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