VoxEU Column Energy

Reasons behind the 2022 energy price increases and prospects for next year

20 Jul 2023

Throughout 2022, the weaponisation of natural gas supplies by Russia led to concerns regarding the security of natural gas supply in Europe. This column reviews the reasons behind the increases in energy prices and prospects for 2023–24. Decisive EU policy and market rebalancing helped reduce concerns about shortages, bringing prices back to physical fundamentals. Similar spikes to those experienced in the summer of 2022 are less probable in the winter of 2023–24. Managing demand, increasing diversification, and renewing focus on the security of supply remain necessary.

Authors

Miguel Gil Tertre

Ignacio Martinez

Manuel Rivas Rábago

Throughout 2022, the weaponisation of natural gas supplies by Russia led to concerns regarding the security of the natural gas supply. Significant gas price spikes were the main contributor to the high electricity prices that had a major impact on the EU economy.

This has fuelled debates on the role of energy in the current inflationary environment (Killian and Zhou 2023), the capacity for the EU to phase out its fossil-fuel consumption from Russia (Pittel et al. 2022), and industrial competitiveness in a context of high energy prices. A renewed focus on the security of supply and access to commodities necessary for the green transition has come to the forefront (Paduano and Arezki 2022).

Natural gas as the main driver of the crisis

The 2021–2022 energy crisis was not related to the green transition. Energy prices increased due to the following reasons:¹

reduction in the supply from Russia
uncertainty and fears of shortages
lower-than-usual hydro and nuclear electricity output in the summer, which pushed gas consumption for electricity

In 2022, Russia supplied 70 billion cubic metres (bcm) less to the EU than in 2021 (a total of 150 bcm in 2021). The EU had to change the origin of 40% of its imports,² the majority by pipeline under long-term contracts.³ While natural gas prices over the previous decade were between €5/MWh and €35/MWh, at some point they reached levels more than ten times higher than the average prices in the previous 15 years. As the most expensive technology sets the electricity price, this led to price increases in wholesale electricity generation.

Figure 1 Russian weaponisation of gas supply and EU energy policies

Sources: DG ENER Chief Economist Team based on ENTSO-G and Platts

Figure 2 Households’ retail prices for gas and electricity (EU average)

Sources: European Commission based on VaasaETT

Higher gas prices were instrumental in attracting additional LNG and reducing demand. However, extremely high prices between July and August 2022 were not necessary to increase imports due to network congestion (European Commission 2023). These prices can be attributed to intra-EU competition in the face of fears of a limited supply. Ultimately, this benefited those trading the assets⁴ and represented a significant wealth transfer (European Securities and Markets Authority 2023).⁵

The difference between the prices of the Dutch Title Transfer Facility (TTF) and global prices like the JKM (the LNG benchmark price assessment for spot physical cargoes) ⁶ amounted to around €35/MWh on average between June and August 2022. During the summer of 2022, the TTF became also detached from prices at other trading places in Europe, as well as from the price assessments by price-reporting agencies.⁷

Figure 3 Daily day-ahead prices and LNG imports⁸

Sources: DG ENER Chief Economist Team based on ENTSO-G and Platts.

The crisis was exacerbated by the lower-than-usual hydro⁹ and nuclear¹⁰ output.¹¹

Figure 4 Changes in power generation in the EU between July-September 2021 and July-September 2022

Source: DG ENER Chief Economist Team based on Eurostat and ENTSO-E

Better prospects for winter 2023–24 thanks to decisive EU policy action and market rebalancing

Decisive EU policy as outlined by the REPowerEU plan and market rebalancing helped reduce concerns about shortages, bringing prices back to physical fundamentals. Similar spikes as those experienced in the summer of 2022 are less probable next winter due to the following reasons:

Storage levels are at historically high, at 78% as of 30 June 2023 versus 63% on average on the same day during the reference years 2016–2021 (Figure 5).

Figure 5 Evolution of European gas storages: reaching historically high levels since autumn 2022

Source: European Commission based on GIE-AGSI

Natural gas demand has gone down. Demand from August 2022 to May 2023 was 17% lower in comparison to the past five-year average (Figure 6). Part of the reduced demand last year is structural.¹²

Figure 6 Natural gas demand reduction in Europe: Overshooting the 15% voluntary consumption reduction target

Notes: The reference period is defined as the average of the very same month of the previous 5 years. For April to December, it is 2017–2021 and January to March 2018–2022 (as laid out in the Demand Reduction Regulation).
Source: European Commission based on Eurostat.

The EU has diversified its supply. The weaponisation of energy by Russia last year can no longer influence the market in the same way: today only about 20 bcm/year comes via pipeline from Russia, versus 155 bcm/year in the five years before 2022.

Figure 7 Increase of LNG imports in Europe

Source: European Commission based on Refinitiv

New LNG importing terminal projects with a total capacity of around 30 bcm/year are helping the EU to secure an alternative supply. The total added capacity via FSRU and LNG is 20.6 bcm/year in operation and 49.8 bcm/year, to be commissioned.
There is less uncertainty compared to 2022 after the efforts the EU made last year. Market players do not need to buy gas no matter the price to ensure the security of supply.

Conclusion

The EU has been able to absorb an unprecedented energy shock without blackouts, shortages, or a recession. However, this resulted in significant price spikes and significant fiscal support from Member States to cushion the impact on households and businesses. Market fundamentals point to a better situation in winter 2023–2024, limiting the risks for similar spikes as the one in summer 2022 and therefore easing the impact of energy on inflation.

Several issues must continue to be monitored, including the continuation of demand reduction, global LNG supply, gas demand in China, and weather.

The path to the green transition points to significant price volatility ahead. Managing demand, increasing diversification, and renewing focus on the security of supply remain necessary.

Authors’ note: This column builds on a paper presented at the ECB Central Banking Forum in Sintra (Gil Tertre 2023). The views expressed are purely those of the authors and may not in any circumstances be regarded as stating an official position of the European Commission.

References

European Commission (2023), “Commission staff working document on coordinated gas demand reduction measures”, European Commission.

European Securities and Markets Authority (2023), “TRV risk analysis: EU natural gas derivatives markets: risks and trends”, European Securities and Markets Authority.

Gil Tertre, M (2023), “Structural changes in energy markets and price implications: effects of the recent energy crisis and perspectives of the green transition”, paper presented at the ECB Central Banking Forum, 27 June.

Kilian, L, and X Zhou (2023), “The inflationary impact of energy prices”, VoxEU.org, 10 February.

Paduano, S, and R Arezki (2022), “The energy balancing act between security and transition”, VoxEU.org, 1 July.

Pittel, K, M Schularick, B Moll, A Peichl, A Löschel, M Kuhn, C Bayer, D Rezza Baqaee, and R Bachmann (2022), “What if Germany is cut off from Russian energy?”, VoxEU.org, 25 March.

Footnotes

At the start of 2021, a strong post-COVID-19 Asian demand in the global LNG market started to put pressure on markets, although not to the extent of the price increases in 2022.
Natural gas (mainly via pipeline) from Russia represented 40% of the imports into the EU at the start of 2022. In March 2023, Russian gas imports by pipeline and LNG represented 8% and 7% of the total EU gas imports, respectively.
In the short term, most of the replacement is via the spot markets that usually trade at a premium.
Natural gas traders had significant profits (sometimes even 10 times above the historical range, according to their financial statements).
In this context, it is worth mentioning that, according to the European Securities and Markets Authority, there is a significant concentration in EU financial energy commodities markets, at both clearing and trading levels.
Platts JKM is the LNG benchmark price assessment for spot physical cargoes. It is referenced in spot deals, tenders, and short-, medium-, and long-term contracts both in Northeast Asia and globally. JKM reflects the spot market value of cargoes delivered ex-ship into Japan, South Korea, China, and Taiwan. Deliveries into these locations equate to the majority of global LNG demand.
This is largely because the gas system of North-Western Europe presented infrastructural limitations to address the shortages of Russian gas, both in terms of pipeline transmission (West-East) and in terms of LNG regasification capacity. Such limitations were partly responsible for the general increase of gas prices since the beginning of the crisis in Europe following Russia’s weaponisation of energy. The abnormal spread between the TTF and other regional hubs in August 2022 indicates that, until bottlenecks are resolved, the TTF may not always be an accurate proxy for the EU outside North-Western Europe.
After stabilising in Spring 2022, TTF natural gas spot and futures prices raised steeply and continuously from June 2022 to their peak in late August 2022. The rise in European gas prices has been fuelled by (i) an incident in June at Freeport LNG terminal (freezing around 20 bcm/year of capacity until a partial restart in February 2023) and, more considerably, by (ii) the drop of Russian supplies over the summer with a significant uncertainty as to when or if these supplies will come back to the EU market and if further drops in Russian flows were to be anticipated (North Stream froze 58 bcm/year of flows in June 2022, before partially restarting them in July 2022 and indefinitely interrupting them in August 2022).
Weak hydroelectric production due to droughts in Europe, exerted additional pressure on the already tight European wholesale electricity market. Hydropower generation was down by 20% (-17 TWh), during July and September 2022 compared with the same period in 2021. Hydro generation during summer 2022 remained at the lower bound of the 2017-2021 range.
The French nuclear fleet (around 6% of the total EU installed capacity, according to Eurostat) was down by 36% (-31 TWh) between July and September 2022, compared to the same period in 2021. Nuclear generation drastically decreased, from 4.6 TWh in the first week of July 2022 to a new low during the last week of August (3.8 TWh) and then bounced back to around 4.5 TWh in the last week of September 2022. Subdued nuclear generation continued well into the last months of 2022, registering an increase in its output to 6.3 TWh during the second week of December. However, the output remained below historical levels.
Gas-fired generation was up by 19% between July and September 2022 compared with the same period in 2021.
Weather was responsible for only 20% of the demand reduction according to International Energy Agency estimates. The weather was not very different from the average of the past five years, but Heating Degree Days – a measure of how much energy is required to heat a building due to colder weather – across the EU were 12% lower on average in 2022 than in 2021, lowering space heating requirements. It is also important to note that while prices have considerably decreased compared to the peak in summer 2022, they are still materially higher than the historical/pre-crisis level. Since early June 2022, TTF is traded between roughly €30-40/MWh, while pre-crisis gas prices were around €20/MWh on average. So, the crisis’s impact on gas prices, and therefore on the cost structure of gas-intensive industries, is still there.