Contemporary energy dynamics suggest we are heading towards years of likely price volatility, with a strong necessity for governmental support schemes to channel the investments required to achieve the green transition. The final destination of this journey, as well as the travelling speed, will ultimately depend on available resources, technology, and consensus. This consensus, in turn, relies on the capability to distribute in a non-regressive way the costs of the transition.
For the time being, a strong signal has come from the Rome G20 Summit, where (also thanks to the Italian Presidency authority) the need to keep global warming below 1,5 degrees Celsius has been unanimously recognized, same as the shared goal of reaching net zero emissions “by or around mid-century”. After Rome, Glasgow – whose results have been judged by many as inadequate and inconsistent. Still, Glasgow has shown, perhaps for the very first time, a universal political consensus on the priorities of global warming. While it remains true that no decision has been taken on how to reach such a goal – thus lacking a shared roadmap – the political consensus constitutes a necessary, albeit insufficient in itself, precondition.
The causes of the energy crisis and market dynamics
The current energy crisis has a wide range of causes, although some key responsibilities can be easily identified. Regarding oil, OPEC and Russia has commonly shown a high degree of control over produced volumes, which has contributed to keeping prices high. President Biden’s decision to sell part of the strategic reserves, in order to reduces prices, has had almost no effect on markets. Then, just a few days later, prices went down sharply: yet, the first commentators have accused the Omicron variant of Covid19, and not the role of strategic reserves. Therefore, it has been the virus, and not Biden (to quote Oil & Energy Insider, “Oil Prices Crash As Covid Does What Biden Couldn’t”).
As regards natural gas, what we are watching is the perfect storm. Due to a drought, Brazil has been forced to switch from hydroelectric to imported gas; the North Sea wind has remained rather feeble, limiting energy production that has been substituted necessarily by gas again; and China increased its gas consumption above pre-Covid19 levels. Add some extraordinary maintenance and malfunctions of pipelines and you have an (hopefully) unique cocktail with skyrocketing prices. This dynamic has also forced us to come to terms with the fact that gas markets, thanks to the role of LNG, have become truly global. Though most people were looking at the European crisis, most regasification plants in Europe have remained, if not empty, certainly below capacity (since the beginning of the crisis, they have never gone above 38% of their capacity). GNL is largely brought by sea where prices bring it, going towards Asia because Asian importers have been willing to pay higher prices than European ones.
Here lies the issue of European “dependency” on Russian gas, and Moscow’s ability to blackmail Europe by threatening to cut supplies. Another dependency, much more real, is the one of the Russian Federal budget on the revenues generated by the export of fossil fuels. Moscow might not even be able to afford such cut of supplies (we Europeans buy their gas, which, in turn buys Russian welfare policies). Natural gas pipelines are, in the end, the upholders of this indissoluble marriage: the marriage between a gas field and a market. Pipes cannot change their direction and the gas fields supplying Russian gas sold to China are not the same ones supplying gas to Europe. Power of Siberia 2 (the new ongoing pipeline from the Yamal region – the ones from where pipelines reaching Europe depart – to China) could potentially alter the situation - two pipelines for a single gas field, but its implications would not be shown until 2030.
In recent months, Gazprom delivered to Europe the amounts it was legally bound to deliver, though it refused to deliver additional volumes. The stated justification has been the Russia’s priority to its own stockpiles of natural gas, while the alleged one is related to the necessity to put pressure in order to complete Nord Stream 2. This can be debated endlessly. For the time being, it is more purposeful to stress how the commitment to deliver supplies has been remarked; and, however, the supplier is hardly able to set the price.
The gas markets are in fact, global. Prices are largely decided by Asia (through LNG spot as price makers and long-term contracts, including Gazprom, as price takers); and others just follow suit. The upward pressure on prices has been global (although less evident in the US due to shale production); additionally, this price surge has been almost independent on the ratio of renewable penetration in countries’ energy production. Finally, this surge is likely to be cyclical, as figures for Q2 2022 show: prices are half the current ones. Yet, before that, we have to go through the winter and, especially in Europe, the low levels of stockpiles are somehow worrying. At the end of October, Europe had stocks for 76% of its capacity, while last years the level was above 93%).
The severity of this cycle could not be depending only on weather conditions. What could not be cyclical is the volatility of prices. With the progressive reduction of energy generated by oil and coal, the interquel competition among fossils is disappearing. If, as was the case this year, renewable production also declines, gas represents the only viable alternative: less wind and more gas. When the alternative is only one, it inevitably applies pressure on prices.
Energy prices between emission permits and carbon tax
Energy prices have many different components. The price of fossil fuels also inevitably carries the costs of emission permits. Those costs are transferred to the final users by the supplier, otherwise its activity would not be economically viable. Emission permits, therefore, manifest themselves to the final user as a form taxation on consumption. While the price surge of gas due to the perfect storm is largely cyclical, the one deriving from EU taxes is structural. Emission permits would, in fact, be progressively reduced over time; and the price of a single permit has increased from 35 to over 73 euros in 2021. The “cost of emission permit” component is permanent and tends to increase over time. EU Commissioner Frans Timmermans has affirmed that “only” 20% of the current price hike can de attributed to (overall) taxation, while the rest is due to market dynamics. Yet, that “only” 20% is significant (the hike has gone beyond 0,80 euros per kWh) and could be overestimated, while this structural price surge is becoming evident. Additionally, all the parties and stakeholders agree that this “taxation” deriving from more costly emission permits might keep growing. If it exceeds 80 euros, it would render CO2 capture economical only for electricity generation.
Nowadays, gas price changes are almost directly transferred to the energy price. This happens because wholesale prices are determined through a marginal price system (hour prices are qual to the prices of the suppliers listing the higher prices, normally the ones of a natural gas energy plant). A discussion on Pay per Bid or involving other techniques to decouple electricity prices from natural gas ones is long overdue.
Markets, taxes, and a bit of European weakness. The main virtue of a carbon tax seems to be accompanied by an ideological, rather than progressive, approach to the remaining fossil fuel, namely natural gas. We do know that we cannot exclude natural gas from energy generation, at least until electricity stockpiling capacity is not increased and perfectioned. While we hope that by 2050 heat pumps will be the main type of house heating for buildings, this would not happen overnight, especially concerning urban real estate. Hydrogen could play a key role, but if only the green one is accepted (and, to substitute gas, a network must be created), this would take time, if doable. In the meantime, a quantum of gas remains necessary, and it should be available at competitive prices.
Even the European Commission has shown limits in its crisis management. Its summit has decided only to study the markets, recommending helping the poorest consumers and working on price containment measures. In other words, it has not decided anything. More broadly, and with a view on nuclear energy, today’s magic word is taxonomy, the list of projects and sectors considered to be sustainable A taxonomy has not been yet approved due to the disagreements over the inclusion of natural gas and nuclear energy. Those who may not be in the virtuous list would not be eligible for Community funds and, through the ESG, not even for private funding. An exclusion of gas would render it almost impossible to finance new import infrastructures, and the same goes for nuclear energy. Furthermore, as for nuclear energy, it is worth remembering that the decision over new plants does not lie with the Commission, but with the Member states (thus, some countries, like France, could finance them regardless of taxonomy).
If the EU excluded natural gas projects from the taxonomy, it would be betting that current infrastructure will be sufficient to supply all the gas we need from now until the economy is decarbonized.
The long road towards the green transition
Green transition does not come cheap. Accelerating it might mean lower growth levels and higher energy prices at the same time. Slowing it down, conversely, might have dramatic consequences on or future development. A study quoted by the Financial Times claims that each degree Celsius of global warming corresponds to a billion people leaving their home regions, which would have become uninhabitable.
In order to simplify the transition path, we can use the train analogy. Imagine a train that departs from station 2021, with destination 2050. At each intermediate stop, this train has to drop fossil fuels and load at least the same amount in renewables to keep its engine (or its economy) running. What would happen if, at station 2024, not enough renewables are available? It can avoid dropping fossils, and reach station 2025 at full speed, thus having polluted the atmosphere as much as possible and having accelerated global warming. Or it can proceed at a slower pace, which, however, would imply pressures on prices and, consequentially, political and social tensions.
How to solve those problems? First, by arriving on time to the intermediate stops. An energy process is very simple in words: it only requires an energy source and a converter that transforms it in work. When the source changes, however, the converter has to be changed as well, including house stoves. In world with almost 8 billion people, the issue becomes a complex one. This is not a revolution, unlike the storming of the Winter Palace, but a long journey, stop by stop, towards decarbonization. Actions should be prompt (and the IEA states that we would need to spend yearly more than 300% of what we spend now), and we need to develop new technologies. Special attentions should be reserved to the social costs of the energy transition: sharp energy bills increases, or other regressive measures, would end the consensus. And when the consensus ends, the transition ends.
If frictions happen at any stop along the journey, the decision would be between accelerating and decelerating. In that case, it would not be possible to appeal to science since the choice would be a political one, and politics retains the exclusive jurisdiction in mediating between social and environmental costs.
Nonetheless, it would be useful to remind political decision-makers that any environmental cost that may seem acceptable today could be a multiplier of the social costs that might be paid tomorrow.