Why are energy prices going up so much, and what does it mean for consumers and investors?

UK energy prices are going through the roof, with electricity the most expensive in Europe and gas at its highest for 13 years. Saloni Sardana explains what’s going on.

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UK electricity prices have hit record highs to become the most expensive in Europe, with “day-ahead” power prices (the price of spot electricity) hitting £540 per megawatt hour (MWh) on Monday. UK prices are at their highest since 2008, says Cornwall Insight, an energy-market analyst. 

Gas prices quoted in therms (a unit of heat) are trading at £1.89, doubling in as little as two months, and five times higher than September last year. 

In a taste of what is to come if energy prices keep rising, two fertiliser plants in the north of England have been shuttered because they have become too expensive to run. The operator, CF Industries Holdings, did not say when production would resume. 

And the rise in energy prices has stoked fears that we may be in for a very cold and expensive winter. So why are prices rocketing and what might it mean for investors? 

What is going on?

A fire at a National Grid site in Sellindge near Ashford in Kent has forced the shut down of the main power cable to the continent. That means reduced electricity imports from France until March. 

In normal circumstances, the UK could rely on interconnectors linking to other countries such as Belgium, Norway, and the Netherlands to import electricity. But most of Europe is also experiencing a surge in energy prices. 

Wholesale European electricity prices have shot up, too, and natural gas futures in the Netherlands have raced past €60/megawatt hour to hit a record high this week. Dutch gas prices have risen by around 450% over the year, and French and German wholesale electricity prices are also trading at record highs. To add to the problem, gas stockpiles are at their lowest in ten years.

What is behind the rise in natural gas prices?

There are several reasons behind higher gas prices. 

Summer heatwaves prompted a big increase in demand for air conditioning and refrigeration, coupled with a resumption of economic activity after Covid-19 lockdowns were eased. But at the same time, calm weather saw wind speeds drop dramatically, cutting the amount of electricity produced by wind turbines. That’s driven demand for gas up significantly as it is the country’s main fuel for power stations.

Another factor is supply constraints. Russia, a key energy exporter, limited pipeline exports to Europe due to excessive domestic demand. Meanwhile “greater competition with Asia for liquefied natural gas (LNG) shipments had also forced prices higher,” reports the Financial Times. 

Carbon credits, which firms need to purchase in order to use coal-fired power generation, have almost tripled in price since the start of the year. The European Commission has been reducing the supply of carbon credits to the market, which has also contributed to higher gas prices. 

How are governments reacting?

Governments in both the UK and continental Europe have expressed alarm at the pace at which gas and electricity prices are rising. 

In the UK, there are fears that Ofgem, the energy regulator, may be forced to announce a  second rise in electricity energy bills, less than a year after it already has done so. 

Ofgem already said in August that energy bills would rise for 15 million households by at least 12% from October. 

Meanwhile, in Spain, the government announced plans to claim €3bn from the country’s utility groups and announced a raft of measures including a cap on gas prices, a drop of 0.5% in electricity taxes up to 5.1%, and redirecting profits made by energy companies. 

In France, the government is mulling whether to extend energy voucher benefits to more households to tackle soaring prices. 

Are things going to get any better?

It looks like things will get much worse before they get better, with analysts predicting huge rises in electricity prices. 

On an annual basis, a doubling of wholesale electricity prices from about €50/MWh to €100/MWh could significantly drive up the cost of electricity to consumers.

Goldman Sachs warns that the energy crisis isn’t confined to just natural gas and electricity prices. "European energy pricing dynamics offer a glimpse of what is in store for other commodity markets", the bank said this week. 

The price rises could hit commodity markets, as  "these markets are becoming increasingly exposed to any type of supply disruption (like Russian gas exports) or unexpected demand increase (like hot weather)," says Goldman.

What does this mean for consumers? 

For consumers the most likely effect is higher electricity bills and higher costs in general for many of their purchases. 

High gas and electricity prices exacerbate supply chain disruption and can cause inflationary pressures. Given supply chains have already been disrupted due to a combination of Brexit and the pandemic, higher electricity prices can add further woes and “will shrink the disposable income of the poorest households with their high propensity to consume,” warns Bruegel an economic think tank based in Brussels. 

What does this mean for investors?

If Goldman’s predictions are realised and commodity prices increase too, businesses will face higher costs and be forced to raise prices. 

A bigger and more likely area of concern is the risk that higher energy prices feed into a period of stagnation, where the higher costs weigh on companies’ earnings but inflation keeps creeping up. 

In the long-term, it shows how difficult the transition to renewable energy will be, despite ambitious pledges made by a number of countries. It also means COP26 – the summit of world leaders, which is due to take place in Glasgow in November – will be an even more challenging balancing act and comes at an awkward time for the UK when consumers are likely to face much higher energy bills. 

This could make a case for investing in nuclear energy, despite the fact the UK has had a poor record of building new reactors, and countries such as Germany are phasing it out completely by 2022. 

Investors would be wise to have exposure to both renewables and fossil fuels, as high energy prices mean fossil fuels are here to stay for a while at least. 

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