Over the past two years, natural gas prices have more than doubled. Those of us who use gas every day, such as for cooking and heating our homes, have seen enormous cost increases but many are unsure why. So what has happened? Everything. A combination of economic and geopolitical factors have created a price shock. While the cost of gas has substantially recovered since the initial outbreak of COVID-19 and the subsequent 2020 lockdowns, the Russian invasion of Ukraine has pushed prices even higher than those seen during the pandemic. This has been further exacerbated by a range of domestic factors, such as a limited coal supply and government policies.
Background
Gas prices rise and fall, often with the price of crude oil. The price of oil as a global commodity is determined primarily by global supply and demand. Australia is a net exporter of gas and coal, meaning most of our fossil fuels are exported overseas. Subsequently, as the global price of coal increases, the cost of generating domestic electricity from coal is also increasing. This price spike is coinciding with coal plant owners looking for the exit as a result of the growing popularity of renewable energy. For example, Origin announced Australia’s largest coal plant, Eraring, would shut down in 2025, seven years ahead of schedule, because of the increase in the use and profitability of renewable energy.
In an attempt to meet rising electricity demand and a lack of supply, some energy generators have increased gas-powered generation. However, as Australia exports much of its gas resources, any additional gas for domestic consumption must be bought from within the rising international market. Yet, gas prices internationally have been severely impacted due to a number of factors over the last two years.
COVID-19 Pandemic
When the pandemic hit, the world shut down. Oil prices fell sharply because there was little demand and production subsequently also slowed. As people could not go anywhere, and industries were closed, there was simply less need for both oil and gas.
However, as vaccines became widely available towards the end of 2021, many felt comfortable travelling again and businesses returned. More vehicles took to the road and more planes took off. The demand for oil and gas climbed, but supply could not catch up because of the COVID lockdowns. This was the first wave of increasing gas prices.
By early 2022, supply and demand seemed to stabilise. Enter Vladimir Putin.
Invasion of Ukraine
When Russia invaded Ukraine in late February 2022, prices shot back up. This invasion has disrupted the global energy market. It prompted international governments to speak out in Ukraine’s defence.
Russia is a leading oil producer, consistently in the top three in global oil production. In protest to the invasion, Europe and many other countries placed immediate sanctions on Russian oil and gas. However, as a consequence, Europe in particular had to start scrambling to find alternative energy sources. This means that Europe is willing to pay any amount to keep their houses warm in the incoming winter. Therefore, Australian gas, oil, and electricity companies are in a moral controversy debating whether to ship their gas to Europe for financial gain or whether to save Australian businesses and consumers by staying within price caps.
The long-term effect of the war in Ukraine and how it will impact the global oil markets is unclear. Analysts say some Russian oil is almost certain to be going to waste because the European Union, Russia’s biggest and closest customer, has vowed to end most purchases from Moscow within six months. As US President Biden declared, “Defending freedom is going to cost”.
However, if the economic sanctions are successful and hurt the Russian economy as expected, Putin may be forced to withdraw. If this occurs, which it may not, the price of oil should decline and the price for gas should follow.
Government Policies
Leaders globally are split over how to respond to the high prices. Several countries have fuel price caps. The market rules have built-in price caps so that if wholesale prices are too high for too long, the limits automatically kick in. The calculation is based on a rolling seven-day cycle and on June 2nd , the Australian Energy Market Operator (AEMO) enforced a cap on gas prices in some Australian states (Queensland, New South Wales, Victoria, and South Australia) in response to the recent spike in wholesale prices. Chief executive of national employer association Ali Group, Innes Willox, said on May 31st, “The price pain is already intense for those businesses who’ve found themselves suddenly needing new energy contracts amid local and global turmoil”.
A price cap ensures that businesses who are already struggling do not have to worry about increasing prices. However, this price cap is already four times the normal average price of gas. So while it comes as a solution to the battle, the war is far from over. As Australian Energy Regulator (AER) Chair Clare Savage describes, setting the price cap is “not about setting the lowest price. We are required to set a price that will allow retailers to recover their costs, earn a reasonable margin and support retailers to compete and offer better deals and products in a competitive retail environment. If a large number of retailers are unable to recover their costs and are forced to exit the market – as we have seen recently in the United Kingdom – that will add more cost to consumers”.
Consequences
The price of energy is a key driver of inflation that is rising worldwide, making the cost of living more expensive. Higher oil and gas prices increase the cost of inputs, contributing to inflation directly because they are a key ingredient in many industries and businesses. For example, crude oil is a key ingredient in petrochemicals used to make plastic. Therefore, more expensive oil tends to increase the prices of many products made with plastic, meaning that consumers must pay more for those products.
At this point, there is little evidence that gas prices will drop anytime soon. With uncertain economic and geopolitical circumstances, it is difficult to find solutions to a fluctuating global market.
