February 2022 Insights

In the U.S. month-ahead prices more than tripled between October 2020 and October 2021 to reach their highest level since 2008, before subsiding somewhat in more recent months. But Europe and Asia have had it a lot worse. Benchmark prices in both regions hit an all-time record in late December – around ten times their level a year before.

These sharp movements have already had a major impact on consumers and businesses around the world. In the UK alone 27 energy providers, serving 2.3 million households, have gone bankrupt since September 2021. UK utilities have faced difficulties due to the surging global wholesale price of gas. This has caused a similar rise in power prices, as a result of the country’s significant gas power use. These soon outstripped a cap on consumer tariffs, causing the bankruptcy of small and medium-sized utilities.

To forestall further bankruptcies, the British Government’s Office of Gas and Electricity Markets (Ofgem) recently announced that the price cap on energy prices will soar by between £693 and £708 from April 2022 – increasing bills by a staggering 54% for approximately 22 million customers. The price hike risks dragging hundreds of thousands more people on low incomes into fuel poverty – the condition of being unable to afford to heat your home adequately.

In France, the government has taken a different tack, forcing the majority state-owned energy giant Electricité de France to share some of the burden of rising prices with consumers. In January this year, the company’s shares tanked after it cautioned that the Macron government’s move to cushion the impact of soaring power prices on consumers would cost it up to €8.4bn. It also warned of extended outages at several nuclear plants.

As energy prices surge, power outages are becoming a more and more frequent occurrence across the globe. Some 350 million people – over 4% of the global population – were affected by a major power outage in 2021, according to a new report released by research firm IHS Markit Global Power and Renewables. “The report, Are We Entering an Age of Increasing Power Supply Disruptions?”, states that emerging power supply challenges including extreme weather events and unsynchronised pace of the energy transition are posing more challenges to system efficiency.

Rama Zakaria, associate director of global power and renewables at IHS Markit, said: “While power supply challenges are not new and power supply disruptions have long plagued certain parts of the world, new challenges are emerging and exacerbating older ones.”
But what are these emerging new challenges? And how will they affect energy prices going forward?

As lockdowns and other forms of COVID-19-related restrictions brought economic activity to a grinding halt, global demand for energy fell off a cliff, as too did energy prices. On April 20, 2020, as pandemic-induced pandemonium sent global markets crashing, oil futures famously went negative for a brief moment. As global demand for energy crashed, so too did the supply. This is analogous to what happened to the global supply chains for many of the basic goods we depend upon. What we have discovered since is that it is far easier to press the pause button on the global economy than it is to release it.

As restrictions began to ease, in the second half of 2020, demand for products and services exploded, which in turn fueled a surge in demand for energy. But energy supplies could not pick up fast enough to meet the resurging demand. The result was a sharp rise in energy prices. After crashing to anomalously low levels for much of 2020 oil has been steadily rising, reaching close to $100 in recent weeks.

Another reason why oil prices have been steadily rising is that OPEC+ began withholding 10 million barrels of oil a day – more than 10% of average global supply – in 2020 and are still withholding a large amount, thus creating a synthetic shortage in the market, all at a time of rising demand. Unless there is a sharp fall in demand, triggered by, say, a global recession, or a sudden pick up in supply, the only way prices can go is up.

It is impossible to discuss surging energy prices without making at least a brief mention of the inflationary effects of central bank policies. Since the pandemic began the world’s five largest central banks have printed roughly $10 trillion of new money, with the Federal Reserve and the European Central Bank (ECB) accounting for roughly three quarters of it. This is on top of the roughly $20 trillion of new money conjured into existence before the pandemic. After over a decade of low, zero or negative interest rates and endless quantitative easing programs, the central banks have finally got what they wanted: high inflation in just about everything including energy. Now they are struggling to contain it.

Central banks all over the world, from the Bank of England to Banco de Mexico, to Banco Central do Brasil, to the Bank of Russia, are frantically hiking rates. The Fed is also considering raising rates and reducing its asset purchases. There are serious doubts about whether it will be able to pull this off without causing a sharp sell-off in the financial markets, as happened in late 2018 after the Fed had raised rates to 2.5%. The ECB’s recent actions may prove to be instructive. On February 3, its president Christine Lagarde finally acknowledged mounting inflation risks and, as Reuters put it, “opened the door a crack to an interest rate increase this year.” Two days later she was forced to moderate her position following a sharp sell-off of Italian and Spanish sovereign bonds.

Another reason why energy prices are surging is that Europe got a little overenthusiastic about its ability to go green. As a result, it began neglecting more traditional (and some might say dependable) energy sources. Europe’s top domestic producer of natural gas, the Netherlands, began phasing out its main gas field Groningen in 2018. In the UK many gas storage facilities have been closed down. It’s the same story across the channel. By September 2021 European gas storage levels were at their lowest in at least 10 years ahead of the crucial winter heating season. One of the results has been a historic surge in European gas prices.

Skyrocketing carbon prices, partly due to rampant speculation on the EU’s carbon market, and rising carbon taxes have also fed through to energy prices. Since January 2021 carbon prices on the Intercontinental Exchange have more than doubled, from €33.70 to €89.77 (on Feb. 22). Despite all the pressure to go green, the uncomfortable truth is that renewables are still far from ready to take over the baton from fossil fuels. One of the reasons for Europe’s current energy woes is that it had a much less windy autumn, which led to a sudden slowdown in wind-driven electricity production. As energy market analyst and renewables champion Gail Tverberg recently warned, the temporality of most renewable energy sources means we will always depend to a certain extent on fossil fuels:

Renewables are available only part of the time, so other types of electricity suppliers are still needed when supply temporarily isn’t available. In a sense, all they are replacing is part of the fuel required to make electricity. The fixed costs of backup electricity providers are not adequately compensated, nor are the costs of the added complexity introduced into the system.

If analysts give wind and solar full credit for replacing electricity, as BP does, then, on a world basis, wind electricity replaced 6% of total electricity consumed in 2020. Solar electricity replaced 3% of total electricity provided, and hydro replaced 16% of world electricity. On a combined basis, wind and solar provided 9% of world electricity. With hydro included as well, these renewables amounted to 25% of world electricity supply in 2020.

We are still a very long way off from a so-called “net-zero” world. If we do get there (and one can only hope we do), it will be after investing an estimated $150 trillion of funds over the next 30 years, according to estimates by Bank of America. That’s the equivalent of double current global GDP. And with the private sector unable or unwilling to cough up the funds, most of that will have to come from yet more central bank money printing – at a rate of around $5 trillion for the next 30 years. And that can only mean yet more inflation and higher energy prices.

As renewables fail to deliver on their promise, both Europe and the Asia Pacific region are vying for natural gas imports from large producers such as the U.S., Russia, Canada and Iran. One of the reasons why demand has surged in the Asia Pacific region is that China decided in 2020 to halt imports of coal from Australia, its biggest supplier, after Canberra backed calls for an international inquiry into China’s handling of the Coronavirus pandemic. But Beijing couldn’t replace the coal and had to pivot to natural gas.

At the same time, Russia, the world’s second largest producer of natural gas, is experiencing supply problems and as a result is not exporting enough natural gas to meet its customers’ insatiable demands. Geopolitical tensions are also on the rise in Algeria, which provides the lion’s share of the natural gas consumed in Spain.

Europe is already encountering multiple natural gas problems. Its supply from North Africa is not as dependable as it was in the past. The countries of Russia+ are not delivering as much natural gas as Europe would like. Russia will instead be increasing its exports to its strategic partner China in the coming years. Unless Russia finds a way to ramp up its gas supplies, greater exports to China are likely to leave less natural gas for Russia to export to Europe in the years ahead.

With natural gas supplies exceptionally tight, particularly in Europe, and prices of the commodity close to record highs, a huge amount of attention is focused on Nord Stream 2, the 750-mile, $11 billion underwater gas pipeline connecting Russia with Germany, in the process bypassing Ukraine. The pipeline was finished in September 2021 but is still yet to receive final certification from German regulators. When up and running, it will significantly boost deliveries of gas directly from Russia to Germany and then on to other parts of Europe, relieving some of the pressure in energy markets.

The problem is that the pipeline project has faced stiff opposition from the United States, the United Kingdom, Ukraine and several EU countries who argue that it will increase Moscow’s influence in Europe. It is worth noting that the United States, as the world’s largest producer of natural gas, has a direct financial interest in preventing Russia, the world’s second largest producer, from increasing its market share in Europe. As the Wall Street Journal reported on February 17, “U.S. natural-gas producers and global commodity traders are emerging as some of the biggest beneficiaries of the surging energy prices spreading pain in Europe.”

At the same time, the drum beats of war have reached deafening levels in Ukraine. As I write these words, on the morning of Friday February 25, Russian troops have not only invaded Ukraine; they have already reached Kiev. All that in the space of little more than 24 hours. Meanwhile, analysts are still trying to digest the meaning and implications of Vladimir Putin’s earlier decision to recognise the breakaway regions in Eastern Ukraine. As another Vladimir (Illyich Lenin) once said, “there are decades where nothing happens and there are weeks when decades happen.” This, it seems, is one of those weeks.

Both the U.S. and the EU have responded to Putin’s moves by imposing round after round of sanctions on Russia, including a decision by German President Olaf Scholtz to halt the process of certifying the Nord Stream 2 gas pipeline. It’s not clear just how long this moratorium could last although the German government has clarified that it will not be permanent. In the meantime, Europe’s gas supplies will remain tight, at least until warmer (and hopefully windier) weather returns.

There is a risk that tensions between Russia and Ukraine (and by extension NATO) will continue to rise. One can only hope that cool minds will prevail. If not, the consequences for Europe and the wider world could be very serious indeed.

Oil prices are already surging. On February 24 Brent oil rose above the $100 mark for the first time since 2014. Russia could retaliate to sanctions by cutting off gas supplies to the EU. That would plunge Europe into a far worse energy crisis while sending global energy prices spiraling even higher. Given Russia’s role as a leading global supplier of food, energy and other core minerals (e.g., aluminium, titanium, platinum, palladium, nickel and potash), Western sanctions could very easily backfire. If there is one lesson modern history has taught us (or at least should have), it is that when war involving one or more major energy producers breaks out, energy prices tend to surge.