Wholesale energy markets: the effects of the energy crisis in Europe

This EEF Online Briefing was organised as a follow-up of the one held in February 2022, to better understand the changes in EU wholesale markets and their responses to the energy crisis.

Ryszard Pawlik, Advisor to MEP Jerzy Buzek (EPP, Poland) opened the discussion by acknowledging EU’s success in surviving one of its most difficult winters, also thanks to the gas regulation and the increased energy savings efforts. However, he also reminded that the hardest time may still be ahead of us, requiring further proactivity both on the part of Member States and of the European Parliament.

Mark Copley, CEO, EFET presented European-wide markets, coordinated responses, trading and hedging as an answer to the energy crisis. In particular, he stressed how their combination can considerably help in achieving security of supply, decarbonization and consumer protection.

Arben Kllokoqi, Director for Electricity Market Design, EFET first outlined the main characteristics of wholesale energy markets. He discussed the different categories of risk (political, legal and regulatory risk, market-systemic risks, operational risk and weather exposure) and the related existing mitigation measures in energy trading. He then analysed the two dimensions of markets: timeframes (forward and spot markets) and venues for trading activities (exchanges, over-the-counter and bilateral trading). Finally, he considered the market participants, suppliers and consumers, explaining that traders play a key role optimizing and balancing between their risks.

Mr Kllokoqi then focused on decarbonization and the importance of existing market-based instruments to achieve this objective, like the EU ETS or guarantees of origin. They play a crucial role because a surge in the CO2 can lead to an increase in the marginal cost of fossil-fueled power plants, too. Indeed, it is thanks to this mechanism that the switch to renewables is triggered, and such tools can be complementary to the proposed flexibility solutions of the electricity market design revision. Finally, our panellist highlighted how consumers’ empowerment can only be effectively achieved with adequate information, infrastructure, incentives and support schemes.

Mark Simons, Board Member, EFET explained the evolution of gas prices (2021-2022), highlighting that in the TTF market they had increased before Ukraine’s invasion, for two reasons: on the one hand, the very low temperatures of winter 2021 which led to a major increase in gas demand to fill storage during the summer; on the other hand, several cuts in Russian gas supplies already at that time. After the invasion, price spiked, and the situation worsened with the US Freeport LNG explosion and cuts in the Nord Stream production. Since summer 2022, the situation stabilized thanks to the increase in LNG imports to the EU (mainly from US and Qatar), demand reductions and a mild winter.

Our speaker emphasized that Europe’s gas market was never designed to cope with the sudden loss of its largest supplier, but that it has proved to be very resilient. In this respect, the outlook of the market for 2023/2024 shows that the EU gas storage is almost already half of what is needed for this year, thanks to an improvement in its filling capabilities. Besides, Europe’s gas consumption will likely be characterized by an increase of about 20% of LNG import capacity in 2023. For this reason, it is key to build sufficient regasification terminals in Germany, Italy and Greece.

Mr Simons also pointed out that there are still some uncertainties to be faced: an increase in the LNG imports in China (after the end of COVID-19 lockdowns); the possible complete cut of all Russian gas supplies flowing through Ukraine; problems in the French nuclear power fleet, which could lead to an increase in its gas demand; infrastructure failures and winter weather. Finally, he focused on the Market Correction Mechanism, a temporary measure introduced in the EU at the end of 2022. It can act as a price cap for gas in cases in which its price reaches €180/MWh. Considering the current gas prices, it will not be easily triggered, and it would only apply to derivative contracts – leaving bilateral and physical contracts out of its scope.

Jan Haizmann, Chair of Legal Committee, EFET focused on the “force majeure” element of recent events, which makes them hard to be avoided or overcome and, when it comes to contracts, it leads to the impossibility of delivering or accepting the obligation on the part of the claiming party. In the specific case of the Russian gas disruption, Dr Haizmann explained that it caused a major insolvency risk for several European buyers (utilities and suppliers), which led to a nationalization of certain companies. However, agreeing on standard solutions to respond to trade restrictions has not been easy because not all contracts are the same.

Subsequently, our panellist analysed the sanctions regimes in the US and EU, that first started in 2014 with the Russian occupation of Crimea. As of 2023, gas and power trading remain outside of their scope. On the financial side, major Russian banks have been eclipsed from financing trade, which has complexed the payment methods for commodity transactions. Since the invasion of Ukraine started, the EU has adopted 10 sanction packages with the objective of reducing Russian income from exporting commodities to Europe. Inevitably, Russia has responded with unilateral sanctions too: buyers of Russian natural gas based in “unfriendly states” would have to pay in Russian roubles, and gas deliveries to Poland and Bulgaria would be suspended for a certain period. Dr Haizmann concluded his presentation by highlighting that, despite the recent developments, gas trade between Russia and western countries continues, as it remains out of the scope of the sanction regimes.

The Q&A sessions between the audience and our speakers addressed relevant aspects of energy trading in wholesale markets. They especially focused on adequacy issues in the electricity market, possible future uncertainties in the gas market due to a global economic rebound, the existing barriers to long-term contracting, and liquidity problems for European utilities during price spikes.