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Why This Energy Crisis Is Different

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Demonstrators protest against high electricity rates in Madrid on June 5. Alejandro Martinez Velez/Europa Press via Getty Images

Demonstrators protest against high electricity rates in Madrid on June 5. Alejandro Martinez Velez/Europa Press via Getty Images

An energy supply crunch is looming in Europe as soaring energy prices are contributing to inflation, posing risks to economic recovery, and hurting households and firms. Whether this emerges into a full-fledged energy crisis now depends on luck: how severe or mild winter weather is in Europe and other regions that compete with it for energy supplies. There’s nothing new about boom and bust in the energy sector, of course, but Europe’s price surge is a harbinger of more volatility to come as the world copes with the impacts of climate change and accelerates its transition to clean energy. To safeguard both the economy and the clean energy transition, policymakers should develop stronger tools to manage energy market swings and smooth the inevitably messy transition process.

The gathering storm in Europe’s energy market has been thrown into sharp relief in recent weeks as customers and firms have paid staggering prices for their electricity in response to surging natural gas, coal, and carbon credit prices. As of September, European natural gas spot prices were about six times what they were at this time in 2019, the last pre-pandemic year. Prices in Europe are closely linked to those in Asia, as gas prices need to rise high enough in Europe to attract supplies that would otherwise head to Asia. Asia has seen prices surge to four times what they were at this time in 2019. Benchmark natural gas prices in both Europe and Asia recently soared past $20 per million British thermal units. Coal prices have similarly skyrocketed for several reasons, including the gas price surge since coal can substitute for gas in electricity generation.

In response, the price for electricity, much of which is still generated from gas and coal, is soaring. In the United Kingdom, wholesale electricity prices have risen to more than 10 times last decade’s average. The key European Union benchmark power contract has doubled this year. In Spain, soaring electricity prices are front-page news and have prompted protests against the government. In Germany, power prices have exceeded their 2008 peak. As a result, firms are curtailing output, and the price of electricity-hungry commodities, such as aluminum, is surging. In Britain, several smaller power companies have gone bankrupt, and power-intensive factories shut down. Households are feeling the pinch too, with the U.K. energy regulator hiking the maximum price utilities can charge retail consumers to reflect surging wholesale electricity rates.

A confluence of factors is responsible for Europe’s energy crunch.

First, a series of extreme weather events and unusual seasonal patterns have impacted both gas demand and supply. Winter in much of the Northern Hemisphere, especially Asia, was unusually cold early this year, followed by an unusually cold spring in Europe, all of which boosted demand for gas heating. The deep freeze in Texas also hampered U.S. gas production, resulting in lower U.S. liquefied natural gas (LNG) exports to Asia and elsewhere during February. Subsequently, unusually severe summer heat waves in China, Europe, the United States, and some other parts of the world boosted gas demand for electricity for cooling.

Wind generation in Europe has been far below average this year due to long periods of less windy weather.

Second, other potential sources of electricity generation have been hampered. Wind generation in Europe has been far below average this year due to long periods of less windy weather. Gas and coal demand has risen to offset reduced renewable energy output, pushing up prices. Demand for fossil fuels is set to spike further as Germany takes another three nuclear reactors off the grid this year as part of its nuclear shutdown. Meanwhile, drought conditions in China and South America have led to reduced hydropower output, drawing supplies of globally traded gas into those markets instead.

Third, economic recovery from the pandemic has been strong in both Europe and Asia, pushing up demand for energy to power homes, factories, and other businesses. China’s LNG demand during the first half of this year increased by more than 25 percent over the same period the year before, making it the largest LNG importer ahead of Japan.

Fourth, despite worsening market tightness and surging benchmark prices, Russia’s state-owned gas company, Gazprom, has not increased its pipeline gas shipments to the European Union beyond its long-term contractual commitments either because it is unable or unwilling to do so (a topic of much debate among analysts). This is perhaps most evident in the sharp drop in Gazprom-owned gas stocks within the European Union. With Gazprom announcing the completion of its controversial Nord Stream 2 pipeline, the severity of Europe’s natural gas price crunch this winter may depend on how quickly Russia starts up gas deliveries through the pipeline or boosts shipments via the existing pipeline through Ukraine. Supplies into Europe were further hampered by production and maintenance issues in several gas-producing countries. And Europe’s own domestic gas production has been in decline.

Fifth, climate policy itself is pushing up........

© Foreign Policy

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