This article was originally published in PFI, 6 April 2022
Conflict in Ukraine has pushed gas and energy prices across Europe to sky-high rates, accelerating concerns that we are too reliant on gas. How should the industry balance the need to decarbonise with the need to keep energy supplies secure and affordable? Rod Morrison explores.
- These are extraordinary times best exemplified by power prices in the last two years that have seen wild swings from one extreme to another.
- Europe has grown increasingly reliant on outside sources for energy amid a domestic focus on developing green energy initiatives – a situation worsened by the conflict in Ukraine.
- With subsequent record prices, it would be wise for renewable generators to nip in with an offer of some long-term power purchase agreements (PPAs) to stressed corporates before the tide turns.
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Owners of renewables generation plants are currently making hay while the sun shines and the wind blows.
Record prices mean record profits but only, of course, if you are unhedged. Indeed, it would be imprudent not to be hedged and therefore imprudent to be making record profits – but the temptation now must be to throw off the hedging shackles and grab the record prices while they are available.
More schemes are looking at the merchant route (a) because prices are so high, and (b) because, in any case, there is a limited number of long-term buyers.
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When will the gas market return to normality?
When prices were depressed by COVID-19 there was a way out, i.e., when the pandemic came to an end.
Now there surely must be a way out of €200/MWh in the foreseeable future, hopefully as political turmoil subsides, and the gas market returns to normality.
For Europe, dependent on Russian gas, that could see a long way away, but events could change fast.
Renewable generators, particularly those with a portfolio of assets, will be tempted to alter the mix between hedged and merchant in favour of more merchant as part of the yearly review.
Indeed, with prices where they are, this could be forced upon them. But probably a more prudent approach would be to try harder to find utility or corporate buyers who must themselves be under a good deal of stress given what is going on with the price they pay for energy.
If the long-term power price curve does settle back down, locking in some extra pounds or euros now long-term would seem a good strategy.
Construction price inflation
Inflating economies is not a one-way street for generators, however.
Even as power prices sail through the roof, anyone building a new asset to take advantage will be hit by rampant construction price inflation.
Developers bidding into round four of the UK contract for difference (CfD) programme are now asking for bigger financial subsidy pots to support their projects – whether the schemes be onshore or offshore. The bigger the project, the bigger the cost increases.
As the bids went in on January 14, the request seems to be a little desperate.
Power prices reached its depths – £30-€35/MWh – as COVID-19 took hold in spring 2020, but have now scaled unforeseen heights of more than £200/MWh and €200MWh in some countries as the energy crunch hits home.
That, of course, is in Europe. In the U.S., apart from a few wild days in Texas last winter and in California every summer, prices have remained pretty static over the last year.
The scale of the U.S. fracking revolution is such that the country has been immune to many aspects of the energy crunch and is indeed stepping up to the plate to send vast quantities of gas to Europe.
The impact of the conflict in Ukraine
The gas price still drives the power markets. The global gas price was shooting up before the Russian invasion but now of course there is extra pressure.
Green energy benefits from a buoyant gas market. But it would be interesting to see what would happen if gas were taken out of the equation now as those who favour net-zero suggest, as opposed to an energy transition approach.
Life would be unsustainable. We have already seen plenty of governments in Europe stepping in to help consumers with their bills.
Has the Russian invasion shown that we in Europe are too dependent on gas or should we ramp up production? That appears to be the political question right now that will play out over the summer as governments seek to ramp up their gas supplies while net-zero proponents become more vocal in their demands.
Gas price crash?
One scenario put forward by analysts at Citi is that gas prices could crash, with production being ramped up in the U.S. and Russian dumping gas on Europe once the war ends in order to fight off the U.S. competition.
This is a similar debate to one that took place during the reign of President Trump when he was on a mission to sell gas into Europe. Diversify via U.S. gas or keep focused on Russia?
It will be interesting to see what will happen when the political turmoil subsides, will the prospect of cheap Russian gas still hold sway?
One bank, ING, is to stop funding new gas fields although it remains on midstream and downstream. That is one way of not taking gas price risk.
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