[ANALYSIS] The energy crunch: how bad is it?

Prices for electricity and gas skyrocketed in Europe last year and this winter, inflating energy bills for households and businesses, prompting governments to introduce relief measures while wondering how to counteract the underlying reasons for the energy crunch in the longer term.

In Germany, for example, the wholesale price for electricity more than tripled in 2021 to an average of €97 per megawatt-hour (MWh) compared to the previous year, reaching the highest level in 20 years, the Institute of Energy Economics at the University of Cologne (EWI) found in an analysis.

While 2020 saw lower-than-normal demand for electricity, natural gas and hard coal, and therefore cheaper power, the economic recovery in 2021 sent energy prices skyrocketing. Natural gas in Europe cost as much as 150 euros/MWh. On average, gas prices in 2021 were approximately 49 euros/MWh higher and therefore five times as high as in 2020. Prices for imported hard coal also increased (to over 30 euros/MWh).

Dennis Hesseling, head of infrastructure, retail and gas at the Agency for the Cooperation of Energy Regulators (ACER), told Euronews recently that “The pipeline supplies we get from countries like Russia, Norway and Algeria, despite this higher price, have not actually supplied more gas to Europe. They have kept their suppliers quite at the regular volumes. And that’s a bit strange because normally if the price goes up and you’re a supplier and you have spare capacity, you could use this opportunity to sell more gas at a higher price.”

In Germany, the wholesale price for electricity more than tripled in 2021 to an average of €97 per megawatt-hour.

Of course, we all know now that the lack of new supplies from Russia, which is the EU’s leading gas exporter, was because Moscow wanted to capitalise on the crisis to make the case in favour of the controversial Nord Stream 2 pipeline. The 1,230-kilometre conduct running under the Baltic Sea and directly linking Russia and Germany is now complete but didn’t begin operations due to bureaucratic hurdles.

The project has been heavily criticised inside and outside the EU for perpetuating the bloc’s dependence on fossil fuels and extending President Putin’s geopolitical influence. Gazprom, the pipeline’s main backer, and the Russian government have denied any involvement in the energy crunch and have also said Russia could deliver 10% more gas if Nord Stream 2 is approved.

With the invasion of Ukraine, use of the new gas pipeline is off the cards as Germany buckled under the pressure of the US and its EU allies. Whether it will ever come on stream is questionable since “the bilateral Russian-German vision is not part of a shared vision of Europe and has weakened Europe’s position as a guarantor of the common good in favour of German mercantilism,” says Carlo Andrea Bollino, a professor at the University of Perugia.

All this has meant that between 2020 and 2021, the year-on-year increase in the price of electricity, gas and heating oil was the highest on record, comparison website Verivox has said. The price of gas climbed by almost 47%, meaning a household with an annual consumption of 20,000 kilowatt hours (kWh) paid more than 1,700 euros last year, up from about 1,160 euros in 2020. Electricity prices increased by more than 18%, meaning a household with a consumption of 4,000 kWh paid 215 euros more last year.

Some of the price increases look especially dramatic because of the comparison with 2020. While part of this increase is due to the current bottlenecks in energy supply, the main part of the increase in (energy price) inflation arises from the comparison with the below-average prices of crude oil and energy in the previous year.

Some of the price increases look especially dramatic because of the comparison with 2020.

Bottlenecks in energy supply at a time when the economy picks up again after a year of lockdowns in 2020 are the main reason behind the high prices in Europe in 2021 and 2022. The main reason behind the high electricity prices is the high gas price, though some have blamed it partially on the conversion to green energy. But Fatih Birol, executive director of the International Energy Agency (IEA), retorts that: “Unfortunately, we are once again seeing claims that volatility in gas and electricity markets is the result of the clean energy transition. These assertions are misleading to say the least. This is not a renewable or a clean energy crisis; this is a natural gas market crisis.”

This is backed by the International Energy Agency (IEA), which wrote in January: “We estimate that the effect on European electricity prices of the sharp spike in natural gas prices is nearly eight times bigger than the effect of the increase in carbon prices.”

Meanwhile, the price of energy in Malta has remained static for five years, after the significant reductions off 2013-2015. After years of hearing wild claims about a so-called unspecified “exorbitant” price being paid for the LNG we import for the gas-powered station, the Opposition has gone completely quiet as the price of gas quintupled abroad and remained the same in Malta.

The chart shows the sharp drop in energy prices in Malta after the election of the Labour Government in 2013 and how the annual rate of change since then has been zero, compared to the EU and a selected group of countries.   

And we continue to enjoy low prices despite the sharp increases in the last two years. In fact, as on 1 January 2022, Malta’s zero annual rate of change in the price of electricity could be compared to a 27% increase in the EU, ranging between just under 12% in Croatia to 58.4% in the Netherlands.

We continue to enjoy low prices despite the sharp increases in the last two years.

Sharp increases in energy prices are one of the main drivers of inflation in the EU. In fact, looking at the harmonised consumer price index over the past 12 months, it is noticeable that, whereas higher energy prices added 2.31 p.p. to the EU index, whereas the net change in Malta was -0.25 p.p.

Inflation obviously has an impact on industrial producer prices. In Malta, the effect was a 13.7% increase in the industrial price index, but this was significantly lower than that in Germany, where producer prices increased by 24.2% year-on-year in December 2021, the highest rate ever recorded and an indication of a continuing trend of rising inflation.

Producer prices, for products produced and sold in domestically, eventually also impact consumer prices and they influence companies’ competitiveness on the global market. Any further inflationary impact will depend also on companies’ ability to pass energy price rises on to consumers and in turn households’ ability to either pay higher prices (or limit consumption) and their bargaining power for higher wages.

Several aspects of the pandemic have had an impact on prices. These include the collapse of crude oil prices in 2020 and the subsequent economic recovery; temporary tax cuts; the introduction of carbon pricing in some countries at the beginning of the year; and the closure of many shops due to the pandemic containment measures, which meant that customers could not benefit from sales offers. The influence of basis effects can be expected to subside eventually, as it did after similar instances in the past.

The record-breaking surge in energy prices in Europe threatens to derail the post-pandemic economic recovery, strain household incomes and even tarnish the nascent green transition. A series of market, geographic and political factors have coalesced into a perfect storm that shows no signs of abetting. Analysts are already warning that the crisis, which is exacerbated by a mixture of temporary and structural problems, will be prolonged and the worst may yet to come.

Although the Government has acted tempestuously to protect consumers and industry from energy price hikes, this comes at a cost to the public purse.

In fact, Finance Minister Clyde Caruana had warned in his Budget speech that higher inflation and energy prices could impact the fiscal deficit by 5.4 p.p. in 2022.

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