Gas: a sustainable upward trend

How are gas prices set?

First­ly, it is impor­tant to dif­fer­en­ti­ate between the prices paid by sup­pli­ers on whole­sale mar­kets and the retail prices paid by con­sumer; the sit­u­a­tion varies from coun­try to coun­try. In Cana­da, for exam­ple, the retail price varies with the whole­sale price, which is deter­mined on the North Amer­i­can mar­ket. The reg­u­la­tor requires that the ener­gy (whole­sale gas pur­chase) and trans­porta­tion (pipeline ser­vice) parts be charged at cost. Hence, the sup­pli­er only makes a prof­it on the dis­tri­b­u­tion part, which is only approved once a year by the reg­u­la­tor. In the Unit­ed States, reg­u­la­tion varies between states but is more like that of France, with its tar­iffs being updat­ed every month.

In Ger­many, reg­u­la­tion is more flex­i­ble and retail con­tracts are gen­er­al­ly renewed once a year with a tar­iff increase. In France, retail prices depend on the Ener­gy Reg­u­la­tion Com­mis­sion which decides on the evo­lu­tion of reg­u­lat­ed tar­iffs. The price of gas is updat­ed every month, while the price of elec­tric­i­ty is updat­ed twice a year.  Final­ly, tax­es rep­re­sent about one third of the reg­u­lat­ed price. On 1^st Octo­ber, the annu­al bill for an aver­age house­hold was €1,482 includ­ing tax – the high­est it has been in the last six years. In France, this is a tar­iff that serves as a sig­nal to the mar­ket and applies to the 2 mil­lion house­holds sup­plied by ener­gy com­pa­ny, Engie. Alter­na­tive sup­pli­ers offer prices around the reg­u­lat­ed tar­iff. In oth­er coun­tries where tar­iffs (reg­u­lat­ed or not) also evolve accord­ing to for­ward con­tracts, signed one month in advance, the increas­es observed are sim­i­lar. These prices depend on what pro­duc­ers and sup­pli­ers antic­i­pate the price to be for the fol­low­ing month.

What are the fac­tors of price variation?

Price vari­a­tions are linked to the sta­tus of importer. A coun­try like France imports 99% of its nat­ur­al gas. For the EU, the main importers are Rus­sia (41%), Nor­way (16%), Alge­ria (8%), Qatar (5%) and the Nether­lands (3%). But Rus­sia accounts for more than 50% of the mar­ket share for Ger­many and East­ern Euro­pean coun­tries. Price vari­a­tions are deter­mined by three impor­tant play­ers. First­ly, there is the increase in demand due to the recov­ery of pro­duc­tion after the Covid cri­sis. Sec­ond­ly, there is a lim­it­ed sup­ply due to a lack of stocks and geopo­lit­i­cal ten­sions. And final­ly, there is the weight of envi­ron­men­tal policies.

As far as the sup­ply effect is con­cerned, coun­tries usu­al­ly build up stocks to smooth out peaks in demand. So, when price ris­es, stocks are reduced and there is a short-term adjust­ment. As such, over the past year prices have risen sharply while stocks have fall­en sharply, part­ly due to a cold win­ter. How­ev­er, because of the high price, these stocks were only par­tial­ly replen­ished. On the demand side, peaks can­not be smoothed out, so we are cur­rent­ly sub­ject­ed to the shocks of the eco­nom­ic recovery.

Fur­ther­more, geopo­lit­i­cal ten­sions do not encour­age pro­duc­ing coun­tries to export more. The Rus­sians, for exam­ple, are ready to dou­ble their gas pro­duc­tion for Europe, but they demand some­thing in return: the com­mis­sion­ing of the recent­ly com­plet­ed North Stream 2 pipeline. A pipeline through the Baltic Sea and Ger­many to avoid depen­dence on the high-tax pipeline through Ukraine. 

Final­ly, there is the envi­ron­men­tal fac­tor. Joe Biden’s cli­mate plan is an exam­ple, which strict­ly reg­u­lates uncon­ven­tion­al extrac­tion meth­ods (hydraulic frac­tur­ing) and the reduc­tion of sub­si­dies for fos­sil fuels. In addi­tion, the Euro­pean CO₂ mar­ket is now a major deter­mi­nant of ener­gy prices. The price of allowances per tonne of CO₂ was €6 in 2017, ris­ing to €20–35 in 2020. It has now reached €62 per tonne.

Is this increase sus­tain­able or temporary?

In the short term, six months, the sit­u­a­tion is cycli­cal, linked to the eco­nom­ic recov­ery. If we look at future prices, they indi­cate a return to nor­mal for the sec­ond quar­ter of 2022. The flaw in this analy­sis is that it is dif­fi­cult to pre­dict the evo­lu­tion, as the price of gas varies accord­ing to numer­ous trade-offs, between cur­rent and future prices, between stor­age and de-stock­ing deci­sions, or even accord­ing to inter­na­tion­al events. But in a few weeks’ time, we will know a lit­tle more about the com­mis­sion­ing of the Russ­ian gas pipeline, which would be a real turn­ing point towards sta­ble or even low­er prices.

What can we expect from ener­gy prices in a con­text of con­tin­ued decarbonisation?

In the long term, there is an upward trend in ener­gy prices that comes from envi­ron­men­tal com­mit­ments. Gov­ern­ments want to encour­age the con­sump­tion of low-car­bon ener­gy, yet it is more expen­sive than fos­sil fuels. This is the whole point of the Euro­pean CO₂ mar­ket. More­over, price volatil­i­ty is like­ly to increase due to the inter­mit­tent oper­a­tion of renew­able ener­gies. Gas-fired pow­er plants are the quick­est and eas­i­est way to pro­vide ener­gy when there is no wind or sun.

What are the con­se­quences of high­er prices and what scope do gov­ern­ments have for action?

Com­pa­nies will pass on the increased cost of ener­gy in the price of their goods and ser­vices and so the con­se­quence is like­ly infla­tion. House­holds can be expect­ed to reduce their gas con­sump­tion, but this remains large­ly a con­straint. For gov­ern­ments, it is a polit­i­cal oppor­tu­ni­ty to send a sig­nal in favour of pur­chas­ing power.

Interview by Clément Boulle