What India Needs to Learn From Spiralling Gas, Electricity Prices in Europe

The current crisis in Europe of spiralling gas prices, coupled with a cold snap, brings out that the transition of any part of the world to green energy is not going to be easy. It also brings out the complexity in such a transition, that energy is not simply choosing the right technology, but that it has economic and geopolitical dimensions as well.

The European Union (EU) has made its problem of a green transition worse by choosing a completely market-based approach for gas pricing. As we saw in Texas earlier, such policies fail during vagaries of weather, pushing gas prices to levels where the poor may have to simply turn off their heating. In winter, gas prices skyrocket in the EU, as they did last year and again this year.

For India and its electricity grid, one lesson is clear. Markets do not solve the problem of energy pricing, as they require planning, long-term investments and stability in pricing. The electricity sector will face a disaster if it is handed over to electricity traders as is being proposed. This is what the so-called separation of wires from the electricity they carry means in the Narendra Modi government's proposed amendment to the existing Electricity Act.

Let us look at the current problem of gas in Europe, particularly of the EU, which has chosen gas as its choice of fuel for electricity production, as it goes off coal and nuclear while also investing heavily in wind and solar. The argument advanced is that gas would provide the EU with a transitional fuel for its low carbon emission path as it produces less emissions than coal.

As I have written earlier, the problem with green energy is that it requires a much larger capacity addition that planners are not taking into account. In higher latitudes, during winter, days are shorter, and we, therefore, get fewer hours of sunlight. This seasonal problem with solar has been compounded in Europe with low winds this year, reducing the electricity output of windmills.

The EU has banked heavily on gas to meet its short and medium-term goals of cutting down greenhouse emissions. It is another matter that gas is at best a short-term solution as it still emits half as much greenhouse gas as coal. Gas can be stored to meet short-term and seasonal needs, and even production increased easily from gas fields with requisite pumping capacity. All this requires advanced planning and investment in surplus capacity to meet the requirements of daily or seasonal fluctuations.

Unfortunately, the EU is a strong believer that markets magically solve all problems. It has moved away from long-term price contracts for gas and into spot and short-term contracts; unlike China, India and Japan who all have long-term contracts indexed to the oil price.

Why does the gas price affect the price of electricity in the EU? After all, natural gas accounts only for about 20% of the EU's electricity generation.

Unfortunately for the people, not only gas but also the electricity markets have been "liberalised" under the market reforms in the EU. The energy mix in the grid is determined by energy market auctions, in which electricity producers bid their prices and the quantity they will supply to the electricity grid. These bids are accepted, in order from lowest to highest, until the next day's predicted demand is fully met. The last bidder's price then becomes the price for all producers. In economists' language of the neoliberal era, this is its "marginal price", discovered through market auction and, therefore, the "natural" price of electricity.

At present, the marginal producer is natural gas, and that is why the price of gas also determines the price of electricity in Europe. This explains the almost 200% rise in electricity price in Europe last year. This year, according to the EU Commission, "Gas prices are increasing globally, but more significantly in net importer regional markets like Asia and the EU. So far in 2021, prices tripled in the EU and more than doubled in Asia while only doubling in the US.” (emphasis added).

The coupling of the gas and electricity markets by using the marginal price as the price of all producers means that if gas spot prices triple, as they have currently, so will electricity prices. No prizes for guessing who gets hit the hardest with such increases! Though there has been criticism of using marginal price as the price of electricity for all suppliers, irrespective of their respective costs, the neoliberal beliefs in the god of the market has ruled supreme in Europe.

Russia has long-term contracts as well as short-term contracts with EU countries. President Vladimir Putin has mocked the EU's fascination with spot prices and gas prices and said that Russia is willing to supply more gas via long-term contracts. Though the European Commission authorities agree that Russia has honoured its long-term commitments, it claims that Russia could do more to meet the EU's short-term needs, which are causing a huge spike in gas prices there. The question here is that you either believe in the efficiency of the markets or you don't. You cannot argue that markets are best when spot prices are low, as in summer, and lose that belief in winter, asking Russia to supply more in order to "control" the market price. And if markets indeed are best, why not help the market by expediting the regulatory clearances of Nord Stream 2?

This brings us to the knotty question of the EU and Russia. The Ukraine crisis that is roiling the relationship between the EU and Russia is closely linked to gas as well. Pipelines from Russia through Ukraine and Poland, along with the undersea Nord Stream 1, currently supply the bulk of Russian gas to the EU. Russia also has additional capacity via the newly commissioned Nord Stream 2 to supply more gas to Europe.

There is little doubt that Nord Stream 2 is caught not simply in regulatory issues but the geopolitics of gas in Europe. The US pressured Germany not to allow Nord Stream 2 to be commissioned, including the threat of sanctions. It was then Chancellor Angela Merkel’s virtually the last major decision that she resisted this pressure and forced the US to back off.  The Ukraine crisis has created further pressure on Germany to postpone Nord Stream 2 even if it means worsening its twin crisis of gas and electricity prices.

The net gainer in all of this is the US, which gets a buyer for its more expensive fracking gas. Russia currently supplies about 40% of the EU's gas. If this drops, the US, which supplies less than 5% of EU's gas, could be a big gainer. The US interest in sanctioning Russian gas and not commissioning Nord Stream 2, has as much to do with its support to Ukraine's, as seeing that Russia does not become too important to the EU.

Nord Stream 2 could help forming a common pan European market and a larger Eurasian consolidation. Just as in East and South-East Asia, the US has a vested interest in stopping trade following geography instead of politics. Interestingly, gas pipelines from the Soviet Union to Western Europe were built during the Cold War as geography and trade got primacy over Cold War politics.

The US wants to focus on NATO and Indo-Pacific, as its focus is on the oceans. NATO is, after all, North Atlantic Treaty Organisation, and of course, the Indo-Pacific means the Indian and Pacific oceans. In geographical terms, the oceans are not separate but a continuous body covering more than 70% of the world's surface with three major islands -- Eurasia, Africa and the Americas. Though in McKinder’s formulation, the originator of the World Island idea, Africa was seen as a part of Eurasia. Eurasia alone is by far the bigger island, with more than 70% of the world's population. That is why the US does not want such a consolidation.

We are passing through perhaps the greatest transition that our civilisation has known in meeting the challenge of climate change. It needs an energy transition that cannot be achieved through markets that privileges immediate profits over long-term societal gains. If gas is indeed the transitional fuel, at least for Europe, it needs long-term policies of integrating its gas grid with gas fields with adequate storage. And it needs to stop playing games with its energy and our climate future for the benefit of the US.

For India, the lessons are clear. Markets do not work for infrastructure. Long-term planning with state leadership is what we need for supplying all Indians with electricity and our green transition; instead of a mystical belief in electricity markets created artificially by a few regulators, framing rules to favour the private producers of electricity: Ambani, Adani, Tata and Birla.