Why Are European Gas Prices So High in 2023?

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High gas prices in Ireland and Europe have been dominating headlines for over a year now. We’ve all been feeling the pinch as energy prices have been rising, but what are the main reasons why gas prices are so expensive nowadays? In this guide, we’ll walk you through why gas prices have been increasing and what the EU is doing about it!

What Are Gas Prices Like in Europe?

For the last year, European household gas prices have been at their highest ever level since gas became a major part of the European fuel mix. The rise in gas prices has been across the entire continent with each country experiencing it slightly differently. Currently for the first half of 2022, Denmark has the highest gas price of €0.1207/kWh which is almost a 100% increase compared to pre-pandemic prices![1]

What About Gas Prices in Ireland?

Although also experiencing its highest prices since 2018, household gas prices in Ireland are currently the tenth highest in Europe at €0.0690/kWh. Although this is lower than Spain and Estonia, it still reflects an almost 20% increase since pre-pandemic levels!

Here’s a table showing the increase of household gas prices in Ireland:

Last Updated: 17/10/2022
Source: Eurostat

Why Have European Gas Prices Been Increasing?

2021 saw European gas prices rising extremely rapidly impacting both the wholesale and retail gas markets as well as the electricity markets. The impact of the crisis has pushed inflation within Europe to ever more unbearable heights and has made government intervention in the energy markets more likely. There are lots of reasons for this astronomical rise in the gas price, some related to unprecedented events that have market-wide consequences and others to more structural issues within the gas markets.

Perhaps the most important causes have been the unprecedented events that have caused the gas markets to react unfavourably and pushed the costs up and up. These events have been responsible for much of the economic woes that Europe is currently experiencing but they have had unique impact on the gas markets:

COVID-19 Pandemic

When COVID-19 hit Europe in early 2020, supply chains across all sectors and industries experienced disruption. This disruption was due to national lockdowns, decreased travel between countries, and social distancing rules making it more difficult for suppliers to get goods and services to where they need to go.

The resulting inflation has led to central banks around the world raising interests rates to new highs for the first time in over a decade in an effort to quell the rising prices. In the Eurozone alone, household energy has been the biggest contributor with a rise of 19.7% compared to the overall inflation figure of 9.1% [2]. The reality is that this inflation is likely to be part of our lives for a while until supply chains recover fully.

Cold Winter 2020

In 2020, Europe experienced a particularly cold winter [3] that meant an increased demand for gas to heat home. Naturally this sapped much of the gas reserves leading to a depletion for the following year.

Gas Reserve Shortage

Usually, Europe keeps reserves of gas stored up for such events so that customers can have gas supplied to their homes, and that prices remain relatively stable. However in 2021, these reserves were subsequently not restocked during the summer [4] and consequently left Europe with a shortage for the winter.

Higher Gas Demand from Asia

There was an increase in the demand for gas in Asia that also pushed up the wholesale prices. During the summer of 2021, Europe lost out on US gas to Asian bidders [5]. This has increased reliance on the Nord Stream 2 pipeline.

Russia and the War in Ukraine

The Russian decision to invade Ukraine had immediate repercussions on the commodities markets. During months-long speculation of the war, the natural gas price had already been affected by Gazprom - the Russian state-owned gas company - supplying less than the demand in Europe [6]. Due in part to the issue of Ukraine, there was also politically motivated pressure for German regulators to approve the Nord Stream 2 pipeline which had been a contentious issue between the two countries (as well as with the US and other EU nations).

Two days before the invasion took place, Germany put the brakes firmly on the approval process for Nord Stream 2. The impact of the international sanctions aimed at bringing about Russian financial collapse has been noticeable for commodities and natural gas. As soon as Russia invaded on 24 February, the price of natural gas shot up again, breaking the record set by the December peak and again causing additional strain to suppliers. As of early September 2022, Gazprom shut off its Nord Stream 1 pipeline indefinitely [7].

Why Have European Gas Prices Been So Volatile?

As well as unprecedented events causing European gas prices to rise, there have been some structural reasons that have made the gas prices in Europe particularly sensitive to supply shortages and changes in demand. These structural features of the European gas markets have also impacted the current volatility of both electricity prices and gas prices.

What Is Gas-on-Gas Pricing?

Traditionally, gas prices were based on the global price of oil. This was known as oil price escalation (OPE) where if the price of oil rose, the price of gas would also rise and vice versa. This was used to keep gas prices stable and linked to the price of another energy commodity.

As Western energy markets were liberalised in the 1980s and the 1990s, countries such as the US, the UK, Northern Europe and some of Southern Europe, there has been a shift from oil indexation to gas-on-gas pricing (GOG), where gases compete with one another. This shift has been most recent in Europe with the steady increase of gas-on-gas pricing with 80% of natural prices using GOG in 2020. In Europe, the gas price is determined the Dutch TTF trading platform which shows the real-time price of gas:

GOG marks an increase in financialisation in the gas markets and, since prices are determined by supply and demand rather than linked to another commodity, it is highly efficient in getting the gas delivered to where it is needed. However, this makes gas prices extremely sensitive and so we’ve had an increase in volatility.

In addition, if the price is affected by a supply shock in one part of the market, it will affect the price in another part meaning that all gases are priced similarly. This is why European countries that have little to no Russian gas in their fuel mix, such as Ireland, Spain and Portugal, still experience the same price volatility as more dependent nations such as Germany.

What Is Marginal Pricing?

A common question many energy customers have is, if they don’t have gas or are on a “100% renewable energy tariff”, why are my energy bills increasing? If you are not using gas or you're using energy that doesn’t include gas, then why are you being affected by the rise in gas prices? The reason for this is the link between gas prices and general electricity prices, known as marginal pricing.

What marginal pricing means is that the price of electricity is always priced to the most expensive energy source that is needed to satisfy the demand. For example, if the demand is low and renewables are sufficient, then the price of electricity is also low. However, if the demand is high then more expensive sources are needed to satisfy demand and therefore the price is set at that more expensive price.

Currently demand is very high and we are reliant on gas-fired power stations in order to satisfy demand. As well as this, the price of gas is currently the most expensive and therefore also sets the price for the rest of the electricity market. Here’s a graph to show how marginal pricing works:

How Will The EU Intervene in the Gas Markets?

In the face of the crisis, the European Union has left it mostly to the national governments to deal with the rising energy costs. The impact of various national measures has been both irregular in terms of response but also effective for dealing with each individual country’s needs. However, the threat of having all Russian gas supply shut off has left the continent as a whole vulnerable to the crisis. In light of this, the EU Commission has decided to intervene on an emergency basis in the electricity markets [8].

What Has the EU Done Already?

Though not having actively intervened in the electricity markets, the EU has taken a number of steps to ensure the security of supply for the future as well as providing options for Member states to consider in tackling the crisis.

1. Toolbox for Rising Energy Prices [9]
   Announced in late 2021 when the crisis was starting, the EU outlined a number of measures for each Member State to take in regards to acting against the rising prices. These options included: reducing taxation, helping energy companies manage the high costs, and providing support for vulnerable people who were struggling against inflation.
2. RePowerEU Initiative [10]
   RePowerEU is an initiative to help diversify the EU’s energy pool and ween the country off of Russian gas. It’s to serve as a push towards accelerating the development of renewable energy.
3. Gas Storage Regulation [11]
   This regulation was pushed forwards to set a European standard of gas storage readiness. Due to the weak position of low gas reserves before the crisis in 2021, all member states are required to have topped up at least 80% of their gas capacity.

What Is the EU Planning on Doing Now?

Up until now, the EU’s response has been limited and mostly left to the national governments. However on the 14 September, the EU Commission released a plan to directly intervene into the European energy markets [12] in order to deal with Russia’s complete gas shut off. In its emergency intervention, the EU will help reduce both the volatility for both energy suppliers and for energy consumers.

What’s In the EU’s Emergency Intervention?

The EU’s emergency intervention will include three major actions: demand reduction, revenue cap, and a solidarity contribution.

1. Demand Reduction
   The EU will require each Member State to reduce their gross electricity usage by 5% during the 10% hours displaying the highest level of demand for electricity - the peak hours. Each Member State has the freedom to implement this in whichever way they deem best suited.
2. Inframarginal Source Revenue Cap
   The most significant intervention into the electricity markets will be the introduction of a revenue cap on inframarginal producers. Due to the marginal pricing mechanism, the average electricity wholesale price is set at the most expensive source to produce which is currently gas. In an effort to mitigate the influence of the gas price of the rest of the electricity prices, the EU plans to intervene by setting a revenue cap on those producers who have zero to low operating costs. This cap will be set at €180/MWh in order to allow for producers to still fund their operations but allow the market to fund the high gas prices.
3. Solidarity Contribution
   The EU commission’s plan also calls for an exceptional solidarity contribution where the fossil fuel sector who have benefited from excessive profits from the crisis will be obliged to pay a windfall tax.

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References

[1] https://www.ecb.europa.eu/stats/macroeconomic_and_sectoral/hicp/html/index.en.html (Date Accessed: 17/10/2022)

[2] https://www.euronews.com/2021/09/23/why-europe-s-energy-prices-are-soaring-and-could-get-much-worse (Date Accessed: 17/10/2022)

[3] https://www.europeangashub.com/european-gas-storage-fill-up-the-tank-please.html (Date Accessed: 17/10/2022)

[4] https://www.ft.com/content/deaa7583-e69f-4a5f-9486-cc05c710a51a (Date Accessed: 17/10/2022)

[5] https://www.euronews.com/2021/10/12/what-is-russia-s-role-in-europe-s-natural-gas-crisis (Date Accessed: 17/10/2022)

[6] https://www.offshore-technology.com/news/gazprom-shuts-down-nord-stream-1-pipeline-indefinitely// (Date Accessed: 17/10/2022)

[7] https://www.bruegel.org/blog-post/europes-gas-and-electricity-price-surge-one (Date Accessed: 17/10/2022)

[8] https://energy.ec.europa.eu/topics/markets-and-consumers/eu-energy-prices_en (Date Accessed: 17/10/2022)

[9] https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=COM:2021:660:FIN&qid=1634215984101 (Date Accessed: 17/10/2022)

[10] https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=COM%3A2022%3A230%3AFIN&qid=1653033742483 (Date Accessed: 17/10/2022)

[11] https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=celex%3A32022R1032 (Date Accessed: 17/10/2022)

[12] https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=COM%3A2022%3A473%3AFIN&pk_campaign=preparatory&pk_source=EURLEX&pk_medium=TW&pk_keyword=Energy&pk_content=Proposal (Date Accessed: 17/10/2022)