[petejh]

Some changes to the European gas market coming down the line which are interesting*, if you're that way inclined. Likely we'll be seeing in the UK some form of what's being proposed.

The EU, via Germany, announced yesterday an intervention to the standard 'marginal pricing' market for electricity. Marginal pricing is the mechanism by which virtually all commodities are traded. Two excellent explainers below, the first on how marginal pricing works, the second on how the EU's proposed new market mechanism will work.

Basically the new model proposes that spot market price for electricity per MW/hr, as set by supply/demand, will remain unaffected. Electricity generators with the lowest costs of generation - and thus the highest profits (solar and wind, nuclear) - are to have a greater proportion of their profits taken away. Higher-cost generators - thus lower profit margins, e.g. those that use coal or gas to produce electricity - are to have a smaller proportion of their profits taken away. The surrendered profits presumably will be used to fund subsidies to help people afford electricity. Illustration below (y-axis = cost of generation as it's not obvious).




It will be interesting to see what incentives perverse or otherwise this new market system introduces, as it couldn't be more different to the usual way commodities markets set prices, which as a consequence incentivises (via larger profits) those producers with the lowest-costs. Many questions around how it will work with forward pricing, and which generators it will end up incentivising in the short-term versus long-term. Also whether this is a temporary intervention or a long-term change to the market. I'm interested to see what if any impact this will have on renewables investments.

No doubt economists will be carrying out studies for years to come on the European gas and electricity market of 2022..

Explainer on marginal pricing here: https://neon.energy/marginal-pricing
Explainer on the new European market model: https://twitter.com/LionHirth/status/1566652036623515649?s=20&t=6wALlTuHIxJ7dZHk7NUwxA



*I find this stuff pretty fascinating and it couldn't be much more relevant to people's lives than this year. But I'm sure many won't. Also am I the only one amused at the irony of a mainstay of capitalism - the marginal pricing mechanism for commodities in a free-market - being rendered unworkable due to a Russian invasion?

[Johnny Brown]

Classic economist line there - The market is working great, it just produces a terrible outcome.

There was a letter to The Times on this:

https://twitter.com/wilkesb/status/1565258473960624130/photo/1

Basically the new model proposes that spot market price for electricity per MW/hr, as set by supply/demand, will remain unaffected. Electricity generators with the lowest costs of generation - and thus the highest profits (solar and wind, nuclear) - are to have a greater proportion of their profits taken away. Higher-cost generators - thus lower profit margins, e.g. those that use coal or gas to produce electricity - are to have a smaller proportion of their profits taken away.

This Twitter thread suggests this is already the case in the UK. It also implies that marginal costing is not really the free market your link suggests.

[SA Chris]

The flaw there is "show that new leadership was capable of making the tough decisions". I'm not holding my breath.

[petejh]

Classic economist line there - The market is working great, it just produces a terrible outcome.

Also immortalised in sayings such as 'the worst system possible, except for all the others'.

This Twitter thread suggests this is already the case in the UK. It also implies that marginal costing is not really the free market your link suggests.

Had a read, he isn't suggesting this. He's suggesting it should be changed to the system described in my original post, i.e. the German proposal to stop 'marginal pricing' (the cause of current high prices), begin 'revenue cap pricing'.

[abarro81]

I think JB is referring to this tweet:
I should, however, add a twist. Many renewable energy producers are already subject to contracts that essentially fix their prices, with the government already taking the risk on price variation. See https://lowcarboncontracts.uk.

I don't know what proportion of solar in the UK is on a fixed price, but historically these have been pretty common - I was under the impression that "merchant" solar (selling at grid prices) was relatively uncommon in Europe until recently and most projects will have been using a fixed price either via government or a commercial PPA arrangement?

I was also under the impression that some of our nuclear fleet operates on a strike price mechanism that's essentially the same as this, though maybe that's only the stuff that's not been built yet?

[seankenny]

*I find this stuff pretty fascinating and it couldn't be much more relevant to people's lives than this year. But I'm sure many won't. Also am I the only one amused at the irony of a mainstay of capitalism - the marginal pricing mechanism for commodities in a free-market - being rendered unworkable due to a Russian invasion?

I don’t know the first thing about energy pricing but it is interesting, thanks for posting. One possible way to think about what’s happening might be to consider that markets fail all the time due to failures of information, and that now energy prices have gone so high that they no longer contain any useful information. Or any useful information beyond “you can’t afford this” to which the only possible response is to stop consuming the stuff.

Stiglitz’s Nobel lecture is good on this - https://www.nobelprize.org/uploads/2018/06/stiglitz-lecture.pdf.

As you say, a goldmine for future studies.

[Johnny Brown]

Yep, referring to Pete's summary rather than the link.

the current excess electricity profits arising because prices are based on the cost of gas production already flow to the government, a little-known fact.

What isn't clear to me is whether marginal pricing is the true free market your link claims, or subject to a lot of fixing to stop energy firms going bust, as that fella on twitter implies.

Either way, as Sean points out, we're seeing the limitations of the correct functioning of markets aren't we?

[Nigel]

Are the profit magins for each producer type capped at the same amount? Or is it a sliding scale of some kind?

[petejh]

How's your German?

https://twitter.com/jbebermeier/status/1566352756125884417


It doesn't go into that much detail, about relative sizes of margin remaining after cap. Devils will be in the detail no doubt.

[petejh]

Yep, referring to Pete's summary rather than the link.

the current excess electricity profits arising because prices are based on the cost of gas production already flow to the government, a little-known fact.

Got you.

What isn't clear to me is whether marginal pricing is the true free market your link claims, or subject to a lot of fixing to stop energy firms going bust, as that fella on twitter implies.

I doubt if that's clear to anybody! Big subject.. Pick a market without distortions, perverse incentives and downright corruption. 'the best worst system we have etc.'.

[abarro81]

I don't know what proportion of solar in the UK is on a fixed price, but historically these have been pretty common - I was under the impression that "merchant" solar (selling at grid prices) was relatively uncommon in Europe until recently and most projects will have been using a fixed price either via government or a commercial PPA arrangement?

I just did a very quick bit of digging on commercial PPAs - I get the impression that in this will just be shielding a company from paying full price at the moment: Google (or whoever) will be selling into the grid at an exorbitant price and buying back at the same exorbitant price... so no-one is really making any excess money off PV or wind installations with those contracts. You'd just effectively be forcing a company that's locked themselves into fixed prices out of a fixed price contract, for better or worse

[petejh]

Either way, as Sean points out, we're seeing the limitations of the correct functioning of markets aren't we?

Depends what you think is the 'correct' purpose of markets I suppose. If you believe markets exist - at all times and under all circumstances - to make our lives easier by making exchange of goods efficient whilst sheltering us at all times and under all circumstances from economic shocks, then yes it's reaching its limit.
But I'm inclined to agree with the energy economics prof, who's implying that most markets most of the time do make our lives easier by allowing efficient exchange of goods, but sometimes under exceptional circumstances, they don't and may need interventions to cushion the shock. But be very careful you don't fuck about with markets too much once a major crisis has passed or you risk throwing out the baby (efficient markets) with the bathwater (high prices in a major crisis). As per the link above:

The power market, the mechanism that clears demand and supply, works smooth and fine. It’s not
dysfunctional or broken. It works exactly as you would expect it to work, given sky-high gas prices.
What’s wrong is not the market, but the outcome it produces. That’s a hell of a difference. High prices
are an existential threat to many households and firms.

None of the above implies electricity markets produce outcomes that are desirable. Currently, I think
they do not. I’ve been advocating for cushioning policies for those affected since March. But claiming
that “this market system does not work anymore” is, in my view, simply not true.

[Offwidth]

Thanks for this Pete.

On a related subject I watched this debate yesterday which had some interesting stuff on pros and cons of windfall taxes with a look at some alternatives

 https://ifs.org.uk/publications/ciotifs-online-debate-it-time-windfall-tax

[Fultonius]

I had written a reply to this a few weeks ago on my phone, but lost wifi then never got round to posting and at some point lost the draft. I think it was something like this:

As JB alludes to, in the UK our electricity market is far from "free", and it will only become increasingly less so.

All major offshore wind farms basically operate on a 15yr contract with the Low Carbon Contracts Company. This price is set in an auction pre-construction. If the market rate is higher, wind producers pay back the LCCC the difference, when prices are low the LCCC pays producers the shortfall.

In the early days the "strike price" was in the £100/MWh (10p/kWh) region, but the latest rounds of bidding are down in the £45-£50/MWh. Which means, at current wholesale prices, those (older) producers are currently paying back £100-£200/MWh to the LCCC.

Originally the LCCC added a levy to consumers bills, but it can't be long until they    https://utilityweek.co.uk/lccc-expects-to-return-39m-of-cfd-payments-to-suppliers/

The Low Carbon Contracts Company (LCCC) has said it expects to return more than £39 million of Contracts for Difference payments to suppliers as result of exceptionally high power prices over the last three months of 2021. The body said the final quarter of the year was the first in the scheme’s history in which generators returned more money than they received.

I need to read up more on this - I'm not sure what happens if the LCCC is consistently in surplus, do those with the lowest strike price get a proportion back?

[Edit]Aaah, so the £39m rebate is for the LEVY paid by all suppliers to fund the LCCC, rather than a return to the individual wind producers (I guess they will get a proportion). [/edit]

Either way, the more offshore wind that comes on, the more the price is stabilised at a low level. There are higher balancing costs, but last time I checked I think it was around 20% on to of the base cost of electricity. Gone are the days where wind was "expensive and costing consumers millions".

I think new gas (and certainly new nuclear) are also part of the CfD market, but not sure. Would be pretty shit to be an electricity producer with a fixed price for the produced electricity and a highly variable and unpredictable input cost (gas).

[petejh]

Yes that is mostly all explained in the first post (most of it is in the diagram). Your last sentence is what happened to all the small electricity suppliers who went bust this year and last, due to them not making any profit margin on the spot wholesale cost of electricity, after they'd forward sold electricity at lower fixed prices to retail consumers, not banking on the macro risk that the world might change and wipe them out..
And is also why the market system (marginal pricing model) produces high electricity prices - gas fired generators are the most expensive producer at the far righthand side of the cost curve hence they set the price i.e. they don't make a loss because they are in effect producing a fungible commodity with one price - electricity in this case - and that commodity has enough demand to justify them producing it. Note that there are producers beyond the righthand side of the cost curve who aren't producing at x-demand level. If demand went up to x+1, the more expensive producer would start producing and the cost of electrify would increase to the new marginal cost of most expensive producer.

The reason the market system is hurting people is because 40% of supply has been removed in exceptional circumstances, and until alternatives are created there isn't enough supply to supply everyone at a reasonable cost. Hence Aussie coal in barges to German coal-fired plants.

The market is still a free market if it includes contracts for difference. It's just forward hedging to reduce investment risk, like all commodities markets do. It's common for commodity producers sell a proportion of their product at a forward hedged price to reduce margin risk in low price cycles. OK it might have been put on the wind companies by the government, but much more likely is that the wind companies wanted a degree of certainty on their investment provided by a guaranteed price. Same as for the nuclear - ask a company to put up 50% cost of a new nuclear build with no certainty of a minimum price to cover the risk of them losing money during a commodity cycle low; no chance it'll ever get built. Can't have it all - if you want full profit margin on the commodity sold then as an investor you have to be prepared to put up all the money and take the risk that the commodity price (in this case electricity) might be low for years and you make a loss - as the O+G giants do in the inevitable cycle lows.  And then you risk a windfall tax during booms anyway!

[Johnny Brown]

Thanks Pete, that’s a clearer explanation of the market than I’ve seen elsewhere. However it feels to me like we shouldn’t be too far away from a time where renewables are sufficiently big and reliable that a company could provide all green power AND undercut the whole gas-based marginal pricing model. Say Uk wind & solar plus French nuclear & Norwegian hydro bought in to cover gaps? Or are we saddled to gas prices as long as they provide any input at all, anywhere?

[petejh]

UK wind, solar and nuclear (and coal) are undercutting the cost of gas-produced electricity right now. Have been pretty much all year ever since wholesale gas price rose last year. Look again at the diagram in the link on marginal pricing - wind, solar, nuclear, coal, in that order, are the lowest cost of electricity production. Gas is by far the costliest. Again partly why coal is in big demand as it's cheaper than gas (currently) and the west has it.

[petejh]

The 'being saddled to gas prices' is the part that the UK and the EU are unsaddling right now. They're doing it by slightly different mechanisms but which have broadly the same result for retail consumers.

UK is introducing a sliding (rising) cap on price charged per unit of electricity dependant on generation technology - starting low and rising, from wind through solar/nuclear/coal to gas. The cap is lowest on wind, higher on solar, higher again on nuclear, higher again on coal.  On gas there is no cap on profit margin because the profit margin is small already (due to high cost of production remember).

So it's a market intervention, because that isn't how commodities markets should work whe nthe product is fungible - electricity is fungible, same thing everywhere. By having the sliding cap you disincentives the cheaper form of production in the long term.

The EU want to do something similar, except the difference between the cap unit price a wind farm receives versus the excess profit the EU takes, will be paid by the wind farm into a fund which in turn pays for subsidies to retail consumers. The UK seems to be capping the price the wind farm charges the retail market, and government pays the wind farm the difference between the cap and the actual unit price of electricity the company would have charged the retail customer based on marginal pricing, had there been no cap.

Both approaches preserve the model of marginal pricing of electricity because it's this market model that incentivises efficiency, but they're shielding the retail customer from paying the marginal price.

The CfDs the wind/solar/nuclear companies signed up to muddy the waters a bit, as noted above by various people.

[Nigel]

How's your German?

Scheisse I'm afraid.

I think your last post might have answered my question about sliding scales, although I'll admit I'm not sure! Reading you as my only source (no time to delve) I'm still not totally clear on the difference between the UK vs EU proposals. Got any links that might make it clearer? (In English!)

Thought it might be of interest to contextualise UK electricity generation per type, over the last decade, as this plays into the overall picture and people are unlikely to know this off the top of their heads:



Some clear patterns there *.

Also worth knowing that 50%-ish of our gas usage comes from North Sea gas fields classed as "domestic", about 30% comes via pipeline from Norway, and about 20% as LNG on ships from Qatar, the US etc. 2021 figures here, expect similar this year:
 

You can put all that together to see that we are quite exposed to high gas prices as we use a lot of gas, in order to replace coal. But we also in total use a lot of nuclear and renewables so, whatever any pricing changes do, they should have an effect (?). Note that it might look like we are smashing it on renewables, but we are around the EU average (Google it).

*These figure do vary by a couple of percentage points here and there from the UK Gov figures in link below: https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/1032260/UK_Energy_in_Brief_2021.pdf but they ballpark agree and its a better visual. The trend is correct.

[andy popp]

it feels to me like we shouldn’t be too far away from a time where renewables are sufficiently big and reliable that a company could provide all green power AND undercut the whole gas-based marginal pricing model. Say Uk wind & solar plus French nuclear & Norwegian hydro bought in to cover gaps?

Apologies if I'm misunderstanding the point/question here, but I understand that Denmark regularly generates more than 100% of its electricity needs from wind - 115% yesterday, 120% last Friday. I can't see that the country enjoys any great natural advantages over the UK when it comes to wind power, so of course it should be possible. No idea about what it means for energy prices though I'm afraid.

[remus]

Apologies if I'm misunderstanding the point/question here, but I understand that Denmark regularly generates more than 100% of its electricity needs from wind - 115% yesterday, 120% last Friday. I can't see that the country enjoys any great natural advantages over the UK when it comes to wind power, so of course it should be possible. No idea about what it means for energy prices though I'm afraid.

The UK also semi-regularly generates more than it requires from renewable sources (which can have the interesting side effect of energy prices going negative i.e. energy companies paying consumers to use power!) The issue is the variability in the amount of power provided by these sources means you either need a hugely over-specced amount of power from these sources to cover lulls (which has loads of it's own problems), or you need significant base load capacity (the nuclear + hydro JB was referring to) and preferably a power source that can respond quickly to fill any gaps between the base load and whatever you're getting from renewables at the time (which is currently done with gas and a little pumped hydro in the UK).

Another option is that the world gets a lot better at adjusting it's power usage to what is available at the time (make toast while the sun shines). I guess this will happen to an extent. Yet another option is distributed battery storage, for example in people's electric cars: say you have 20million EVs, each with a 50kWh battery, that gives you ~1TWh of battery storage which compares well to something like DInorwig pumped hydro (~9.1GWh) (glossing over the huge practical difficulties of what using all those batteries would actually entail).

On a more concrete level, power grids between countries are typically getting better at connecting to each other (using high voltage DC interconnects) which means that when e.g. Denmark produces 120% of it's capacity in wind it can export that power to someone who can use it. This does seem to work well but can cause stability issues if the link goes down (as happened recently with a France/UK interconnect).

[andy popp]

My ignorance showing, I didn't realise the UK also manages this quite regularly. Clearly reliability is the main issue and though I get the impression it happens more than semi-regularly here there must be times when it doesn't - but I don't know how often that is. Yes, the surplus is exported elsewhere in the EU.

[petejh]

I’m still of the opinion that the fire which shut down the IFA UK-France interconnector last year was Russian sabotage and a warning shot by Russia, pre-Ukraine, of the sort of thing it could do to electricity supplies mid-winter to compound the European gas tightness. A disruption to the interconnection system at this time would almost certainly tip the balance into temporary blackouts.

Similar to the suspected Russian sabotage of various undersea internet connections between Svalbard, Greenland, Canada, Iceland in the last few years. If you do some digging around Reuters, Bloomberg etc. it’s considered at least ‘suspicious’.

Interestingly they developed the cable cutting capability as a response to the network of sensors under the Atlantic and pacific which detect Russian subs. I was based for a short time at Brawdy in south wales, where the Atlantic  sensor cables came ashore and the US had a ‘secret’ listening station. Interesting story of them tracking a whale transiting all the way across the Atlantic to provide proof the system works to a disbelieving US Navy.

[teestub]

I’m still of the opinion that the fire which shut down the IFA UK-France interconnector last year was Russian sabotage and a warning shot by Russia, pre-Ukraine

This seems a bit tin foil hat territory, any credible sources?

[chris j]

My ignorance showing, I didn't realise the UK also manages this quite regularly. Clearly reliability is the main issue and though I get the impression it happens more than semi-regularly here there must be times when it doesn't - but I don't know how often that is. Yes, the surplus is exported elsewhere in the EU.

The unreliability of supply is a problem that has to be solved by storage sooner or later.  Take Scotland for an example - they have a rapidly growing renewable capacity, but when it's properly cold in winter there's often a high pressure and no wind for days at a time. Given the SNP & Greens unwillingness to replace any of the nuclear plants I don't know where they expect to turn other than relying on NS and Norwegian gas.

[Fultonius]

My ignorance showing, I didn't realise the UK also manages this quite regularly. Clearly reliability is the main issue and though I get the impression it happens more than semi-regularly here there must be times when it doesn't - but I don't know how often that is. Yes, the surplus is exported elsewhere in the EU.

The unreliability of supply is a problem that has to be solved by storage sooner or later.  Take Scotland for an example - they have a rapidly growing renewable capacity, but when it's properly cold in winter there's often a high pressure and no wind for days at a time. Given the SNP & Greens unwillingness to replace any of the nuclear plants I don't know where they expect to turn other than relying on NS and Norwegian gas.

I think the intention is massive oversupply of renewables, with beefing up of interconnectors (similar to the Danish example). In 2020, renewables produced 97% of electricity demand in Scotland. With the planned 26GW of extra wind to come online from Scotwind and all the other projects ongoing, Scotland will be producing vastly more than it consumes....on average.[current installed capacity in Scotland is 12GW].  As you say, it still won't be enough to tide over the longer winter lulls, and this will need to be covered by imports, storage and peaker plants. It's rarely windless across the whole of the EU, and new/bigger interconnectors are being installed and planned all the time. I guess hydrogen is likely to have a big role in smoothing out the intermittency, along with EV "storage" (although, that's better for daily smoothing, rather than longer term supply) - that said, I wonder if we'll get look ahead weather-based costing in future?  Say it's windy in January, prices drop so everyone tops up their car. Next week, it's high pressure, so prices rise and less people charge or they sellback to the grid. Many ways to solve this problem!

I guess the idea will be any gas power that is kept "available" will ultimately need to have carbon capture and storage.

[petejh]

I’m still of the opinion that the fire which shut down the IFA UK-France interconnector last year was Russian sabotage and a warning shot by Russia, pre-Ukraine

This seems a bit tin foil hat territory, any credible sources?

No none at all. It's my theory and we'll see. Many things can be labelled tinfoil hat territory because they fall outside someone's sphere of awareness. 2 years ago you might have labelled the current commodity wars and Europe's response to them as tinfoil hat territory, and I wouldn't have blamed you because the likelihood seemed low of such events playing out as they have.

With the fire, if you look back at the timing and what was going on with EU and UK energy markets around the time of the fire and some of Russia's signposting at the time, it does look very suspicious. Then with what followed this year it looks even more so. It's just probability, definitely not saying there's any strong proof. I think the probability for it to have been nefarious is higher now than it normally would be for the same fire in a different set of surrounding circumstances, that's all.

The cable-cutting in various oceans around the world has plenty of credible sources which are easily found. You can find them yourself from various outlets. It's happened before and will no doubt continue to happen along with cyber attacks.

[teestub]

The cable-cutting in various oceans around the world has plenty of credible sources which are easily found. You can find them yourself from various outlets. It's happened before and will no doubt continue to happen along with cyber attacks.

Yes this is plenty believable without looking up, what happens on the high seas etc. lots of open space.

Do you think that someone gained access to Sellindge or some sort of computer based action?

I think if someone said that if Russia would invade Ukraine a couple of years ago and that would fuck up wheat and steel due to the majority produced there, (being only a couple of years after Crimea) that would not seem anywhere near as far fetched as Russian sabotage of large scale infrastructure of a Western superpower.

[petejh]

Well, it’s not just ‘fucking up wheat and steel’ though is it.

If 2 years ago someone had claimed that Europe would lose, over a short period of 6 months:
40% of its gas imports
70% of its thermal coal imports
~30% of its oil imports
Along with the steel, wheat etc.
And the threat of nickel (not yet stopped by Russia, one of the cards it has remaining), aluminium, a suite of related petrochemicals and other metals involved in manufacturing.

And that it would lead to the shutdown of European and UK fertiliser producers (input cost too high) and steel producers (ditto).

And that virtually all western commerce would cease trading in or with Russia and divest all assets.

Along with lot of other stuff.. such as Russia’s army (and flagship of t he Black Sea fleet) being decimated by British and US weapons.

I think you’d have said then that the above was highly unlikely.

Do you think that someone gained access to Sellindge or some sort of computer based action?

No idea how they could have managed it, if it was sabotage. Just that it doesn’t seem at all unreasonable to consider it.

[teestub]

I guess your long list comes down to whether you thought it was likely that Russia would invade Ukraine. I didn’t really spend much time thinking about that, but I’m sure plenty in the upper echelons of the forces did. I’m sure any analysis of a Russia military action would have included the trade implications.

Last time I checked fertiliser was still being made at Teeside, but that may have changed. They shut during Covid due to the gas cost until they got a bailout so not unexpected.

[petejh]

Not really. It comes down to a lot of connected things all needing to have occurred for our current situation to have come about. One being Russia invading Ukraine but also Europe’s response. None of what’s happened was obvious or even the most likely outcome.

CF shut their plant in Elesmere, they kept their Teeside plant running by importing US LNG. Not sure if they’ve now shut or are keeping going. But if you take two minutes to research the list of European fertiliser producers that have shut or are doing, you’ll find it’s a long list.

[teestub]

What were Europe’s response options really, let Russia run through a European country unopposed? Do you think there would have been a suitably low level of support that wouldn’t have lead to Russia becoming pissed off and turning the various taps off? Could you imagine Germany having said ‘soz Ukraine but we really do love that gas’.

[petejh]

What were Europe’s response options really, let Russia run through a European country unopposed? Do you think there would have been a suitably low level of support that wouldn’t have lead to Russia becoming pissed off and turning the various taps off? Could you imagine Germany having said ‘soz Ukraine but we really do love that gas’.

What are you talking about? Germany pretty much did!

It can’t have escaped you that Germany and Russia have strong ties, both historically and more recently. The ex political leader of Germany has close business interests in both of the nord stream pipelines, he was instrumental in getting them constructed and his business links profit from them!
He was nominated for the Gazprom board… (turned it down as even he saw it might be too toxic this year, there’s always next).
He’s been slated for recently taking holidays and private meetings with Vladimir Putin.

Germany’s response has come a long way from the early days when they were very reticent to go hard on sanctioning Russia, or supplying weapons to Ukraine. Even today there’s not been one unified European response to Russia, it varies by country. There’s no doubt this ‘divide and conquer’ nature of Europe was what Putin was hoping for more of.

[teestub]

here's an article from 2 days after the invasion with Germany commiting to provide arms 'reversing a historic policy of never sending weapons to conflict zones'.
https://www.politico.eu/article/ukraine-war-russia-germany-still-blocking-arms-supplies/

if Germany were the most intransigent and even they were swayed early on, then there may not be a unified Europe but at least the mjor players are moving in the same direction.

[petejh]

I'm not sure what you're trying to achieve here?  Articles of commitment to sending material are one thing, actions as they say speak very much louder than words. And when you look into what Germany actually sent... comparatively. It's not even remotely questionable to point out how seriously conflicted Germany were at the beginning of the Ukraine invasion.

Which leads to the point about likelihoods, nothing being certain, and Russian thinking... Clearly the plan was to take Kyiv quickly. It failed, but that was never a high confidence outcome as we all remember at the time. If Russia had achieved taking Kyiv and toppled Zalenskyy, as planned, then Germany would have had no time - and arguably no incentive - to come to the position it eventually has arrived at now with regard to sanctioning Russian energy. Germany had the most to lose and the least to gain from severe sanctions and no doubt Putin knew that. Along with other European nations, where the motivation and popular outcry against Russian aggression would have been totally different dynamic in the face of seemingly inevitable Russian domination and success in Ukraine. Instead what has actually happened is Ukraine fought hard and well and slowly got better arms, intelligence and training from the west. That changes the political background, because European populations can see it isn't a lost cause unlike Crimea. Now we have attrition against Russia to the point of the recent Ukraine successes. A quick Russian victory (as in Crimea..) would have avoided all of the last 4 months of battles and Russian losses, and presented a very different background to decision-making for European energy policy. (imo)

 

[teestub]

I'm not sure what you're trying to achieve here?  Articles of commitment to sending material are one thing, actions as they say speak very much louder than words. And when you look into what Germany actually sent... comparatively. It's not even remotely questionable to point out how seriously conflicted Germany were at the beginning of the Ukraine invasion.

Here’s some data on this bit if anyone is interested (Germany 3rd worldwide in total commitments after US and UK)  https://www.ifw-kiel.de/topics/war-against-ukraine/ukraine-support-tracker/

[petejh]

But fourth in supplying ‘military aid’. And quite a large proportion lower than the military aid given by Poland in third.

This being the largest economy in Europe and fourth largest in the world…

And while ‘humanitarian aid’ is also no doubt very important, without the military aid there’d be no Ukraine.

[Oldmanmatt]

I’m still of the opinion that the fire which shut down the IFA UK-France interconnector last year was Russian sabotage and a warning shot by Russia, pre-Ukraine, of the sort of thing it could do to electricity supplies mid-winter to compound the European gas tightness. A disruption to the interconnection system at this time would almost certainly tip the balance into temporary blackouts.

Similar to the suspected Russian sabotage of various undersea internet connections between Svalbard, Greenland, Canada, Iceland in the last few years. If you do some digging around Reuters, Bloomberg etc. it’s considered at least ‘suspicious’.

Interestingly they developed the cable cutting capability as a response to the network of sensors under the Atlantic and pacific which detect Russian subs. I was based for a short time at Brawdy in south wales, where the Atlantic  sensor cables came ashore and the US had a ‘secret’ listening station. Interesting story of them tracking a whale transiting all the way across the Atlantic to provide proof the system works to a disbelieving US Navy.

If you were to, say, look at recent RN purchases, in terms of outside sourced vessels (not built specifically for) and proposed role changes and imminent acquisitions for the RFA (currently under the banner of “research vessels”) and follow the timeline of purchasing decisions. Not to mention the bullshit “hunting Russian submarine too close to North Atlantic cables” rather dramatically stressed in the “Warship” documentary recently… You might find your suspicions reinforced. In truth it’s been a primary doctrine for around five years already and preparation to defend against such was already underway. I suspect the timeline accelerated unexpectedly. I also suspect that the Ukraine timeline was upped by Russia with a view to attending the Samarkand conference in a position of strength, which has backfired, one assumes. I, with only the merest of evidence, wonder how much of both the Ukraine and energy crises have been engineered with this summit in mind. Note Putin’s note post summit, is considerably less strident.

[Oldmanmatt]

Oh! Look! A very fast vessel, perfectly equipped for deploying Clearance divers, Special forces and/or ROVs. That’s handy isn’t it (three similar on order for the RFA, which has slipped under the MSM radar I think).
https://www.royalnavy.mod.uk/news-and-latest-activity/news/2022/july/29/20220729-new-testbed-ship-to-enhance-experimentation-in-royal-navy

[Offwidth]

Latest from Guardian Live feed on the war:

Agence France-Presse reported the foreign minister, Dmytro Kuleba, as saying Germany’s decisions were a “mystery” and that there was a “weapon wall” in Berlin that the chancellor, Olaf Scholz, had to tear down.

Kuleba said in an interview with German newspaper the Frankfurter Allgemeine Zeitung, published online:

We ask for Leopard tanks and Marder [armoured vehicles] and Germany supplies armoured vehicles of the Dingo type

We are grateful for them. But that is not what we need most in combat ... What is the problem? Why can’t we get what we need, and what Germany has?

[Oldmanmatt]

I’m still of the opinion that the fire which shut down the IFA UK-France interconnector last year was Russian sabotage and a warning shot by Russia, pre-Ukraine

This seems a bit tin foil hat territory, any credible sources?

I meant to add my tuppence worth to this.
This sort of thing is exactly why we and everyone else have Special Forces units. It is not in the least bit far fetched, nor is a lack of evidence even slightly surprising. I know I have been serving on various vessels that have been suddenly diverted for dark pick ups after “things” have happened. Usually these things are subtle, fishing nets jamming power station cooling intakes or catching on ships shafting etc etc. Sometimes they’re not, like limpet mines on Greenpeace ships or Nerve agents splashed around sleepy English cities. Or car bombs under academics seats. Or terrorists gunned down on Garage forecourts on British territory. Of course you hear about the ones you’re meant to hear about, but there are plenty of others that only a few are aware of. Oh, and then the ones that you weren’t meant to hear about, but something went wrong. Russia used weapons of mass destruction on British soil, very recently; why would sabotage of a power relay be less likely? This is not to say that that’s what happened.

[petejh]

I’m still of the opinion that the fire which shut down the IFA UK-France interconnector last year was Russian sabotage and a warning shot by Russia, pre-Ukraine

This seems a bit tin foil hat territory, any credible sources?

No none at all. It's my theory and we'll see. Many things can be labelled tinfoil hat territory because they fall outside someone's sphere of awareness. 2 years ago you might have labelled the current commodity wars and Europe's response to them as tinfoil hat territory, and I wouldn't have blamed you because the likelihood seemed low of such events playing out as they have.

With the fire, if you look back at the timing and what was going on with EU and UK energy markets around the time of the fire and some of Russia's signposting at the time, it does look very suspicious. Then with what followed this year it looks even more so. It's just probability, definitely not saying there's any strong proof. I think the probability for it to have been nefarious is higher now than it normally would be for the same fire in a different set of surrounding circumstances, that's all.

The cable-cutting in various oceans around the world has plenty of credible sources which are easily found. You can find them yourself from various outlets. It's happened before and will no doubt continue to happen along with cyber attacks.

https://www.theguardian.com/business/2022/sep/27/nord-stream-1-2-pipelines-leak-baltic-sabotage-fears

This isn't anything at all to do with Russia signalling to the EU and UK what it will do to a north sea oil/gas pipeline this winter should they feel they need to use that leverage. Nope, nothing like that going on here.

[teestub]

Obvious false flag ordered by Truss to take people’s attention away from the economy in the only way possible, by starting WW3.

[petejh]

Good shout. No cost of living crisis to worry about when there’s hardly anyone living.

[moose]

Can't Russia just shut down the supply through the pipes whenever it wants (I thought they had already had partial shutdowns and cited maintenance etc?), without having to do something so obvious and permanent as sabotage?  Or am I missing the point, and the brazen will to destroy and intimidate is the message?

[SA Chris]

My thought exactly moose. All a bit suspicious.

[Oldmanmatt]

It is not a secret that Russia has been interfering with, charting and surveying both cables and pipelines for many years now. A considerable amount of RN resources have been tied up with countering that activity and doctrine is heavily weighted in that direction. Much of the current purchasing is aimed in that direction. It was partly why I was recruited for the OPV project when the batch 1 River Class were pulled out of mothballs, then later (when they opted for a different approach) into the RFA, with a view to building up appropriate manpower for they’re new, smaller vessels, tasked exactly with this mission.
On the other hand, right now, it’s hard for Russia to operate in the North Atlantic, because of those recent changes in defence priorities. The Baltic is another matter. It is not covered by the UK/US navies to anything like the same degree. It would be quite the “point”, perhaps, to carry out the sabotage close to NATO territory, even if it is a lightly defended part. Also, out of the Atlantic SOSUS coverage. US Helos operating in that zone, would be highly unlikely to be engaged in sabotage (that’s an underwater activity, Subs, Divers etc), but they are the primary anti-submarine weapon of both US and UK fleets.
The Russian surface fleet has been allowed to degrade significantly, they have concentrated on subsurface warfare for the last two decades, there they’re capabilities are quite formidable.
Russian sabotage and making a point, is an entirely plausible scenario and the Baltic very vulnerable to such actions.

[SA Chris]

It's also been done / happened somewhere where it will be a pain to fix. Someone nearby with buckle spread and a DSV or two could earn a lot of money.


Info on the challenges here

https://www.offshore-mag.com/pipelines/article/16761444/precommissioning-the-nord-stream-pipeline

[petejh]

Some decent analysis here:
https://www.telegraph.co.uk/world-news/2022/09/27/putins-nord-stream-2-sabotage-sends-warning-will-blow-pipes/
https://www.telegraph.co.uk/world-news/2022/09/27/how-putin-could-have-carried-nord-stream-attack-may-have-set/


I also wonder if they needn't even use submersibles in this case. They own the pipeline, pipelines get pressure tested and cleared using slug-clearers (pigs) fired along them. (I only know because I once was hanging off a pipeline in an oil-sands refinery in Canada when a maintenance contractor fired a pig through it, scary as hell.)
I wonder if they could have sent a sort of specially engineered slug down the pipelines programmed to exploded at a set point.

[SA Chris]

Highly unlikely, remnants of some sort would come out the other end, or be found when they eventually pig the line. Easier just to use a trained diver and a small vessel. The extent and type of the damage will determine how easy it is to fix.

[Oldmanmatt]

https://en.m.wikipedia.org/wiki/Seafox_drone

Used extensively by the RN.

Could I perhaps point out the line “to clear mines OR OTHER OBSTACLES it is tasked with clearing”.

This is 20 year old tech. There are autonomous equivalents in operation now.

Something similar, dropped over the pipe line at it’s max range, programmed to follow the pipe until it cannot go any further and “clear” the obstacle.

Loitering and autonomous munitions are not just the preserve of the skies.

I would think it more likely than pre-placed munitions which might (likely would have been) found.

[Johnny Brown]

I read on twitter the apparently informed opinion that you wouldn't need to interfere with the pipeline directly, just shut down/ suddenly reduce the input pressure without telling the output end, and the pipe would rupture at the weakest (deepest?) point due to reduction in internal pressure.

No idea if that's true but sounded vaguely plausible?

[SA Chris]

I don't think it's possible with gas, can be done with a downhill fluid pipeline, but there are lots of sensors and failsafes in place to stop being able to do anything like this, mostly likely controlled from a remote location.

[duncan]

Gazprom has just announced that they are going to stop pumping gas through Ukraine (it's a bit more complicated than just turning the tap but that'll be the effect).

Russian sabotage and making a point, is an entirely plausible scenario and the Baltic very vulnerable to such actions.

One explosion could be an accident, three in quick succession in the same place looks like carelessness. Neither pipeline are going to be used in the short or medium term and both could be repaired within that timescale. Damaging them is not going to change gas supply this winter. This is theatre, like poisoning people with Novichuk or Polonium.

"You've got a nice gas field here ... we wouldn't want anything to happen to it"

(1'45")

This feels like a concerted attempt to put more stress on European gas costs in the hope support for Ukraine will start to unravel.

[petejh]

Yes. But it's much more than theatre. There are real consequences to the European energy market being stressed beyond a certain point.

Russia's intention seems to boil down to a well thought-through strategy to crash the European energy market (and thus the European economy) due to the mechanism by which the energy market (all commodities markets) operate. Energy producers hedge their own sales against downside risk to guarantee their sale price. The mechanism to crash the market is:
1. for those hedges to be margin-called due to increases in gas price.
2. the margin calls go so high they can't be met.
3. energy producers default, banks lose trillions.
4. European credit evaporates, manufacturing base and European market collapses, takes down the European economy.
5. Central banks step in with massive support/stimulus.
6. (imo) Ukraine losses prominence and priority. Russia keeps gains. World continues on into the energy transition towards net zero etc. with a new economic backdrop in which the west have far less leverage over certain parts of the world (inc. Russia) that have the raw materials required for the energy transition.

In essence another 2008-style collapse due to margin, requiring massive central bank intervention.

It appears that Russia's intention now is to create the conditions for this overall crash to occur, through the further squeeze on gas and signalling suggestions of future sabotage. Necessitating the EU and UK central banks to step in and bail out the energy producers and prop up the failing economy to the tune of global financial crash proportions. In those economic circumstances support for Ukraine would be hard to sustain. That is Russia's hope.

Below is the theory (and how traders may seek to gain from it) in a bit more detail from an analyst. People can DYOR to find the source. This is info, I'm not saying I condone anything. If accurate it highlights again why so much of the leverage behind this war boils down to markets and commodities whether people like it or not.

European Energy's "Lehman" Moment - Is There A "Tepper" Play?
Market risk is now arguably at its highest point since March 2020 when COVID crashed global markets. Central banks led by the Federal Reserve look set to continue hiking interest rates to combat inflation, meaning a very real risk of recession via a “hard landing.” And all this is happening as the war in Ukraine continues to escalate and the European energy crisis deepens. As such, now is clearly not the time to be aggressive, but rather to be cautious, thoughtful and patient in searching for opportunities in public equities.

Against this backdrop, in recent weeks I’ve been trying to think ahead of current events in anticipation of future market “sale windows.” In last week’s Bulletin #28, I discussed how there may be a window (or even a wave) of opportunity in Q4 and coming into 2023 as underperforming hedge funds hit by this year’s “tech wreck” will likely see significant investor redemption requests. I expect this to result in forced selling by these hedge funds to meet redemption calls, thereby creating a potential opportunity for value-focused investors to pick up equities at depressed valuations.

I also think another area of possible opportunity is the recently posited “Lehman moment” for the European energy market. This has been a market narrative that has gained traction in recent weeks, following Equinor’s warning that the European energy trading market faces possible collapse with margin calls of at least $1.5 trillion. The warning essentially indicates that the current energy crisis risks turning into a financial crisis that could collapse the wider European economy.

At the core of the issue is how electricity is traded and supplied. European electricity producers (i.e. utilities) typically hedge their sales by going short electricity futures contracts until they actually produce and sell power into the market. This allows these producers to lock in their selling price for the power to be sold. However, as power prices have again surged (due to Russia cutting of the gas supply into Europe), these hedges have resulted in very large paper losses for utilities, requiring them to post additional collateral with their hedge counterparties (brokers, banks or power exchanges).

The feared implication of these margin calls being unmet is economic disaster for Europe, moving quickly from major disruption in power markets, to financial crisis among utilities, banks and power exchanges, to the shutdown and likely collapse of the European manufacturing base and ultimately the European economy. This is the Lehman scenario for European energy, and is another possible instance of financial markets rhyming with history - essentially ongoing losses from electricity contracts and a collapse in energy supply could trigger a European economic crisis, similar to how subprime contagion triggered the GFC in 2008/2009.

Hence the various support measures and bailouts across Europe recently, most notably Germany’s €29bn nationalisation of Uniper, Sweden’s provision of €23bn in credit guarantees as emergency liquidity support to various utilities, Finland’s €10bn loan and guarantee scheme and the UK’s £40bn energy bill bail out for businesses via a price cap plan. To date, the cumulative cost of various emergency support measures has been estimated at ~€500bn - but note this is before winter has even arrived, and before yesterday’s news regarding the possible sabotage of the Nord Stream 1 and 2 pipelines and the threat of a total cut-off of Russian gas into Europe via Ukraine. It therefore remains to be seen whether the measures to date will be sufficient to avoid a Lehman scenario in Europe.

In considering this frightening scenario, it also strikes me that opportunity is often the partner of crisis, and in this context I’m prompted to recall the opportunity amid the original Lehman collapse. Specifically, I’m reminded of David Tepper’s play on US banking stocks in February/March 2009, right near the bottom of the GFC market crash. CNBC recounted Tepper’s rationale for betting on bank stocks at the time:

Tepper was sitting on a pile of cash, having sold out of most of his positions in the spring of 2008, and didn’t have any debt. So when the U.S. Treasury put out a white paper in February 2009 announcing its Financial Stability Plan, which included the Capital Assistance Program designed to shore up the capital of banks, he took his time and read the fine print.

The white paper and term sheet said the preferred stock the government was buying in the banks would be convertible to common shares at prices far above current trading levels at the time — which meant it was indeed a time to buy, buy, buy.

So he did. The fund began amassing sizable positions in bank-related securities: common and preferred shares, and junior-subordinated debt, to be exact. His targets, Bank of America and Citigroup in particular, as rumors circulating that the banking behemoths would be nationalized in early 2009 edged the stocks to near collapse.

Tepper was able to buy Bank of America preferred shares at just twelve cents on the dollar and Citigroup bonds at just nineteen cents. As those stocks rallied by the end of 2009, Appaloosa raked in the billions.

Looking at a chart of five bank common stock positions disclosed as being held by Tepper’s Appaloosa Management around that time (Citigroup, Bank of America, Wells Fargo, Fifth Third Bancorp, Capital One and Hartford Financial), their performance in the subsequent ~15 month period from when the U.S. Treasury published its Financial Stability Plan in February 2009 was an average return of ~344% across this basket of five names:


I believe the Tepper play on banking stocks during the original Lehman crisis is instructive for how investors might approach any Lehman-like moment today in the European energy market.

A current example of such an approach is the Uniper bailout itself which triggered a relief (or escape?) rally for Uniper’s previous majority shareholder Fortum Oyj (FORTUM:FH), which is up ~31% MTD:


To be clear, I do not believe we are at an equivalent moment of apparent collapse for Europe yet as the US financial system was post-Lehman in early 2009, but it is a scenario worth preparing for. Energy is essential for economic activity as the current crisis has proven, and it is perhaps now the ultimate “too big to fail” sector, meaning a Lehman-like scenario could put the European energy sector into play at very depressed valuations with the benefit of government backstops.

My current thinking means I am actively monitoring some selected European energy-related names, specifically in the utilities and energy services sub-sectors where there is some government ownership and diversified business models (i.e. activities spread across traditional energy, transition fuels and renewables, and other adjacent markets).