Summer summary of energy markets

Living in exciting times

It has been a very eventful first half of 2023 and the autumn will be just as challenging. The average global temperature is higher than ever, the price of emissions is more expensive, biomass is more expensive and politics is more uncertain. At the same time, the energy crisis continues and may well bring more surprises. Here is an overview of some key aspects for the autumn.

Costly climate change

With the El Niño weather phenomenon in the Pacific Ocean, global temperatures are now soaring. Simply explained, El Niño is the warm phase of the Southern Oscillation and results in warmer surface waters and winds than usual. It is not a new phenomenon, but because global temperatures are now so much higher than before, El Niño has a stronger impact. At the time of writing, we are experiencing the warmest July days on record globally, increasing the risk of passing critical tipping points. The climate challenge is a much bigger crisis than the energy crisis and will survive both Putin and the Swedish power generation debate. One consolation in the climate challenge is all the proven alternatives that quickly reduce emissions in the energy, industry and housing sectors. In many cases, there is also a clear economic link between reduced emissions and increased profitability.

The emitter pays

As the cost of the deterioration of our living conditions due to climate change is realised, we can assume that the price of emissions is rising and is increasingly reflected in all activities of society. In Europe, fossil fuel power generation accounts for more than a third of the electricity mix. But more importantly, fossil fuels dominate European electricity pricing because, as in most markets, the price of electricity is set by the last traded volume. In the EU, we have decided that emissions should cost at the source and with the latest wave of reforms in December, the price of emission allowances reached €100/tonne in February, an increase by a factor of 17 in six years. For the European electricity price, this means that the cost of emissions for power generation has risen from 2 - 5 cents/kWh in 2017 to over 35 - 95 cents/kWh today. All else being equal, in Europe this closes the door to the "low price years" before 2021. And Sweden is in Europe, which bears repeating.

The political risk

Energy has always been political. This has been particularly evident in the last year. But politicians are usually better at short-term decisions than long-term reforms, as the popular price supports show. European governments have recently spent more on energy price supports (over €800 billion) than on education (around €700 billion by 2021). And most of these subsidies have been unconditional or targeted. Given the widespread skills shortage and need for training in most sectors of society, including the energy sector, this is a worrying observation.

In Almedalen last week, it seemed that the worst of the polarisation in Swedish energy policy has subsided, which is one of many reflections we make in the Energy Strategy podcast. This is good news because the conflict between different types of energy is largely a politically created conflict. In the energy sector and industry, however, the picture is clear - all power generation is needed. The sooner the political schism subsides, the more room there will be for pragmatic decisions. And perhaps the government's bill this winter will offer an opening? Otherwise, it is at the local political level that the situation is really coming to a head, and more and more municipalities and regions are realising that access to power and electricity is the prerequisite for jobs and tax revenues.

Worries of major challenges

One of the major challenges facing energy companies in the autumn is biomass. Securing sufficient volumes at low prices is particularly difficult this year. During the global energy crisis, it first seemed that biomass as a fuel would escape the supply stress and the sharp price increases that affected gas and coal as fuels. But this has turned out to be wrong and was rather due to the fact that, unlike gas and coal, where the daily replacement price on the market is used in the optimisation, it is often the purchase price that is used as an input for biomass. In addition, the biomass market is less transparent and contracts both upstream and downstream are much more rigid than in coal and gas markets.

As with fossil gas, the loss of biomass from Russia and Belarus affects the volume and price picture. At the same time, biomass is used as a substitute for fossil gas in the energy crisis. Add to this the reduced activity in sawmills and the construction sector and smaller residual products such as sawdust, and the situation becomes precarious to say the least. This autumn, we at Sigholm will therefore be spending a lot of time helping our customers with price, volume and time risk management in the biomass business, both financially and strategically. There is much to learn from risk management in coal and fossil gas, but also best practice in the design of risk mandates and the quantification of the risks embedded if the upstream and downstream contract structures are not appropriately aligned.

The ongoing expansion of Swedish nuclear power

In contrast to the decline of nuclear power in Europe, Swedish nuclear power has fared somewhat better. In Sweden, there are plans to increase power output but also to extend the lifetime of nuclear power from 60 to 80 years. For the remaining six reactors, this means a total of 120 more years of nuclear power production, which is a major expansion. It also increases the need for final disposal, which has become significantly more expensive and is estimated to cost SEK 120 billion more than was assumed 20 years ago.

The energy crisis continues

Relations with Europe's former most important energy supplier, Russia, have not improved, but rather the opposite. Meanwhile, mild weather and clear price signals have resulted in a better gas market situation than in a long time. Perhaps even too good - Europe's gas stocks are now 80 per cent full, compared to a seasonal average of 60 per cent. This means that at times it can be difficult to balance surpluses on the gas market, precisely because the gas storage facilities are full and the pressure in them is so high that large volumes of gas cannot be injected. The imbalance may result in a sharp drop in prices for both gas and electricity. The situation lasts until mid-October, when the gas storage withdrawal season begins. Then the respite is over and the risk of another sharp price spike increases significantly.

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Sigholm Markets & Strategy provides analyses, long-term forecasts and insights to help you navigate the systemic change. The world is changing, which we highlight in lectures, workshops and case studies. Do not hesitate to contact us with your questions: https://sigholm.se/en/expertise/markets-strategy