Energy Wonderland

January 24, 2013 | 00:00

Energy Wonderland

In which King Coal makes a comeback, President Putin loses his patience with Gazprom, Prime Minister Cameron contradicts himself and Executive Director Maria van der Hoeven says it's time for some real action on the gas market.

You know the problem: coal-fired electricity production is on the rise in Europe, at the expense of gas-fired power, with negative repercussions for carbon emissions. You also know why: coal in the US is being displaced by cheap shale gas and exported to Europe, and low carbon prices in the EU Emission Trading Scheme (ETS) make gas relatively unattractive compared to coal.
Result: Europe, self-proclaimed global climate leader, is looking silly.
So what is to be done? One obvious way to go is to "fix" the ETS, i.e. to drive up carbon prices somehow, for instance by removing emission credits from the system. This "reform" of the ETS is a subject that is high on the agenda in Brussels.
Enter Maria van der Hoeven, the Executive Director of the International EnergyAgency (IEA), who has an urgent message for European policymakers. In an op-ed she wrote for EER, which you can find below, she issues a plea not to reform the ETS merely to raise the price of coal relative to gas. This, she says, would be extremely costly to consumers and businesses. And in the current economic climate, skyrocketing energy prices are the last thing that Europe needs.
A much better approach, says the IEA Chief, is to "fix" the European gas market. To get rid of oil-indexed contracts and oligopolistic structures (she does not write this literally, but that's how we may interpret her words) and to move toward an "efficient, integrated and functioning" gas market that would make the blue fuel more competitive against the black one.
Van der Hoeven also points out that the gas-to-coal switching problem is probably temporary. If and when economic growth picks up, carbon prices will also go up, and the situation will correct itself. Better not meddle too much now.
She may have a point. Energy reporter and analyst Alex Forbes also pointed out in an important recent article for EER, that there are many reasons why we can expect gas to become more competitive again. One of those reasons is precisely the fact that the "fix" recommended by Maria van der Hoeven is already happening. Spot gas trading and hub-based gas pricing are on the rise, oil-indexation and long-term contracts are on the wane. This process should, if theory proves correct, make gas more competitive in future.
It does mean, though, that the drive towards an integrated "internal energy market" should be kept up in the EU. Member states should not fall back on nationalist reflexes whenever things tend to go "wrong" in energy markets.
Why, wasn't this exactly the message of David Cameron's EU speech on Wednesday? The UK Prime Minister stressed the importance of the internal market in energy. "At the core of the European Union must be, as it is now, the single market", he said. "But when the single market remains incomplete in services, energy and digital - the very sectors that are the engines of a modern economy - it is only half the success it could be."
Amen. However, Cameron also said that "Power must be able to flow back to Member States, not just away from them. (...) Countries are different. They make different choices. We cannot harmonise everything." There seems a little contradiction here. Isn't "harmonising everything" exactly what the internal market is about?
Ask the Russians. They have the same problem with the one-size-fits-all approach of the EU energy market as the British, but for the opposite reason: they don't want a gas market in which there is no room for oil-indexed long-term contracts!
This, at any rate, is the official position of the Russian government. However, as Andrej Tibold, editor-in-chief of Eurasian Energy Observer, writes in a new article for EER, there are signs that behind the scenes Moscow is starting to accept the new realities of the energy market. There seems to be a growing realization in the highest levels of the Russian government, says Andrej, that Russia's gas giant Gazprom needs to adapt to the new global gas commodity market that is starting to emerge.
Indeed, according to two foremost experts on the Russian gas industry that Andrej talked to, in a few years' time, Gazprom - if it does not clean up its act - might even be split up in a production and supply unit and an infrastructure unit.
Unbundling Gazprom?
You may feel that sounds like a tale from Alice in Wonderland. But aren't those the best tales to read?



If Europe wants to address the "coal renaissance", it should reform its gas market

Coal is making a remarkable comeback in Europe. Indeed, Europe, which collectively pays so much to stay at the forefront of the clean energy revolution, is consuming ever more of the dirtiest mainstream fuel. But the way to address this problem is not merely to reform the EU Emission Trading Scheme (ETS) to push up the price of coal high enough to make gas competitive. This would be hugely expensive to energy users and hurt the European economy. Instead, policymakers should finally get serious about reforming the gas market to make gas a more competitive fuel. 

European coal consumption is on the rise, as is clear from the IEA's most recent Medium-Term Coal Market Report, published in December.
Understandably many observers regret this development, but rather than simply bristle at the environmental impacts of coal displacing cleaner gas, Europeans should look at the underlying factors driving this trend and address their implications.

One reason for rising coal is that the shale-gas revolution in America is driving cheap coal abroad, where it can significantly undercut European gas, whose prices are often linked to expensive oil. That link itself is fundamentally dubious, since oil and gas are different kettles of fish when it comes to their applications. Another reason is that prices for traded carbon credits in the EU's Emission Trading Scheme (ETS) have fallen to new lows over the past year, thanks to the global recession and a dip in both industrial output and power demand. Other factors, like a drought-driven reduction of Spanish hydro-power that ups coal demand there, or a slowing Chinese economy that puts downward pressure on global coal prices, also help.
European policymakers are now in the process of reforming the ETS - a task that we support, and which is vital to maintaining its relevance in terms of driving long-term investment into cleaner energy systems. Lowering the cap on the ETS or withdrawing some credits from the scheme could address the problem of over-supply and push the carbon price higher.
However it would be a mistake to use ETS reform as a primary means to make gas more competitive with coal. That would require drastic measures that go much further than current reform proposals. Pushing the carbon price high enough to encourage significant coal-to-gas switching would cost European consumers billions of euros in the midst of an economic crisis, only to subsidize a fuel which is currently inflated thanks to contractual particularities - and which has been subject to acute supply crises in eastern Europe over the past decade. It would also be a political non-starter.

Gas is a relatively clean-burning fossil fuel, and there is good reason why we at the International Energy Agency have hailed the potential for a Golden Age of Gas globally. The American experience is a case in point, where a booming gas industry creates jobs and can serve as a bridge to a veritable clean energy economy. And it’s true that the gas-fired power sector is suffering as a result of cheap coal. But tilting the market to favour gas washes over the underlying market drivers - and is an expensive proposition to address carbon concerns.
The reason the carbon cap has been ineffectual in raising carbon prices is because Europe is now emitting less carbon than projected when the scheme was set. Granted, that is mostly thanks to a slowdown in economic activity. But coal has breathing room in terms of carbon precisely because European emissions are down. And the recession is not the only reason - renewables in Europe have been growing at an exceptional clip this year as prices fell dramatically, particularly for solar photovoltaics and wind power. So even with rising coal consumption, emissions remain below the levels projected a few years ago.
All this being said, moving away from high-emitting fuel sources must remain a key priority for our societies. What does that mean for the current European situation? The answer must be more efficient, integrated, and functioning markets, both for energy and for carbon credits. For gas, that means reducing drastic price differentials by integrating the market on a European level, promoting more competitive and transparent gas trading, and moving toward a more integrated gas market globally. Looking a few years forward, North American natural gas exports will start to ramp up in the medium term, and some renewables are starting to reach maturity.
Finally, the greatest boost to the carbon price and to clean energy investment will be the recovery of the European economy and the restoration of confidence. Chalk up one more reason for Europe's leaders to settle the euro-crisis now.
Maria van der Hoeven has been Executive Director of the International Energy Agency (IEA) since September 2011. Before that she was Minister of Economic Affairs in the Netherlands. EER interviewed her in March of last year, see here. See also her op-ed "Subsidy cuts show that renewable energy is coming of age", published by EER on 22 March 2012.

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