A green response to the natural gas price shock

The world is experiencing boom and bust cycles in the energy market. It would therefore be understandable if the current surge in the price of natural gas in Europe and its knock-on effect on the price of coal and oil were only seen as another turning point in the sector’s commercial trajectory. It would be a mistake. Because, this time, there is the additional dimension of its consequence on the rhythm, the nature and the progress of the “green transition”. If this dimension were ignored, higher prices would spur more fossil fuel production and this would run counter not only to public sentiment, but also to efforts to shift to a clean non-fossil energy system.

The crux of the dilemma for governments created by this latest price shock is to find a way to navigate the long-term imperatives of decarbonization and also to manage the political and social backlash from consumers affected by high electricity costs. and fuel. COP 26 should add the resolution of this dilemma to its agenda. It will be a recurring problem.

The price of natural gas in Europe has climbed about 600% in the past 12 months. A year ago, it was trading at just under $ 4 / mmbtu; today, it hovers around $ 25 / mmbtu. And, in a reversal of the classic feedback loop where the price of oil would lead to a change in the price of gas, this time it was the price of gas that drove up oil and coal prices. Indeed, with the former becoming more and more unaffordable, consumers have turned to the latter. The average price of Brent crude in 2020 was $ 42 / bbl. Today it’s just under $ 80 / bbl. Thermal coal has also hit all-time highs above $ 200 / tonne.

There are many reasons for this price spike, but they boil down to the enduring influencers of the energy market – the interplay of demand, supply and geopolitics.

On the demand side, the most powerful driver has been the global economic recovery. Added to this are the micro factors of the drop in hydroelectricity in Brazil and China due to drought, the reduction in wind power due to unfavorable wind conditions in the North Sea and the underperformance of the reactors. nuclear in Europe. The high summer heat in the United States, Europe and China also played a role.

On the supply side, there have been three economic bottlenecks and a geopolitical bottleneck. Economic lockdowns were the cold snap in Texas in February this year, which froze gas wells and slowed the export of US LNG, the start of maintenance work suspended since 2020 due to Covid-19 and the drop in the production profile of the giant Groningen field in the Netherlands. This field should close in two years. The problems were compounded by the diversion of US LNG cargoes destined for Europe to Asia and the low stocks.

The geopolitical stumbling block is Russia. Historically, Russia has supplied around 40% of Europe’s gas needs, but it has always had the capacity to supply more and could have come to Europe’s rescue this time around. But he decided not to. Analysts have speculated on the reasons. Most think it has to do with the 1,230 km long Nord Stream 2 pipeline connecting Russia to Germany. The United States opposed this pipeline on the grounds that it strengthens Russia’s influence over Europe. As a result, the EU has not yet approved its operationalization. Russia has hinted that it could relax its stance on gas supply if the pipeline is approved. Who knows how this saga will play out, but for now it is worsening the imbalance between supply and demand.

A few years ago, the impact of changes in the natural gas market would have been geographically limited. Indeed, its market would have been defined by rigid long-term contracts which define the source of supply, the destination and the prices. The contracts have been structured to allow only a limited deviation from these conditions. Today, the gas market is different. It is global, integrated and liquid. What happens in one region is therefore quickly reflected in other geographic areas. The CIF spot price of LNG landed at Hazira, Gujarat averaged around $ 6 / bbl a year ago. Today, given the boom in Europe, Indian buyers would have the chance to get their hands on a cargo under $ 25 / bbl.

The (populist) political response to this latest energy shock would be to give free rein to the markets. Rising prices would encourage companies to increase natural gas production, and consumers would turn to cheaper alternatives to coal (and even oil) and maintain demand. Such a market-driven response, however, would render commitments to phase out coal and limit fossil fuel production hollow, and challenge targets for achieving net zero carbon emissions.

The sustainable response would be to take advantage of this price shock to improve energy efficiency, intensify demand conservation, intervene to prevent the switch to coal, and increase investment in battery and storage technologies and transmission infrastructure. to increase solar and wind energy supplies. This would, however, leave unanswered the difficulties faced by consumers due to power outages and higher fuel costs.

World leaders will meet in Glasgow next month for COP 26. On paper, at least, they are aligned with the nature of the climate crisis and the actions that need to be taken to address it. The hope is that they will turn this alignment into tangible action. The natural gas crisis has highlighted the obstacles on the road to the green transition. Leaders will need to work together to reduce these barriers, especially those created by our continued dependence on fossil fuels. It may take some time to discuss how governments can best help each other stay on the “green” path and also manage short-term political constraints.

This column first appeared in the printed edition on October 4, 2021 under the title “Staying the Green Cape”.
The author is president of the Center for Social and Economic Progress (CSEP)

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