With the European economy recovering from the pandemic, we have observed a pick-up in power demand. In recent weeks, power prices have risen sharply, alongside natural-gas and carbon prices. Despite the substantial increase in the EU carbon-emission prices, exceeding 60 €/ton in September 2021, the strongest contributor to the power-price increase is the natural-gas price, as our Chart of the Week shows. The increase in natural-gas prices has been driven by a combination of events, including the strong rise in global gas demand, global liquified-natural-gas (LNG) supply constraints, and lower-than-anticipated gas exports from Russia to Europe leading to increased competition between Europe and Asia for LNG. With gas demand anticipated to increase over the winter for heating, inventories below their historical average and supply bottlenecks, upward pressure on power prices is likely to continue over the coming months. The sharp increase in prices has also forced several small UK retail energy suppliers to cease trading, with some 1.2 million UK homes affected.
Natural gas plays a key role in the European power mix. Combined-cycle gas turbines (CCGT) represent the default generation technology for gas power plants, given their comparatively high efficiency and operational flexibility, and are 'price makers' across most European power markets, amid a rising share of intermittent renewables capacity. Therefore, changes in natural-gas prices or in CO2 prices are largely reflected in increases in baseload power prices. This creates an inherent price hedge for CCGT operators, but leaves end-users exposed to power-price volatility. Nevertheless, further sharp increases in natural-gas prices may support coal generation in the short term, despite decarbonization policies and coal being only half as carbon efficient as natural gas.
Power prices and CCGT gas-power-plant variable costs (€/MWh)
* A CCGT (Combined Cycle Gas Turbine) plant is assumed to be 55% efficient and CCGT carbon intensity is assumed at 0.365 tCO2/MWh.
**TTF Day-Ahead Price; TTF = Title Transfer Facility
Sources: Bloomberg Finance L.P., DWS Investment GmbH as of 9/21
Natural gas is anticipated to play a key role as a transition energy over the coming decade. Although the current gas demand-and-supply imbalances are likely to ease over the course of 2022, the current power-price dynamic highlights the strategic need for predictable gas supplies and storage to mitigate power-price volatility. The current power-price dynamic is also contributing to a faster transition to renewables. Amid rising power prices, the average 10-year Power-Purchasing-Agreement (PPA) price in Europe recently increased to 55 €/MWh, a 46% increase year-on-year, increasingly pushing European renewables into grid-party. In the long term, a materially higher share of renewable power coupled with power and green hydrogen storage may contribute to reducing power prices across Europe, in our view. Or to put it differently: current high power prices are largely a result of cyclical (gas), and not structural (CO2 levies) forces. We believe the former to abide in the medium term.