The article below is from our BRIEFINGS newsletter of 30 September 2021
Bundle up this winter. Rising power and natural gas prices are pushing up bills for households across Europe and the U.S. At the Goldman Sachs Asset Management Forum, Kaelyn Lucas and Joanna Saw from the corporate credit team explain the drivers that are moving prices up and the outlook for corporates and consumers.
What’s driving power and natural gas prices to record highs across Europe?
Joanna Saw: Soaring natural gas prices are feeding into power prices, so as gas prices have jumped by 2.5 times year-to-date, we’ve seen power prices roughly double across Europe over that period. It’s really due to a perfect storm of events: A long winter drove demand during key periods when gas supplies are normally refilled and stored for the winter; cargoes of liquefied natural gas have been redirected from Europe to Asia; and Russia, a key exporter of gas, has slowed exports to Germany and the rest of Europe. All of these factors are resulting in higher power prices and, in fact, generating stronger demand for coal which is also seeing higher prices due to carbon pricing. The U.K. is being particularly squeezed given that the country is a net importer of power from France and Ireland, which have both been tightening exports.
What are the implications in this case for investors?
Joanna Saw: Invariably there will be winners and losers from these record commodity prices. We think the net winners will be investors who are long energy prices, such as large energy and power generation companies, while the net losers and those who will be most exposed are the buyers and suppliers. Households can also expect to pay higher utility bills given that 30% of the costs are tied to gas and power prices. U.K. utility bills, for example, are set to increase by 12% for the winter period due to price increases over summer 2021. And, with current forward prices, bills are expected to jump 25% further for the summer of 2022, which will hurt households’ disposable income and boost inflation expectations for next year. The utilities in the U.K. are particularly hampered by a consumer energy price cap that was introduced in 2019 by the regulator Ofgem, which limited utilities’ ability to pass on rising wholesale prices to customers (the price cap is reviewed by Ofgem every six months). As a result, many utilities are now struggling to absorb the higher costs; in some cases, the smaller utilities are shutting down.
And what does the situation look like in the U.S.?
Kaelyn Lucas: In the U.S., natural gas prices are approaching levels that we haven’t seen since 2014, with a 30% run-up in U.S. Henry Hub natural gas prices. In fact, this is the first time gas prices have broken above the $5 per million BTU threshold since then. Overall, we can also expect to see higher winter heating bills for customers and higher costs for utilities. Similar to what Joanna notes, this is really a perfect storm of events in the U.S., where an unprecedented heat wave reduced the availability of gas to store for the winter months. We’ve also seen relatively flat gas production and record exports.
How will the electric and gas utilities manage the higher costs?
Kaelyn Lucas: The impact on gas utilities should be relatively neutral, as costs are likely to be shouldered by their customers. In fact, we haven’t seen much bond price reaction because the expectation is that utilities will pass on the higher prices to consumers via regulatory mechanisms. Transmission and distribution utilities—which have less coal and gas exposure—will tend to fare better than natural gas utilities, which cannot switch fuels to more economic inputs such as coal and wind. But to the extent this situation persists, it could make investments in decarbonization and other capex more challenging for the vertically integrated electric utilities, while increasing the utilization of coal—and carbon emissions across the industry—in the near term.
The main impact, of course, will be customer affordability: The gas utilities have benefited from a decades-long tailwind of a declining cost environment, resulting in lower customer bills. Across the U.S., the average heating bill is around $60 a month and 40% of that can be attributed largely to purchased gas costs. So a 50% increase in the cost of gas would equate to a 20% bill increase. Over the long term, if higher prices persist and become the new equilibrium, this could potentially force U.S. households to allocate more of their income to paying gas bills while limiting utilities' ability to raise rates absent regulatory intervention.