Page 38 - bne monthly magazine October 2022

38 I Cover story bne October 2022
were up ten-fold but demand fell only 7% in the first half of this year. The demand elasticity in the gas business is very low indeed. As governments are very reluctant to make consumers pay for political reasons, reducing
gas demand by using marketing mechanisms is almost impossible so Europe burns more gas than it should.
“While it is essential to continue targeted supports for vulnerable households, the overall result has been that governments have burned money in a race to consume more gas,” says Bruegel. Italy has not reduced its demand at all, which lead to substantial amounts of gas transiting Austria to meet this demand. If Italy had cut demand by only 3% then its tanks would be 80% full now, not the current 63%, Bruegel concludes.
The European gas market is a complex system that is nevertheless quite efficient at dispatching gas across the continent. But since
Gazprom cut off supplies to Europe via Nord Stream 1 pipeline indefinitely at the start of September the European gas transport system is stretched to breaking point.
Bruegel says the system faces four major coordination problems: refilling of storage; gas use reductions; new supply; and ensuring continued gas flow to where it is most needed.
“All four areas require national government intervention, with coordination failures leading to a less secure, sustainable and affordable system,” says Bruegel, which it goes on to say is not happening.
One of the biggest changes in the last year is LNG has gone from being a top-up supply of gas to keep the system running smoothly and as a buffer to external shocks to one of the key sources of fuel and that has sent its price through the roof.
“Prior to the crisis, Belgium imported moderate volumes of LNG, steady volumes of gas from the Netherlands and Russian gas via Germany in winter months to meet peak demand. Trade
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with the United Kingdom fluctuated depending on demand. As the crisis has developed, Belgium has increased its LNG imports to maximum capacity and has boosted pipeline imports from the UK. As a result Belgium has become a significant net exporter to Germany, a vital aid as Russian gas flows are cut,” says Bruegel.
Prices and money
The power system is already in crisis. Faced with the prospect of freezing homes as the first snows fall, most European governments have focused on their own populations and thrown money at the problem rather than cut demand. Hundreds of billions of euros worth relief packages have already been spent and more will follow if prices continue to climb. The efforts so far run the risk of fragmenting Europe’s power market and could lead to massive over-investment into redundant generating capacity that will also undermine the investments into new renewable capacity which is the long-term solution to the current crisis.
“Subsidising energy consumption instead of demand reduction has been a common and misguided approach. Governments run the risk that energy consumption subsidies become unsustainable, eroding trust in energy markets, slowing action in sanctioning Russia and increasing the cost of the net-zero transition,” says Bruegel.
Even before the blackouts arrive, the wild swings in prices have already wreaked havoc on the power business. The European power market is highly coordinated but the business of buying and selling electricity – essential so that generating capacity and demand remain matched every hour of the day – remains a local business and exposes smaller traders to big losses. Since September 2021, nearly 30
UK energy suppliers have filed for bankruptcy. Bankruptcies elsewhere include Bohemia Energy, the largest alternative supplier to state-owned CEZ in Czechia, which filed for bankruptcy in October 2021, while multiple energy providers have said they will withdraw from the French market, with Planet Oui activating an accelerated safeguard procedure in January 2022.
It’s also costing a lot of extra money. The volatility in the market has pushed up the margin requirements for traders. Normally contracts on supply are
signed well in advance of delivery dates to ensure demand and supply can be matched. Central counterparties (CCPs) that facilitate these trades demand a percentage of the contract as a down payment, but that share has risen to 80% of the contract price creating a liquidity problem that sends up costs for everyone. If the volatility gets worse then banks may stop providing the credits to cover these charges which would create a liquidity crisis that could spill over into the banking sector, says Bruegel.
Several large utility players have
already got into trouble. The German government is preparing to bail out its major utility company, Uniper, with a rescue package worth €15bn; the Élysée has announced a €10bn package to finalise the nationalisation of Electricité de France (EDF); and in early July CEZ, Czechia’s biggest utility, signed a credit agreement with the country’s finance ministry for up to €3bn, providing liquidity to the company.
In the face of spiking energy prices governments have been throwing money at the problem to protect consumers too. When prices began to rise in the summer of 2021 as Gazprom squeezed supplies
of gas European governments rushed out subsidies, but in the meantime
that spending has become structural and enormous. Since September 2021, governmental interventions have spanned between 0.1 and 3.6% of GDP and come to a total of around €230bn in the first half of this year. That number
is set to as much as double before the end of this year. The value of gas and electricity traded in the EU has jumped from about 1% of GDP in 2020 to over 10% of GDP based on August 2022 price levels, according to Bruegel.
At some point the cost of fuels like LNG and the subsidies governments are doling out to their population become unsustainable: it becomes cheaper to shut down half your economy than it does to pay for gas and your citizens' power bills.