Forward contracts are baking-in huge price increases for the UK and Europe. An oil crisis hits the economy like a big wave breaking on the beach: The impact is immediate and dramatic as the crest plunges onto the shore. An electricity crisis is another kind of shock: Akin to a rising tide, it is slow but relentless and then, surprise, you are overwhelmed.
The difference explains why policymakers and investors focus on oil and tend to ignore electricity. That’s a big mistake because another big predicament over electricity prices is coming, not unlike the one Europe weathered late last year.
Almost unnoticed, regional forward electricity contracts for late 2022 and, especially, for 2023 have risen significantly over the last few weeks, heralding further utility bill hikes. In some cases, forward contracts have set record highs, having surged about 40% over the last two months.
Electricity prices jumped in December and again in late February for a few days. Since then, day-to-day prices have fallen back. The drop is misleading. In electricity, what matters are the cumulative averages. Monthly averages are painting a worrisome picture.
So far in May, the benchmark German one-year forward electricity contract has averaged 222 euros ($235) per megawatt hour, heading toward its highest ever monthly level, above the previous record set last December at 207 euros per megawatt hour. Before 2021, the highest average for the same benchmark contract was 83 euros in July 2008.
The war in Ukraine, which has lifted natural gas and coal prices, is the main driver of this crisis. It’s also exacerbated by low nuclear power production in France: State-owned Electricite de France SA recently cut its 2022 nuclear output guidance to less than 300 terawatts hour, down more than 30% from what it produced a decade ago.
European utilities buy electricity months ahead in the wholesale market to fix costs for their customers. And so the current price increases in forward contract are effectively baking-in significant retail increases for next year. The surge will be similar to those of last autumn, when electricity bills became a hot political potato from Spain to the UK.
Once again, the increases may force governments into spending billions of dollars to cushion the impact, via subsidies and tax breaks. The problem now is that the utility bill hikes would come on top of widespread distress over the cost of living, further straining family budgets. That’s more trouble ahead for the European Central Bank and the Bank of England, which are already battling multi-decade high inflation. If the oil shock caused a wave of inflation, the electricity shock will lift the inflationary tide further.
With oil, spot prices on the market will make pump prices fluctuate on a daily basis. With electricity, the shifts reveal themselves monthly — and will be especially dramatic going forward. In the UK, for example, the maximum price utilities can charge households for their electricity — popularly known as the price cap — is currently re-calculated twice a year. Because late 2022 and early 2023 prices have traded at high levels for several weeks already, the cap is set to increase significantly. Cornwall Insight estimates the electricity and gas dual-fuel tariff is likely to increase to £2,595 ($3,238) per year by October, up more than 30% from £1,971 currently. Earlier this year, the same tariff jumped 54% before the government intervened to cushion the blow.
The trends are similar in other countries. German utilities and large electricity buyers are now trading power for delivery throughout 2023 at more than 200 euros per megawatt hour, a record high for that year. To put that into perspective, forward prices in 2019 hovered around 50 euros. French 2023 forward electricity prices last week surged to more than 300 euros per megawatt hour, a record for the contract. In January, the same contract traded for less than 130 euros per megawatt hour.
The impact of those increases will not be evident in retail prices until later this year. But when the the power market reaches high tide in late 2022 and early 2023, the impact on families and small businesses will be the same: Many will drown.