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Louis Boujard – Utilities and Renewable Equity Analyst at ODDO BHF

Needless to say that the situation on the European energy market is tight. The economic impact of the turmoil are bigger than anticipated and it is now time for rapid intervention to limit the inflation pressure and smooth the impact of what has become during the summer break an unavoidable recession.

Availability of energy is not guaranteed for this winter

Managing the price is a key issue but for this winter the big question is about the available volume of energy. Anticipating the rising risk of supply disruption from Russia, even before the partial cut of gas through Nord stream 1, the European Union has set a mandatory minimum level of gas in storage facility at 80% by November 1^st 2022 and 90% for subsequent year. On average, across Europe, this storage level has already been reached at the end of August. On the basis of the current trend, it seems likely that the level will be close to 100% when winter comes. Unfortunately, even at this historical level there is no guarantee that enough gas will be available for each single country in Europe during the winter because while we will tap on the storage additional purchase are needed to avoid a rapid depletion of storage. Thanks to the large LNG import capacity of Europe it is possible to partially offset Russian missing flow but in case of total cut from Russia the equation becomes highly uncertain in particular in countries highly dependent to the Russian flows with limited LNG import capacity. Without Russian flow the equation hardly match and it will be needed to rely on lower consumption (Industrial client consumption already drop -21.3% last July in Germany due to the rising cost) but also gas power plant outages and… a mild winter. Most of us never had to face a restriction on what is supposed to be a primary good and we might have to learn it the hard way this winter.

Affordability is a key question

Fortunately, this situation of possible restriction will not last forever. As soon as next year additional LNG import terminal are expected and it is likely that by next spring at least part of the volume energy issue will be fixed regarding the gas flow but the question of the purchasing price of energy will have to be addressed as well. In fact with the current power market price model in Europe (which is based on the well known supply and demand equilibrium price) it appears that the equilibrium price is set by the gas power plant (so called marginal technology). As such with excessive gas prices, the contagion of the gas issue (which represented only c.0.5% of GDP in 2021 becomes indirectly a 3 times bigger problem representing c. 1.5% of GDP because it is a gas AND a power issue. With the rising cost of gas, Gas + Power in 2Q22 is already 3 times bigger than last year and represent 4.5% of European GDP. If nothing is done on the price issue the potential cost to the economy will keep on increasing dramatically. Indeed, the recent rising costs have not yet been recognized in the final bill of the clients (both industrial and household) meaning that much higher inflation could be expected if the current gas and power prices had to be paid by the final energy customer.

Without Russia cheap power is not likely

Unfortunately, the cut from Russia was not expected and because of it the volume of available gas for long term supply to Europe is limited since it is already dedicated to other market. It seems likely that significant supply that could be dedicated to Europe will not be available before 2024-25 which is the reason why even if there is enough LNG import terminal in Europe next year to get rid of Russian flow for the security of supply, it is not necessarily going to translate into a short term drop in gas prices. For it to happen new fields need to be developed and it takes time.

Since it is not possible to fix the problem with lower gas prices the best solution is to circumscribe it

In front of this situation the political short term fix is to focus the fight on the correlation of the power and gas market in order to limit the impact on inflation. The solution to be discussed on the exceptional meeting in Prague on September 9 will bring a partial solution to the power bill. The most probable scenario looks like a special tax on the fixed cost technology (nuclear, Hydro, Lignite and part of renewable) and “recycle” these profit in lower cost for customers. Alternative solution can be discussed but whatever the final solutions look like one should not expect it to be a definitive fix of the energy issue. The price will remain high and the short term solution will only bring a partial relief on the power bill. Whatever is done the level of the power and gas bill will keep rising for a while and the economic incentive for energy savings and energy transition will become obvious to everyone.

Disclaimer

This document has been prepared by ODDO BHF for information purposes only. It does not create any obligations on the part of ODDO BHF. The opinions expressed in this document correspond to the market expectations of ODDO BHF at the time of publication. They may change according to market conditions and ODDO BHF cannot be held contractually responsible for them. Any references to single stocks have been included for illustrative purposes only. Before investing in any asset class, it is strongly recommended that potential investors make detailed enquiries about the risks to which these asset classes are exposed, in particular the risk of capital loss.