Energy Price Crisis

Mike:?I’ve just seen this article that suggests German year-ahead electricity contracting prices are now at €995/MWh while in France they are at €1,100/MWh.?Other than the obvious panic, what other behaviours might this drive??This is now more than just volatile spot market pricing, so is this sufficient to drive new lower cost investments??How will these investment decisions be complicated by the EU's planned 'emergency interventions' that are talked about in the same article??Can market forces be left to do their job or is this a situation that the designers of the market just never envisaged?

Andy:?Thank goodness we haven't built too many interconnectors, otherwise we too would be picking up the 4 digit power prices! ?

Mike:?But aren’t we exposed to continental gas prices? ?…and given that gas sets the marginal price for electricity, aren't we heading in the same direction?

Andy:?I don't think we are fully exposed to continental gas prices, though. ?The gas interconnector is weak and their lack of LNG import facilities mean they are constrained there, so it’s harder for their panic prices to infect us. ?I think Germany is in a much worse position than UK, so prices there will be extreme.

Mike:?Despite this, a quick scan of the internet suggests that GB 'season ahead’ prices are currently at over ￡750/MWh this winter and ￡550/MWh for next summer ...and the trends appear to be exponential!

Andy:?Just looked, frightening exponential shape to them! We're still not as exposed at continent though. I’ve just compared continental and UK day ahead and they are about 50% higher which correlates with Germany being at €1000.

Mike:?So, back to my original question...?is this market completely broken, or could this drive a whole range of investments that we haven't seen before.?At these prices even wave power starts to look commercially viable!?

Andy:?Trouble is everyone knows this is just a temporary thing. ?New supply (in particular gas) will come on and politicians know they cannot afford to let this carry on for long, so they will engineer a price correction somehow.?

Some economists might say this is good evidence that the market is working.?Prices are allowed to rise which will bring on new supply or destroy demand, which are the correct market responses.

Mike:?Sadly the demand is destroyed among those who are least able to pay, who finish up in even greater poverty.?(CREDS have just put out a useful opinion piece on this.)?Also, the new supply will presumably all be from fossil fuels because that can be delivered quickly with none of the other barriers that the other solutions have.

Andy:?Yes, it's not good, but it is how markets work. I was thinking about industry too, that will start to shut down or relocate to places where energy is cheap. On a positive note this might kill off Bitcoin!

Mike:?It's certainly looking like pubs will struggle.?Or at least the ones who didn't negotiate an energy deal before the prices started rising.

Andy:?I'm sure pubs and breweries are just the tip of the iceberg, there will be many businesses out there who are suffering. ?They will have to raise prices or fold. ?

Mike:?I wonder what interventions would be needed in this 'functioning market' for the solutions to demand reduction to be (for instance) a serious effort to insulate people's homes?

Andy:?The trouble with interventions like insulation is the lag (no pun intended!). It will take many years to make significant changes to housing, if only someone had thought of this earlier ??

Mike:?I think what we're saying here is that we have energy markets that are designed to deliver energy from fossil fuels.?They are not designed to deliver sustainable energy solutions.?

Andy:?CORRECT, they were never designed for zero marginal cost generators, they exacerbate the missing money problem where marginal energy prices set by the variable cost of the most expensive supply are supposed, but never can, cover the fixed and capital costs of all generators. ?But now the missing money has turned up in abundance with scarcity pricing not just at the peak but all year round!

Mike:?…and the current price spike may be (relatively) short-term but the underlying problems are not.?We've known for years that over-dependence on one source of energy (gas) is problematic.?Yet, here we are again.?

Andy:?…and this has been compounded by relying on one major supplier, which it turns out does things with our money we don't like.

Mike:?We also know that we have an urgent need to remove our dependence on fossil fuels.?What is it going to take to deliver lasting reforms to markets that deliver on both of these priorities??It feels like the ‘age of the trilemma as the basis of energy policy’ is back with us, despite Greg Clark suggesting it was over back in 2018.

Andy:?To be honest Greg Clark may have said the trilemma was over, and people were all excited about the four D’s (decarbonisation, digitalisation, distribution and democratisation) as a replacement, but I never thought it was dead. ?I can’t think of a time since the late 2000’s when the trilemma was invented that we haven’t wanted to progress towards decarbonisation, ensure security of supply, and do it in an affordable manner, although to be fair this latter vertex has morphed from “liberalisation” through “competitiveness” to “cost” then “affordability”. ?I can’t think of a time when (in reality) the three weren’t in tension, satisfying any two has always provided a serious challenge to the third.

Mike:?Yes, I think that events over the last two years have demonstrated that it is still very much alive and kicking.?First we had an international pandemic that created economic conditions that some have described as being equivalent to the worst recession in 300 years.?As we started the journey of recovery from that economic shock the talk was all about the cost and affordability of energy as markets responded to the swings in demand for energy caused by COVID.?Then, as the UK hosted COP26, we again became occupied by the urgency of the challenge of reducing global greenhouse gas emissions.?Sustainability was, once more, at the centre of our political discourse.?However, not long after this, Russia invades Ukraine and energy prices skyrocket, at least in part due to the challenge that a war in Europe creates for security of energy supplies.?And then, we have just had the hottest summer on record, proof if ever we needed that climate change is real...

Andy:?We do cycle around the vertices with monotonous regularity, making one aspect king for a short while like an endless game of rock, paper, scissors. ?The promotion of the four D’s in the late 2010’s is a case in point, the environmental vertex makes it through to this trendy acronym, but affordability and security are swept under the carpet. ?The focus on the environmental (or more specifically the carbon) vertex reached its cyclical peak at COP 26, but now the situation is completely upended. ?I’m regularly asked down the pub if the lights will stay on, and all the headlines are about affordability. ?Germany is bringing coal out of mothballs, in the UK we are running coal plant in the summer, the EU is causing Russia to flare it’s gas at the border - to hell with the environment! ?We’ll pay what it takes to get the gas, even the UK’s Green Party is calling for fossil fuel subsidies to keep the gas flowing.

Mike:?I fear we may have forgotten the intention of having a ‘trilemma’ at the centre of our energy policy.?As you say, we currently appear to be cycling around the vertices at an alarming rate rather than keeping the three ‘in tension’ as policy is created in response to the latest shocks. ?Delivery of policies that respond to each of these driving forces in turn appears to be simply adding to the volatility within our energy markets and the drivers for change within the energy system.

Andy:?I’ve little doubt that in a couple of years’ time, when things are more settled (or at least perceived to be), and there have been further climate induced disasters, the environment will resurface as top dog. ?It seems unlikely energy prices will ever collapse back to their pre-covid levels though, so the price rises that have always been essential for driving decarbonisation (but couldn’t be allowed to be seen as a symptom of decarbonisation) will start to figure in investment decisions. ?With carbon prices at an all-time high now would be a good time to ratchet up the carbon price floor without anyone noticing!