Europe faces winter of discontent with high prices here to stay

World Wednesday 12/October/2022 14:51 PM
By: DW
Europe faces winter of discontent with high prices here to stay

Brussels: A barrel of European Brent crude cost around $94 (€95) this week, after rising 4% to a 5-week high of $98 per barrel last week on news that OPEC+ (OPEC plus Russia) had agreed to cut production by 2 million barrels per day, about 2% of global supply, from November.

On Tuesday, US President Joe Biden said there would be "consequences'' for Saudi Arabia following the Riyadh-led alliance's move to cut oil production. While he remained vague about specifics in an interview with CNN, he suggested he would act soon. White House officials said the administration would reevaluate its relationship with the Saudi Kingdom.

The cut comes as the EU prepares for slowing growth due to higher energy prices, with recessionary fears competing with inflationary ones as the key issue facing policymakers.

"This shows that the energy crisis in Europe is threatening to escalate into a global price war," German business paper Handelsblatt put it, suggesting it pits Europe and the US against OPEC, its partners, and large oil importers like China and India.

While oil prices have fallen from highs of $130 per barrel in the summer when Western nations first imposed sanctions on Russian oil, most observers don't see it going much below $100 over the next 12 months.

As for gas, the European benchmark rose to a record high of €335 ($337) per megawatt-hour (MWh) in the spring. Since then, prices have — as with oil — fallen, back to about €225 per MWh, though are still up 300% since the start of 2022. Gas prices are directly linked to electricity prices, so if they stay high, electricity prices follow. The European Commission has announced reforms of the electricity market that would see a decoupling of gas and power prices, but the timing for that is not clear.

Kremlin-controlled energy giant Gazprom has said European natural gas prices could climb by another 60% this winter. In retaliation against sanctions following Russia's invasion of Ukraine, Moscow cut the flow of natural gas to Europe via the Nord Stream 1 pipeline to 20%, sending prices rocketing.

What's keeping prices high?
Energy price hikes in the past year — 60% for oil and 400% for natural gas — have been driven by rising demand as the coronavirus pandemic wound down and lower supply mainly due to disruptions caused by Russia's attack on Ukraine.

Three factors have cut energy supplies from the market and pushed prices higher: The first is OPEC's production cut. OPEC+ supplies around 40% of the world's oil consumption. The second is the US Strategic Petroleum Reserve releases being wound down. And thirdly, the likelihood of disruptions to Russian supplies.

Adi Imsirovic, a senior research fellow at the Oxford Institute for Energy Studies, adds to the list two demand-side factors: the economic situation in China and the likelihood and extent of a global recession.

"Gas is particularly prone to spikes due to weather and tight supplies. My guess is that gas should trade on average at around €160/MWh with spikes in the winter of over €200. Oil should average around $100 for the next 12 months," Imsirovic said.

Bram Claeys, a senior advisor at the Regulatory Assistance Project (RAP), a non-partisan organization focused on the green transition, says gas prices are likely to stay high for the next few years.

"I doubt, but can't be certain, that prices will ever come back to the level they were before. If only because, presumably, Europe will structurally shift away from Russian pipeline gas, towards more LNG, which is inherently a more expensive product," he said.

Prices next year could remain very high given that Europe will need to fill its storage without most of the Russian gas, says Anna Mikulska from the Baker Institute Center for Energy Studies at Rice University.

"The EU imperative to fill storage to 90% will be pushing prices up through the year. In addition, there will not be that much new LNG supply coming online next year — next to nothing really, which will potentially tighten the markets, especially if China resumes industrial activities," she said.

The weather and other contributing factors

The severity of the coming winter is another factor, as is how quickly French energy giant EDF manages to get its nuclear fleet back up and running. Another is the success of governments in reducing demand in industry and households through energy savings and faster roll-out of renewables.

"Structurally of course we are in a gas crisis, therefore we need to stop using gas. All gas, not just Russian gas. This will take time, but the crisis will accelerate investments in renewables and efficiency," said Claeys.

Ashley Kelty, director of Oil & Gas at Panmure Gordon, a corporate investment banking company, points to a popular misconception that the Ukraine war is the sole driver behind the current energy crisis.

"In reality the current situation has come around due to the culmination of years of underinvestment in oil and gas, political hubris, and the rise of environmental, social and governance (ESG) investment," he said.

Imsirovic believes that Europe can survive without Russian oil, which accounts for around 30% of supplies for the EU. But it can't survive without Russian gas, which makes up 40% of gas in the EU.

"Without oil, there will be problems, but [Europe] can survive," he said. "But it would really struggle without Russian gas. Lights will probably have to go out next winter."