July 26 (Reuters) – Several major European industrial sectors have been hammered by high power costs over the past year after Russia’s invasion of Ukraine cut natural gas flows to the region and high inflation and interest rates cooled global consumer demand.
European output of chemicals, paper, crude steel and aluminium have all slumped from pre-crisis levels, and many energy-intensive operations risk permanent closure unless power costs drop significantly from current levels, according to the International Energy Agency’s latest electricity market report.
However, forward power price markets indicate that future power costs in major manufacturing hubs such as Germany, France and Poland will not only stay well above historical averages, but will remain prone to regular steep rallies as energy systems retool away from fossil fuels.
In contrast, power costs in Spain and Portugal will remain relatively stable and substantially lower than the average across Western Europe, thanks to price caps that are expected to stay in place for the foreseeable future.
These price caps in turn look set to result in widening power price discounts for consumers based in Spain and Portugal – known as Iberia – compared to Western European consumers, and may offer potential power price relief for industry.
IBERIAN EXCEPTION
The price caps in place are a result of the so-called Iberian Exception, which argued that Spain and Portugal should be able to come up with their own price-setting power rules due to the fact that Iberia historically relied far less on Russian gas imports than the rest of Europe.
European lawmakers agreed, and allowed for Spain and Portugal to strip out the price of natural gas in their electricity price-setting system and enact a new pricing method from mid-2022. read more
Since then, the power price differences for Iberia-based consumers and those in Germany, Europe’s largest power consumer, have been significant: Power prices in Spain for the second half of 2022 averaged less than half of those in Germany.
So far in 2023, German and Spanish power prices have traded relatively close together, but forward power markets expect price trends to diverge later in the year as German values climb again.
BUSINESS MOVES
In the year or so since Russia’s invasion of Ukraine disrupted Europe’s gas flows and sent power prices soaring, many energy-intensive businesses have had no option but to scale back or halt operations until energy costs drop and greater clarity emerges regarding the energy price outlook.
However, with long-term power prices now expected to remain well above historical averages, some business may now consider relocating some or all operations to lower cost locations.
Some will consider shifting energy-intensive production processes outside of Europe altogether, targeting the lower operating costs available in Asia, Africa and elsewhere.
But others will be keen to exploit the favourable tax treatments afforded to businesses that manufacture products within Europe, and so will look to stay within the Eurozone.
For those firms, Spain and Portugal will likely emerge as potential locations for some production processes and operations, due mainly to lower energy costs.
Spain and Portugal have not been entirely free from some power cost inflation even with the Iberian Exception. So far in 2023 Spain’s power prices have averaged around 90% more than the average for 2018 through 2020.
However, Germany’s power prices in 2023 have averaged 165% more than the 2018-20 average, and are widely expected to trend higher through the remainder of this decade.
As a result, many of Germany’s most energy-intensive sectors may have no option but to review if and how they can shift operations elsewhere.
In particular, Germany’s chemicals and fertilizer sectors – the largest in Europe – will urgently need to find low-cost operating bases or risk mounting financial losses tied to staff furloughs and under-utilized production lines.
Some of these may be able to relocate operations to locations in Iberia, and might be able to resume output before overseas competitors take over their lost market share.
Other industries may struggle to accommodate operations shifting from Northern to Southern Europe, especially for businesses that are tightly integrated into manufacturing supply chains that rely on just-in-time inventory management and other tightly-knit industrial systems.
However, with high power costs inflicting extensive damage to much of Europe’s industry, it is clear that some sector reshaping is inevitable, and Spain and Portugal may be viewed as preferable locations to regions outside of Europe where costs might be lower but market access to Europe’s consumers may be limited.
<The opinions expressed here are those of the author, a columnist for Reuters.>
Reporting By Gavin Maguire; Editing by Kim Coghill
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Opinions expressed are those of the author. They do not reflect the views of Reuters News, which, under the Trust Principles, is committed to integrity, independence, and freedom from bias.
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