2021 was the year electricity went from mundane to something that everyone had an opinion on. While prices fell sharply in the first half of 2021, culminating in prices below 5 EUR/MWh during the summer, developments in 2021 have been the complete opposite. We have had a constant stream of record-high prices and large regional price differences. Prices are now in the triple digits. At the same time, the EU has continued to transform the energy sector and put forward its ‘Fit-for-55’ plan to realise its emissions targets.

As shown in Figure 1, the Nordic power price rose from extremely low levels at the start of 2021 to reach 100 EUR/MWh by mid-September. Despite this, November saw further all-time highs, with the current record being 247 EUR/MWh at the end of November. Price volatility has also been extreme during some periods, with some windy days resulting in very low prices only for prices to rise again suddenly when gas-fired plants have been needed to cover demand on the Continent.

These are exceptional circumstances and reflect the coincidence of several factors pushing prices upwards. The question is whether the current situation reflects a new normal and foreshadows greater political intervention in the market in future.

Dry summer and fall

Following record water inflows in 2020, 2021 started with record-high reservoir levels. These fell quickly through a cold and dry winter and, by the end of June, reservoir levels had returned to normal levels. The unusually dry weather continued however and, by mid-September, reservoir levels had reached a new seasonally-adjusted low. The picture varied considerably across Norway, with normal reservoir levels in the north and extremely low reservoirs in the south. Nevertheless, this lack of water explains just a small part of the high prices seen this fall.

Large price differences between north and south

Price spreads between bidding areas have been larger than normal. During the autumn, the price in southern Norway was on occasion several times that in central and northern Norway. A combination of limited transmission capacity between north and south and markedly higher reservoir levels in the north have caused prices in southern Norway to be far more sensitive to foreign price developments than prices up north.

Transmission capacity between Norway and Sweden has also played a key role. Svenska kraftnät routinely limits transmission capacity on Sweden’s borders with Norway and Denmark to help manage internal bottlenecks within the Swedish grid. This affects regional prices in Norway. In the autumn, the other Nordic system operators openly criticised Svk for this practice and they are now reportedly looking for options to increase the use of cross-zonal transmission capacity.

High carbon and gas prices

Continental European power prices have been consistently higher than those in the Nordics due to a significant increase in fuel and carbon prices. The carbon price has risen from 30 EUR/tonne at the start of the year to over 80 EUR/tonne at the time of writing. This increase is the result of both a tightening of the EU ETS as part of the ‘Fit-for-55’ package and changes in fuel prices. Coal generation has been cheaper than gas generation over extended periods, pushing up demand for emissions quotas and, as a result, their price.

The gas price has risen several-fold over the course of 2021 due to low gas storage. A cold winter resulted in high gas demand and depleted storage levels. Since then, storage volumes have been slower to recover than normal as a result of reduced transport capacity from both Russia, due to a fire in a Russian gas processing facility, and Norway, due to maintenance. At the same time, gas demand in Asia has been high as the Asian economy seeks to make up production volumes lost as a result of Covid restrictions. This has led to a marked increase in demand for LNG as Europe and Asia fight over gas volumes. With much of Continental European generation capacity fired by gas, increased gas and carbon prices have pushed up power prices on the Continent and spilt over into power prices in Norway and the Nordics in general.

Low wind generation in Europe

As if that was not enough, there have been periods of extremely low wind generation in Continental Europe during both the summer and fall. In Germany, wind generation has largely failed to reach normal levels for the entire year. In June, July, September and November, wind generation was significantly below normal levels. Between June and November, the shortfall amounted to 7.7 TWh, about 15% of normal generation over the period. So far, December appears unlikely to buck the trend of underperformance.

This has affected power prices both directly, as a result of reduced supply, but also indirectly, as a result of the need for additional gas-fired generation that has added to gas and carbon prices.

New interconnectors with Germany and England

In May, the NordLink cable to Germany opened and later, in November, the North Sea Link cable to England started operations. With sky-high power prices in both markets and significant net exports, these cables have also contributed to higher prices, especially in southern Norway. Higher interconnection capacities can, in general, be expected to contribute to higher average prices in Norway and smaller price variations throughout the year. Normally, greater interconnection capacity should also reduce Norwegian prices in dry years relative to a situation in which interconnection capacity was lower. However, with extreme prices in the connected markets, interconnection capacity has resulted in higher Norwegian prices despite a dry summer and fall.

A multitude of factors have conspired to bring about sky-high prices

Thus, many factors have helped drive prices upwards in 2021. To what extent has each contributed to the total change in prices and which has been most influential? To answer these questions, we have used our power price model, TheMA. Specifically, we have modelled the power price for 2021 assuming that gas prices, carbon prices and interconnector levels had remained at 2019-levels (2020 was itself an unusual year due to the effect of Covid-19 and the extreme hydrological situation). We have then tested the impact of each individual price driver.

The results are shown below. (Note that the numbers shown refer to the yearly average price for 2021, which is lower than the current spot price.)

The average Nordic system price in 2019 was 38.9 EUR/MWh. When we account for the increase in generation capacity and changes in demand over the intervening period, we see that the average price would have been almost 16 EUR/MWh lower in 2021, assuming that we had experienced a normal hydrological year and unchanged fuel prices, carbon prices and interconnector capacities.

However, this downward price pressure is offset by the observed changes in fuel and carbon prices. The change in gas-fired generation costs resulting from changes in gas and carbon prices is the single largest contributor to higher prices in the Nordic power market.

That said, increased interconnector capacity since 2019 has also pushed up prices. We estimate that it has increased the system price by around 6 EUR/MWh. Interconnection also accounts for much of the price difference between north and south—the effect on prices in southern Norway (NO2), where these cables make land, could be as much as 13 EUR/MWh this year.

A dry summer and fall have also supported rising prices in 2021, despite starting the year with plentiful water reservoirs. Developments this year have proven how quickly market conditions can change.

Monthly forecasts suggest that December and the first half of January are likely to be cold and dry, which implies continued high prices in both Continental Europe and the Nordics. How high will depend on both the weather and developments for gas and carbon prices. High gas prices will likely persist throughout the winter. However, the market is expecting a gradual decline in prices over the coming years, which is likely to bring Nordic power prices down to around 60 EUR/MWh.

Differences in area prices between northern and southern Norway are expected to remain for the next few years at least. The size of the spread will depend on demand developments in northern Norway and Sweden and the extent of trade capacity restrictions between the two countries.

EU energy and climate policy raises ambitions and implements more powerful measures

Developments this year have, among other things, shown that European energy and climate policy has a significant influence on Norwegian power prices. The marked tightening of European climate policy in 2021 will significantly impact the Norwegian power market and Norwegian targets and initiatives to reduce emissions and develop low-carbon industry.

In April, EU Member States and the European Parliament agreed to increase the EU’s 2030 climate target from a 40 to 55 percent reduction in emissions. Achieving this target will require a rapid acceleration in the pace of decarbonisation. However, the EU stresses that the Green Deal is a growth strategy aimed at creating income and jobs by laying the foundation for new industries.

In the summer, the European Commission put forward the first part of a comprehensive set of policy measures intended to achieve its goals, the so-called Fit-for-55 package. These instruments will affect all areas of the European economy. The key policy proposals include:

• A tightening of the EU ETS cap to achieve a 61 percent reduction in emissions in 2030 relative to 2005 levels (cf. a 43 percent reduction previously). Emissions from the maritime sector will be included in the EU ETS, while the rules for aviation emissions will be tightened.
• More stringent emissions targets for non-EU ETS emissions. At an EU-level, the 2030 emissions reduction target will be raised from 29 to 40 percent relative to 2005 levels. A recommendation that a new emissions trading scheme to cover emissions from construction and the road transport sector be introduced from 2025.
• The introduction of a duty linked to the embedded emissions of imported goods (Carbon Border Adjustment Mechanism) such as aluminium, cement, iron, steel and fertiliser.
• More ambitious targets for, among other things, the share of energy sourced from renewables, energy efficiency and low-emission transport.

In December, the second part of the policy package was published. This included, among other things, several proposed changes to the market framework for gas. These changes are intended to facilitate the increased use of low- and zero-emissions gasses like biomethane and hydrogen. The Commission also put forward a revised Energy Performance of Buildings Directive, which includes more ambitious targets and stricter regulations.

Many of these proposals have met with controversy within the EU and the proposal to introduce an emissions-linked import duty has met with opposition from major trading partners like the US and China. The policy package will now be discussed and collectively agreed upon through negotiation between EU Member States and the European Parliament in a process that could easily take 1.5–2 years.

In addition to the Fit-for-55 package, work is being conducted in parallel on the EU’s taxonomy for sustainable finance. The accompanying regulation sets standards for those activities that are seen to be in line with the EU’s long-term energy and climate policies. New regulation is also expected regarding nuclear power and natural gas.

Glasgow climate summit—heading in the right direction but stopping short

The Glasgow climate summit, COP26, can be summed up as an inadequate but nevertheless long step in the right direction. Several countries have set more ambitious climate targets and many important initiatives were launched. The British presidency emphasised that the hope of limiting global warming to 1.5 degrees hung in the balance and asked that comprehensive measures to reduce emissions be taken quickly.

Cooperation between countries was reportedly better than at previous summits and progress was made in several areas. Among other things, agreements were reached on rules for global trade in emissions quotas, increased support from wealthy to developing countries and far-reaching measures to prevent deforestation.

A new government and coalition agreement

The energy transition and raised EU energy and climate policy ambitions have also made their mark on Norwegian energy and climate policy. Recent developments pose several challenges for markets and the new administration. In the Hurdal coalition agreement, the new government, which took office in October, has highlighted a range of energy and climate objectives that will be central to future policy:

• Norwegian emissions will be cut by 55 percent by 2030 through, among other things, the electrification and decarbonisation of the transport sector and the development of an integrated hydrogen supply chain
• The competitiveness of Norwegian energy-intensive industry will be improved by, among other things, ensuring sufficient power supply and grid capacity for existing energy-intensive industry and new, green industrial development.
• Measures to counteract the negative distributional effects of the transition to a sustainable economy will be introduced.

The agreement also emphasises that power sector cooperation between the Nordics and the rest of Europe will be strengthened and developed consistent with Norwegian interests.

There is no shortage of things to do. Several issues are mentioned as the subject of further investigation. Among others, we have overall planning for renewable generation, to include offshore wind infrastructure, that covers hydropower, small-scale generation and both onshore and offshore wind; an investigation of the relationship between power exports and security of supply; how network tariffs can better meet the needs of industry while also reducing regional variation; extensions to the state’s responsibility for network infrastructure as and when necessary, notably as a means to reduce consenting delays; large-scale investment in offshore wind and the development of an offshore grid; and efficient measures to transform commercial transport, notably by establishing shore-side electricity access and encouraging the use of biofuels, fossil-free airports and infrastructure for climate-friendly heavy transport and shipping.

Living in exciting times

In Norway, high power prices have hit consumers hard and at times dominated current affairs programs and newspaper columns—sometimes on par with the Delta and Omicron variants.

The sudden increase in prices in the fall obviously hit consumers hard and politicians have responded with several measures to compensate households facing higher power bills this winter. Electricity duty has been reduced, housing support increased and an instrument to support students has been introduced. Now, just before Christmas, a further support measure has been unveiled through which the state will pay a part of the significant increase in almost all households’ electricity bills this winter.

The measures that have been adopted thus far are intended to provide relief for the exceptional market situation we are now in. However, we also expect large market fluctuations in the future that will affect Norway, Norwegian consumers and politicians. We anticipate further proposals for market and regulatory reform that will to a greater or lesser extent influence both price formation and trade. It will be no less challenging—or important—to find an approach that realises the energy transition while ensuring acceptable consequences for both households and industry. There is still plenty to get excited about for those working on energy and climate issues.

With that, we wish all our partners and clients a Very Merry Christmas and Happy New Year!