Is gas-fired power back in the money?
Wholesale gas prices collapsed at the end of 2022, making gas-fired power generation profitable in Europe for the first time in months. But the economics of gas power plants remain extremely challenged, while those of renewables are still much more compelling.
Ultra-expensive gas rendered gas-fired power unprofitable for much of 2022
Recent falls in wholesale gas prices briefly reversed that situation
Gas plant profitability could easily flip negative again, temporarily benefitting coal
Economics still favour switching from coal to wind or solar PV plus battery storage
Marginalising gas in Europe would alleviate pressure on Asian economies and reduce coal burn
Europe’s fleet of gas-fired power generators were among the big losers from volatile wartime gas prices in 2022. Soaring fuel costs pushed gas power plants into the red. To avoid incurring losses, EU gas power plants pared back production by 16 TWh (2%) in 2022 compared to the three-year average. Coal picked up the slack, with gas-to-coal fuel switching making the headlines in several western European power markets.
After a wild ride, last year ended with a major correction that brought the EU benchmark gas price back below the level it was trading at prior to Russia’s invasion of Ukraine. This improved the economics of gas-fired power, but not enough to prompt widespread fuel switching from coal back to gas.
The European Union’s policy to refill gas stocks to 80% before this winter proved to be highly successful. A combination of brimming EU gas stocks, a flood of liquefied natural gas (LNG) imports and the onset of abnormally warm winter weather triggered a precipitous decline in the price of gas trading on the Title Transfer Facility (TTF), the Dutch gas trading hub.
Europe’s sudden switch from gas undersupply to gas glut drove wild price swings on TTF. The front-month contract cratered from its mid-summer peak of almost €250 per MWh in August to less than €60/MWh in the first weeks of 2023. Since gas is the price-setter for power generation across much of Europe, power prices declined sharply in some key EU markets, recasting the economics of coal- and gas-fired power.
The surge in TTF gas prior to February 2022, and the energy market frenzy that followed Russia’s full invasion, pushed combined-cycle gas turbine (CCGT) power plants firmly out of the money. The price of thermal coal soared too, but coal-fired power remained cheaper than gas on a per-unit basis. The upshot was a brief revival in coal, evidenced by gas-to-coal switching.
Fuel switching occurs when the profitability of one power source surpasses that of another. Profitability is calculated by deducting the cost of fuel from the power price. In power markets subject to carbon pricing, the calculation must also factor in the cost of buying allowances to cover the amount of CO2 emitted by each power plant. For gas, this profitability calculation is known as the ‘clean spark spread’. For coal, it is called the ‘clean dark spread’.
Germany’s fuel switch shimmy
Market data compiled by TransitionZero shows that for an illustrative German CCGT with a typical plant efficiency of 56%, the clean spark spread (CSS) started 2022 in negative territory and stayed there for most of the year. The German CSS hit a nadir of -€140/MWh when Russian troops stormed into Ukrainian territory, and averaged -€16/MWh throughout 2022.
This means that an unhedged CCGT buying fuel and selling power in month-ahead markets would have lost on average €16 for every megawatt-hour it generated. In the absence of hedging to lock in preferable gas and power prices months or years in advance, such a plant would have shut down and re-sold any contracted gas supply back into the open market.
For coal plants, the story was rather different. For a typical 42% efficient German hard coal or lignite plant, the clean dark spread (CDS) averaged a healthy €67/MWh throughout 2022 – despite the cost of coal imported via Rotterdam almost tripling in price between January and July.
The recent collapse in the TTF gas price pushed the clean spark spread back into positive territory in December. With EU gas stocks nearing maximum capacity, these prices are a signal to decrease LNG imports into Europe and increase gas burn in the power sector to help the gas market achieve balance. The impact was a tangible increase in German CCGT generation at the tail-end of 2022.
Overdose of uncertainty
The surprise of gas prices plummeting in the depths of winter during a supposed wartime energy crisis has torn up prevailing narratives. Some analysts speculate that gas prices will remain depressed for months, allowing latent demand to return as lower energy costs enable some mothballed industrial activity to resume and underutilised CCGTs to ramp up output.
In reality, the only certainty is more uncertainty. Lower fuel costs are no panacea for gas in Germany, the EU’s largest coal-fired power generator, because gas profitability (CSS) has not overtaken that of coal (CDS). While futures markets indicate a convergence in clean and dark spark spreads in 2023/4, this alone will not prompt a resumption in coal-to-gas fuel switching. The clean spark spread struggled to stay above zero in the first weeks of January 2023 and, as recent events have proven, energy markets are notoriously fickle.
Numerous factors could tip the balance this year: China’s reopening and renewed appetite for LNG is likely to trigger a rebound in gas prices globally. Unaffordable prices have already forced a 20% reduction in total EU gas demand, raising questions around whether deindustrialisation will be reversed or become structural, lowering the baseline for gas consumption over the longer term. The EU’s incoming gas price cap, the availability of French nuclear and Norwegian hydro, Russia sanctions and the weather are all potential wild cards.
The decarbonisation discount
The renewables megatrend shows no signs of abating, regardless of what happens to wholesale gas and coal prices. The falling gas price might have brought CCGTs back into the money, but it barely dented the deep discount offered from switching to zero carbon power sources. The levelised cost of energy (LCOE) of wind and solar is far below both coal and gas, which means that switching from coal directly to clean power sources still makes more economic sense than transitioning via gas.
TransitionZero’s Coal-to-Clean Price Index, which tracks the economics of coal, gas and renewables-plus-storage in 25 countries, shows that this holds true even in the unlikely event that the carbon price were to turn negative. At today’s prices, coal-to-clean switching in Germany offers an economic saving even if carbon-emitting power sources were subsidised to the tune of $61 per tonne of CO2.
There are many reasons to doubt whether coal-to-gas switching will resume in 2023. Gas supply and demand are both subject to heightened uncertainty, with a high likelihood of fresh price volatility.
Gas has a lower carbon footprint than coal, so further price spikes and negative clean spark spreads would entail a climate cost in terms of extra emissions. But to fixate on this is to lose sight of the bigger picture: expensive gas will underpin the economics of coal-to-clean fuel switching and, if sustained, accelerate the transition to decarbonised electricity both in Germany and across Europe.
Europe’s gain, Asia’s pain
Europe, once the ‘market of last for LNG’, is now driving global gas trade dynamics. In 2022, the conventional ‘Asian premium’ for gas was turned on its head. European buyers outbid Asian rivals, paying a premium to secure available spot LNG cargoes and refill EU gas stocks. European LNG imports broke new records, helping to turn the EU’s gas storage deficit into a healthy surplus that few anticipated at the start of 2022.
Europe achieved its gas restocking target at the expense of emerging markets. As gas market tightness loosens, the Asian premium is returning, particularly amid a harsh cold spell in the region. But it is far from certain that price-sensitive Asian economies will return with a vengeance to spot LNG procurement.
Futures data suggests that the market is undecided on what the immediate future holds for gas in Europe and, as a result, Asia. Spot developments in recent weeks have yet to be built into negotiations over long-term LNG sales and purchase agreements (SPAs). As a result, LNG is expected to be priced at a premium throughout 2023/2024.
What this means for emerging Asia in the immediate term is that LNG buyers will continue to feel the pain, with affordability being an ongoing theme. Longer-term, the pains of $30/MMBtu spot LNG will continue to cast a long shadow over upcoming LNG-reliant gas infrastructure buildout in the region.
Marginalising gas
The fate of European clean spark spreads is a cautionary tale for Asia. If baseload gas-fired power generation is uneconomic in wealthy western economies, how can developing or middle-income countries afford a gas-based transition? This conundrum places greater importance on European decarbonisation and energy efficiency measures.
The quicker Europe reduces gas demand and rolls out wind and solar power, the less gas it will need to procure from global LNG markets at the expense of coal-reliant Asian economies. Gas will continue to play a role filling in the gaps, but in the face of heightened volatility and absent Russian piped exports, pushing gas to the margins of the European energy mix is a no-regrets course of action.
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