My best wishes for 2014 (wishes, not forecasts!)

By Benedict De Meulemeester

By Benedict De Meulemeester on 8/01/2014

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In my home country Belgium, we have the nice tradition of ‘New Years letters’. Children write letters full of semi-philosophic observations and wishes which they read to their parents and grand-parents on New Year’s Day. In this tradition, I also want to write a few words in which I look back on trends observed in the past months and try to look forward on what could happen in the new year. As I have remarked before, I am not in the forecasting business. So don’t expect any forecasts on prices or events. I will try to think about what might happen to guide the reader as to what she/he should look out for in the next months in the news on energy markets.

1. Will the European gas prices move? Up? Down?

The gas markets in Europe have traded flat in the past two and a half years. Impossibly flat. The main concern of analysts in this market was trying not to fall asleep. Prices traded towards a level of 26 – 28 euro per MWh in the wake of the Fukushima disaster. Upward pressure continued as Asian demand remained high. And this was / is not just more demand in Japan due to nuclear shutdowns. New LNG import terminals in China, South-Korea and other Asian countries have also put pressure on the demand side. At the same time, expected LNG export projects in Australia were delayed. Without further delays, the first of the Aussie new LNG will start flowing in 2014. As of 2015, they are expected to hit the market in full strength and US LNG export projects add extra volumes. Can this (anticipated) increase in supply cause a downtrend in 2014? Or will, on the contrary, prices increase as supply projects suffer further delays, Asian demand continues to soar and European demand picks up in the wake of an economic recovery?

A downtrend in gas markets would be a welcome relief to Europe’s energy markets. In the last three years, consumers haven’t had any chances of securing some good prices for future gas budgets. The same would be true for power consumers in the UK, where power prices are closely linked to gas prices. A dip in the gas price would be even more welcome for the power production sector. With relatively high gas prices, low coal prices and large amounts of renewable power on the grid, the owners of gas-fired power stations have been butchered in the last two years. This became clear in the last days as Germany had to announce that its lignite consumption peaked in 2013. A drop in gas prices that improves gas power plant economics would therefore also be good news for our climate policy.

2. Will low wholesale prices for electricity persist?

 Certainly in Germany and Central Europe, the wholesale electricity prices hit historically low levels in 2013. Causes have been: low coal prices, increasing renewable energy production, low prices for emission rights and declining power demand. This has obviously enabled end consumers to fix some really low budgets for power (commodity) for the next years. But we might see some dark clouds on the horizon:

  • The low prices have slashed the profitability of power production. Therefore, we should expect a normal economic reaction: i.e. shutdowns of power plants that lead to a decline in supply and increasing prices. This trend has started already, certainly as far as the unprofitable gas power stations are concerned. Governments are trying to stop this by denying plants the right to shut down or by considering capacity payments to gas-fired power plants (see below). Moreover, it is highly likely that other than economic reasons will also influence our power supply situation.
  • Seeing that their climate and other environmental policy efforts are undone by increasing coal and lignite consumption, governments might decide to shut down coal and lignite-fired power stations, a phenomenon we have seen already in the UK.
  • In many countries, governments are also turning back or rather reducing their programs for supporting renewable energy. They might take that a step too far and slow down the development of renewables too much.
  • And what if in 2014 measures are taken regarding the emission trading system (ETS) that go further than the cosmetics of the back-loading proposal? What if a real shortage of emission rights prices is created? Buyers (and policymakers) have to take into account that theoretically every 1 euro per ton increase in emission rights prices leads to a 0,5 euro per MWh increase in wholesale electricity prices. This theory was empirically proven in 2005 – 2006. And the impact might even be larger this time as more marginal MWh’s are produced from coal, which has higher emissions per MWh factors.
  • Many economists are quite upbeat about Europe’s economy in 2014. It would be very interesting to find ourselves in that situation, not just from a socio-economic point of view. A period of economic growth would show us whether the decline in power (and natural gas) demand observed in the last years can be purely attributed to the economic crisis or whether it was also caused by a more fundamental trend: the effect of climate policy. But a recovering power demand could have a price increasing effect.

As you can see, there are many reasons to observe power markets carefully this year and watch out for signs of a reversal of the current downtrend. However, in the first week of the year, the market was rather pointing in the other direction. It could therefore very well be that the combined forces of low coal prices, unstoppable renewable energy development and declining demand continue to push down prices. And – who knows - if we would see a downtrend in gas prices (see above), we might find even lower prices. If the past years have learned us anything about energy markets, it is ‘Never say never’.

3. Will the non-commodity part of the power bill continue to increase?

Even if commodity prices for electricity have reached historical lows, for many consumers across Europe the total price of electricity has increased sharply. This is due to the increase of the non-commodity part, the grid fees and taxes. Europe’s power supply system is being rapidly transformed from a centralized system with large-scale power stations to a locally distributed system with many small-scale power stations. It is logic that such a systemic transformation causes cost increases. Also, we have to consider that the market system in itself has been redesigned. In the past, markets were regulated and its operators were state-held and/or heavily politicized monopolists. Systemic transformations such as the construction of nuclear power plants or the continuing use of coal when it was no longer economic to produce it, have been and continue to be heavily subsidized. However, these subsidies were often paid from other sources than the power consumers’ bills. Therefore, they were less visible. In today’s liberal markets, every cost of the power market transformation is passed through in the bills of end consumers. This makes the cost of the transformation much more visible than what we have seen in the past.

This obviously doesn’t mean that the cost increases should be neglected. In those countries that have pushed for more renewables hardest, we now see impressive add-ons for renewable energy on the electricity bills. Germany is the most obvious example, with the contribution to support renewables now almost twice as high as the wholesale value of the electricity. In other countries such as Spain, Italy, Belgium (especially the Southern part) or (increasingly) the UK, we see a similarly high renewable energy bill for the end consumers. Even if price increases were perfectly predictable when politicians introduced the renewable support schemes, politicians have reacted to them with surprise and have announced reforms of the renewable support schemes. They might take this too far and stop the further development of renewables. I personally think that this would be a sorry thing. The efforts of the past decade have brought down the cost of renewable energy technology. It’s never been cheaper to invest in more renewables than at this moment. It would therefore be very disappointing if we stop the efforts right now. It would be like stopping while the finishing line is in sight. However, maybe countries that have so far been laggards, such as the Netherlands or many Central European countries, should take over the efforts. That would also be a good thing for the balance of both the grids and the internal market for electricity in itself.

The high add-ons for renewable in countries such as Germany, are largely caused by ‘stranded costs’, compensation for high subsidies that were guaranteed to investors in renewable energy when the technology cost was still much higher than it currently is. It should therefore be carefully considered how this cost is distributed in time and across the different actors. Protection of Europe’s electro-intensive industry should be an important consideration. And should we really pay back these costs in the next five to fifteen years or shouldn’t we rather finance them from a long term credit? The next generations will profit (from an environmental but also from an economic point of view) from our current efforts to develop renewable energy. Is it therefore a case of inter-generational injustice when we pass on part of the renewable energy bills to these future generations? In the North of Belgium (Flanders) reforms of the renewable energy support mechanisms seem to have succeeded in keeping the costs at bay without completely stopping the development of renewable energy. Germany has also started its reforms and is discussing the distribution questions actively at this moment. This week, we saw a rather disappointing ‘stopping in the bud’ of the intergenerational discussion by the President of Bayern and of government party CSU Ernst Seehofer. But I would be surprised if this ‘spreading the cost in time’ isn’t discussed again in Berlin.

I am not entirely confident that politicians will manage to make these reforms of Europe’s renewable energy policy a success. I have seen too many cases that prove that politicians’ interventions in the energy market always cause unwanted side effects and price increases. This lack of economic prudence shows itself again as the effects of more renewable are being discussed. Policymakers are loudly protesting the current cost increases caused by renewable energy development. However, at the same time they want to hand out money (capacity payments) to gas-fired power stations to solve a problem (power plant shortage) that hasn’t manifested itself yet, against all forecasts. Who will pay for such capacity payments? Yes, the end consumers in the shape of another add-on on the electricity bill. Worst case, we will see reforms that stop the development of renewable energy but because of the stranded costs issue that doesn’t lead to any cost improvements and capacity payments to gas-fired power stations continue to increase the power bill.

As in every ‘New Year’s letter’, I want to end this blog article with some good-hearted- if slightly naïve wishes. I wish all of you energy buyers out there for 2014:

-        A good dip in the gas markets,

-        Continuing low wholesale power prices (and, if possible, a little bit lower still?),

-        Politicians that manage to reform renewable energy support mechanisms in a cost-efficient and rationally distributed manner.


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