From weather to war

The Kremlin's war against Ukraine is currently causing severe disruption to international energy markets. Petroleum products, coal, natural gas and electricity prices are soaring once again, following last year’s turbulence.

Over-the-counter trading (OTC), the European Energy Exchange (EEX) in Leipzig, and the European Power Exchange (EPEX SPOT) in Paris – all are critically important for electricity trading. They are also where the market prices for Switzerland are set. In the following article, we now take a look at the spot markets, where transactions with short delivery periods are made, and discuss their most important features.

Natural gas prices drive up the cost of electricity . . .

Just a look at 2021 shows the diverse factors that influence the price of electricity.

On the one hand, the European economy was recovering after the pandemic-related slump, while the winter of 2020/21 was unusually severe. In addition, nuclear power plants in France were shut down for maintenance.

The gap in European supply had to be filled by the additional generation of electricity from coal and gas plants, which is bought on the spot market. That makes electricity more expensive, as the spot price is determined by the most costly power plant still needed to meet demand. This is required by the merit order procedure (Box) in force at electricity exchanges and on which the EU internal electricity market is based.

However, gas storage was not at sufficiently high levels during the summer, while in northwestern Europe there was an unusual lull in wind for the time of year, further boosting demand for natural gas. On top of that, demand for natural gas and LNG was high in Asia, there were a large number of weather- and corona-related supply disruptions in the global gas and coal markets, and sluggish additional supplies from Russia. Concerns about a possible disruption or restrictions to the supply of Russian natural gas also pushed up prices.

. . . while costly CO2 certificates drove prices even further

Another cause of higher electricity prices was, and remains, the high prices for CO2 certificates. CO2 emissions such as those emitted by gas-fired power plants have to be covered by certificates purchased through the EU’s Emissions Trading Scheme. As a result of the EU's increased efforts to reduce emissions, prices for these certificates have also risen.

Price drivers for electricity on the spot market at a glance:

• Fossil fuel prices (natural gas, oil, coal) and CO2 certificates
• Politics and regulation (geopolitics, energy system restructuring)
• Weather and seasonal changes (wind, solar radiation, water level)
• Generation (availability of power plants)
• Load (demand for electricity)

What do high electricity prices mean for our household budgets?

In Switzerland, the electricity market is partly liberalised. Only customers with an annual consumption of more than 100,000 kilowatt hours of electricity have had access to the free market since 2009. Today, around two-thirds of large customers make use of this right. Market prices apply to them.

The purchase or sale of a certain amount of electricity is usually agreed in advance for a period of two to three years. This means market prices are reflected in the income statement, with a corresponding delay.

In contrast, households and commercial customers, as well as large customers with market rights who waive their right to market access, are part of the regulated market and tied to their local energy supply company. The market price is also decisive for the electricity that a utility procures and purchases. If an electricity company has its own production facilities, however, the Swiss legislator (box "Price Supervisor ElCom") stipulates how the cost of this electricity must be calculated.

The actual price of electricity (‘energy purchase’ in the table below) accounts for just one third of the total cost to the consumer, thus making our electricity bill less expensive than might be feared on the basis of recent developments. However, because that price is based on forward sales, it should be noted that there is a delay before the current price comes into effect.

The price of the electricity that finally comes out of the socket, i.e. the electricity tariff, is made up as follows:

And what do high electricity prices mean for producers and energy traders like Axpo?

The price increase - caused by fossil power plants abroad - is positive for energy producers in Switzerland, especially for the operators of hydroelectric and nuclear power plants. The owners of power plants win because of the increased prices; but as previously mentioned, the price increase will be delayed due to forward sales.

In addition, financial collateral must be deposited for forward sales. The amount of cash to be provided depends on the price level and volatility – which have both been, and currently remain, very high.

So the challenges are on the liquidity side – having enough cash available to make those deposits. However, energy trading market participants do get their collateral back as soon as they have delivered the electricity. The money is effectively just sitting in a blocked account until the contract is fulfilled.

Collateral deposits are required because exchanges want to protect themselves against the risk of a producer having difficulties delivering the agreed quantities on time. The exchange would then have to procure replacement power for the buyer on the spot market, at significantly higher prices than those originally agreed.