The fallout from Europe’s energy crisis

Moscow’s “indefinite shutdown of Nord Stream 1”, Russia’s main gas connection to Germany, “was supposed to be the Kremlin’s big weapon that would send the wholesale price to new stratospheric levels”, say Ben Hall, Valentina Romei and Sam Fleming in the Financial Times. So far it hasn’t worked. Although they remain historically elevated, European wholesale gas and German electricity prices have instead fallen by 40% and 34% respectively since spiking late last month.

Russia’s share of EU gas imports has fallen from 40% to just 9% since the war began. With German storage tanks 88% full, “confidence is growing in…capitals that Europe can get through the winter without severe economic and social dislocation or energy rationing”.

The energy crisis is forcing a reform of Europe’s electricity market

On Wednesday European Commission president Ursula von der Leyen outlined sweeping plans to reform the continent’s electricity market. Gas is the marginal fuel for European power generation and thus drives electricity prices. This means non-gas electricity producers such as nuclear power and renewables can earn huge revenues while their production costs are now far below market prices. The plan is to cap these revenues, while she is also pushing for a windfall tax of 33% on the profits generated by energy companies.

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No wonder that governments want to raise revenue: “Added together, Europe and the United Kingdom have so far promised to spend more than €500bn ($500bn) to subsidise bills” in response to soaring prices, say Lauren Kent and Anna Cooban for CNN. The scale of the crisis means that proposals like a windfall tax that were considered “crazy in June” are now mainstream, Václav Bartuška, the Czech special envoy for energy security, told The Wall Street Journal.

Energy derivatives and European stocks are feeling the strain too

There are also signs of strain in the energy-derivatives market, says Gillian Tett in the Financial Times. European utility firms are facing crippling margin calls on contracts they had taken out to hedge against price falls. Soaring prices have created “massive paper losses” on these contracts, forcing some governments to step in. Up to €1.5trn may be needed as collateral, with the Finnish energy minister talking of “the energy sector’s version of [the] Lehman Brothers” meltdown. “Designing an electricity market is hard. The juice cannot yet be stored at scale, and has to be delivered at the exact moment it is needed,” says The Economist. European governments are trying to find a way to protect consumers while preserving the incentive for electricity producers to generate – and for consumers to lower the thermostat.

The energy furore is rattling investors further. European stocks have been slipping since mid-August amid fears of recession; last week the European Central Bank raised interest rates by three-quarters of a percentage point. “Bank of America’s monthly fund-manager survey showed global investors are the most underweight on European equities ever,” says Cormac Mullen on Bloomberg. The Euro Stoxx 600’s July lows may be “tested again soon”.