Why have energy prices increased during the pandemic?

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Energy prices have been among the largest drivers of inflation since the start of the pandemic: in March 2020, the winter 2021 power price reached down to £42/MWh but it recently broke a new high of over £70/MWh.

Regulator OFGEM’s price cap fell by 1% in April 2020 and even further, by 7%, in October 2020, reflecting underlying market conditions during the pandemic.

However, it rose by 9% in April 2021 again, according to the Office for National Statistics (ONS).

It’s not as simple as the price cap however when it comes to energy prices, there is a huge amount of factors at play, from demand to geopolitics.

First of all, reliance on fossil fuels is making things more expensive.

Although the share of renewable generation keeps increasing, gas still made up 38% of the electricity supply generation mix in the fourth quarter last year, with 37% coming from green sources – wind, solar.

Commodity prices have been extremely volatile over the last year and there have been huge drops during lockdowns, when demand from transport and industry fell off a cliff due to restrictions.

While businesses needed less energy because they had to stop or slow down operations, domestic consumption has been higher than ever as people were stuck at home.

On top of this, the UK is coming out of a cold winter that has extended well into the spring months.

In fact, it’s been a very rainy May with average temperatures 2.1°C colder than last year’s, so consumers turned up the heating more than they would normally have done.

This meant that Britain had to import more energy than expected from abroad and may have been up against other countries that were also in need.

Moreover, the cost of liquefied natural gas (LNG) isn’t pre-contracted but fluctuates with demand, and right now countries are also preparing to store gas for the winter.

This is pushing prices even higher because storage levels are lower than normal due to the recent spike in demand.

As a result, where forward annual energy prices were averaging at 4.5p six months ago, the cost today has risen to 7p – an increase of 45%.

And if there’s a perceived risk of that there not being enough storage capacity, we may not see prices calming down for another while.

“No summer to autumn period is ever easy-going, with it often being the time that power stations choose to shut down for maintenance and hurricane season comes about, but this year has the added factor of European storage levels being well below normal,” said Corin Dalby, energy industry veteran and founder of philanthropic energy buying consultancy Box Power.

“That’s why business figures need to put their procurement hats on now. By waiting until one month before their current energy contract is due to end, businesses will have no choice but to compare the marginal percentage difference between two or three providers’ rates there and then.”

“Little to their knowledge, one of these providers could have been offering brilliant rates a mere few months earlier – so they’ve missed out on huge savings by simply not checking.

“It’s also possible that the effect of lots of businesses hunting around for deals at the same time results in demand-pull inflation – escalating prices even more,” he added.

The landscape may stabilise once the Nord Stream 2 gas pipeline, which will send gas from Russia to Europe via the Baltic Sea, is completed. The project has only 5% left to be built.

With NS2 active, it will increase the flow of gas into Europe and, depending on demand, push down prices.

The spot price level will determine the appetite, but with bigger volumes flooding the market, the prices will be kept low, according to energy procurement consultancy E&C.

However, according to the Energy Economics Institute, once NS2 is available less LNG needs to be imported into the EU, leading to lower import prices for LNG, which in turn decreases gas prices in Europe.

In all this, the UK is pushing with green initiatives that are setting ambitious carbon reduction targets going forward, which includes putting a price on emissions.

Last month, London published the details of the allocation, auction mechanism and price controls for UK carbon emissions allowances – the UK carbon ETS – as it had to set its own rules after leaving the EU.

It is a method of making power plants and other big polluters pay for each tonne of carbon that they emit.

The price hit £50 per tonne when the scheme was launched on 19 May, making it more expensive to release CO2 in the air for UK companies compared to EU peers. This inevitably reflects in the consumers’ bill, experts say.

Even if the UK derives a big chunk of its energy from renewables, fossil fuels are still needed to ensure continuous supply.

Weather forecasts are getting increasingly better at gauging the weather, but it’s hard to predict it months in advance.

So power generation companies can’t calculate what the output from their solar or wind farms is going to be the following winter, when it’s most needed.

Technologies for battery storage keep getting better but we are still far from being able to rely exclusively on green energy, which is why its own prices aren’t as cheap as they would be taken out of context.

“When the wind blows and the sun shines it is, to a certain extent, cheaper, but the price is set by the last unit of power required… You’re going to get all the carbon effect priced into that, so the renewable generator benefits from essentially a cleared higher price than if you were just bidding in a what’s essentially their marginal cost, which, if the winds blown on sunshine, it’s zero,” Nick Campbell, director of risk and commercial at Inspired Energy PLC (LON:INSE), told Proactive.

“Renewable generation is, is incredibly cheap… but there are other aspects that essentially create a higher price,” he continued.

As a result, it’s difficult to predict how power prices might behave, especially considering how competitive the market is.

“The difference between what someone’s willing to pay, what’s on the bid and what someone’s willing to sell out the offer is wide, so that’s sort of the natural increase price that a consumer of energy would have to pay.

“That’s all factored into what a retail supplier would offer,” Campbell concluded.

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