These are extraordinary times in energy markets. As post-Covid economic pent-up demand is unleashed, energy consumption has risen faster than normal too, outstripping the ability to supply. The laws of basic economics dictate that an excess of demand over supply leads to rising prices. Natural gas and thermal coal prices have increased exponentially in only a few weeks, not helped by unseasonably low output from (variable) wind and solar renewables, all conspiring to push up electricity prices to households and business consumers. 

 

But while the current circumstances might be highly unusual, like an unexpected conspiracy, there is no surprise at the consequences and the rapidity with which they have struck. For years, commentators have been pointing to the risks of energy markets destabilising given how little resilience there is in the system; the wafer-thin buffer margins between peak demand and maximum installed capacity are well known; this was a case of when-not-if. With politicians under pressure to retire coal and other fossil-fuelled power plants to cut greenhouse emissions, but largely fearful of nuclear and in thrall to the fetish of renewables, and daunted by the horrendous sums and who will pay for the investment to make up the shortfall left by coal and abandoned nuclear, many have simply adopted the ostrich position and funked major strategic decisions about reliable future sources of energy which are clean, safe, sustainable and secure: “too difficult. Mañana! Maybe if we close our eyes the problem will go away?”.

 

Subcontracting energy supply: a hostage to fortune

A seductively easy partial solution is, rather than produce all your own electricity, why not buy someone else’s? Here geopolitics come to play as we have seen recently only too clearly in both fuel and electricity markets. This is where energy is “weaponised” for political leverage. The most obvious example, and of zero surprise to anyone with even only a passing awareness of the situation, is the deeply cynical but entirely pragmatic approach being taken by Vladimir Putin with his gas supplies to the EU and his former Soviet allies.

 

We have discussed in previous columns the extent to which Germany in particular has mortgaged its future economy to Russia, with its almost total reliance on non-renewable energy being met by Russian gas supplies through the Nord Stream 2 pipeline once the final coal-powered stations have been closed. Ukraine is in a similar bind. Mischievously, Putin claims that a significant contributor to the current gas price crisis is the EU and other countries resorting to the spot markets to buy gas as domestic energy demand exceeds normal levels; would it not be so much easier if they had fixed, exclusive contracts with Moscow (in practice, with Gazprom)? In context, 40% of all the EU’s demand for gas is met by Russia with the bulk being delivered to Italy, Germany and France. Twisting the noose a little tighter, Putin has deliberately withheld supplies, driving the price up in multiples, now releasing the pressure again (but certainly not letting go of the rope) in a case of straightforward political and economic blackmail: “of course you can have the gas you need! But only if you sign a contract”.

 

The timing of his tactics is not only opportunistic in taking advantage of escalating demand for gas; in the aftermath of the German federal election at the end of September and while parties in the Bundestag go through the rituals of playground politics to stitch together a workable coalition government of whatever pastel shade, it is to remind those on the right of centre that they made a commitment to the completion of Nord Stream 2, and to those on the left who ideologically oppose the project that, should they abandon it, Germany, the world’s fourth largest economy and with no coal and no nuclear power and in the absence of gas would be almost entirely reliant on unreliable renewables; it would face the prospect of becoming a failed industrialised state.

 

But there is another significant impact of Nord Stream 2, particularly for Ukraine with all the sensitivities of the importance of the Crimea and the Black Sea to Russia’s military defence strategy: this new pipeline goes direct from Russia’s north-west coast to the German north coast, entirely under the Baltic; in contrast, Nord Steam 1 which the new pipe not wholly but nearly supplants, is an entirely land-based pipeline with several spurs, each country through which it passes collecting transit fees. Three quarters of Russia’s gas exports to western Europe pass through Ukrainian territory; measured in billions of dollars, the transit fees in 2017 totalled 3% of Ukraine’s entire GDP. Thus, not only is Ukraine heavily reliant on Russia as a direct source of energy, but a not insignificant proportion of its GDP also derives from Moscow through transit fees which may soon evaporate. It is difficult not to conclude that Russia has Germany’s and Ukraine’s crown jewels in a vice.

 

The US National Security adviser, Jake Sullivan, has warned Russia against playing the political leverage game with Europe over gas supplies. Or else what? There are strict international sanctions in place against Gazprom; these have already been subverted when, like the schoolboy caught red-handed pinching apples from the vicar’s garden, Germany was found to have invented a crypto web of front-companies behind which illegal contractual arrangements were put in place with Gazprom to enable the completion of the final 90km of the pipeline. Germany was penalised, forced to set up a modest reparations fund to alleviate fuel poverty in Ukraine. Putin and his GRU dirty tricks wing will hardly be quaking in their boots.

UK vulnerabilities

Will Mr Sullivan be offering the same warning to President Macron of France as he too weaponizes energy for political leverage? As the post-Brexit fishing licence war with France hots up once more, France has yet again threatened to withhold electricity supplies from the French mainland to Jersey. Although not yet mentioned as a possibility, were the Brexit Northern Ireland Protocol re-negotiations to turn sour, would Macron threaten the wider UK by unplugging the electricity interconnector between France and England through which 6% of our electricity supply is met?

 

The UK potentially faces an energy hiatus unique to itself: in the event of Scotland’s successful secession, energy will be one of the big political sticking points, encompassing not only what remains of North Sea oil and gas, but also the effective partition of the National Grid (electricity from Scottish offshore windfarms finds its way to England, while the Ben Cruachan hydro plant in Argyll is the Grid’s one-shot, immediate energy injection when the national system is in danger of being swamped by excess demand). ‘Weaponizing’, political leverage, a bargaining chip, whichever one likes to call it, energy is sure to feature large in any divorce proceedings between Edinburgh and Westminster. The parallels already exist, a taste of which was revealed in Europe this summer.

 

In June, talks between the EU and Switzerland broke down, the Swiss refusing to consolidate their 120 bi-lateral agreements with the bloc in to one homogenous treaty which would effectively have undermined Swiss independence by placing it under the authority of the European Court of Justice. It remains to be seen what path what was billed as ‘Switzexit’ takes: will the slow degradation of Switzerland’s key markets as these separate agreements expire drive them back to the negotiating table? Key in this is the strategic contracts relating to energy supply thanks to Switzerland’s geographic position, its Alpine topography and its highly developed hydro industry. Switzerland holds a strong negotiating card given its hydropower forms the immediate electricity back-up when national grids in Germany, Italy and France run short of capacity.

Chinese knots

Finally, even China, the world’s second largest economy has seen energy weaponised albeit not in the way it imagined. As it rapidly runs out of coal having applied punitive sanctions and tariffs against Australia, by some way the biggest supplier of coal to China, in retaliation for Australia’s vocal criticisms of the Chinese authorities’ tactics towards Hong Kong, how it uses Huawei subversively, and its treatment of Uighur Moslems, it finds itself hoist on its own petard, particularly as alternative coal suppliers such as Indonesia have been unable to make up the shortfall. However, the net result is significant energy shortages and swathes of Chinese industrial output having to be closed for up to 20 days per month. It represents a significant economic risk, and a political risk for General Secretary Xi: command economies are supposed to be stable, predictable and relatively immune from outside influences; not so in this case.

No more kicking cans down roads

We have said before that data is power; demonstrably, energy is power too, in every sense. One side’s opinion of ‘weaponizing’ is the other’s definition of realpolitik. The current hiatus will almost certainly sort itself out. However, when it does politicians will be deluding themselves if they think the underlying problem has gone away. Consistently ducking the capacity and security issue has led to national energy strategies which are often as dysfunctional as they are incoherent, particularly as we enter William Hague’s Revolution by Coercion, the decarbonisation of society with all the pressures it will entail on both the supply and demand for electricity. It is a big wake-up call.

 

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