ENERGY PRICES SLOWING RECOVERY

September 10, 2021 § 1 Comment

Low-cost energy lifts all boats of economic prosperity. Or on the other end of the spectrum, high-cost energy threatens to sink them, especially if prices rise suddenly. Nowhere is the positive scenario more evident than in Iceland. An otherwise resource poor country, cheap energy has elevated it to the third highest gross domestic product in the world. Unlike Norway, a country at a similar latitude, almost all produce is domestically derived. Greenhouses enabled by natural hot water operate for much of the year.

Iceland has the good fortune to be sitting on the Mid Atlantic ridge between the North Atlantic and Eurasian plates. Surrounded by volcanoes, the earth stresses are such that most eruptions are through fissures, unlike those in Hawaii and other places with typical conical protrusions with violent eruptions. Furthermore, with abundant subsurface water and high thermal gradients (subsurface temperatures that rise faster than normal with depth), hot water rises in the faults and emerges on the surface as geysers, or mere hot water lakes.  This hot water supplies heat for 90% of the homes.  It also is used to produce electricity, although in that case the water is from wells drilled a couple of kilometers. I estimate their cost to produce to be well under 2 US cents per kWh. They charge industry 5 cents and domestic users pay 13 cents. Clearly, tariffs are involved. But this compares to Netherlands and Germany at nearly 30 cents for domestic users.

A recent New York Times story reports a different scenario for the rest of Europe (yes, Iceland is in Europe) in that rising natural gas prices in Europe are slowing the post-pandemic economic recovery.  Natural gas prices are reported to have risen to USD 18 per MMBTU.  The pre-Covid 19 figures used to roughly fall out as follows: the US at USD 3, Europe at USD 9 and Japan at USD 17. The US is still low at USD 5, but that is the highest in nearly a decade. Abundant shale gas has kept the price down, but that industry has been battered by the pandemic, so is probably slow to respond to the surge. Remember also that shale gas driven low energy cost was the single biggest factor for US recovery from the recession of 2009.

What we can expect

On natural gas price, in one word: volatility*.  The USD 18 per MMBTU reported today as the spot price for Europe is probably aberrant.  The price was a third of that a few months ago. Also, most utilities operate on long term contract pricing. The high spot price is almost certainly driven by liquefied natural gas (LNG) import prices.  Drought conditions in countries such as China have reduced hydroelectric output and required augmentation with LNG powered electricity. Parenthetically, yet more evidence of impact of climate change. Usually, the spot price is determined by the price of the last cubic foot of gas imported.  For Europe, that is LNG. The winners here are the Russians with pipeline supplied gas, if the contracts allow escalators.

Again, most LNG contracts are long term and pegged to the price of oil.  In the US, most (all?) are based on the Henry Hub spot natural gas price.  It is multiplied by 1.2 and liquefaction cost of USD 2.50 is added to it. Today at USD 5 prices, LNG would be at USD 8.50, a far cry from the spot price in Europe of USD 18.  And so it goes in the commodity trading market.

I would expect US shale gas drilling to pick up in response to the price.  The smaller players, who are fewer yet after bankruptcies last year, will respond. Now that so many properties are in the hands of the major oil companies, expect their response to be more measured.  In any case, I expect US prices to stabilize and there is no serious risk of prices rising to the point where coal has a resurgence. Unlike in the case of oil, all gas pricing is regional. LNG is the only means of transport between regions and it adds a cost of somewhere between USD 3 and 4 to the produced gas price.

The experts are predicting a colder than normal winter.  If that transpires in Europe, the proverbial Katie will have to bar the door on natural gas prices.

Vikram Rao

September 9, 2021

*Everybody look what’s goin’ down from “For What It’s Worth” by Buffalo Springfield (1967), written by Steven Stills.

§ One Response to ENERGY PRICES SLOWING RECOVERY

  • Abe Palaz says:

    Hi Vik
    I agree with your assessment. I think the US policy makers as well as the entire educated world somehow got in to competition to beat the fossil fuels without being discrete. No viable renewable is available at the scale and space in the world today and any potential infrastructure is far from being ready. In absence of such replacement of fossil fuels, killing them all without being discrete is unintelligent and the world will be paying a price for that. We shall all see!
    Abe Palaz
    BELKA Energy Resources LLC

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