Thursday July 18, 2024

Investments, Western market replaced Russian energy - prices reflect the new reality

Published : 05 Aug 2023, 00:48

  By Riku Huttunen
Riku Huttunen. Photo: Ministry of Economic Affairs and Employment .

Before Russia's invasion of Ukraine in February 2022, approximately one third of the energy used in Finland was imported from Russia. That share was reduced almost to zero in a few months, and the energy war launched by Russia increased consumer prices remarkably. As the energy markets have changed, it is the time to look how Russian energy was replaced and what more permanent effects trade changes will have.

New power plants into operation at the right time

Imports of electricity from Russia ceased in May 2022, after which an exceptional amount of new power plant capacity has been commissioned in Finland. In spring, the largest nuclear power plant unit in Europe, Olkiluoto 3, was taken into commercial use producing 1,600 megawatts. Last year, the capacity of wind power increased by as much as 2,400 megawatts. Construction will continue to be active, and by the end of the year, Finland's wind power production capacity is expected to grow to 7,200 megawatts – in other words, production will double in less than two years. Solar energy investments are also growing rapidly.

Thanks to investments worth billions of euros, we are already close to annual self-sufficiency and at the same time have climbed to well over 90% market share of non-fossil electricity. However, this does not decrease the need to strengthen the electricity grid and connections with our neighbouring countries in the west and south. The increase of weather-dependent production highlights the importance of cross-border trade as the levelling effect of power imports from Russia disappeared. With regard to electricity, one should also note that a substitute western supply chain has already been found for nuclear fuel used in Loviisa nuclear power plant.

Crude oil and natural gas now come from the West

Approximately 80% of crude oil imported to Finland before the invasion of Ukraine was Russian and the annual value of imports was approximately three billion euros. During spring and summer 2022, import was stopped quickly and other crude oil sources were found. According to trade statistics, the most important import countries now are Norway, the United States and the United Kingdom.

The natural gas market situation changed even more dramatically. Imports of Gazprom's pipeline gas stopped due to rouble trade requirements overnight in May 2022. Just before the war, imports from Russia covered two-thirds of Finland's consumption and, a few years earlier, practically the entire amount consumed. The Balticconnector between Estonia and Finland, completed in 2020, remained the only import route for pipeline gas. Its importance for the supply and security of supply is evident.

However, the transmission capacity of the pipeline is not sufficient in all situations, especially during the peak winter demand. For this reason, state-owned Gasgrid Finland acquired and commissioned a large floating liquefied natural gas (LNG) terminal in Inkoo. The project was carried through in a completely exceptional timetable with regard to both the company and public authorities. The readiness to import LNG was reached already by end-2022.

Only non-Russian gas may be imported to Inkoo. However, it is still possible to import Russian gas to smaller LNG terminals in Finland, at least for the time being. Although Russian gas imports into Europe have collapsed, they are not yet subject to direct EU sanctions. The legislation that is in the final stages of EU decision-making (the so-called gas package) will enable a Member State to “temporarily” restrict the import of gas into its territory from Russia or Belarus. This option will soon be available also to Finland and the Orpo Government.

In any case, the overall picture is that our common gas market area covering Finland and the Baltic States has shifted to Western gas. The markets and active operators will determine where LNG will ultimately be purchased. In the beginning of the year, it was imported significantly from at least the United States and Norway.

The consumption of hard coal is declining rapidly in Finland due to climate and cost reasons. Since summer 2022, extensive imports from Russia have been replaced by, for example, Australian and North American coal.

A key challenge in terms of heat supply is the ending of wood trade with Russia. The share of cheap Russian forest chips of all our energy wood was about one fifth before the sanctions on both sides. Substitute energy can be found in many sources: other fuels – at least temporarily also peat – and new solutions, such as the utilisation of waste heat and heat storage. However, there are major regional and local differences in the market situation and potential solutions.

What happens to prices?

Security of energy supply looks good at the moment, but the effects of energy war launched by Russia were visible in last autumn and winter as high prices and the effects will not be completely over next winter either.

In the electricity market, imports from Russia previously smoothened price peaks especially in winter. While further wind power lowers prices on average, it also leads to an increase in price volatility. Thus, relatively high prices can occur in winter, which emphasises the importance of demand flexibility, energy savings and storage. Last winter we managed to make energy use much more rational. Good practices should be continued by both companies and consumers and, taking advantage of smart flexibility solutions.

The price of natural gas also strongly determines the price of electricity in Europe. Short-term forecasts predict a rather low price for gas, i.e. around 30 euros/MWh. At the same time, the level of gas stocks in the EU is excellent, at around 80% in the middle of the summer. However, uncertainty about Europe's coming winter - in addition to its potential severity - is caused by the economic development and LNG demand in China, limited global production capacity and shrinking but still existing gas imports from Russia. In any case, the essential change is the transition from long-term pipeline gas contracts to LNG trading and market-based pricing.

The global market for crude oil is divided due to sanctions imposed by Western countries. G7, the EU and Australia have banned shipping and insurance services for Russian crude oil with a price exceeding 60 US dollars per barrel (refined petroleum products have similar price limits). In any case, Russian oil has found its markets in third countries, such as India and Turkey. The price of the free market is higher, over 80 US dollars per barrel, but still far from the highest prices in history. Saudi Arabia continues to play a key role in determining the OPEC supply and thus the global price level.

All in all, we can be calm about energy supplies for the coming winter. At the same time, the cessation of imports from Russia has permanently changed the market for energy products, for example in terms of price determination. Finland has adapted to the changed situation exceptionally quickly. This was possible owing to energy policy based on competitive markets as well as comprehensive preparedness for a rainy day.

Note: The writer is the Director General of the Energy Department of the Ministry of Economic Affairs and Employment.