How to keep the lights on? After a decade of under-investment in oil & gas exploration, the dismantling of strategic energy storage facilities followed by two Black Swan events: Covid and Russia’s invasion of Ukraine, we are in a big energy pickle.
The events over the last 2 years (yes only 2-plus years since the first lockdown) have resulted in soaring energy prices. The supply-demand relationship is clearly out-of-whack. Will it adjust to ‘normal’ again? The concept of efficient markets would suggest so, but how long will it take to get there and how can we keep the lights on in the meantime?
Extremely high oil & gas prices. Why?
For a very long time we have been used to an instant supply of cheap (partially government subsidised) energy, be it to cool & heat and light our homes or to fill up our cars. Fossil fuels are the juice that make economies run, literally. But a focus on renewable energy and the desire for carbon neutrality led to relative underinvestment in fossil fuel power. In the period 2010-2019 investment in renewable power was USD 2.6 trillion globally versus ‘only’ USD1.66 trillion of investment in fossil fuel power. The volatile and overall declining returns on the oil & gas investments over the last 10 years, made the sector both unattractive and unsexy, aka unsuitable (too dirty) for ESG investing. But even before Covid, the total supply investment in oil & gas AND the renewables was not aligned with projected global energy needs. In short, even without Covid and a war, there was never going to be enough supply for the projected demand for the 2020-2025 period.
The oil & gas sector came to a crashing halt in April 2020, when oil prices went negative, and share-prices of oil companies fell to all-time lows. Many extraction sites were mothballed during Covid and restarting these sites now as well as initiating new oil extraction activities will be taking some time. But when eventually the production of oil & gas can be increased, prices could and will stabilise.
The ‘simple’ conclusion therefore is that energy is so costly because there was (1) not enough appetite for investment in recent years; (2) the surge in energy demand post-covid was ‘unexpected’ and (3) the current sanctions on buying oil and gas from Russia, have squeezed the supply-side. Things are especially painful for Europe, which has only 3 countries in the top 20 gas producers worldwide, being Norway (8), Netherlands (17) and the UK (19). With the US and Russia being the biggest gas producers by a very wide margin, it is easy to see why gas prices are so high when the number 2 producer is taken out.
But what about electricity prices?
38% of global consumer spending is going to electricity. Electricity is generated by electric power plants that use turbines to convert fossil fuels (coal, petrol and gas), wind, solar and nuclear power into electricity. Although renewable energy sources have increased as part of the UK energy mix (wind and solar), they can’t always be relied on, and this type of energy can’t be easily stored either. With demand for fossil fuels up and prices high, the price for electricity is equally in an unbridled upward push.
Countries without energy storage facilities (and/or strategic reserves have been caught with their pants down as buying energy on the open market now is like governments competing for PPE early in the pandemic, aka hugely expensive.
What is next for UK prices and what do other big European economies do?
Wholesale energy prices have risen 250% in 2021. In the UK over a 130% of those increases are being passed on to the end user. The UK government can’t do much about this as all energy companies are in private hands. To compare, energy prices in Germany have risen 23% so far in 2022. Germany currently has their gas tanks/reserves 80% full, and projects to have them 95% filled by November 2022, enough to get through most of the winter without having to impose outsize price hikes. In France the government has decided to cap energy price hikes for households at only 4%. This can be done as the main electricity supplier in France is state-owned (EDF) and a whopping 78% of energy is supplied by nuclear power, making France largely energy independent.
The UK electricity providers – without any reserves or storage - must continue to buy energy on the open market, where prices keep rising, and hence are exposing households to uncontrolled prices increases until more supply will become available and the market stabilises. And then it is just hoping the energy companies will decrease prices accordingly….
Until that time the best bet is to decrease demand. Why keep all the lights on in offices and government buildings at night? There is so much energy wasted. Bringing nationwide demand down by 10% will help ‘cool’ prices as #everylittlehelps. So, can the last person indeed please switch off the lights….
Sources & links:
https://www.nationalgrid.com/stories/energy-explained/how-much-uks-energy-renewable
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