian Cal 14 baseload has traded at 44,5 euro per MWh. And late in the afternoon, our jaws dropped as we saw the German Cal 14 baseload contract drop below 42 euro per MWh and as low as 41,7. Who would have thought that within less than two years we would see such historically low prices, when in March 2011, Frau Merkel announced the shutdown of seven nuclear power plants? If anything, today’s prices are once again reminding us of the fundamental unpredictability of energy markets. The only thing you should expect in energy markets is the unexpected. The clients I speak to these days can only express disbelieve. Is this possible? Yes, it is, and it is happening right now. Moreover, there are solid reasons for power prices to drop so low:

  • Coal prices have dropped back below 100 dollar per ton. There are two main reasons for this. The first one is the increased (shale) gas production in the US. Across the Atlantic, power producers have switched to gas-fired production. Excess American coal is flooding the world markets. On top of that, China has started to import less coal as it is expanding its coal production.
  • Demand for power is in a steadily declining trend. This is obviously due to the weak economic performance in Europe. But that is not the only reason. Heavy energy intensive industry moving out of Europe is another cause. And I am convinced that the declining demand is also a result of Europe’s climate change commitments. Just think about the lamps you currently buy. They consume just ten percent or even less of what you frequently bought eight years ago. We also observe that many industrial power consumers have gone through effective power consumption reduction programs.
  • Increasing production of renewable energy is another reason for declining power markets that is to be attributed to climate policy. It is not a coincidence that Germany, with its continuing expansion of renewable power production is currently at the lowest level. MWh’s produced with windmills or solar panels have a zero marginal cost and their increasingly massive presence on the grids causes overall price levels to decline. And despite the fact that in many countries the subsidies to install renewable technology have been reduced, the growth of renewables continues.  Solar panels are claimed to have reached grid parity. Thanks to the rapid decrease of the price of the technology, residential consumers in many countries now no longer need any subsidies to earn money with the panels they mount on their rooftops.
  • The declining price of emission rights is an example of how European climate policy has failed. In the EEX spot market emission rights have been trading below 5 euro per MWh this week. As everybody starts to realize that the European Union is not capable of solving the problem of over-allocation, will we see that price drop back to levels near zero?

The downtrend is strong, supported by fundamentals and is still going on. Of course, at any time something can happen that makes the downtrend turn around. Emission regulations could oblige power producers to shut down coal-fired plants. Or the failure of emission rights trading might be compensated with the introduction of carbon taxes, like we have seen in the UK. Or demand for power might pick up in a strong economic recovery, something we all hope for. Or more nuclear power plants might be shut down in the wake of some safety incident. At this moment we can only recommend to keep yourselves ready to fix prices when this fine downtrend comes to an end. In the meantime, “don’t catch a falling knife”. So many clients are unhappy today for fixing too much of their 2014 prices at levels just below 50, as they esteemed that the market would never drop much lower than that level. Again, their expectations about the market trumped them. So, don’t think you are dreaming, the price in Germany really has dropped below 42 and the downtrend continues.