Consequences of inflation in people’s and companies’ wallets :: Dienas Bizness

Companies and people will see the result of the increase in gas prices not only in the bills for electricity and gas, but also in the prices of heat energy and, ultimately, of all goods and services.

In an interview Daily Business says Andrejs Belijs, Associate Professor at the University of Eastern Finland and Managing Director of the consulting company Balesene OU. He also emphasizes that energy, including heat, will be significantly affected by the EU’s Green Course, which aims to achieve climate neutrality, so that all sectors of the economy will have to reduce CO2 emissions. This will be discussed in SIA Publishing house Dienas bizness together with SIA Gren Latvia, AS Gaso an ace Latvijas Gāze annual industry conference Heat supply 2021: for purposeful achievement of climate goals in Latvian cities.

Natural gas is an important resource for heat supply, and its price also affects heating tariffs in many cities in the northern hemisphere. What happens to natural gas prices?

Natural gas prices are setting new records and there is simply no relatively free natural gas on the market. There are several reasons for this situation. Last year’s crisis in North America’s liquefied natural gas supply is still being felt as the industry needs time to recover. At the same time, the prices of this product in US warehouses are rising, and this factor deters companies from exporting gas. The second reason is the rapid growth in demand in Asia, which has led to record gas prices in the region. One of the reasons for the panic in the market was the fact that the share of short-term gas trading increased significantly. Traditional long-term contracts are usually linked to the price of oil, but this requires the buyer to regularly purchase certain amounts of gas. It is possible to buy gas on the trading platforms, the price of which is not related to oil, and everything depends on supply and demand. Due to the long-standing overproduction of gas on world markets, in current transactions gas was usually offered as free gas at a reduced price. Thus, for example, 2017-2018. In 2007, the current price of gas could be 50-60% lower than the indexed price of oil. For this reason, many European and Asian buyers have chosen to focus specifically on short-term deals. In particular, when a buyer buys gas for electricity generation, he has to take into account fluctuations in electricity demand. It must be borne in mind that the demand for electricity can change even within a day, which requires flexibility in the gas market. Industrial companies, on the other hand, prefer stable long-term supplies. In recent years, much of the current business has been done to meet needs not covered by long-term contracts that are indexed to changes in oil prices. At the same time, intercontinental spot transactions did not exceed 3-5% of the world market. This means that the global gas market is still underdeveloped, but companies depend on local or regional supply and demand dynamics. It is not easy to buy a LNG tanker on another continent without a long-term commitment. Everyone seemed to be accustomed to the new reality, where many do not need long-term contracts, as surplus gas makes it possible to buy gas cheaper. But in 2021, the situation has changed. In short-term transactions, the demand for gas exceeds the supply, and consequently its price increases. The number of intercontinental short-term transactions has decreased to a minimum. Whereas in the past European companies bought liquefied natural gas that was not sold in Asia, this is no longer the case. As a result, in both Asia and Europe, current prices are 100-120% higher than long-term indexed contracts. Electricity companies have begun to look for cheaper alternatives – coal. In Asia, demand for coal has indeed recovered, and coal prices have also risen.

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But under the EU’s Green Course, coal is a climate-friendly and therefore harmful energy resource that generates a lot of CO2 emissions!

It is undeniable that the situation with coal in Europe is more complicated precisely because of CO2 emissions trading. Burning coal produces more CO2 than burning gas, so energy companies have to buy CO2 emission rights using solid fossil fuels. It has always been possible to do this without much difficulty. Today, however, the situation is different. Given the EU’s ambitious climate goals, many industries have decided to hedge against further increases in carbon prices and periodically buy allowances. The price of CO2 has tripled since last year. Rising gas prices will now further stimulate the price of CO2 emissions, as the use of coal will require the purchase of emission rights. The result is a snowball effect: the price of a tonne of CO2 emissions is rising, the price of gas is rising and the price of CO2 is being further stimulated, as electricity prices are breaking records, and the same can be expected for heat prices. And this is not winter, it is not cold, it would require even more gas and electricity.

This is a significant risk of price increases!

The risk of inflation is not theoretical, but is already felt in the gas and electricity sectors, and later also in the heat sector. Even before rising gas prices, French economist Patrick Arcus warned that rising CO2 prices could make European goods and technologies more expensive, boosting cheaper imports and reducing the EU’s competitiveness. Unemployment is currently set to rise further as rising CO2 and energy prices push up production costs. The outlook is unsatisfactory, especially in view of the European Commission’s recent proposal to start reducing free CO2 emission allowances for industry.

There is already talk in European circles about the need to ask Gazprom to increase supplies. As Russia’s largest gas exporter, Gazprom can really influence the market. So far, however, the company has reduced its export capacity, apparently before the launch of Nord Stream 2. This may be Moscow’s political move to convince Europeans of the usefulness of the new offshore pipeline for the Baltics. Of course, any gas shortage situation will sooner or later be resolved by increasing supplies from Russia, the United States or other countries. However, for the time being, the market cycle is upwards, which is also creating tensions in the EU CO2 market. It turns out that these markets are part of one complex chain.

In these conditions of rising energy prices, will we not have to temporarily refuse (freeze) the implementation of the EU Green Rate?

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It is impossible to abandon the Green Deal. The economy would benefit from being more innovative, energy efficient and less polluting. It must be borne in mind that the implementation of the Green Deal in itself means an increase in both carbon and energy prices. However, two important factors need to be taken into account. Firstly, rising prices must not be equated with a financial bubble. We are currently witnessing a bubble that is quite detrimental to the Green Course. Even renewable energy plants are suffering from soaring prices. In the United Kingdom, on the other hand, fertilizer manufacturers are going bankrupt because they depend on natural gas, which is the main raw material for their production. The increase in gas prices is not so much related to the shortage of gas itself as to the dependence of buyers on the current (short-term) market, the activity of traders and panic among buyers.

It should be noted that underground gas storage stores about 20% less natural gas than the average in recent years, and trade in the UK is 12% lower than last year (although this is not a very significant difference). In addition, carbon prices have risen due to hedging rather than investment in new technologies. The question remains open: how can European regulators limit the formation of such bubbles (for example, by restricting purely speculative activities in these markets). The second factor is more important. Many EU Member States lack social policies to help low-income people and small businesses cope with rising prices. Obviously, without an effective social policy, the implementation of the Green Deal will be much more difficult. What is important is not to achieve the goal on paper, but to create a long-term sustainable economy.

Are there any regulations currently being developed that could significantly increase the price of CO2 emissions? How could this affect heat supply tariffs, for example, in the Baltics?

There is a lot of talk about carbon market reform. On the one hand, the EU Commission’s recent proposal to reduce free carbon quotas for industry has received much criticism from industry. If in the past the industry could receive part of the allowances free of charge, then, according to the new logic, less free allowances will be allocated. This is likely to raise prices and affect the competitiveness of European industry. On the other hand, some Member States, in particular Spain, are calling for artificially low carbon prices. But then the question arises: will the market not switch to a normal carbon tax? In general, the issue of carbon market reforms will be very relevant in the near future.


Advantages of local renewable resources

Andris Vanags, Chairman of the Board of SIA Gren Latvija:

As a green energy company in Northern Europe, developing and providing sustainable energy solutions, mainly district heating using local and renewable energy sources, we have long been convinced that the use of local and renewable energy sources, especially district heating in densely populated areas, is the most competitive, efficient and therefore the best solution for customers. This winter, this positive effect will be particularly felt in the form of lower heat tariffs. In cities where renewable resources are used to provide district heating, heating tariffs will be more stable and will experience a lower percentage of tariff changes than in cities where fossil natural gas is mainly used for heat production.

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In Latvia, Gren works in Jelgava and Daugavpils, and in both cities our heat production does not depend on one fuel resource. The main resource is a local, renewable resource – wood chips, the price of which has always been more stable compared to natural gas. The share of natural gas in our thermal power plants in both Jelgava and Daugavpils is relatively small. Such flexibility in the use of fuel resources allows us to react quickly and adapt to the situation in the fuel market, to choose a fuel that is both available and more advantageous in terms of price for our customers. Thus, we can be sure that the price of heat for our customers will be more stable and the percentage increase will be lower than if we used only natural gas.

In Jelgava, we have evaluated the impact of the increase in the price of wood chips and natural gas on the final heat energy tariff, and the forecasted tariff increase for Jelgava residents is 6.6%. In order to continue to offer Jelgava residents a competitive heat price and further improve fuel flexibility, Gren is continuing work on a heat production modernization project that will add up to 35% of non-recyclable fuel or NAIK to wood chips at the Jelgava biomass cogeneration plant. The use of NAIK in a biomass cogeneration plant will not only reduce fuel costs and have a positive impact on the price of heat for citizens and businesses, but will also promote the recycling and efficient use of waste and reduce the amount of waste going to landfill.

The more non-recyclable waste we can use in the production of heat and electricity, the more beneficial it will be for society and the environment. It is important that the use of the most cost-effective renewable and local resources for heating buildings in cities, in a way that is safe for the health of the population and the environment, is facilitated by district heating. Heat production in a single plant using modern, innovative technologies allows for more efficient use of fuel and also significantly improves urban air quality by reducing particulate and dust emissions to air from individual solid fuel heating solutions. Last but not least, the use of renewable resources in district heating reduces the impact on climate change.

Also in the Air Pollution Reduction Action Plan 2020–2030 developed by the MEPRD. It is recommended to promote the development and wider use of district heating in cities. As society becomes more knowledgeable and educated on environmental issues, more and more homeowners and entrepreneurs are choosing district heating every year to heat their buildings – a modern, safe and environmentally friendly heating solution with minimal maintenance costs and low initial investment in connection. In addition, district heating is a very convenient solution for customers with a high level of customer service, which allows them not to think about the maintenance of heating equipment, regular maintenance and fuel supply.

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