Europe’s Power Crisis Overcoming the Gas Crisis – Frustrated by it?

NOT A LOT OF PEOPLE KNOW THAT

By Paul Homewood

This latest analysis from Timera combines with my piece on yesterday’s broken electricity market:

Europe’s power crisis overcame the gas crisis

Europe is currently facing a parallel electricity and gas crisis. The effect of increasing gasoline costs on electricity prices is well understood. What has received less attention is that a rapidly growing electricity crisis is fueling a fresh rally in gasoline prices.

The geopolitics of Russia’s supply dynamics currently dominate the global headlines. The current conflict has exposed the extent of Europe’s dependence on cheap hydrocarbons from a hostile neighbour. Russia’s supply cuts to Europe were the main reason for the sharp increase in gas prices across Europe in the first half of 2022.

Europe’s parallel power crisis unfolded rapidly over the summer. This is being fueled by nuclear availability issues, depleted hydro levels and reduced heat output (both due to fuel access issues and plant closures). Electricity prices across Europe are rising to record levels, now outpacing increases in gas prices.

The price of TTF gas for delivery in 2023 closed last week above 237 €/MWh ($70/mmbtu), up 120% since the beginning of July! The increase in electricity prices during the same period was much stronger. We’ve run out of adjectives to describe this rate of price increase.

The acute tightening of the electricity market across Europe has been the main factor pulling gas prices over the past six weeks. Europe needs more electricity to keep the lights on, and the only option left is gas.

In today’s post, we examine the circular pricing dynamics that are driving an upward spiral of demand destruction for gas and electricity prices in Europe.

Increase the transition gas curve

We rarely publish the same chart in consecutive feature articles. However, to underline the scale of the increase in gas prices throughout the summer, Chart 1 is an update of the one we showed in July.

Chart 1: TTF futures price has increased strongly since the beginning of July

There is a lot of media attention on the front end of the TTF curve. The price for September 22 delivery is up about 35% since we published this chart (green line vs dark blue line).

A much larger consequence is the fact that the price of gas delivery under the Schedule 2023 has increased by 120% since the beginning of July. Pausing for that to sink in… gas delivery prices, which are already very high next year, have more than doubled in the past six weeks. And the same goes for Calendar 2024 (which also more than doubles).

These are seismic changes in the energy cost base of the European economy. They point to imminent widespread industrial demand destruction and a significant increase in the probability of a managed gas distribution.

Europe’s growing power crisis

The main factor driving the rise in electricity prices in Europe in the first half of 2022 is the rise in gas prices. The CCGT governs the setting of marginal electricity prices on European electricity markets. As a result, rising gas prices flow directly into higher electricity prices.

A separate power crisis in Europe began to flare up in the summer. The drivers behind this are:

1. French nuclear availability is very low (EDF recently narrowed its output guidance for 2023 to 300-330TWh and is currently facing cooling issues that are affecting availability in 2022) already weak)
2. Historically low hydroelectric storage from Scandinavia to Iberia (due to widespread drought conditions)
3. Thermal power plants closed across Western Europe (for aging coal, nuclear and gas plants)
4. Fuel supply logistics are driven by a combination of very low Rhine water levels (e.g. affecting the transportation of coal by barge to German power plants) and logistical problems due to pulses. break Russia
5. A period of low wind and solar output in which the above factors are leading to surplus power output deficits.

The combination of these factors is pushing the crisis of power to center stage.

The electricity crisis is now leading to the gas crisis

Europe is short gas molecules within the next 3 years. Given the lack of any feedstock response during this period (in the absence of a return of higher Russian flows), there are three options for reducing demand side to balance the market:

1. Industrial demand (has faced ~15% destruction so far in 2022 due to higher prices)
2. Demand for electricity industry
3. Residential & Commercial Needs (area that governments are more likely to try and defend in the event of rations).

Usually, very high gas prices encourage reduced demand from the power sector. But going forward, Europe is now short electrons as well as a molecule. And the source of marginally increasing electrons comes from burning molecules.

In other words, in order to keep the lights on, Europe has no choice but to burn more gas, other than intervening to reduce electricity demand may also be forthcoming.

A barometer for the impact of the electricity and gas crisis

The market valuation barometer that best reflects the severity of the electricity and gas crisis is the Clean Spark Spread (CSS). This is the difference between the electricity price and the variable generation cost of CCGT plants (ie the CCGT generation margin). Chart 2 shows how French CSS has exploded since the beginning of 2022 (most of this in recent weeks).

Graph 2: CSS Baseload of France striker on 22 Jan vs 22 Aug

Source: Timera Energy, ICE

If the CSS increases, it means that the increase in electricity prices is outpacing the cost of rising gas prices. This happened this summer. This is the most intense price in the French market but CSS futures are also rising to record levels across most of the European markets. Chart 3 shows CSS in France compared to two other major markets: UK and Germany.

Chart 2: CSS Baseload Transitions in France vs UK vs Germany (18Aug22)

The British and German transitional CSS levels may look small compared to the French levels. Don’t be fooled… they are also at record levels. For example, the German CSS Baseload typically ranges from negative to low digits compared to over 80€/MWh currently for Winter 2023.

CSS Infusion and Liquidity Challenge

Forward CSS is an important transmission mechanism that is seeing rising electricity prices drag on the TTF gas curve. As the transitional CSS increases, it increases the incentive for gas producers to hedge for further development. This involves selling electricity and buying gas (& carbon).

In other words, fully rational power generation hedging is bidding to increase forward gas costs in response to higher electricity prices (& CSS).

Volatility in both gas and electricity prices is now exacerbated by very poor market liquidity. Here is a function of:

1. Margin and collateral problems are limiting the ability of market players to trade futures
2. Possibility of risk (eg VaR/limit) issues that limit maturities.

In a market with higher bids, there is little offer of liquidity to cushion the upside. These conditions are set to continue to support extreme price volatility. Market moves are not only in one direction. For example, any increase in Russian supply will likely cause the futures market to close the gap lower.

An important piece of information the market is looking for is some clarity on the structure of policy intervention, for example in the form of industrial volume allocations or auctions. This information is an important input to trying to quantify the volume and price of demand required to open the market.

A significant portion of current electricity and gas futures prices are driven by a risk premium that reflects this uncertainty. The market is used to pricing electrons & molecules based on supply-side flexibility and not demand-side interference and destruction.

Extreme prices create a huge incentive for all energy consumers to cut demand. Whatever the split, let’s hope it catches market price signals instead of trying to dampen or cancel them.