Gas Holding Power Over the Energy Markets

The price of gas and the price of power have become inseparable. An immediate break-up seems highly unlikely.

Not long ago, predicting the price of gas was easy. Gas was always inexpensive and available. But in 2022, we saw record-high peaks followed by a steep fall in the beginning of 2023.

19 06 gas outlook original ISN6 CCR

Antoine Lardeux, gas market analyst at Volue, says the price of energy in Europe has followed the fluctuations of gas prices like a shadow. The result: Dramatic variations in European energy prices – and public outcry.

"The highest priced energy source in the market dictates the price of power. Gas is what fuels electricity plants in Europe, providing balancing power to the grids when output from wind and solar energy drops. High gas prices due to shortage of gas will continue to dictate energy prices in Europe, at least for another year or two", says Lardeux.

Why so volatile?

According to Lardeux, the current situation is the result of a combination of events.

"It all started in the fall of 2021 when Russia cut gas supplies to Europe. Next came a dry winter with reduced hydropower production, while French nuclear power plants were interrupted. There was already a shortage of energy when Russia invaded Ukraine and “weaponized” gas. The combination of less gas, less nuclear, and less hydropower was disruptive to the market", says Lardeux.

Actually, it could have been worse, if it hadn't been for Asia being hit by a new wave of Covid, which led to falling demand for liquified natural-gas, LNG, in many Asian countries.

"LNG found its way from Asia to Europe. Somewhat limited by capacity in European ports, LNG still helped fill European gas reservoirs. This undoubtedly slowed price growth," says Lardeux.

What happens next?

Where do we go from here? The right answer is found by resolving a complicated equation with many unknowns: The war in Europe, the supply of gas from other markets, such as the US, Asia, the Middle East and Africa, and the influx of renewable energy sources. A possible economic upswing and subsequent increase in gas consumption in Asia could also have an impact.

"There is only one fairly certain factor: Russian gas, which now makes up eight percent of total European gas imports, will remain at a low level in the foreseeable future. European politicians do not want to return to a situation where Russia can use the gas as a weapon against them", says Lardeux.

Predicting the future is always difficult. However, Lardeux and his colleagues at Volue Insight have demonstrated a good ability to do just that. Last autumn, they predicted that gas prices would fall towards the end of the year, partly as a result of increased LNG imports and a decrease in energy consumption among European consumers. While the market predicted 130 euros per megawatt at the start of 2023, Volue Insight's estimate was 100 euros, providing a clear bearish signal to the market participants.

"We hit the target pretty well," says Lardeux and adds: "Going forward, we believe in lower volatility in gas prices, as a result of increased production of wind and solar power. This will reduce the need for gas used for heating and power generation. Increased imports of LNG, replacing Russian gas, will also have a dampening effect on prices. During the summer, the energy storages will be filled up. Post-Covid Chinese rebound should increase LNG competition and thus gas prices. Next winter is the big unknown, a dry summer and cold winter may cause prices of gas and electricity to skyrocket again.”

Gas-Power Correlation

Since October 2021, German and Norwegian (NO2) power spot prices have been following the evolution of the short-run marginal cost of gas at almost the same level.

31 01 NO2 DE spread

Fuel Switching and CO2-EUA

Along with the significant drop in gas prices over the last six weeks, hard coal to gas fuel switching prices have dropped lately. As generation costs of efficient gas-fired plants are getting closer to hard coal fired plants, this can have implications of the fuel mix in some European countries. This may lead to a 65 million tones reduction of CO2 emission in 2023. We observe that for the first time in a while, gas prices are once again the major EUA price driver.

23 01 Power Balance Comparisons

Power Balance 2023 – Gas Consumption

For 2023, we expect EU27+UK gas demand to drop by some 550-650 TWh. As we see further decreases in power demand, higher nuclear and hydropower output, as well as a record-high inflow of renewable electricity, thermal power generation may be alleviated by some 190 TWh. With much of that being gas, we expect the power sector to require 290 TWh less gas this year (assuming a gas-fired plants' efficiency of 50%). We also observe industry sectors suffering high costs, and with curbed output, we assess this to lead to 100 TWh of less gas demand. We also expect some 100-250 TWh of less gas consumption from other sectors, including residentials.

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