Is there a global energy price crunch?

Major international news stories in recent days have centred around energy challenges in Europe and China. Europe and China are on opposite sides of the world and get their energy from (mostly) different sources. Europe’s problems are driven by gas while China’s are driven by coal. Global oil benchmarks reached a three year high this week too. So, it may look as if there is a general global energy supply issue. A closer look at other regions shows this is not the case as while there are global linkages in key fuels, they are limited by physical infrastructure and transport costs.

First, a brief reminder of the issues. China is facing widespread power shortages as high demand and fuel bottlenecks mean that it is running short of coal. The rigidities of central planning come in to play. High marginal coal prices and regulated wholesale electricity prices mean many coal plants are running at a loss, so some of them are turning off. Some regions have exceeded their emissions targets and are having to cut back to avoid punishment from the national government. And the spiteful decision to cut off Australian imports due to our temerity to question the source of COVID is backfiring. Sure, there are other sources of coal, but they are often 20 per cent less calorific than Australian coal while requiring the same infrastructure to transport. So, China is getting up to 20 per cent less energy out of its imports. Gas is filling some of the gap (and China continues to build astonishing amounts of renewables), but even China can’t build new gas import terminals, pipelines and power plants at the drop of a hat.

China’s gas demand does have an impact on Europe (which for all practical purposes includes the UK, Brexit notwithstanding). Its gas price rises are caused by a combination of high demand and supply constraints on a global scale. But the impact is being felt more keenly in Europe than elsewhere because it is a major net importer and also has dynamic market structures that allow prices to fluctuate more than the rigidities of Asian markets. This means that Europe can typically get gas – it just has to pay the price.

Europe also has been enthusiastically shutting down coal as part of its climate goals. This has also led to its constraining new local gas supplies, so its internal production has been declining. Some countries have also started closing their nuclear fleet. These trends have combined to deepen Europe’s reliance on imported gas – both LNG and pipeline gas. The latter comes mostly from Russia, which has been unable to increase its supply – due either to its own production constraints or to geopolitical scheming. The fact that it could be either is a problem in itself.

Whatever the reason, the critical role gas plays in European electricity systems means that high gas prices mean high electricity prices too. Using fossil fuels to fill-in for renewables (low wind, low hydro) also drives up the EU carbon price, leading to an inflationary triple whammy. Small consumers are somewhat insulated in the short run by retail price regulations, but that has put the squeeze on suppliers instead and will have to flow through eventually. A tough winter beckons.

Notably, other major energy importers are not suffering to the same extent. Japan’s gas demand has not budged in recent years and has locked in the supply it needs via long-term contracts, so is heavily insulated from spot price volatility. Korea is similar and in a timely move has just increased mandatory gas storage requirements. India is facing its own coal supply shortages, but this is largely due to an unwillingness to pay elevated prices for imported coal.

As for energy exporters, well it’s a good opportunity to cash in. The US has built up its LNG export capacity in recent years and is well placed to make a return on that investment. Unlike Australia, though, the export market does not dominate the domestic market. Gas prices have risen – to all of US$6/MMBtu. This is around a fifth of prices in Europe or Asia right now. The dynamic shale oil and gas industry in the US acts as a strong buffer against volatility and the US probably has the most diverse generation mix of a major economy. It’s true the US has had some high profile electricity blackouts in the last 12-18 months, notably due to extreme cold in Texas and extreme heat in California, but energy markets weren’t the underlying problem,  and better resilience planning is the solution to these challenges.

Similarly, no-one is talking about energy crises in the Middle East or Russia, with OPEC + group of oil exporters very happy with current price levels . Or Australia, come to that. Of course, we are a much smaller domestic market than the US so are more likely to be impacted by regional (i.e. Asian) price volatility. So, the gas price rises may mean more pain for industrial gas users. But much of our coal-fired power has its own supply on site, so the coal price bonanza is largely confined to export markets. A high oil price means high petrol prices, although half the country is not driving very far right now, thanks to COVID restrictions.

This doesn’t mean there is room for complacency. The macro trends driving the price spikes: climate change, climate policies, the commodity price cycle are as relevant here as anywhere else. And the role energy prices are playing in pushing up inflation may have broader economic repercussions.