31-10-2022 15:59

Nordic energy supply: Never waste a good crisis

Is there a way out of Europe’s big energy crisis? What will the next steps be for the world-class electricity systems in the Nordics? Energy supply in the European and Nordic markets is front and centre in the latest Nordea On Your Mind.

Europe's energy price spike is not about a market failure, but rather a supply shortage, Nordea’s Thematic Research team concludes in their new report. The most decisive factor is vastly-reduced imports of Russian gas, largely offset thus far by expensive liquefied natural gas (LNG). A cold winter could still cause problems, so EU members have set aside 2% of GDP to support electricity users. The long-term solution is the REPowerEU plan, worth EUR 210bn in investments, to accelerate the renewable energy transition and reduce EU gas imports by two-thirds by year-end 2022 and 100% by 2027.

On the other hand, the Nordic electricity market enjoys uniquely low costs and emissions, with very little reliance on fossil fuels. Yet several factors are making supply, and therefore prices, more volatile. These include the rising share of intermittent wind and solar power and a growing shortage of baseload nuclear power, owing to Swedish phase-outs, as well as Finnish project delays and cost overruns. Interconnection with the European power grid is also causing Europe's gas crisis to spill over into the Nordic region, driving up prices.

Energy supply shock, not market failure

A shortage of imported Russian natural gas after Russia's invasion of Ukraine has been the key driver behind soaring European electricity prices, but other factors, such as lower-than-normal wind energy output and technical problems at nuclear power plants, have also played a role. In general, it is not the functionality of the electricity market which has been the problem, but rather price levels and volatility caused by the supply shock. This is what needs to be fixed.

Reduce demand and protect consumers

Europe's short-term response has been to fill up gas tanks ahead of this winter by replacing Russian gas with LNG from the US and the Middle East, in particular, while paying up to do so. Governments have stepped up to offer widespread support, including both subsidies and handouts to households, as well as guarantees and funding to help industry players cope with soaring margin calls due to abnormal prices and volatility. Other initiatives to reduce energy demand are also on the table.

More capacity needed in the Nordics

In the Nordic context, it is time to step up investment in electricity generation. There is a pipeline of huge, energy-intensive, industrial projects in areas such as fossil-free steel making and mining of electrification metals. Additional needs derive from vehicle electrification and pressure on grid and price stability due to an increasing share of intermittent renewable energy in the electricity system. This will need to be managed by having a greater buffer of additional intermittent energy, additions of predictable electricity generation and adding power electronics and storage capabilities to the grid.

Faster sustainable energy transition

Europe's renewable energy transition will face short-term setbacks from using coal- and oil-fired power to meet peak demand during the winter, to offset lost Russian gas imports. The flipside is that the “forced” renewable transition will be even faster. The EU Commission's REPowerEU plan released in May 2022 calls for investments of EUR 210bn in 2022-27 to improve energy efficiency and reduce Russian gas imports by two-thirds by year-end 2022, and by 100% by 2027.

Be prepared to live with more volatility

We suspect that European energy imports from Russia are unlikely to ever fully resume, regardless of the outcome of the war in Ukraine. Elevated and volatile fossil fuel prices are therefore likely here to stay. Big investments in renewable energy generation should alleviate this pain point in the long term, but will require quicker and better permitting processes. We believe nuclear power could have a role to play, most likely in the form of small modular reactors (SMR). This would require political decision making here and now, however, and permit processes and project lead times would make any nuclear capacity additions before 2035 unlikely. For the Nordic region, we see a future scenario where oil, gas and coal are essentially only for backup and peak load, wind power represents by far the biggest net capacity addition in the next couple of decades (in many cases combined with hydrogen production), with continued buildout of solar and biomass. Nuclear SMRs are a possibity for the 2030s, at least in Sweden and Finland.

Industry viewpoints

For perspectives on wind power as part of the solution, we spoke to Peter Zachrisson, CEO of wind farm developer SR Energy, who lays out the case for wind energy and describes the challenges of slow and cumbersome permitting processes.

“We believe it (wind power) can represent a very considerable share of total Nordic electricity generation, and that it can grow to become the second biggest energy source after hydro power. We are very fortunate in the Nordic region to have cheap, clean, reliable hydro power whose output can be regulated to meet actual demand. Not least because this makes it possible to add plenty of intermittent wind power to the system,” says Zachrisson. 

To understand the nature and drivers of the energy crisis, we interview Swedish state-owned power utility Vattenfall's Head of European Energy Trading Frank van Doorn and Head of Nordic Energy Trading Laurent Cheval.

“While the Nordic region relies mainly on hydro, nuclear and wind power, its electricity prices are influenced by price levels on the continent, which relies much more on gas. Prices are significantly affected by weather, seasons and commodity prices, with the lack of wind, cold winters and gas supply shortages being factors driving them up,” says Cheval.

We also spoke to Tomas Kåberger, professor at Chalmers University of Technology, for unique insights into the energy system from academic, industrial and regulatory perspectives.

“Talking about 'needs' tends to downplay price and costs, which are ultimately decisive for the demand. The dramatic decrease in the cost of solar and wind electricity over the last decade has made these energy sources the lowest-cost option for new power in most parts of the world. This year, renewable electricity generation capacity is set to grow more than the total growth in electricity demand,” says Kåberger.    

Nordea On Your Mind is the flagship publication of Nordea Investment Banking’s Thematics team, which produces research for large corporate and institutional clients. The research does not contain investment advice and typically covers topics of a strategic and long-term nature, which can affect corporate financial performance.

Top decision makers at Nordea’s large clients across the Nordic region receive Nordea On Your Mind around eight times per year. The publication’s themes vary widely, and many are selected from suggestions by clients. Examples of covered topics include artificial intelligence, wage inflation, M&A, e-commerce, income inequality, ESG, cybersecurity and corporate leverage.

Nordea On Your Mind