Theme: Energy
Coal and gas prices at unprecedented levels
Falling investments during the COVID-19 pandemic and a rapid rebound in demand have sent coal and gas prices soaring this year. The situation has been further worsened by fears of a cold winter, which have resulted in significant hoarding – thus increasing the competition between Asia and Europe for coal and gas supplies. There is scope for normalisation in prices next spring after a rough period for power consumers all over the world. Still, rising CO2 prices will keep electricity prices elevated in the EU. Oil may be next in line to spike as investments suffer from a reluctance to finance fossil fuels. The energy transition is a huge challenge, since the world has been better at fighting fossil fuel production than at building new green alternatives.
Sharp waves in demand, prices and supply. This year, coal and gas prices have risen to levels we have never seen before. In early October, natural gas prices in the Netherlands were almost six times higher than normal. At this writing they have fallen sharply but are still three times higher than normal. Oil prices, on the other hand, are currently around USD 80-85/barrel, which is "only" 35-40 per cent higher than the 50-year real average price of approximately USD 60/bl. The pandemic is central to what has happened, since it has led to sharp fluctuations in supply, demand, and investment over the past year and a half. When the world stopped in the spring of 2020, the demand for most things plunged.
Bloomberg's energy price index fell to its lowest since 2003. Average 2020 oil, coal, and gas prices were 30, 40, and 50 per cent lower than normal, respectively. As a result, investments in new production of these commodities fell to extremely low levels. For upstream oil and gas, investments in 2020 globally fell to an estimated USD 335 billion, or 40 per cent lower than what is assumed to be necessary to meet demand over time. Today’s lower production of natural gas is one short-term consequence.
China and Europe are competing for coal and gas
Countries around the world stimulated their economies both monetarily and fiscally, with China in the lead. Total lending in China increased by almost 40 per cent in 2020, which is the largest credit expansion since the financial crisis in 2008/09. In China, this has meant more infrastructure and housing construction, requiring more steel, coal, gas and cement, and thus leading to higher electricity demand. From March to August this year, total Chinese power consumption rose by 377 TWh year-on-year: China’s biggest-ever increase in absolute terms. Of course the amount will be even larger for the full year 2021. China has thus needed more coal and gas. With zero growth in Chinese coal production so far in 2021, all of China's increased demand for coal and gas has been directed towards the international market, with demand shocks and a price explosion for coal and gas as a result. Deep worldwide cuts in coal, gas and oil investments have accentuated this further.
Low inventories
Europe had a cold first quarter this year, lower wind power production than normal and a fall in UK gas production of 40 per cent year-on-year in Q2. There has also been limited access to spot volumes of gas from Russia. Overall, this has led to very low inventory levels for natural gas in 2021. Europe and Northeast Asia / China have consequently fought head to head for available spot cargoes of coal and liquefied natural gas (LNG) in the international market. Limited supplies have triggered a huge price spiral.
Cooling measures from China, but winter is still ahead.
China is now doing what it can to counter the situation. Last year's hot credit expansion has been reversed to a credit cooling and contraction. Property developer Evergrande’s problems are partly an expression of this. China has also imposed electricity rationing and ordered the maximisation of domestic coal production, even though it involves reopening unsafe mines. This has led to sharp worldwide declines in coal prices from record highs in early October. Russia has recently promised more gas to Europe in November after spending October filling its domestic inventories while also doing maintenance at several gas fields. Thus, Russia should now be able to export more gas to Europe where gas prices have tumbled from record highs but are still 3-4 times above normal, since uncertainties about Russia’s promises continue to linger in the market.
Price normalisation next spring
The fear of a cold winter has been a key driver behind the price explosion this autumn, and winter is still ahead. It is probably too early to fully de-risk coal and gas prices, since this winter is forecast to have an elevated risk of severe cold spells, which may lead to periods of very high gas prices. In March/April next year, however, both we and the rest of the market expect a sharp normalisation of international spot prices for both coal and gas as we leave winter behind us. As spot prices fall, longer-dated prices for 2023 and 2024 should fall as well.
Painful effects for power consumers around the world
Coal and natural gas are largely used to generate electricity. As prices for these fossil fuels rocketed this autumn, so did power prices all over the world. The normal price of electricity in Germany, the center of the European power market, has historically been around EUR 40/MWh, but this autumn, the front-month German power price has traded as high as EUR 330/MWh. Even more astonishing is that the full year 2022 traded up to a high of EUR 184/MWh, or 4.6 times the normal level.
Higher carbon prices
In the European Union, the CO2 price is a factor cost in power production. Since this has tripled in a little more than a year, it has added greatly to the rise in EU power prices. While coal and gas prices are likely to normalise significantly by the end of winter, we do not expect more than temporary setbacks in the CO2 price and instead expect it to rise towards EUR 75/tonne in 2022-2023. As a result, the new “normal” power price in Germany and thus the EU is likely to be around EUR 70-90/MWh rather than the previous normal of EUR 40/MWh. One important consequence is far higher profitability for renewable energy projects – helping to accelerate EU renewable energy expansion.
Oil prices may be next in line to spike
While we have seen coal and gas prices soar to record levels this autumn, oil prices have not reached anything near such multiples. At this writing, oil prices are around USD 80-85/bl, only 35-40 per cent above the long-term average of USD 60/bl. The main reason for the above- normal price level is restrained supply from OPEC+ since May 2020, rather than robust demand. Oil prices have not spiked like coal and gas prices have, because oil demand has been strongly affected by reduced aviation/travel and still is, to some degree.
More cautious investment behaviour
But oil demand is now moving closer to pre-pandemic levels as the world gradually reopens. In addition, there seem to be some fundamental changes in the oil market. Non- OPEC+ producers, typically Western countries, are not ramping up investments in new supply as quickly as we have seen in the past, especially US shale oil producers. Over the past 10 years, shale oil’s mantra has been volume, volume, growth, growth, an approach that yielded no profits and led to widespread bankruptcies. Today’s mantra is profits, profits, and no growth. At the moment it seems to be a successful recipe.
Less appetite for financing fossil fuels
It is not just US shale oil players who are seeing things a bit differently. Most fossil fuel producers in OECD countries are feeling deeply unloved by both politicians and investors. Financial institutions that have been their close allies for decades are now rapidly cutting ties, which means access to external capital is drying up. It is thus very natural that these companies are now much more careful with capital expenditures than before. Global capex in upstream oil and gas is rebounding after a deep trough in spending during 2020, but apparently at a more careful pace than in earlier cycles.
OPEC+ is in control
With no immediate volume threat from its Western competitors, OPEC+ is left to rule the oil world as it wishes, and that is all about maximising profits through restrained supply and high prices. But even OPEC countries like Kuwait, Nigeria, and Angola are experiencing production declines today due to subdued investments over the past few years.
A challenging energy transition
The energy transition is a huge, challenging and complex task. In simple terms, it is a balance between winding down the current fossil energy system while building alternatives at the same pace. Today the world seems to be better at fighting fossil fuel production than at building new, alternative green energy supplies. If so, the result can only be a wider energy crunch, with very high fossil fuel prices – enduring longer than the current pandemic-induced fluctuations and winter 2021/22 risks. Fossil fuel supplies will eventually rise in response to higher fossil fuel prices, and that is not what the doctor recommends for the environment. The only real medicine for the global environment is to build alternatives fast enough to displace fossil fuels and enable the necessary transition. Low wholesale fossil fuel prices for producers and high fossil fuel costs for consumers due to carbon penalties together with a rapid build-out of the alternatives are the solution.
The Hertz rental car moment
In October, Hertz ordered 100,000 electric Model 3 cars from Tesla to replace 20 per cent of its total car fleet with electric vehicles. This essentially means that EVs have come of age both cost- and technology-wise, rendering an increasing range of fossil fuel cars uncompetitive. Fossil fuel cars use 3-5 times more energy per kilometer than EVs and are much more expensive to maintain, due to the complexity of their engines and gearboxes. Petrol (gasoline) accounted for 27 per cent of global oil product demand from 2015 to 2019. There will be no growth in petrol demand once EVs reach a global new- sale market share of 20 per cent. China reached a market share of 17 per cent in September and will soon have zero growth and then a decline in petrol demand.