“The war in Ukraine and Russia’s decision not reopen the Nord Stream 1 gas pipeline are currently pushing energy prices higher. As gas is used as a buffer in the production of electricity, the reduced supply is tending to push electricity prices up. Moreover, problems with water shortages in Nordic reservoirs, reduced capacity at French nuclear power stations, the closure of German nuclear power stations and challenges delivering coal to German power stations via the Rhine have created a near-perfect storm for the electricity market,” explains Jakob Magnussen, who expounds on the ramifications:
“Fear that there is simply not enough gas in the system for winter is severely unsettling the market. However, Europe is not entirely unprepared, and gas reserves are somewhat more substantial than one year ago. That can keep the wheels turning for quite a while, even if Russian gas supplies are cut completely. Nevertheless, some companies having to cease energy-intensive production for a shorter or longer period during the winter remains a real risk.”
“Furthermore, dramatic price increases are a challenge for producers and utility companies active in the financial markets for electricity and gas. The huge price rises mean marked changes in the market value of financial contracts, so a producer who has sold their output via a contract will therefore receive significant margin calls – in other words, demands to provide more money as collateral. This is the reason why Sweden and Finland have recently offered billions in guarantees to the energy sector,” says Jakob Magnussen.
How can companies limit their energy consumption and prepare for a winter of volatile energy prices?
“There is no one-size-fits-all solution, but if you are not already focused on shifting away from fossil fuels, the current situation serves to underline that doing so is a good idea. The most obvious steps are to be aware of which time of the day and year you consume most power. Can you move energy-intensive production to the nighttime hours, for example? Can you postpone production during the winter, when there is a risk of even higher prices? These are some of the measures many companies are currently considering,” says Arne Lohmann Rasmussen.
“Companies can also enter a fixed-price agreement with their energy supplier. However, there is a risk of locking in your future price at the peak. Risk mitigation is normally a good idea, but price fluctuations are currently so extreme that companies risk pricing themselves out of the market if competitors later benefit from lower prices. Many airlines, for example, hedged oil prices at USD100/bbl prior to the pandemic and then found themselves bound by this as the oil price and demand subsequently went into freefall. Furthermore, companies should be aware that significant price fluctuations place particular demands on the creditworthiness and risk management of suppliers, as dramatically fluctuating prices may potentially mean your company assuming a large counterparty risk,” explains Arne Lohmann Rasmussen.
What is the outlook for next year?
“This is a serious situation for both the gas and electricity market. We are concerned that the high prices will continue, as there is little prospect of Russia turning on the gas taps at the moment. Looking ahead to 2023, gas and electricity prices appear set to remain high and volatile, which will severely erode consumer purchasing power and undermine growth,” states Arne Lohmann Rasmussen.