The Price Peak

The story of our economy in 2022 was dominated by energy. The increased cost of gas as Russia turned off the taps has stressed the balance sheets of households, businesses and governments.

Locally there have been glimmers of hope. firmus gas prices have been cut by around 20% on both its networks from 1 January. That came in response to sustained falls in wholesale costs in the last quarter of 2022.

A wholesale unit of gas, known as a therm, peaked at over £7 in August but has consistently been below £4 since the start of October.

The Utility Regulator says firmus’s wholesale costs in its regulated Ten Towns network will be around £3.20 in January compared to £4.05 in October. However, before the current energy crisis a therm had for years typically cost about 60p. So the recent price falls reduced the price from ruinous to merely eye-watering.

To assess if downward price moves can be maintained we first need to understand what has driven the recent trend. For that we can turn again to the invaluable data of the International Energy Agency (IEA), the intergovernmental agency that acts as a sort of global energy think tank and policy advisor.

It identifies three main factors: mild weather, healthy storage levels and strong Liquified Natural Gas (LNG) supply to offset reduced Russian pipeline supplies.

The IEA says that unseasonably mild weather across Europe in October reduced gas demand by over 30% yearon-year and effectively delayed the start of the heating season in most European markets.

That coincided with an influx of LNG cargoes from exporters like Qatar, the US and even Australia. Those two factors in turn allowed a near record build-up of European gas storage.

At the beginning of November, EU storage sites were close to 95% full – well above the EU’s 80% target. At one point in October EU hour-ahead gas prices actually fell into negative territory amid infrastructure constraints. However, the IEA warns that none of this should lead to optimistic conclusions about the future. A cold snap could quickly change sentiment and there are potentially tougher tests to come.

Firstly we start this year in a very different position to 2022.

Although Russian gas deliveries to Europe were cut sharply during 2022, they were close to normal for much of the first half of the year, so over the full year they amounted to 60bn cubic metres. It is implausible that Russia will deliver anything like that in 2023. The IEA estimates 25bn cubic metres at best and more likely none at all.

And then there is China. If the Chinese government can successfully manage its way out of its zero Covid policy and economic demand rebounds it will be thirsty for LNG imports.

The IEA estimates that if Chinese demand returns to 2021 levels that would capture over 85% of next year’s expected increase in global LNG supply and limit the amount of LNG available to the European market.

The IEA has modelled a scenario where mild weather leaves EU and UK storage around 30% full at the end of this winter. To this it adds an assumption of no Russian pipeline gas, a Chinese rebound and some recovery in European nuclear and hydro output.

Mix that all together and you get a gap of 27bn cubic metres that is needed to satisfy the conditions of refilling gas storage levels to 95%. That level of storage is important because without it there is risk that EU gas storage sites would be less than 30% full by the end of this year.

A continued drawdown of storage in line with historical averages would then create a risk of widespread gas supply curtailments starting in February 2024 and an extreme price spike of the sort we saw last August.

So what can be done? The IEA suggests that governments across Europe need to go bigger on the policies they have already been pursuing through 2022. Those are broadly grouped under five headings: improvements in energy efficiency, a more rapid deployment of renewables, the electrification of heating, encouraging behavioural change by consumers and scaling up supply. Some of those policies will obviously come with an upfront investment cost The IEA estimates the cost of around 100bn euro. It attempts to put that into context by pointing to the 330bn euro that has been mobilised by EU member states over the last year in emergency packages to shield consumers from high prices.

It reckons that the 100bn euro would be recouped in about two years by lowering gas import bills. So governments will need to get busy with implementation this summer. And meanwhile cross their fingers in hope of another mild winter.