Europe Energy Crunch, Explained

gas storage levels are low compared to years prior. But is it a crisis? And the op ed claims it's all caused by renewables? Is that true? So I texted him back and I said, well, I actually didn't know the full answer, but as luck would have it, I'm recording a pot on the topic and we'll find out then. So to help us figure out what's what, we've got David Hoster, being his head of research for AMIA the Europe Middle Eastern Africa region. He'll walk us through the

big picture why the energy crunch, why now? And walk us through all the contributing factors. Gas coal, carbon and renewables. This interview is based on an ongoing coverage of European gas, power and carbon markets being a Fuss. You can find this analysis on BFC and the Bloomberg Terminal, BNF dot com and BENF Mobile. As a reminder, BENIF does not provide investment of strategy advice and you can do the full disclaimer at the end of the show. I'm Mark

Taylor and you're listening to switch on to BENF podcast. David. Welcome, Hi, Mark, it's good to be here. Thanks for joining. Okay, so, just reading the news here in the UK, you know there's all this news about long queues at the petrol stations or the British Army today was announced that they were coming to to deliver the patrol to the stations. You hear about electricity distributors going out of business. I'm hearing about high natural gas prices. But honestly I don't

really know what's going on. And I get text messages from friends saying like, hey, you're an energy can you explain what's going on? And I say no, I can't actually told one. I'm doing a podcast today where we'll get an explanation and just to listen to the show. So can you help me and my friends understand what's

going on a bit better? Yeah, it's funny how these kind of quote unquote boring topics that you and I care so much about have suddenly made headline news in the right So so suddenly where in this energy crunch and all these inner working tubes and flows that are really boring where it come to the front, right, So you used to go into the petrol station, of course there's petrol, and used to kind of turning on the lights, and of course there's lights, and suddenly suppliers switching high prices,

high gas make you question all of that And the answer is that probably probably it's not that bad. And there's the stage in trading is like the cure for high prices as high prices, so you know, if prices are high, that will kick off the necessary investments and trades and flows too to bring them down again. But it just feels a little bit like we're and and that doesn't just feel we are in in in a crunch at the moment where a lot of factors come together.

And I think what what is surprising too many people is how connected today's markets are if you think about gas, if you think about power, these are you know, kind of commodities that are often generated and sourced locally. But in the case of gas, we are now suddenly in this global market where something that happens in Korea, something

that happens in Japan affects us directly. And that's new, right, where gas prices are really really high, and then power prices are high as a result of thought, and then we have these other kind of crisis or perceived crisis in other commodities as well. So I think it's really come to the forefront. There is an element of hype as well. People go crazy, and then you know, the papers write about people going crazy, and that makes people

go more crazy. But there is a real interesting story here, and it touches on all the major commodities, and it touches on all the major markets, and it's frankly like a very interesting time to be in energy and then especially as we're looking transition to a net zero world, but not necessarily an interesting time to pay my electricity

bill or go to the petrol station. Okay, so what we want to do in this episode, everybody is just kind of lay this out so we understand, you know, tick tick tick, what's going on with each of these types of commodities and markets. To help understand what's going on. But let's just put this to bed, Like, is this a crisis, a crunch somewhere in between? Is it real? You mentioned hype a second ago, Like, what's the real deal?

It is a crunch, and it is real because high prices are hitting consumers, high prices are hitting suppliers, high prices are hitting companies. So you know, you and I were in the UK, we have this observed situation a few weeks back where a fertilizer planned was coming offline because the gas prices are very high. So why should

we care about this? Well, we do care because as a side product of the fertilizing process as c O two and c O two is one of the inputs for dry eyes, that's one of the inputs for meat and poultry industry. And suddenly we're in the situation where you know, we can't get deliveries from our supermarkets because they don't have frozen goods because they don't have dry eyes.

And suddenly becomes very real. Right, there is a a real element in terms of like where we're going long term with this, and we said this had been here for a long time. Long term prices will go down in the power sector, and that's because renewables coming in. The renewables are you know, near zero marginal cost, So we expect prices to go in the long term. And and too many people it's been almost a surprise that in the meantime prices can go up again. There isn't

just this one way street where prices go down. There is an element of hype, asn't any trade, but there is also kind of real shortage and part of this supply and demand, and part of it goes back to COVID, right, like all these disruptions in the supply chain that we had the last year are coming back to bite us. A ripple effect, Yeah, there's there's a ripple effect. There's this experiment that I really like about phantom traffic jam.

I don't know if you know this experiment. It's basically a bunch of cars going around in a circle and there's no obstacle, but they're just going around in the circle and then after a while you get these ripple effect. Well, one driver goes a little bit slower, and the next one goes a bit slower, and suddenly you have a traffic jam and what is a perfect circle, Like there shouldn't be any obstacle, but there's still this traffic jum And I think it's a really nice image for the

global supply chains and how they're connected. And in this case, there was a real obstacle, which was COVID, and we're still seeing these these ripple effects were odd pieces of the supply chain don't work. That's fascinating. I'm sure everybody in in Washington, d C. Was thinking just now Root sixty six when you said that that infamous traffic on that road happened just because of that. When somebody taps

the brakes, you know, everything else stops. I didn't even think about the you know, the fertilizer plant not be able to pay their their gas bill shutting down, that leading to disruptions in the in the cold chain, in supermarkets. I mean, come on, it's all it's all interconnected. It's fascinating. Can we start with gas actually just going to tick through these things of what's going on with each of these these commodity markets. Yeah, let's do that, all right?

So just give it to a straight What's what's going on with gas? So the gas market in many sents, it is one of the biggest drivers for this crisis, and it's really to do in Europe with concerns around Europe's ability to refill gas storage before the winter. Right, So Europe has gas storage, and during the summer, when demand in Europe is low because we're not heating there isn't so much demand from domestic users, we fill up the storage before the winter, and then over the winter

we deplete that and we still import. So the storage level is a really important indicator of where we are going in terms of the winter, whether the market would be tight meaning there's kind of not enough supply for the demand, or whether we lose where there's oversupply, and that's you know, prices are all around tightness. Source stores filled up right now. So part of the driver of

these high prices is concerns around storage. Right. We import gas over the summer stored and then we use it over the winter and we keep importing all the while.

And this year storage levels are really low historically, so we're only at compared to where we would be on a five year average, and that's creates tightness in the market and really some concerns around the winterhead because if we have a cold winter mark we could be ending up with zero or next to no storage left at the end, and that then creates a ripple effect kind of coming back to this traffic journal we talked about earlier. That could then last into the summer when we're competing

with Japan and Korea, and then into next winter. So what happens now could like you know, trickle down, ripple through the system and lead to a tight situation next winter as well. In the UK, we always like to kind of see some sunshine. Would we really get to see some sunshine this winter because if we if we if we end up with a colder than you know, just really the colder, much colder than average winter, then um,

that could be could your problem? There's a I was just sitting here at my desk freezing, wearing a jacket. My kids come up from school and like, Dad, can we can we turn on the heat And I'm like, come on, it's still September. I kid, turn on the heat. They please, We're freezing And I was like, Hi, fine, so September here we are September and I'm turning on

the heat. Yeah, and you were coming off a cold winter, if you if you cast your mind back to a couple of months earlier, we had a really cold winter this year, you know, there was kind of we were heating well into March May. So that's the issue, right where low one supply and low on storage, and then supply just hasn't come in the way it usually does. So imports from Russia, which are a big factor and this have been low. And there's a bunch of reasons

for that. And then llen G, which is liquid natural gas, which has been increasingly playing a role in European supplies, has also gone down. And that's due to global competition, and it's due to kind of long term contracts from Japan and Korea in particular, where they import gas, and they just called on these contracts to be fulfilled and there just wasn't enough to go around to fill up

European supplies. And I think I read the other day that China has a what does it fill at all costs contract for LERG, you know, so that they'll pay just basically whatever to make sure they have their supplies. Yeah, right, that sounds a really strong signal. And on top of that, they also announced this week that they're going to restrict some of the health and safety protocol in coal mines, so if there's an accident in a coal mine, they'll

just run production back up quicker. And that's a really strong signal. And if one of your biggest buyers says, hey, guys, I'm going to buy at all costs, and then you know, hearts are fluttering in Europe when that goes ahead, and that means that, in a way, of the European energy transition an our kind of gas picture. At b NIEF we like to call about this kind of one gas world. That's increasingly the case, and that's new, that's a new phenomenon.

And I think I read in your analysis that the UK has not kept up with their storage right, so they're replying more on L and G because they haven't invested as much in storage, so there's not as much to draw fround. Is that right? Yeah? This problem is structural and goes back a long time. The UK actually used to have a huge amount of storage and was called the North Sea. So we would in the UK ease the North Sea as a storage and then also have it as it you could ramp up and down

domestic supply. That's not the case anymore, and some storage sites we even shut down. So there's a structural need to build more storage going forward. But it's also not a quick fix, right, so we can build new storage now to take pressure of this winter or possibly even the next winter. But what the UK can do though is to really think more about their the lergy contracts, you know, improving the energy infrastructure and thinking about how

they're going to contract an increasingly global market. I think there was a perception in Europe that llen G from the US in particular, would take the pressure of reliance

on Russian imports on domestic production. But you know, allen G has a global commodity goes where prices are high, and even the high prices in Europe because you know, the tightness in the market was visible from the summer or European gas team has said the market will be tight, and prices started to rise accordingly, but there was still not enough to attract fuel and ships from the US. And then you know, frankly, there's just a a time element like if if if a tanker leaves the US

and goes to Asia. It takes so too many days to go there and then suns when it's come back and fill up and go the other way. So it's not like you can turn a switch and allen G just flows like these these chips around their way. And there's some excellent analysis that the allergy has team has done about um, you know, twelve small reasons that all upset the supply chain. And you know you talked about fuel earlier. Shipping supply chains also in disarray for a

number of reasons. So you can see all these elements coming together to form this perfect storm. Is that the title of the report, twelve small reasons LERG supply gets mest up. I don't know. Well, we'll look it up and we'll put in the notes. It's the lesser like some of the lesser lesser talked about reasons. But there's this whole litany of things and and some local factors

as well. Right, if the UK had a fire in one of its major substations, there's some unplanned outages and some plant maintenance work on the power plants because those measures were deferred during COVID times. So all the maintenance schedule us a little bit upset. And in a way, it used to be that the winter season was what the focus was on, right because say, well, during the winter, everything needs to be ready and we think about supply margin. But now that was already the k last year that

the shoulder seasons are actually more dangerous. The shoulder seasons is gonna bring and autumn when suddenly the system is getting ready for winter. But winter might come early, or we might have a lull in wind power. So the shoulder seasons in many ways have become more dangerous than the winter seasons now for a very short break. Stay

with us. So globally connected gas market, lower than average storage, higher dependence on L and G, which is becoming more competitive to to get contracts, Difficulty getting gas from Russia. They're filling up their own stores before sending it over to Europe. The list goes on with gas. Let's let's keep going with with Cole. So Cole is kind of a weird one. I think I remember back in Geez.

I don't remember what year it was. I think it was around Fukushima, around when Germany said, you know what, we're going to shut down our nuclear as well, and they did, and they kept on the coal, but now it's going out of being run of the market by economics, right, Can you explain kind of what's going on with coal, how some is surviving, how some is contributing, you know, more to the grid right now? Basically what's going on

with coal? So Europe has embarked on this journey where us say we're gonna shut down COLE, right and we're gonna phase out COLE and as you mentioned, some market stuff put in strict timelines. Others are probably working on them, and even markets like Poland, which is very reliant on coal, have said they want to phase out COLE eventually. So

that's good. The challenge at this point is that while coal was really out of the market last year when when we had all these COVID upsets in the market, this year it is back, and it's back because of high gas prices. And in Europe there are two types of coal. So there's hard call, which is kind of more energy dense and that's kind of traded globally to to degree, and then there's lignite, which is the kind

of brown call, is less energy dense. It's mind locally it is very polluting and the irony of this year is that lignite is the only call that's in the money. So if your own a lignant cold station at the moment, you're you're just printing money because gas is high, hard core is high. Carbon pyramids are high as well, but you're still cheaper than the competition. So it's been a

real reversal from from last year. Last year we were at the point where every gas plant that could possibly run to displace coal was running and cole was kind of at its absolute minimum. We still we still think that in the long run economic coal fiz art will continue, but this year has been kind of a bit of

a reversal of fortunes in that sense. And it's going to be bad for emissions, right, It's not great for emissions, And we're actually forecasting that will be up on emissions, up on last year, up in probably north and then even up on you, which is the reference here of the of the before times. So it's it's not a great picture when you look at emissions at the moment. Jeez, Okay, we'll get to renewables, but can we touch on carbon first since we're kind of on that with CEO two.

Emissions and the impact on cold etcetera. I mean, so Europe has a carbon price, right something that is more or less unique to to a whole you know, continent. I guess you could say, but can you explain kind of what's going on with carbon and where it's at right now? The European carbon market is one of kind of the main instruments for the European Union to decarbon as the power market, and it's effectively putting a regulated price on, putting a cap on carbon emissions and then

let the market define with the prices. And that price was very low of blong time, and then maybe eighteen months ago so we really started picking up and going up. And right now the carbon price is at around sixty five euro per ton, which is double what it was

last year or less. And that's been driven partly by expected tightness in the market, you know, as in Europe we have a whole package called Fit for fifty five or we call it, where Europe tries to reduce its missions to and then the carbon market is part of that. So the carbon market has been rising anticipations of regulations and policy that will constrain supply of carbon permits in the future, and At the same time, there's been a whole influx of trader is of a kind of new

participants in the market that has driven the price. And because the carbon price and the gas price are linked to a degree, it has kind of risen with the gas price. But the carbon market has decoupled from the gas market over the summer, and that's partly because it is now so ridiculously high that kind of both markets are almost like free floating. You know. It's like when you're in a plane, you're the one of these space planes. You're in the apex of the curve, and everybody is

just floating and unconnected to like the fundamentals. So we would expect the market to be high, and we actually we're still bullish on the market in October, but it just won't catch up with a stampede in the European gas market. So still be high, but gas is going to be still higher kind of going forward. Yeah, at this point, it's hard to see how gas prices can come down quickly because of real tightness and because there's

there's no quick solution that could elevate the shortness. For for this winter, it seems like the carbon market is kind of doing its job right. It's it's it's putting a price on emissions. But my question, maybe you don't know the answer to this. I don't know, But is support for the market still strong? Are people saying it awesome, this is great, it's do a good job. But in the face of an energy crunch, are people saying, like, I wish we didn't have this, this carbon market, Like

what's the general feel? Yeah, that's a good question. Maybe just take a step backward. The carbon market is not just looking at the carbonizing the power market, but it's also looking at the carbonizing industry. It will do the combonizing transport. So because gas is so high in the power market, the carbon price is not the factor at the moment. It is one factor that drives high prices, but you know, gas is by far the most important one.

What's interesting those as we're extending the carbon market to more sectors, as we're tightening some of the kind of availability for for certificates for industry, the carbon market just background and gives some free allocation to two sectors, which means that you know, industrial sectors at the moment are not really tight on permits. But if the price is really high and remains really high. That should worry steel producers, That should worry aluminium smelters, that should worry a whole

bunch of industries that are further down the line. So in a sense, you would expect opposition not necessarily come from the power sector, which is like busy elsewhere, but from industry, and a lot of the reforms that are underway for the for the European car markets and for this package are still in discussion right so as these discussions rumble on, we're looking for signs whether participants and saying Okay, sure, we'd love to join your market and

really start contributing, but you know, this price is really really high, and if we're on the hook for that very soon, then we don't even have a chance to develop the technologies that we need to address that. Because in in the power market, there's a bunch of things you can do. You can switch off coal and turn on more gas and that reduces your carbon emissions and your kind of helps with the price. But in an industry we're looking for like really substantial changes to two processes.

We're looking for a more use of hydrogen, you know, which we've talked about a lot in the past podcast as well and our research. We're looking for kind of electrification, which is meaning like using power and replacing some some other processes to have a very high price. Now already it's really tricky for industrial users. So that's that's maybe where more pushback will come from. Finally, let's let's touch

on renewables. So all these high prices seem to make it a good time to be an owner or developer of renewable energy, is that right? Yeah, It depends what kind of contract you're in, right, Okay, Okay, let's put it this way. If if you're an owner of emergent power plant, this is a good time to be in the market. Merchant power means. So previously we supported renewables by giving them fixed off take contracts in the form of feeding tarriffs or feeding premiums or contracts for difference.

These are all like fixed price mechanisms that allow you to go to the bank and say, hey, here's my price for the next the years and kind of please borrow some money from you. Increasingly, we're seeing more merchant renewable plans where you maybe only hedge a part of your output and then you go to the wholesale market for your revenues, and if the whole snak is really up,

I mean good, good for you. Right, So, so e merchant renewables are in the money, a lot of plans will be on off take agreements where you might have a kind of ceiling where we're kind of the upside is capped. But on first evidence, this is good for renewables, but it's it's it depends on what what governments will do next. Right, So, in order to get to get us to a position where we can truly decarbonize the energy system, we need investment, and we need quite a

lot of investment. So having renewables going into the marketing situation where prices are high, it's good because it means that you can negotiate better terms, you can negotiate better off take contract So it is it is good. But at the same time, some governments are also quite dittery about high prices. You know, one one of the examples we've seen in Spain where they're proposing a clawback mechanism to kind of reign in some of the excesses quote

unquote clawback. Does that mean like if I've received, you know, money for the power I've sold, they're going to ask for that money back pretty much, or they just give me less going forward. Well, this Spanish government is proposing a temporary claw back where they will take some of the windfall profits that merchant renewables are making and also that utilities are making with their own assets, and then

subsidizing consumer bills with that. So that kind of taking from the generation side and putting it into the retail side, and that is a well, is probably a well intended measure, but it was brought in in such a chaotic and kind of quick way that it might have led to some real collateral damage. Vedroller announced last week that they would hold renewables development until they get further qualification. So it really kind of puts tears up the market. Let's

kind of put a bow on this. Let's let's say let's say you're in the public sector, right, you're the Spanish government or you're the UK government. What are some of the levers that you have to pull to adjust some of these things in renewable energy and gas, in carbon call, what have you? Coming back to what I mentioned earlier, there's no like real quick fix for for

high gas and that's that's just really a reality. So you can there's there are important things that need to be done to avoid this in the future, right, So investing in storage will be important, investing in energy infrastructure will be important also to build in a bit like more flexibility in the grid. And we've we've been saying this for a while, right, some of the high prices spice we've seen in the market where due to limit a limited amount of flexibility or not the right kind

of flexibility. And in in terms in terms of the other long term fixes, we still believe doubling down on renewables and other attornative tone technologies to cut reliance on gas is a good idea, all right. So this is not a time to take the foot of the accelerator. It's a time to push through and make sure that

you deliver on those goals that you've said. Okay, So the shortest version is that there's no quick fix for any of this, but there are solutions for longer term stability as long as the GASP power project connected the way they are. Any an upset from the gas market will also always translate into the power market. So if you want to break that gas length then renewables and potentially nuclear is one of the main solutions you want to be looking at. Okay, I got one more for you.

So as I was sitting here Thursday, you know, freezing with my my winter code on in in my room, I was thinking I should get one of those one of those Dison you know, space heater fan things. Then I looked it up and I was like, that's six d pounds geez. And then I thought, well, okay, well my gas bill for this winter be higher than that six hundred pounds right. So I don't know if you can answer this, but like, do you think it'd be you know, worthwhile? Is that the consumers should be thinking of.

So your your gaspel in the UK won't be rising in the same way that the wholesale market rises. And the reason for that is what's called the well it's it's a cap on consumer prices. So consumer prices will rise very shortly and they probably rise around twelve which is the maximum that the government can put up at any one point. But that's not enough to to help

your your retailer. And I don't know which retailer you in, but you know, in the UK we've seen this market liberalization where a lot of retailers come in and we had at the peak of the market that where around seventy retailers to choose from, and the UK government really encouraged you to switch as well and look for better deals. So the issue is that runaway prices in the wholesale market. Retailer is a cut between a rocket and a hard place because their prices are going up, but they can't

charge their markups. So that means consumers remain protected. But retailers are really in a tough situation if if they hadn't hedged for this properly, and hedging means you know, signing long term contracts. You look in the summer and then you kind of see, okay, how much do you

wanted to forward contract for the winter. If they haven't done this, or if they weren't able to because they didn't have the balance sheet to do that, then kind of that's kind of a business critical problem and that will lead to retailers going bust and we've seen you know, a bunch of retailers going bust in the past weeks in the UK. As a consumer, you're you're you're protected from that, so it doesn't filter food to to you.

You might be some somebody else will either kind of take you over, or the government can step in as a supplier of last resort. So so one thing we can be very certain on is that consumers won't be left without gases winter. They won't be left without power this winter. If there's a real gas shortage then and more likely snarios that a industrial users will shut down because of very high prices, or they can be made

to shut down if they have flexible contracts. Either way, we will ask consumers pay for this one way or the other, right not maybe not for your bill, but maybe through reduced output or taxation. If the government steps in as a supply of last resort, that will, you know, inflate government spending. So so one way or the other, this will come back to haunt us. So what you're saying is I don't need to buy the Dyson fan,

the Dyson heater. I I think I think at this point you may be better off checking whether you haven't done everything you can do to insulate your house and kind of reduce heat loss. And I think that's that's you know, an energy efficiency is a good good thing to invest in. An adult. It will probably last longer than that and fun. There you go, Hey, and you had one more line in your report that I really like that. The the ultimate thing that Europe should probably

do this winter is pray for sunshine. That would that would be helpful if if we have a Warren Winters off the system, David, Thanks for joining. Thanks Mark. Today's episode of Switched On was edited by Rex Warner of gray Stoke Media. Bloomberg an e app is a service provided by Bloomberg Finance LP and its affiliates. This recording does not constitute, nor should it be construed as investment advice, investment recommendations, or a recommendation as to an investment or

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