Natural gas, the new gold of 2021

World natural gas supply is unable to meet demand.

Pablo Soriano Linares

Consulted with Carlos Marcelles de la Casa

For several weeks now, headlines have been making headlines about how the price of electricity in Spain has been breaking record after record. The reasons behind this fact lie both in the high price of natural gas and in the way prices are set in the Spanish wholesale market. The functioning of this sector and its auctions require a complex explanation that could well be the subject of another article. What we are talking about today is the Spanish energy mix, specifically the importance of natural gas and its evolution of supply and prices in recent months.

It is generally known that the price of gas is a determining factor in setting the price of electricity in Spain. This is due to the fact that around 20% of our country's energy production is directly related to this commodity. However, it should be noted that this figure fluctuates, as these combined cycle power plants (which use natural gas as their main fuel) have to make up for the production shortfalls of renewables when the latter do not have the necessary weather conditions to achieve their production targets.

The price of gas is a determining factor when it comes to setting the price of electricity in Spain. This is due to the fact that around 20% of our country's energy production is directly related to this commodity.

But why has the price of gas risen so much in recent months (see Figure 1). The short answer is that there is not enough supply to meet demand. On the one hand, global demand has soared as a result of the reopening and reactivation of Western economies after Covid-19. However, this fact alone does not completely justify this high price increase, as it is a cyclical variable. The main reasons are structural and are twofold.

Graph 1: Evolution of the world natural gas price between October 2020 and November 2021 in USD. Source: Business Insider, 2021

First, the winter of 2020 was particularly cold in Europe and Asia, which, coupled with major quarantines in several countries in these regions, drained natural gas reserves. Covid-19 also delayed maintenance work on natural gas storage facilities, which would not have resumed until the summer of 2021. This made it impossible to replenish reserves (Brower, McCormick, Shepard, Chu, & Jacobs, 2021). Also, to further aggravate the situation, Norway and Russia, suppliers of 20% and 33% respectively of European natural gas, have exported smaller quantities. The Russian case is of particular interest because the reasons behind this reduction in gas deliveries mix domestic supply needs for the winter, and geostrategic pressures for the commissioning of the new pipeline to transport gas from Russia to Germany (see Figure 1).

Image 1: route of the new "Nord Stream 2" pipeline. Source: Euronews, 2021.

Secondly, the ecological transition has played a crucial role in this price rise. In the European energy mix, renewables, and especially wind power, play an increasingly important role in electricity generation (see graph 1). However, in recent months the winds have been calm in Europe, which has led to wind power generation producing well below its capacity (The economist , 2021). This has led to increased demand for natural gas in Europe. In addition, the steps taken in Western Europe are also being replicated in Asia, particularly in China, which is employing measures to decarbonize its economy by replacing coal-fired thermal power plants with combined cycle power plants (General Electric, 2021).

Graph 1: Energy mix of the European Union in 2019. Source: own elaboration based on Eurostat data, 2021.

So, to summarize, on the one hand, Europe is becoming increasingly dependent on wind and gas for energy production, making wind power more unproductive than expected. On the other hand, China and other Asian countries are storing gas for the coming winter. In addition, the usual producers are offering lower-than-usual production rates. Thus, as long as natural gas supply and demand remain in such imbalance, the price of electricity will continue to rise. However, the worrying thing is that there is no simple solution in the short term, although the populist speeches of many governments claim otherwise. A few small tax reductions, as in the case of Spain, will not solve this problem on an international scale. The joint reserves proposed within the EU could be a stopgap, but, once again, not a definitive cure.

Bibliography

Brower, D., McCormick , M., Shepard, D., Chu, A., & Jacobs, 2021. There’s not enough natural gas. Recuperado el 31/10/21 de: Financial Times.

Business Insider, 2021. Natural Gas Market. Recuperado online el 31/10/21 de: https://markets.businessinsider.com/commodities/natural-gas-price

Euronews, 2021. Navalny poisoning leaves Nord Stream 2 pipeline's fate in the balance. Recuperado online el 31/10/21 de: https://www.euronews.com/2020/09/25/navalny-poisoning-leaves-nord-stream-2-pipeline-s-fate-in-the-balance

Eurostat, 2021. Where does our energy come from? Recuperado online el 31/12/21 de: https://ec.europa.eu/eurostat/cache/infographs/energy/bloc-2a.html

General Electric, 2021. Coal-to-Gas Transition in China: Junliangcheng Power Plant Adds over 650 Megawatts with GE’s Advanced 9HA Technology. Recuperado online el 31/12/21 de: https://www.ge.com/news/press-releases/coal-to-gas-transition-in-china-junliangcheng-power-plant-adds-over-650-megawatts

The economist, 2021. What is behind rocketing natural-gas prices? Recuperado online el 31/10/21 de The economist: https://www.economist.com/graphic-detail/2021/09/20/what-is-behind-rocketing-natural-gas-prices