In the last ten years, the price of electricity has dropped from €40 to €20/MWh. The financial crisis of 2008 pulled the rug out from under the strongly inflated prices (€87/MWh) that prevailed just before the Lehman Brothers crash of the same year – the largest filing for bankruptcy in US history. The market has never properly recovered since. Energy companies are finding it ever more difficult to cover their costs; in many cases, generating electricity is now a loss-making business for the producers.
“Actually, the low price of electricity depends on how much it costs to burn coal,” sums up Andreas Regnell, Vattenfall’s Head of Strategy.
The price of coal continues to largely determine the price of electricity in Europe. It is quite simply the case that coal (and gas)-fired power plants set the price for many hours throughout the year, even in the Nordic region. However, renewables have now begun to significantly influence the price during certain hours when coal power is not required in order to match consumption.
Regnell highlights three main factors behind the current pressure on the price of coal and thus electricity:
1. The economic powerhouse of China used to import 3% of its coal requirements, and although the country produced 97% of the coal it needs, the extra percentage meant that the price of coal remained high in Europe. Now that China’s economy has slowed down, the country meets its needs entirely from home-produced coal.
2. Shale gas in the USA dramatically changed the rules of the game on the energy market. The giant US market essentially became self-sufficient in energy, and the coal from its mines which previously filled the gap is now sold on the world market.
3. The price of emission rights, i.e. the cost of emitting carbon dioxide and other greenhouse gases, has dropped from €30 to €5 per tonne.
“As long as emission rights cost so little and there is a market for coal, the energy companies will continue to burn coal, as it’s cheaper than burning gas,” Regnell says.
At the same time, renewable solar and wind energy is continuously being supplied to the electricity market in accordance with climate policy decisions already taken. In Germany, solar and wind power have eliminated the need for gas power, which used to bridge the gap at consumption peaks.
Earlier forecasts that indicated a continuously increasing demand for electricity have turned out to be wrong. Both private consumers and the electricity-intensive industry have learnt to manage their electricity sparingly.
“Most things indicate that the demand for electricity will remain at the current level for the foreseeable future, while major overcapacities persist. A painful conversion is impending for many energy companies in Europe, with continued large reductions in the value of their assets as a consequence,” suggests German energy market expert Frank Krönert from engineering consultancy Sweco.
The energy companies are playing survival of the fittest with each other: they intend to hold out longest and avoid shutting down their own plants. This means that overcapacity will continue, which ought to benefit the customers in the form of low prices, according to the classical formula of supply and demand – because at present, full production costs (including fixed and capital costs) are about €50/MWh whereas only €20 is actually received in payment.
But customers do not feel the benefits of low prices as they are paying for the ongoing transition to renewable energy sources via earmarked charges on their electricity bills.
“Even though wind and sun are free, it costs money to build the relevant installations and no one is willing to pay these costs unless they get price guarantees, i.e. subsidies,” says Regnell.
The Germans have taken the lead in renewable energy, and playing a pioneering role is expensive.
“Germany has invested heavily in developing new technologies at an early stage – involving relatively high investment costs – so price surcharges on German electricity bills are obviously higher than in Sweden, for instance,” says Frank Krönert.
LOOKING INTO THE FUTURE
So what do the experts think will happen with the price of electricity in the future?
“Well, we already know what prices will be paid for electricity to be supplied in 2025, as today’s electricity market allows trading far into the future. At the moment, the price of electricity for 2025 is €23/MWh on the energy exchange.”
The forecasters take into account the effects of political decisions already talking about future investments in renewable plants, climate measures, etc.
“The market outlook for the next three to five years is, in our view, a fairly good prediction as there are few important price setting factors that can change a lot during this relatively short time frame. Beyond that, we cannot predict how European energy policies will pan out further into the future. Will the system of emission rights be tightened up? Can we expect joint European decisions or national solutions? Many parameters must be included in the equation and many of them are very difficult to predict,” says Regnell.
The energy companies are now complaining about the imbalance of the market, but no complaints were heard when the imbalance was the other way around before the financial crisis. Sheer economics forces them to phase out electricity production that is taxed and/or not subsidised.
“The closure of four nuclear reactors in Sweden will happen earlier than planned, as taxes and other charges weigh heavily on the running costs. Although it is possible to shut down the four 1970s reactors, a fast shutdown of additional existing plants would lead to problems in the security of supply and a shortfall when the need for electricity is greatest,” says Regnell.
Better balance in ten years
No one knows with certainty what awaits us, but one thing is sure: if the producers cannot sell their output, they will shut down their operations. Both buyers and sellers are needed for a functioning market.
“It naturally takes two to tango. The market will gradually return to a situation with a better balance between supply and demand. It is difficult to judge how long that will take, but several factors including planned German decommissioning of nuclear and coal suggests that we will have a better balance in 2025. The second big and even more important factor for the price level is the price of coal and gas, and if I knew how they will develop, I would switch industries and become a trader,” says Regnell.
“What is very clear is that we have to get used to the current low price environment and adjust our business to survive in it - if we are wrong and prices go up, we can enjoy it. But it is nothing we can bet on,” Regnell concludes.