Perfect storm - what's behind the surge in wholesale energy prices?

Richard King, trading and risk manager at carbon and energy consultancy Envantage, explains why news of the fire at the IFA1 interconnector site has come at an already volatile time for wholesale energy prices and examines the key factors that have contributed to prices reaching an all-time high.

Prices in the wholesale energy markets in the UK and Europe have surged to record levels over the past week. As we head into the winter period for the northern hemisphere, a number of supply issues are increasing risk premiums and the very real possibility of there being insufficient energy to meet the demand of homes and businesses.

Powering the reopening of the economy

Demand for all energy commodities (oil, gas, coal) has seen strong growth throughout 2021 as the development and distribution of Covid-19 vaccines has allowed the reopening of large sectors of the economy, with the return of consumers to the High Street driving the fastest economic expansion during this summer for over 70 years. ?However, this expansion in energy demand across the globe has come when European markets face a number of supply constraints that have pushed the Continent’s Transmission Systems Operators (TSOs), such as the UK’s National Grid, into taking more expensive actions within the market to ensure security of supply.

Given the unseasonably cold temperatures across Europe during the spring, gas inventories at European storage sites were heavily depleted which, coupled with intense competition for flexible LNG tanker supplies from booming Asian economies during the summer injection season, has meant that gas volumes currently held in storage are at their lowest levels since 2013 for this time of the year, significantly raising premiums for winter gas contracts.

Pipeline issues

Pipeline supplies of gas into Europe have also been heavily disrupted all year, with extended outage requirements at Norwegian gas assets in the North Sea and a lack of additional gas supplies from Russia via the Ukraine and Poland, as Gazprom looks to secure approval for its controversial new Nord Stream 2 pipeline that would export gas directly to Germany under the Baltic Sea. Despite the completion of the pipeline in early September, the necessary regulatory approval from German authorities to begin physical operations of the pipeline may not be secured until the first quarter of 2022, which will starve Europe of gas supplies for the onset of the early winter period.

Investor interest in carbon markets

Added to this, we have seen further bullish momentum within the energy markets due to surging carbon markets, with Dec-21 EUAs doubling in value since the beginning of the year from €33/t to €60/t. Financial investors have taken the EU Commission’s increased ambitions to cut greenhouse gas emissions for the European economy as a signal to buy into the market, elevating prices to record levels.

These issues have been building all year with prices steadily increasing through the summer months as the potential for supply disruptions during the winter has become more and more apparent. However, price increases have reached stratospheric levels this week as additional supply constraints have hit the market at once, with historically low wind speeds for the early September period severely curtailing wind generation just as a number of unplanned outages at thermal and nuclear power stations have forced prompt power prices for the Day Ahead market to trade in excess of ￡500/MWh. The final piece of news yesterday morning that the 2GW IFA1 interconnector between France and the UK would be out of action until next March following a fire at a substation in Kent saw prices for the Win-21 baseload power contract jump by 20% to trade as high as ￡200/MWh.

With such levels of extreme volatility within the markets currently, UK companies that are exposed to these price rises may find it increasingly challenging to continue operating during the next six months. Indeed, this week, fertilizer producer CF Industries announced the closure of two facilities in the UK in the face of rising cost and, unfortunately, they are unlikely to be the last business forced to take remedial action.

Strategies for mitigating risk and improving resilience

There are a number of short, medium and long-term strategies UK businesses can adopt to mitigate the risks of volatile market pricing:

Short term: check if you can reduce your immediate spend by reviewing the way you are purchasing your energy in the current environment

Medium term: explore whether onsite and renewable generation options are a viable way of reducing your reliance on traditional supply channels

Long-term: ensure you are on the right strategic path to targeting and implement carbon reduction policies

To find out more about how Envantage and our trusted network of specialist partners can help you to define a more sustainable future in the low carbon world, get in touch with our expert team.