European powerhouse: Why gas addiction is a hard habit to break | Techno Glob

Europe is in the grip of an energy crisis. Piped gas imports from Russia are down 80% from last year, sending prices skyrocketing. Unfortunately, with quick and easy solutions for shortages, Europe’s dependence on gas – and its key role in setting electricity prices – will take time to resolve.

In the first of a new series of reports on how Europe is handling the crisis, our Europe Power & Renewables service outlines the challenge ahead. Fill out the form to access a free extract of the report, or read on for a quick introduction.

Why high gas prices have such an impact on the cost of electricity
Like the market for commodities such as oil, copper and wheat, the current market model of the European electricity sector is based on marginal prices. This essentially means that market prices are determined by the variable cost of the most expensive source needed to meet demand.

With gas generators providing Europe’s marginal power supply, gas costs are the main factor behind today’s high electricity prices.

Gas isn’t the only power sector challenge adding price pressure
High gas prices are clearly an important problem, but they are not the only problem facing the European electricity sector.

Significant power generation losses from nuclear and hydro have so far defined Europe’s energy mix in 2022. In France, safety inspections and repairs have resulted in lost generation of more than 60 TWh in the first three quarters of the year – with annual production likely to fall beyond a 30-year low – while in Germany the shutdown of three reactors at the end of 2021 has resulted in the loss of more than 25 TWh of generation so far this year. Germany will now keep its three remaining reactors in case of an emergency. In France, the ongoing inspection program means that production estimates for 2023 are only marginally better than for this year.

Meanwhile, drought in Europe led to a 60 TWh reduction in hydropower generation, while low river levels also put some coal deliveries at risk. With this year’s summer heat wave increasing the use of air conditioning, overall demand losses remained low. As a result, the sector has very few options to boost supply, with the contribution of gas and coal producers both increasing.

What do we do in the short term?
Wind (+ 34 TWh) and solar (+ 27 TWh) partly made up for the supply shortfall. However, solar will contribute much less over the winter, while low reserves mean that hydro can be of no use in correcting the supply imbalance in the short term.

Getting out of gas will therefore mean using more coal, more nuclear and, to a much lesser extent, oil. Unfortunately, capacity at all three is limited, although Germany is allowing mothballed coal plants to restart and postponing shutdowns. Coal production is up 30 TWh since the start of the year, but that’s almost entirely in Germany and Italy.

Electricity demand has so far remained relatively resilient, but the EU has taken steps to propose provisions to achieve load reduction during peak periods and encourage measures to reduce overall demand . However, interruptions or selective rationing cannot be ruled out as a last resort to maintain supply to critical and vulnerable consumers.

What about the longer term implications?
Marginal pricing has worked well in a market made up of a mix of technologies with different characteristics. However, the continued growth of renewables, with their near-zero marginal costs, makes a shift to an alternative market model almost inevitable at some point. But while governments and legislators understandably want to contain costs to consumers, they must be careful not to discourage ongoing investments in low-carbon generation and ensure that the market is flexible enough to support them.

The comprehensive report on which this article is based is the first in a series of information on the impact of the energy crisis on the European electricity sector. In future reports, our research clients will be able to access our latest analysis, data and research on market developments and how governments and regulators are responding.

Complete the form at the top of the page to access the free report extract, which looks in more detail at supply issues, fuel costs and electricity prices.
Source: Wood Mackenzie

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