Economic forecasts for this year have been based on a fall-off in energy prices. The threat of a Russian invasion of Ukraine – and wider pressures in energy markets – now put this very much in question. Gas markets, the vital factor for Ireland, now show prices holding currently elevated levels right through this year and into 2023. If this is the way things pan out , the energy squeeze will continue on households and businesses, with big political and economic consequences.
There are bigger things at stake in the Ukraine crisis than energy prices. But in terms of the economic impact, energy supplies to Europe – and prices – will be the key conduit. And warnings signs in energy futures markets – where traders buy and sell contracts for future delivery – are already flashing.
These prices can change quickly, but right now expectations are that wholesale natural gas prices will remain not far off €90 per megawatt hour right through next year. On Friday, prices were around €93, a roughly fivefold increase on one year ago, when they were trading around €18-€19 per megawatt hour. This is a big change from just a few months earlier, when prices had been expected to drop to about €40 over this summer.
There are a lot of other issues at play as well as geopolitical factors – demand in energy markets has surged as economies reopened recovered but supply problems have remained. If current prices – or anything close to them – are now the new normal, that provides a real upward shift to price levels across the economy.
It could get worse in the short term, depending on whether Russian president Vladimir Putin pushes ahead to invade. And while events are entirely unpredictable, Europe – and Ireland's – exposure is obvious, even if much less gas is delivered through Ukraine itself than was the case up to recent years. Vladimir Putin has already weaponised Russian gas supplies to Europe, cutting them by about one quarter from last year's levels in recent months, leading to a rundown in storage supplies.
This partly relates to a row about the new Nord Stream 2 gas pipeline from Russia to Germany, built by Russian company Gazprom along the floor of the Baltic Sea and into Germany. Critics argue that this gives Russia too much control over the European gas market, but a deal between former German chancellor Angela Merkel and US president Joe Biden had seemed to clear the way for the pipeline, now completed, to come into operation. Now the US is warning that an invasion of the Ukraine would mean this would not happen, and the new German government is also struggling with the consequences, intensified by Merkel's decision to move away from nuclear power.
For Ireland, imported gas supplies are crucial. Around half or our gas comes from the Corrib field, but its contribution will decline. The rest comes via gas pipelines from the UK. While Ireland does not source gas directly from Russia, supplies from there account for more than 35 per cent of EU gas. And so any interruption will quickly be reflected in already-high gas prices, or possibly in supply disruptions. More than half of Ireland’s electricity is supplied by gas-fired plants, while Russian coal fuels the Moneypoint power station, now not due to cease operation until 2025. We have a lot at stake here.
In the game of chess, both sides may hold gas and energy as a hostage. The EU could, as part of sanctions, decide to hit Russian energy imports and deny the revenues to Russia. “Member countries are ready to tolerate a possible negative effect on income because peace is in danger in Europe,” EU trade commissioner Valdis Dombrovskis said in an interview this week.
But Putin is well aware of the potential impact on Europe if he cuts off, or reduces, gas or other energy supplies, though he will lose cash – Russia exported more than €200 billion in fuel last year, benefiting from soaring prices, of which some €50 billion was from gas.
Energy supplies have long featured in political disputes. In the 1970s one of the most high-profile figures worldwide was the suave Saudi Arabian oil minister, Sheik Yamani, a central figure in the cut in oil supplies to the West in 1973 and in the second oil crisis in 1979. following the fall of the Shah of Iran.
“We are masters of our own commodity,” Yamani once declared. With gas now vital in the energy transition to greener fuels, Putin knows he has a strong hand, though not without costs and longer-term risks to Russia, just as the Middle East-led Organisation of the Petroleum Exporting Countries faced in the past.
It all points to prices remaining high here, maintaining the pressure on consumers and businesses; interruptions to supply remain a risk, with Ireland’s energy supplies delicately balanced. A Government review of energy security is due early this year with big exposures to consider.
And all this is in the context of the transition to greener energy.
“Greenflation” – higher energy prices as the world transitions to cleaner fuels – is a real issue. ECB executive board member Isabel Schnabel explained it in recent comments in an online panel reported by Bloomberg: “While in the past energy prices often fell as quickly as they rose, the need to step up the fight against climate change may imply that fossil fuel prices will now not only have to stay elevated, but even have to keep rising if we are to meet the goals of the Paris climate agreement.”With investment in fossil fuel production falling and time required before more green energy comes on stream, the squeeze could continue, with implications for inflation and interest rates.
So both political and economic factors are pointing to energy prices staying high, with or without a Russian move on Ukraine. In turn this will put pressure on the Government to respond, with the immediate political risk being that the €100 reduction in energy bills for households will appear little more than a drop in the oil tank.