Energy disruptions shows we still need fossil fuels

The price of gas and electricity has shot up in recent weeks. It has been a perfect storm.

| 5 min read

Hurricane Ida took out substantial amounts of US gas and oil output from the Gulf area. Light winds left the Europeans short of electrical energy from renewables. The Russians seemed to keep European gas markets short of supplies perhaps as part of an effort to force completion of the Nord Stream 2 Pipeline project and associated contracts for the additional gas by this new route.

Asian demand was healthy for gas, creating more competitive pressures on Europeans keen to import more LNG. As a result of these shortages short term gas and electrical power prices doubled or worse.

Some of this is temporary and should correct. Unless there is another damaging hurricane soon the US will restore lost output and ease their market supplies. Chinese activity has been slowing so they might not be needing so much additional energy. The winds might pick up in the autumn taking more of the strain of providing the motive power for electricity generators.

The weather-related incidents have reminded the world that it is still very dependent on fossil fuels for power generation, let alone for base heat for homes and factories. More coal has been burned as people have sought alternatives to the gas in short supply and to the wind that will not blow. It is an irony that shortages have been increased both by a sustained period of too little wind, and a brief period of too much wind in the south of the US.

We have also been reminded of the fragility of power structures, with the New Orleans area badly affected by wind damage to power lines, and the UK suffering from a fire hitting its main interconnector to import French electricity.

Energy transition

Attention will shift in the run up to COP 26 to how much progress the different main countries have made in reducing their dependence on fossil fuels for electricity. It was meant to be one of the easier wins to switch over from coal and gas to wind, solar and hydro. Germany is still around 40% dependent on fossil fuels, China about 67% and the USA 60% for power generation, so each of these three giants of the carbon world have a long way still to go to take out coal and gas stations and substitute reliable renewables.

The gas market is dominated by US and Russian supply, with both countries being very large users and substantial exporters of their surplus. Algeria, Qatar and Norway are also important world suppliers.

The IEA expects gas demand to increase this year and to reach a new high level, surpassing its pre pandemic volumes. Recovery of the economy, switching out of dirtier coal, and the problems with renewable alternatives all point in this direction. More gas is now priced by its own market forces rather than through indexing it to oil. In the short term this has allowed even more price appreciation at a time of scarcity.

Russian dependence

The advent of the Nord Stream 2 gas pipeline has caused tensions in the US relationship with Germany and the EU. Both Presidents Trump and Biden urged the Germans not to become more dependent on Russian gas, seeing it as a strategic weakness. It looks clear it is going ahead and Germany will enter into contractual dependence on a large increase in Russian gas.

This will ease the immediate shortages once the gas starts to flow and may help Germany reduce some of its coal dependency – but it does leave Russia able to influence the EU from a position of strength.

As large, quoted oil and gas companies look to sell off their fossil fuel assets and scramble into more renewables it also means the unquoted players and state actors that will dominate the remaining fossil fuel reserves stand to profit from still supplying product that will remain in demand.

As the EU, UK and maybe Biden’s US press on with more renewables the rest of the world will still look to fossil fuels to power growth leaving a good market for these supplies. During periods of too much or too little wind, even the virtuous West will need more fossil fuels to keep the lights on.

We have just had a reminder of what a bit of weather disruption can do. It can deliver super profits to out of favour sectors and activities. It can also give a nasty twist to the inflation which central Banks assure us will be temporary. The bull market depends on a recovery in the wind and more balance in energy markets to ease the current supply and price troubles.

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Energy disruptions shows we still need fossil fuels

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