What’s Behind Europe’s Skyrocketing Energy Prices

(Bloomberg) -- Europe’s power costs have been pushed through the roof by a supply crunch in natural gas, the risk of military conflict in Ukraine and bottlenecks for renewable energy. Compounding the problem, France’s aging nuclear reactors -- the backbone of the region’s power system -- are becoming more unreliable. Wary of the discontent and disruption that often results from soaring energy bills, governments have stepped in with measures to keep homes warm and factories running. 

1. What’s the problem?

Benchmark European gas surged above 180 euros a megawatt-hour to a record on Dec. 21, compared with about 20 euros at the start of 2021. That’s because, although the omicron coronavirus variant had dampened some demand, there is pressure on energy supplies. Coal plants had been shuttered, stockpiles of gas -- a key fuel in European power stations -- were lower than normal and the continent’s increasing reliance on renewables was becoming a vulnerability. Power prices also climbed, with German year-ahead electricity and futures contracts for the first quarter of 2022 in the Nordic region also reaching records. 

2. What are governments doing about it?

Several are trying to soften the blow to consumers with measures ranging from gas tax cuts to direct payments for struggling households and reductions in charges that finance subsidies for renewables. The French government has decided to force state utility Electricite de France SA to sell more power at a deep discount to rivals. It already froze gas tariffs until the end of 2022, pledged to compensate suppliers with loans until prices recede and offered financial help to struggling households. Britain is offering a package of aid worth 9 billion pounds ($12.2 billion) including support for winter fuel payments, discounts for low earners and other policies. The country faces an estimated 18 billion-pound increase in energy bills from April, when a cap on energy prices is expected to rise by more than 50%. 

3. Why the gas shortfall? 

Gas inventories in Europe in January were the lowest on record for the time of year. China, which is by far the biggest consumer of energy and commodities in the world, ordered state-owned companies to secure supplies at all costs. Prices in Europe would need to stay high to attract cargoes of liquefied natural gas away from Asia, where China is stockpiling to power its economy and build reserves. Earlier in 2021, Norwegian gas flows were lower than average during maintenance work at its giant fields and processing stations, and supplies from Russia were limited while it was rebuilding its own inventories. Russian President Vladimir Putin calmed the gas market in October by offering to help stabilize the situation, saying Russia could potentially export record volumes of the vital fuel to Europe. Later, though, a key new avenue for Russian exports to Europe became complicated by geopolitics. 

4. What is that avenue? 

The Nord Stream 2 pipeline under the Baltic Sea, built to bring more Russian natural gas to Western Europe, has been delayed by a diplomatic standoff over Russia’s decision to mass more than 100,000 troops along the border with Ukraine. The U.S. government already opposed Nord Stream 2 because of concerns over Europe’s energy dependency on Russia. On Feb. 7, U.S. President Joe Biden said the project would be blocked if Russian leader Vladimir Putin orders an invasion of Ukraine. Putin has repeatedly said there are no plans for an invasion. 

5. How are power prices set in Europe? 

Utilities and big companies buy and sell power years in advance, relying heavily on forecasts about the economy and long-term fuel costs. The broader European power market has traditionally been focused on the price for the following day, with auctions supplying a day-ahead price functioning as the benchmark. Traders submit bids and offers for each hour based on their calculations of supply and demand, and then an average price is calculated by the exchange handling that market. Consumer prices are set by state regulators after utilities request rate changes based on how much they’ve paid for wholesale power, transmission investments and overall upkeep of their grids.

6. What’s new in the system?

The huge growth of renewable energy, which is more intermittent than fossil- or nuclear-fuel generators. Because weather patterns can create big price shifts, markets for shorter time periods later the same day have also become vital. Germany has closed most of its nuclear power stations as part of a longer-term policy, putting further strain on European grids. France, traditionally one of Europe’s biggest power exporters, is struggling to maintain output from its fleet of nuclear reactors due to long periods of planned and unplanned maintenance. European electricity prices jumped in early February after EDF cut its nuclear output target for a second time in a month. 

7. How reliant is Europe on wind?

Northern coastal countries including the U.K., Germany and Scandinavian nations have become leaders in wind generation and technology. In Spain, the growth in wind and solar plants helped to send its share of renewable energy to a record 44% of total power in 2020. France also is producing more power from wind, but its electricity generation is still dominated by nuclear plants. 

8. Which countries are most at risk of running out of power? 

Those with limited cable links to their neighbors. In a crisis, they are less able to benefit from Europe’s interconnected market, which enables power to flow to where it’s needed the most and where it fetches the highest price. Ireland’s grid operator warned in September that there was a risk of blackouts due to lack of wind. Many U.K. plants are old and break down from time to time. If big outages coincide with little wind or sun, the nation could be close to running out of electricity. 

The Reference Shelf

• Bloomberg Opinion’s Javier Blas helps to explain why Europe is so low on gas, and what Putin is likely to do with gas exports. 
• More on Britain’s energy squeeze from Bloomberg Economics.
• Bloomberg Opinion’s Therese Raphael says energy regulation in Europe is looking dated.
• Research by BloombergNEF on European gas prices.

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