by Charles Russell
“Gas markets are on red alert…prices are up 250% since January. On an energy equivalent basis, gas prices are now the most expensive fossil fuel, on par with gasoline prices when oil was over $100 a barrel…we have to ensure that the climate crisis does not turn into an energy crisis. The thing I am the most concerned about as prices and volatility trend higher over the coming years that it does not undermine public support for climate progress. Once we lose public support, that is a very hard thing to gain back”Joseph McMonigle, Secretary-General of International Energy Forum. September 21st, 2021.
A somewhat alarming statement from the Secretary-General of the IEF, but not entirely misplaced in our opinion. Cheap gas has been a boon for affordable electricity, cheap industrial goods, and the reduction of atmospheric emissions.[i]
Gas prices in Europe have hovered between $4-$8/MMBtu over the last few years. For gas-powered generation assets that feed the power markets, this translates into an electricity cost between $25-$56/MWh. A reasonably affordable range and not atypical of actual power prices in wholesale markets over the same period.
As gas prices exploded higher to $15/MMBtu in August and upwards of $20/MMBtu in early September, the marginal cost of production for gas generators (and thus price they can offer their power at) stood well above $100/MWh.
Typically, there is enough diversity and redundancy in the power supply stake to absorb fuel price shocks – when prices go up, another generation unit becomes more economical. Thus, the realized power price does not follow in lockstep when a single fuel source’s price increase (or decreases). Renewables, which we are long-time investors in and believe have a time and place, have been proposed as a universal solution to our electricity needs; the drawback of the universalist assertion is decreased diversity in the power stack, enfeebling the entire system.
The UK has unfortunately found itself on the wrong side of this dynamic lately. With abnormally low levels of wind at the beginning of September, the total power supply dropped. As coal and nuclear are being phased out, gas remains the only one-demand energy supply. Gas generation ramped up (as gas prices were hitting all-time highs), which meant that the power price was (and is) becoming the fuel increasingly on the margin. It sets the price if it’s required to meet demand and there are no cheaper alternatives.
A further wrinkle is that less efficient gas units are likely to be dispatched under a power-constrained scenario. “Peaking” gas units are typically less efficient due to their stop/start characteristics, the age of the asset, or some combination of both.
The blue line in the chart below graphs the marginal cost of production for a gas unit under different gas prices, holding the unit’s thermal efficiency constant. As we hit August 2021 and gas prices climbing from $15 to $20/MMBtu, we have modeled out what an equivalent cost of production (and thus power price assuming it’s the fuel source on the margin) would be for efficiency figures typical of older gas units meant to serve peak demand.
The implications here are important. The surge in gas prices halted CF Industries fertilizer operations in the country, prompting food scarcity concerns and calls for a three-day workweek– a maneuver not seen since a previous energy supply concerns in the 1970s. British Steel has pressed pause on operations periodically as prices are “spiraling out of control,” and absorbing the cost is too punitive. Just yesterday, Europe’s largest zinc smelter announced it was curtailing production due to electricity costs.
The parabolic move in power prices seen in the UK and Germany today will likely moderate back to more reasonable levels shortly. However, we are concerned that these events will become more frequent with a greater persistence of consequences as society attempts to rapidly remove traditional energy sources while paying a little homage to availability, reliability, and cost. In short, as society makes more economically unsustainable decisions in pursuit of environmental sustainability, the environmental sustainability we desire becomes increasingly unsustainable.
Historically, decreasing energy availability and increasing energy cost are a bad recipe for economic productivity. Tension is already evident. Poland is keeping a coal mine active, despite a €500,000 per day fine from the European Union for failing to force a shut down on an accelerated timeline. The mine fuels a power station that supplies 7% of the country’s electricity. The Polish government is not willing to threaten energy security or its economy (and likely social cohesion), even at a steep penalty, until they have a carbon-neutral solution in place.
The root cause of the issue described above is the decontextualization of climate change and environmental concerns from the economic and social reality in which those challenges have meaning for people. Environmentalism’s significant failure is its reductionist drive, leading to simplistic solutions for complex problems within an adaptive and ever-changing societal system. By failing to think about the electricity system as a part of a larger interconnected system, that must be considered not only in its parts but also in the whole, the drive to decarbonize creates unintended consequences. As pressing an issue as climate change may be, no issue is so pressing that an unstable solution, what one might call an unsustainable solution, makes sense.