One day solar energy will determine the gas price en def

Hans van Cleef – Senior Energy Economist ABN AMRO Hendrik Steringa – Researcher, writer

ABN AMRO Energy One day solar energy will determine the gas price “One day solar energy will determine the gas price”. This surprising prophecy, made by a senior strategist of Gasterra several years ago during a presentation at the Energy Convention in Groningen, the Netherlands, has hitherto failed to materialise. Meanwhile, however, shale gas has asserted itself as the main driving force behind the gas price in some regions, notably in the US. But not in Europe. The gas market, unlike the oil market, remains strongly regional and in Europe, where the shale gas revolution has yet to get off the ground, shale gas has so far only had a limited impact on the gas price.

Europe must therefore rely mainly on energy saving and renewable energy to influence the demand for, and price of, gas. With renewable energy becoming increasingly prominent in the European energy and climate policy, the question on the table is: can renewable energy one day determine the gas price? And, if so, when?

On the eve of the global energy transition That we are on the eve of a fundamental change in the energy world is sufficiently clear by now. The movement towards more sustainable energy is under way. This is due to a combination of a progressively tightening climate and environmental policy, dependence on unreliable regimes, rapid technological developments and falling cost prices of renewables, such as wind and solar. Sooner or later, renewable energy will replace fossil fuels as the main source of energy. The sudden surge in the supply of gas and oil from unconventional sources appears to have postponed this at present. Even so, various reputable organisations remain convinced that renewable energy will take

over from fossil fuels as the main energy source.

No so much because of a lack of oil and gas, but rather due to simple economic reasons: an abundant supply and, ultimately, the lower cost of renewables. Or as a Saudi Arabian minister put it several years ago: ‘The stone age didn’t end because we ran out of stones’ Graph 2: Cost of power generation (in USD per MWh)

Graph 1: New investment in renewable energy (in bln USD)

Source: Economist.com

Source: Economist.com

Power generation as future driver of demand for gas?

Looking at the energy system in a broad sense (transport, heating and electricity), the share of renewable energy is still modest. However, zooming in on the electricity supply, we see renewable energy advancing almost irrepressibly.

These developments in the electricity sector have an essential bearing on gas. As the International Energy Agency (IEA) notes in its report ‘Are we entering a golden age of gas?’: “Power generation is the largest gas using sector today and is expected to be the biggest driver of gas demand growth in the coming decades”. But in mid-2014 the IEA also claimed that solar energy alone could account for 27% of global power generation by 2050. Moreover, IEA projections regularly underestimate the development of renewable energy. A DNV-GL survey among 1600 energy professionals produced a similarly optimistic result, predicting that it should be possible to generate 70% of the power supply from renewables by 2050.

Various other European countries have set themselves less ambitious targets but are also committed to renewable energy and energy saving – partly to meet mandatory European energy and climate targets, but also to reduce the growing dependence on imported energy from Russia (the EU’s chief supplier of gas), particularly in view of the mounting geopolitical tensions with that country. Though the driving forces and ambitions regarding the energy and climate policy differ within the EU from one Graph 3: German Energy transition

country to the next, the share of renewable energy is growing in virtually every member state. The first concrete steps towards a European energy transition have thus clearly been made.

The role of gas in the European energy transition The EU has set itself the aim of reducing greenhouse gas emissions by 80% in 2050. The energy and climate policy implemented for this purpose has so far mainly led to a more sustainable electricity supply. But an increase in

Europe’s Energiewende Now for Europe. The outcome of the DNV-GL survey corresponds broadly with the concrete renewable electricity target that Germany, the most influential country within the EU, has set itself: a minimum of 45% in 2030 and 80% in 2050 (and 60% of the final energy consumption).

Source: German Energy Transition

renewable electricity alone is not sufficient to influence the demand for gas and, hence, the gas price. In Europe a large proportion of the gas is converted into heating – in Germany even as much as 50%. To see whether and how this has an effect on gas demand, we must turn to the 2050 energy roadmap of the European Commission.

According to the calculated scenarios, the share of gas in the total energy mix will at best show only a slight increase in 2050 (Figure 3). A study of the University of Oxford draws the same conclusion.

However, this study also indicates that the share of gas in the European energy mix actually decreased in the past years. This drop is mainly visible in the electricity sector, the sector where initially the future rise in demand for gas was expected. The researchers conclude that this decline has been largely offset by the growing use of coal due to the relatively high gas prices and cheap CO2 emission rights, but also partly by renewable energy.

The 2050 roadmap scenarios assume a renewable energy percentage varying from 41% to 60% of the total energy mix (including heating and transport) in 2050, compared to 6.8% in 2005. The percentage assumed for gas varies from 19% to 26%, compared to 24% in 2005. As the future demand for gas is mainly determined by the developments in the electricity sector, we need to look at the detailed section of the 2050 roadmap that focuses specifically on the full decarbonisation

of the electricity sector. The section consists of four possible ‘pathways’ for achieving this objective. As shown in Figure 4, the EU sees a role for a combination of more or less renewable, nuclear and CCS (combination of coal and gas) in three of the four scenarios.

These scenarios are based on the consumption for power generation, while leaving transport and heating out of consideration.

Graph 4: EU decarbonisation scenarios for all sectors - 2030 and 2050 range of fuel shares

Which scenario can influence the gas price?

To influence the gas price, gas must be seen as a back-up energy source for renewable energy.

As long as the consumption of renewables is not significantly greater than that of gas, the price of gas will be barely influenced by renewables. The first scenario (40% renewable, but much smaller for the total energy mix – see figure 3) is thus eliminated, which leaves scenarios two (60% renewable/20% gas/coal), three (80% renewable/10% gas/coal) and four (100% renewable). Before the gas price can be

Source: European Commission

determined by renewables within these scenarios, several more conditions must be satisfied: The consumption of gas must be variable, i.e. gas must be used flexibly as a back-up for renewables. Only then will the spot prices be influenced and not – as is currently indirectly the case – the future price trend; Gas must be cheaper than other fossil fuels, such as coal and oil; The effect will be significantly greater if the share of renewable energy and energy Graph 5: Four scenarios for the energy in the electricity sector (excluding heating and transport) in 2050

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saving is substantial, also outside the electricity sector To achieve this, the price of CO2 emission rights must increase

If these conditions are met, you could arrive at a situation in scenarios two, three and four where the spot prices of gas are determined by renewable energy.

Turning point 25 years from now?

Clearly, in a scenario where the gas price is determined by renewable energy, a new factor enters into the equation – because the total demand for gas is not rising, but falling. Less

demand automatically puts prices under pressure.

So you could say that the decrease in demand for power generation is already leading to price effects. This could be one plausible explanation for the downward trend of gas prices in Europe in recent years. Nevertheless, the effect is still minimal and the current downward trend in European gas prices has more to do with the decoupling of oil prices, mild winter weather and high stocks.

This may change if the EU sticks to its energy and climate ambitions. In this case, renewable energy should account for an estimated 50% of the total energy mix in 2040. Moreover, as we already indicated, the gas prices for the electricity sector could be influenced by renewable energy in scenarios two, three and four. This suggests a turning point somewhere between 2040 and 2050, i.e. in about 25 years’ time. That may seem long but, given the current composition of the energy mix and the term of the current investments, it is actually quite a short period of time.

Conclusion: renewable energy can determine the gas price; possibly earlier than many think

1

RES = Renewable Energy Source

Source: European Commission

As noted earlier in this article, looking at the energy system in a broad sense (transport, heating and electricity), the share of renewable energy is still limited. But the share of

renewables used for power generation is rising strongly, and a 100% scenario in 2050 for the electricity sector is by no means improbable.

However, looking at the total energy mix, i.e. including transport and heating, gas seems set to continue playing a considerably more important role. For this reason, given the technologies of today, the realisation of a 100% renewable energy mix for all sectors before 2050 is less likely.

We have seen that the question as to whether renewable energy can determine the price of gas can, under certain conditions, be answered with ‘yes’. However, before we reach this point, substantial technological innovation is required and the use of renewables within transport and heating must really take off. More stringent 2 regulations to increase CO emission prices under the Emission Trading Scheme can give an additional boost. If these conditions are met, renewable energy can start influencing the gas price between 2040 and 2050. That is in 25 years’ time, which is closer than many think.

ABN AMRO Group Economics Hans van Cleef Senior Energy Economist Tel: +31 (0) 20 343 46 79 Mail: hans.van.cleef@nl.abnamro.com Twitter: @hansvancleef

Hendrik Steringa Researcher en writer Tel: +31 (0) 6 41 09 16 39 Mail: hendriksteringa@gmail.com Twitter: @nrgtransition

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