By Linus Claesson
Policy makers have shifted from a single net zero goal to a “trilemma” of goals comprising net zero, security of supply and affordability.
Even in the depths of the Cold War in the 1970s and 1980s, the Russian natural gas continued to flow to Europe. A sharp cut in gas supply would mark a sharp twist in history – but, alas, could be a real possibility given today’s rapidly changing geopolitics.
European natural gas consumption amounted to around 527 billion cubic meters in 2021, of which around 170 billion cubic meters were supplied by Russia; clearly, interrupted streams would prove very disruptive. The European Commission’s plan to reduce dependence on its eastern counterpart hinges heavily on offsetting liquefied natural gas imports and accelerating the deployment of renewable energy. Rising LNG imports represent the main short-term contributor to energy diversification, but this market is already tight and additional demand would tighten it further. To attract large additional quantities of LNG, European gas and LNG prices would have to rise to a level where demand destruction would take place elsewhere, most likely in Asia. In the short term, LNG demand has low price elasticity, which means gas prices in Europe may need to rise from current record highs. Furthermore, electricity prices in Europe are determined by the variable operating costs of each marginal unit of production, which means that if natural gas prices increase, electricity prices will increase in parallel.
This dynamic places European households in a particularly vulnerable position. In addition to inflation in the cost of petrol and food, the average household would see its gas and electricity bills increase by almost €900 per year, or around 76%. On the other hand, policy measures, including clawbacks and tariff freezes, are expected to cover around 40% of the implied increase, limiting the average household increase next year to around 47% compared to 2020.
The “trilemma” of balancing the conflicting dynamics of net-zero ambitions, security of supply and affordability clearly poses challenges to the investment decision-making process. How should investors juggle political intervention, a cost of living crisis, growing investment needs and higher capital intensity, while facing the tail risk of reduced European gas imports natural ? We believe one answer lies with power grid assets and renewable energy developers, who we view as positively exposed to many or all of these dynamics. These assets are benefiting from higher inflation as well as ongoing and upcoming policy initiatives, which we believe is likely to increase their earning power. Companies with such assets can represent an interesting starting point to begin the search for attractively valued ways to mitigate the impact of energy inflationary compression in Europe on credit portfolios.
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