Europe’s Energy Crunch: Wicked Coal is Helping, but Government Interference with Gas Markets Increases the Risks Ahead
Combining a supply squeeze with a market ‘correction’ mechanism (or price cap, to call it what it is) is a risky proposition.
The Week of December 19, 2022: Europe’s ongoing energy crunch, the economy, regulation, fiscal policy, and much, much more.
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E urope has so far weathered this winter without the lights going out. Although it is worth paying attention to a series of “temporary” closures of energy-intensive businesses across the continent — not all of them will return, and their replacements may well be located outside of Europe — the fact is that most Europeans have managed to avoid freezing this holiday season. One of the reasons why is that an old villain has turned up to save the day.
Europe passed its first winter test without Russian energy, keeping the lights on through this month’s cold blast. The secret to its success: burning more coal than it has in years.
Consuming large amounts of coal represents a difficult choice for European nations that had promised to ditch the carbon-intensive fuel to contain climate change. Russia’s cut to natural-gas supplies after invading Ukraine and outages at French nuclear plants have spurred the revival.
I doubt if this really represented a “difficult” choice, but it probably was an embarrassing one.
Wall Street Journal:
The effects of war have turbocharged coal’s comeback. But a flaw in Europe’s approach to the transition toward renewable sources of energy has also played a role.
The continent has invested in wind and solar energy while closing dozens of coal-fired power plants over the past decade. When it is cloudy or the wind is low, and demand is high, Europe doesn’t have the capacity to maintain electricity supplies from clean sources.
This “flaw” (intermittency) was hardly a secret, but the central planners running the EU’s climate policy either (i) thought that it could somehow be magically wished away or (ii) cared more about scrapping coal-fired power plants than thinking through how things would work without them.
My guess? The latter.
And when there’s not enough renewable energy around, because, say, of anticyclonic gloom (or Dunkelflaute, if you fancy a little foreign flair), well (via WSJ):
[P]ower prices rise to encourage utilities to fire up fossil-fuel plants. Gas mostly filled the gap in recent years. But coal has taken the lead of late—partly because Germany and other countries brought plants back online, and partly because gas is so expensive that it is more profitable for utilities to burn coal . . .
[F]inding ways to meet demand when renewables flicker is one of the biggest challenges facing governments and companies over the next decade, energy executives say.
Neither hydrogen nor batteries, which could store power to be released when wind speeds drop, are ready to be produced or deployed at scale. “I find it hard to say at this point which is the likely winner,” said Pieter de Pous, program leader for fossil-fuel transition at think-tank E3G. Building more grid connections so renewable power can be funneled across borders is also key, he said.
Sorting this out before creating energy systems that are heavily reliant on renewables would have been . . . wise.
Meanwhile, (via Wall Street Journal, December 19):
European energy ministers reached an agreement Monday to impose an emergency limit for natural-gas prices, which have been sent soaring by Russia’s invasion of Ukraine.
The ministers agreed to impose a price cap if month-ahead prices remain above 180 euros a megawatt hour, equivalent to $191, on the European Union’s main trading hub for three consecutive days. Prices must also be at least €35 higher than a reference level for global liquefied natural gas during the same period.
The plan “will shield citizens from skyrocketing energy prices,” said Jozef Sikela, minister of industry and trade for the Czech Republic, which holds the EU’s rotating presidency. He said the agreement ministers reached on Monday includes safeguards “to steer us clear from risks to security of supply and financial-markets stability.”
The price cap, which EU officials refer to as a market-correction mechanism, can apply beginning Feb. 15 . . .
A market “correction” mechanism, eh? What could go wrong?
It’s easy enough to understand where the pressure to “correct” markets has come from. In a recent (December 18) article for Bloomberg, it was estimated that higher energy had cost Europe roughly $1 trillion (so far). Government interventions (support regimes, bailouts and so on) to help offset this increase in energy prices have (so far) cost $700 billion. But, there is a limit as to how much more governments can spend, given the amount of debt they have piled up: a predicament made worse by higher interest rates and recession.
And this problem is not a one-off. As I have mentioned in earlier Capital Letters (and elsewhere), there are concerns about next winter (2023), as it seems highly unlikely — to put it mildly — that Russian gas will be available to be used to refill storage facilities as it was in 2022. No matter, the EU — being the EU — is setting storage targets.
Bloomberg:
By Feb. 1, reservoirs should be at least 45% full to avoid depletion by the end of the heating season. If the winter is mild, the goal is to leave storage levels at 55% by then.
Much of the missing Russian gas, then, will have to come from imports of liquified natural gas (LNG). And, as Bloomberg explains, the market for that is expected to remain tight until 2026 (when new export production capacity, particularly from the US and Qatar) becomes available. Europe (as noted below) is building new LNG import capacity, allowing it to bring in, according to a report in the Wall Street Journal, an extra 40 billion cubic meters of LNG by 2023. That’s about twice the amount of new export capacity estimated to be coming onstream next year, and customers in Asia will doubtless be interested in taking a good slice of it.
Bloomberg:
LNG imports into Europe are at record levels and new floating terminals are opening in Germany to receive the fuel. Government-backed buying has helped Europe attract cargoes away from China, but colder weather in Asia and a potentially strong economic recovery after Beijing eased Covid restrictions could make that more difficult . . .
Chinese gas imports are likely to be 7% higher in 2023 than this year, according to China National Offshore Oil Corp.’s Energy Economics Institute. The state-owned company has started securing LNG supplies for next year, putting it in direct competition with Europe for spare shipments. China’s historic drop in demand this year was equivalent to about 5% of global supply.
China isn’t Europe’s only problem. Other Asian countries are moving to procure more gas. Japan, the world’s top LNG importer this year, is even considering setting up a strategic reserve, with the government also looking to subsidize purchases.
European gas futures have averaged about €135 a megawatt-hour this year after peaking at €345 in July. If prices go back up to €210, import costs could reach 5% of GDP, according to Jamie Rush, chief European economist at Bloomberg Economics. That could tip the shallow recession being forecast into a deep downturn, and governments will likely have to scale back programs in response.
Combining a supply squeeze with a market “correction” mechanism (or price cap, to call it what it is) is a risky proposition. In his substack, Andreas Steno Larsen took a look at what it would have meant if this regime had been in place this summer. Such retrospective exercises must be treated with care, but it’s worth noting Larsen’s view that the price cap would indeed have been triggered, making it difficult for Europe to get hold of the LNG it needed.
Looking at the current market, Larsen doesn’t think that the cap will be triggered any time soon, but he worries that this may not be true in the summer, when there could be trouble unless the mechanism is scrapped. We’ll see. The stakes are high. According to Larsen, imported LNG is now the single biggest source of Europe’s gas.
Meanwhile, in another report on Bloomberg, it is noted that there is provision for the mechanism to be scrapped in the event of “adverse effects.” So, at least there’s that.
Capital Matters Conference, New York City, January 26, 2023
National Review’s Capital Matters is hosting a conference called “Innovation, Growth — And Their Newer Enemies” at the Union League Club in NYC. Sponsorship information and tickets are available here https://bit.ly/3VH8i0x
Speakers so far: Larry Kudlow, Kevin Hassett, Linda McMahon, Amity Shlaes, David L. Bahnsen, Jason Trennert, Peter J. Travers, Andrew Puzder and, well, me.
The Capital Record
We released the latest of our series of podcasts, the Capital Record. Follow the link to see how to subscribe (it’s free!). The Capital Record, which appears weekly, is designed to make use of another medium to deliver Capital Matters’ defense of free markets. Financier and NRI trustee David L. Bahnsen hosts discussions on economics and finance in this National Review Capital Matters podcast, sponsored by the National Review Institute. Episodes feature interviews with the nation’s top business leaders, entrepreneurs, investment professionals, and financial commentators.
In the 98th episode David discusses his new article, “Put Not Your Trust in Princes,” and makes the case for a synthesis of a free and virtuous society where the lack of one undermines the sustainability of the other. He does this in response to a new article from First Things editor, Rusty Reno, who will soon join the show as a guest.
No Free Lunch
David has also launched a new six-part digital video series, No Free Lunch, here on National Review Online. In it, we bring the debate over free markets back to “first things” — emphatically arguing that only by beginning our study of economics with the human person can we obtain a properly ordered vision for a market economy . . .
The series began with a discussion with Fr. Robert Sirico of the Acton Institute. Later guests include Larry Kudlow, Dennis Prager, Dr. Hunter Baker, Ryan Anderson, Pastor Doug Wilson and Senator Ted Cruz.
Yes, the six-part series now has seven parts.
Enjoy.
The Capital Matters week that was . . .
I can imagine that different groups of Tesla investors may be concerned about the goings on in Twitter for any one of three reasons (two of which contradict each other). Some may think that the way that Musk has been running Twitter (more generally that is, not the journalist thing) raises questions about his judgment in ways that they don’t want to see in the CEO of a company in which they have invested. Others, by contrast, may remain Musk loyalists, but want him to focus on Tesla rather than spending so much time on Twitter. A third group of Tesla shareholders, which will contain members from the first and second groups, will worry that Musk is going to continue to sell blocks of Tesla stock (for reasons, I suspect, not unconnected with the Twitter acquisition), something that would weigh on the Tesla share price . . .
The Economy
According to economist Justin Wolfers, November 2022’s employment statistics mean that “all that talk of recession” is “nonsense. Bollocks. Cow dung.” Wolfers is wrong. The job gains in November 2022 look like the job gains that the U.S. was experiencing during a recession that emerged in a world that looks, in many respects, similar to the world today . . .
Regulation
Jones Act proponents have been feeling the heat because governors are concerned that New Englanders won’t be. New England is facing high heating costs this winter, and the protectionist law, which requires all ships transporting goods between U.S. ports to be built and flagged in the U.S. and owned and crewed by Americans, makes it difficult to transport petroleum products from the Gulf Coast to New England. Very few tankers meet the Jones Act’s requirements, so the market is not very competitive and prices are high . . .
Fiscal Policy
There is little question that the federal government did a poor job of allocating funds to state and local governments during the Covid-19 pandemic, and that a primary factor in this failure was a dearth of reliable, up-to-date financial statistics on these recipient governments. Thankfully, a new measure tacked onto the National Defense Authorization Act offers hope that federal aid to state and local governments will be more carefully targeted in the next financial emergency . . .
Spending
On page 1,634 of this year’s 4,155-page, $1.7 trillion omnibus spending bill, there’s a welfare program for bees . . .
Central Planning
Many newspapers, including the Wall Street Journal, are reporting the news that, contrary to previous projections by the Japan Center for Economic Research (JCER), China’s GDP will not surpass U.S. GDP by 2035.
This may come as a surprise and a relief, but some of us were always skeptical of the notion that China would achieve great economic success after having reversed its move toward market liberalization in 2012 and returned to central planning for its industrial policy. Based on experience, but also fundamental economic principles, such policies meant that the communist regime would be incapable not only of growing as fast as predicted, but also of sustaining whatever growth it had managed to achieve until then. China wasn’t destined, therefore, to overtake the U.S. economy unless the U.S. irresponsibly adopted similar, statist policies.
The idea that a country can become rich through central planning is a myth . . .
Housing
In the most recent Capital Letter, I wrote about the problems facing the housing market, which is, as I explained, more or less frozen at the moment. When it unfreezes, my best guess is that it will decline, and, over time, relatively sharply. The best chance, I suspect, of avoiding a sharp decline — or minimizing the duration of any decline — is that homes come to be seen as an inflation hedge. For that to occur, inflation will have to be more persistent than is currently expected (although so far as that is concerned, it’s worth noting some words of caution coming out of the Fed). That’s rather cold comfort.
Meanwhile, in another sign of approaching trouble, it appears that flippers (normally defined as speculative buyers who buy and sell homes, often after a renovation, within a twelve-month period) are looking at a much tougher market.
Economics
The post-Covid economy may seem like a new world. Look a little closer, however, and it’s anything but. The most extraordinary thing about the U.S. economy is how ordinary it appears. Despite years of unprecedented policies, the old economic relationships have reasserted themselves with bold familiarity. This is most obvious with the so-called inflation-unemployment trade-off. In short, the trade-off doesn’t exist, and it never did.
Office Property
A couple of weeks ago, I noted that the market for office space was looking dangerously sickly, but there’s no problem that building a (supposedly) green economy cannot make worse . . .
Energy
Senator Joe Manchin (D., W.Va.) has failed in his pursuit of a final approval of the Mountain Valley pipeline from northwestern West Virginia to southern Virginia, as the Senate refused even to give majority support for his effort to attach his “permitting reform” bill to the defense budget authorization. The environmentalist Left and many congressional Democrats have no interest in Mountain Valley or permitting reform for fossil projects because of their ideological opposition to fossil fuels and ancillary capital investment.
Nevertheless, because the opponents of fossil fuels are desperate for an “energy transition” to wind and solar energy in particular, a potential deal on permitting reform on these sorts of lines still (sooner or later) ought to be possible because state and local opposition to wind and solar projects is growing rapidly. Robert Bryce reports at least 375 such rejections since 2015.
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