Understanding the European energy crisis
A detailed analysis of the current situation
![Energy crisis](http://a.c-dn.net/c/content/dam/publicsites/igcom/uk/images/news-article-image-folder/bg_gas_pipes324383736.jpg/jcr:content/renditions/original-size.webp)
Winter is coming?
The North Stream pipeline cut-off is a heated topic that is evolving daily, we will simply analyze some figures:
- Since early 2020 1-year forward gas and power prices have increased by more than 13x.
- Goldman Sachs estimates that the average increase will be 500€ per household, which is €2 trillion or 15% of Europe GDP.
- Around 42% of UK household may not be able to afford heating this winter and 180,000 have joined the “Don't Pay" movement, which is calling for energy bills not to be paid on 1 October in protest.
Germany power and TTF 1-year forward price evolution (rebased to 100)
![electricity](http://a.c-dn.net/c/content/dam/publicsites/igcom/ch/images/website/Articles/1_20220913.jpg/jcr:content/renditions/original-size.webp)
What about electricity?
First, we need to understand how the price of electricity is set, through a simple law of supply and demand:
- To produce a given amount of electricity, the cheapest means of production is used first, then the second cheapest is added, until the desired capacity is reached.
- Renewable and nuclear plants are the cheapest to operate, while fossil-based plants are the most expensive.
- The price of electricity is determined by the marginal price, i.e. the cost of the most expensive plant in the energy mix.
- Although gas-fired power plants currently produce about 25% of the electricity in Europe, they determine the price in about 75% of the cases.
However, unlike other commodities, electricity cannot be stored, so the price can vary greatly depending on supply and demand at any given time.
- A higher gas price means that the most expensive gas-fired power plants in the energy mix need more expensive gas to operate, which increases the price of electricity.
![electricity](http://a.c-dn.net/c/content/dam/publicsites/igcom/ch/images/website/Articles/2_20220913.png/jcr:content/renditions/original-size.webp)
N.B: Some countries such as France use a different model with more state intervention, but we will not develop this here.
Which solutions could be found?
1-Capping the revenue of non-fossil electricity producers
We have seen how a single electricity price is set by the most expensive electricity producer.
- This means that nuclear and renewables benefit from increased margins when gas (and electricity) prices rise.
- The European Commission could propose measures to recover excess revenues from non-fossil fuel power plants, using this money to support consumers’ energy bills.
2-Capping oil price
The G7 announced a measure to be effective on 5 December to reduce oil prices:
- Most insurance, financing and shipping services come from Western countries.
- To benefit from these services, oil buyers would be forced to purchase Russian barrels at or below the $40-60 price cap.
- This should put pressure on Russian oil, reducing demand and leading to lower prices, even for non-participating countries.
3-Paying the bill
One of the first actions that the UK's new Prime Minister, Liz Truss, has taken is to cap household energy costs at £2,500 a year.
- This measure is expected to cost up to £187 billion, which is the largest government intervention since Covid.
Other European governments, such as France, have already capped energy prices.
- However, ECB's Christine Lagarde has warned that the cost of these measures will be carried by governments and not by the ECB, unlike Covid.
Several analysts believe that the impact on the energy mix and the European economy will be as significant as the oil crisis of the 70s.
![energy prices](http://a.c-dn.net/c/content/dam/publicsites/igcom/ch/images/website/Articles/3_20220913.jpg/jcr:content/renditions/original-size.webp)
Which impact on the markets?
For this analysis, given the large proportion of energy and financial stocks in the index, which benefit from current conditions, we will exclude the Footsie 100:
- If we compare the Eurostoxx50 to the S&P500, the market does not seem to price any significant difference since the beginning of the year. (see below)
- Volatility is also in line between Europe and the US: the VIX and the VSTOXX are both around 24%.
- The main market driver seems to be central bank policies, which would explain the similarity in the performance of the two continents' indices.
Eurostoxx50 and S&P500 seems to share the same path since January
![indices](http://a.c-dn.net/c/content/dam/publicsites/igcom/ch/images/website/Articles/4_20220914.jpg/jcr:content/renditions/original-size.webp)
Conclusion
Despite the considerable short and long term impact on the European economy, the current energy crisis does not seem to be really priced in.
Short-term data such as inflation figures or central bank decisions seem to be the main drivers of the market.
It is interesting to note that this crisis does not seem to have an impact on the ECB's policy, which is expected to continue its rate hikes.
The information on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG Bank S.A. accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients. See full non-independent research disclaimer.
Live prices on most popular markets
- Forex
- Shares
- Indices
Prices above are subject to our website terms and agreements. Prices are indicative only. All shares prices are delayed by at least 15 mins.