Spikes in energy prices have been a common phenomenon for decades. As the global economy recovers from the Covid-19 pandemic faster than expected¹ and a cold winter drives up demand for energy, one would expect some degree of cyclical and seasonal increase in global energy prices.

Yet, the volatility that gas markets experienced last December is unprecedented: On 21 December 2021, the price of gas futures on the Dutch Title Transfer Facility (TTF), a European benchmark for natural gas trading, reached €179 per megawatt hour (MWh).² At its peak level, gas prices in Europe had increased by 842% in 2021. This led to a demand shift from gas towards coal, which in turned propelled EU carbon prices to an all-time high of more than €90 per ton. This created additional cost pressures for manufacturers, power companies and airlines that need to purchase those carbon certificates.³

Even though natural gas and wholesale electricity prices have eased back from record levels at the end of last year (see Figure 1), markets are far from cooling down – and this is due to several structural reasons.

So, what does this outlook mean for Germany? How does the current situation affect the competitiveness of local corporates? And what measures can they take to best prepare for a prolonged period of elevated energy prices?

“We are currently facing a ‘perfect storm’ of elevated demand, low supply, high taxation and a geopolitical conflict – and all this is taking place during energy transition,” says Marc Müller, Head of Corporate Coverage for Germany, Austria and Switzerland at Deutsche Bank. Germany will have shut down its remaining nuclear power plants by the end of this year⁸, while the newly formed government plans to accelerate the phasing out of coal production by 2030 instead of 2038⁹.

“We see utilities bolster liquidity buffers and collateral capacity”
Marc Müller, Head of Corporate Coverage for Germany, Austria and Switzerland at Deutsche Bank

In the short term, there are three risks, that German companies face:

This is particularly true for utilities, producers and commodity traders as these companies typically hedge their exposure to price changes with derivatives. But “with high price volatility, they might face higher liquidity in-/outflows due to margin calls and increased collateral requirements,” Müller explains. “This is why we see utilities bolster liquidity buffers and collateral capacity.”

The cash demand can either be satisfied via new liquidity lines or by tapping capital markets, he says. Alternatively, Müller observes, trade guarantees are also becoming more popular as collateral.

For commodity traders, the situation is slightly more complex, says Frank Uhlen, Head of Corporate Coverage Commodity Traders EMEA at Deutsche Bank: While “higher volatility is usually beneficial for commodity traders allowing for arbitrage opportunities which could result in increased profits”, the general increase in commodity price levels combined with unprecedented high volatility though is stressing balance sheets and posing significantly elevated liquidity risks.

“If these companies have a proper risk management in place and can secure the required liquidity to meet their margin call obligations, they potentially can even benefit mid-term”, Uhlen says, as “some commodity houses likely sit on favorable assets waiting for profit realisation over time”.

The second risk – increasing energy costs – is something that affects energy-intensive industries such as, for example, manufacturing, chemical or steelmakers. “These companies are facing significant profitability challenges, in case of continued elevated energy cost,” says Müller. “We, as a bank are helping our customers to bridge these difficult times.” According to Müller, additional limits have been allocated in order to ensure liquidity (for collateral) and lending (for financing alternative energy supplies) is available when needed. “In the energy crisis, we will be part of the solution just like we have been during the pandemic.”

At the same time, he states, that the German government should consider a “re-opening of KfW pandemic toolbox” to support the economy.¹⁰ “During the pandemic, we saw that our government has successfully provided financial support,” Müller says. “In the energy market, this would also be possible by accelerating the incentive to drive the energy transformation. This would not only foster innovation and technological leadership but simultaneously lower the dependency on current energy supplies. In addition, temporarily lowering energy taxes could be a short-term measure to relax the pressure on consumers and assist the competitiveness of Corporate Germany.”

The third risk – a disruption of the energy supply, which would of course be the most extreme and least likely – would affect every company. On 22 January 2021, German gas storage facilities were less than 42% full, which is the lowest value for at least 10 years.¹¹

Germany currently imports around two thirds of its total energy consumption from abroad. For gas, Germany receives more than half of its supply from Russia¹² – which is why the country and its economy are particularly exposed to the risk that Russian President Vladimir Putin might turn the gas taps off as a bargaining tool in the diplomatic talks with Ukraine.

Should that happen, the big question is who could step in to fill the gap. Norway, which is Germany’s second biggest gas supplier and accounts for one third of the country’s consumption, “currently delivers as much as we can”, according to its prime minister Jonas Gahr Støre in a 20 January interview with the German newspaper Frankfurter Allgemeine Zeitung¹³.

“German electricity prices are already among the highest in the world and considerably above the EU average. This weighs on Germany’s position as an economic hub”
Stefan Schneider, Chief German Economist at Deutsche Bank

While increasing electricity prices are not just a German phenomenon¹⁴, the level Germany comes from is much higher, says Stefan Schneider, Chief German Economist at Deutsche Bank: “German electricity prices are already among the highest in the world and considerably above the EU average”, he reflects. “This weighs on Germany’s position as an economic hub.”

According to the Deutsche Bank Research report, For a more successful energy transition: Down with electricity prices published in September 2021, gross prices (i.e. prices including taxes and fees) for commercial customers were 43% above the EU average in H2 2020 - although after excluding taxes and fees, the difference amounted to only about 8%.

Schneider therefore recommends that policymakers reduce the state components of electricity prices as quickly as possible. “They could, for example, abolish the renewable energy surcharge.” According to him, this would be necessary to enhance private investment to shift those industrial processes, currently still reliant on coal, natural gas or oil, to using electricity from renewable sources. Right now, coal still dominates the German energy mix, followed by wind power and nuclear energy (see Figure 2).

Sources

¹ See https://bit.ly/3fYQBGm at oecd.org
² See https://bit.ly/3IEpi0r at theice.com
³ See https://bit.ly/33ZUcl0 at spglobal.com
⁴ See https://bit.ly/3rTVlmn at ecb.europa.eu
⁵ See https://cnn.it/3o1AU5E at cnn.com
⁶ See https://bit.ly/3u4sLkE at ec.europa.eu
⁷ See https://bit.ly/3g3gAfK at ecb.europa.eu
⁸ See https://bit.ly/3G63F7i at euronews.com
⁹ See https://bit.ly/3G9Bm8a at spglobal.com
¹⁰ See Germany’s lockdown lending at flow.db.com
¹¹ See https://bit.ly/3r6T3Bb at agsi.gie.eu
¹² See https://bit.ly/3ACSWR1 at statista.com
¹³ See https://bit.ly/3rXWCZk at faz.net
¹⁴ See https://bit.ly/3u2LYDr at iea.org