Artur Stratan: “We could first resolve the electricity crisis and the gas crisis will sort itself out”

Author: Artur Stratan, Senior Consultant partnerg-i

We are witnessing what is happening on the two electricity and natural gas markets: the main gas supplier to Europe waltzes every day as the market dictates and its own interests and prices react accordingly, in tune with the music of its own repertoire.

I have said it before and I repeat: from the very beginning, the current gas crisis has been grafted onto the impending electricity crisis across Europe. What did Europe’s partner have extra compared to all the others, in addition to gas production, was vision and predictability of what was going to happen at the end of summer across Europe. They did the math and realized that Europe would register great production deficits and implicitly surplus electricity consumption. They noticed that the steps of decarbonization are way more ambitious, rapid and unrealistic than the pace of replacing the old electricity production facilities with the green ones.

The electricity deficit will have to be solved quickly and the easiest form is cogeneration based on natural gas. It was anticipated that for accelerated emergency cogeneration the gas consumption would increase exponentially and they prepared themselves since summer, starting to withdraw gas from its own underground storage facilities in Europe. We cannot associate the market behavior of EU’s external gas suppliers with that of a skilled hunter, because a hunter organizes its stakeout and waits for the prey to come in his sight. The situation was so predictable that our hunter only set a trap, knowing that his prey would take a certain path and at what time it would do so. Then he just went and recovered the game from the trap it had fallen into. Not to mention that the trap was of European origin.

It’s very sad to recognize this, but the whole Europe has fallen into its own trap and there weren’t even any tangible elements to draw attention to what was going to happen early on. The bliss of the general enthusiasm for decarbonization has turned into a destructive overzealousness and contrary to the own European interests.

The entire vicious cycle is in fact a cluster of factors, which repeat with each new iteration, and which do nothing but increase the prices of electricity and gas on the relevant exchanges.

The elements of this cycle, in the order of interdependencies:

1.    the need to purchase electricity

2.    decarbonization ambitions

3.    the need to tax polluters through carbon allowances

4.    the pursuit of financial benefits from carbon trading

5.    the need to cover the electricity deficit by emergency gas cogeneration

6.    the need to import more gas to cover the need for emergency cogeneration

7.    the need to purchase more carbon allowances

8.    the need to increase the electricity price to incorporate the value of carbon allowances and the ever-rising value of gas

9.    the need to purchase electricity and gas from the market at predictable and sustainable forward/future prices

10. panic, generated by the need for long-term predictability

Panic adds in the end to all the elements above. Panic shown by suppliers and consumers of electricity and natural gas and which can no longer buy at predictable and sustainable prices in the long run. What seemed a high and unacceptable price in September became in mid-December a very low and affordable price, compared to the huge levels reached today. The reasoning will continue to apply and we are all wondering whether the high prices in December will become again the low and affordable prices in February or March. And this panic has caused suppliers to place large purchase orders on the market at very high prices. Is this the solution? In the total panic mode, yes. About all the large energy-intensive companies are desperately trying to complete the budgets for the next year and they must include some values for electricity and natural gas. Those values are partial costs of the future finished products and in principle they must be sustainable, to be able to generate products that will find buyers in a certain niche and at comparable prices on the national, European or international competitive market.

In the rational mode, the situation needs a different approach. First of all, we can assume that this crisis will not go on indefinitely and that, in the end, the enlightened minds of Europe will come together to put an end to this bad dream.

Secondly, it should be said that Europe, leaving both markets to chance and not properly supervised, has blown up many more balls than it could handle. The outcome was that the EU could no longer juggle between them and got rid of them all. The huge price of gas that Gazprom has caused in the market probably made the entire cost of Nord Stream 2 pipeline to have already been recovered. With the return on investment, I think Gazprom is no longer that interested in the fate of the gas pipeline and its approval circuit in Germany and by the EU. Gazprom has caused a trend reversal in the market and realized that it does not have to sell a large gas production at low prices, but it’s much more profitable to sell smaller amounts, but at much higher prices, therefore maximizing the annual profits. Russia knows very well that as of this year the intention is for gas imports in the EU to be increasingly low. Therefore, it offers friendly countries long-term contracts, at lower prices.

As every stick has two ends, there is another side of the story. It seems that this period is in fact also a test for EU’s resilience in the middle of winter, at a low level of gas imports from Russia. It is not by accident that many LNG vessels have changed their supply routes from Asia to Europe. As the US has become the largest LNG exporter and the US advocates for the EU to obtain energy independence from Russia, I would say that nothing occurs at random.

I am more than convinced that Russia is already working on the development of a huge hydrogen strategy and that it has already started to invest in the new production facilities. Because there will come a time when Europe will no longer need natural gas, but hydrogen, and try to guess who will be able to offer very large quantities at very low prices to the whole of Europe? This cycle of dependence will be repeated and will have the same outcome as natural gas, until hydrogen is declared dirty and will probably be replaced by another much greener fuel. And because the geographical proximity cannot be changed, Russia will always be there to supply other forms of energy to Europe. This is the game and the actors are the same.

The proposal to jointly make at Community level all the Russian gas imports seems a constructive idea, because otherwise the elements of negotiation specific to each country will disappear. When you negotiate with several countries simultaneously and when you have several pipelines that bring gas to Europe and which can at the same time block the amounts delivered in a certain geographical area, without having the right to be delivered in other areas, already the entire negotiation just seems like a big chess game. When you must negotiate with a single entity, you can no longer make the games on the chessboard and you know, when you are on the other side of the bargaining table, that it’s all or nothing. You cannot play games of pressure or favors to several countries at once, in fact confusing the market and destroying its predictability and the long-term business of industrial energy consumers.

Europe will still have a lot to learn from this major energy crisis and over time additional security measures will be developed. One of them would be to prohibit the withdrawal of gas from the European underground storage in full summer, no matter who the owner of the facilities is. Because this was premeditated this summer, precisely to create the conditions and prerequisites for the perfect storm.

Assuming the perfection of the coupling and interconnection mechanisms at Community level, the second measure that could be assessed would be to ensure the national electricity consumption in each EU member state and to grant permission only to export the surplus electricity not consumed in each country. Regional interconnection should not have worked according to the principle of exporting large quantities and at a higher price, to the detriment of local national consumption at a significantly lower price. If you look at the history of regional interconnections of day-ahead markets for electricity, you will notice the upward evolution of day-ahead prices in the recently interconnected areas. This interconnection has given traders the chance to export large amounts of electricity and sell them at higher prices, therefore generating windfall profits. In this regard, measures for the substantial reversal of cross-border transactions could be identified, transactions which fed in fact this madness of day-ahead prices. And from them, the long-term predictability disappearing, the forward/futures prices have also been contaminated.

A normal electricity or natural gas market is characterized by the fact that forward/futures prices are at acceptable and predictable levels in the long term, without spectacular variations even in the short term. Spot prices (intraday and day-ahead) are also usually slightly higher than forward/futures prices, precisely because they are played in a market for a very short term and usually daily. In this spot market the sale and purchase needs are met to cover deficits and surpluses caused by the lack of profiled forward/futures products or caused by unpredicted events or technological accidents, which make the consumption discipline. In a normal market, the DAM (day ahead market) price must keep a quasi-constant gap to the values of the forward/futures market.

However, in today's energy market we see an exactly upside trend, in which the DAM price is artificially set by unclear market mechanisms and the forward/futures price being forced to follow the ascending curve of the DAM price to create a new price normality in the long term. The situation is completely anachronistic and destroys the concept of predictability. If prices normalize and fall, we will see a storm of withdrawals from supply contracts, but this time by consumers and not by suppliers.

It’s very difficult to understand how an electricity producer, with approximately the same production costs, can increase the price on the wholesale market by several times, only because the market allows it. Even if the market goes haywire sometimes, intervention is needed, stating that the market no longer works according to normal rules and in fact it fell to an area of excessive speculation of the selling price, behavior which requires intervention in the sense of elimination of the causes that led to the deviant market behavior. Although it may not look so, there are quite many energy specialists who could hit the right nail on the head, identify the causes and recommend the measures with maximum effect to come out of the crisis.

And as both crises, of electricity and natural gas, are chained and fused, in order to resolve the general energy crisis, one of them should be resolved first and the other will sort itself out. We could begin with the electricity crisis, because the gas crisis probably hasn’t said its last word.

On Wednesday, December 22, forward/futures gas prices skyrocketed on the TTF exchange in Amsterdam. Until the beginning of December, prices remained very high until the delivery month March 2022 and then would fall, for the subsequent delivery months, to EUR 30-40/MWh. Due to recent belligerent press statements, and due to the already established panic, all prices until March 2023 jumped to the level of EUR 105-135/MWh.

An external energy partnership of the EU cannot be built just at declarative level. Any statement must be supported in the long run by facts, because this is the only way to win the trust of a partner. This relationship must remain a purely commercial one and without any trace of politics or geostrategy. Both the EU and its external partner have their place under the sun and can collaborate without using energy vectors against each other. They just have to want it.

Translation from Romanian by Romaniascout (www.romaniascout.ro)