Demand Destruction
Published: 12/11/2024
4 minute read
Demand Destruction
Was demand destruction seen in 2023 a result of high prices or were there more factors at play?
In 2023, the natural gas market witnessed significant changes, notably in Europe and the UK, where demand plummeted. In this blog, Charles Ramsay, Senior Energy Management Analyst, looks into the various reasons behind this decline in demand, questioning whether high prices were the sole cause or if multiple factors played a role. Looking into policy modifications, economic impacts, and advancements in renewable energy, Charles provides a thorough understanding of the current landscape and future trends of natural gas demand. Through an analysis of data, market dynamics, and geopolitical events, we'll explore the complex relationship of cause and effects shaping this crucial energy sector.
What is demand destruction...
Firstly, what is 'demand destruction'? Demand destruction in the energy industry refers to a permanent or sustained decline in the demand for energy commodities like oil or gas which can happen for various reasons. This can occur as a result of economic downturns, technological advancements, policy changes, or shifts in consumer behaviour.
According to Bruegel, demand for natural gas noticeably decreased over the past few years. One primary reason for this is, since the Russian invasion of Ukraine, a reduction target was set by the EU Commission to reduce its natural gas consumption from August 2022 by 15%, based on average consumption between 2017 and 2022. This 'demand shedding' aimed to help offset price rises by increasing supply margins. Reduction targets have now been extended until March 2025 and following this, European demand in 2023 was roughly 18% lower than the average demand from the baseline years, and 8% lower than in 2022. In the UK, demand dropped by about 13% over the same period, despite the absence of statutory reduction targets.
Price environment...
To begin with, it's worth mentioning since the Russian invasion of Ukraine, there has been a seismic shift in natural gas flows and how Europe receives its gas. Russian flow has been cut significantly from around 35% in 2021 to around 8% in 2023. This reduction, among other factors pushed prices up to 640p/th in 2022 as the continent explored and continues to explore other options to replace this loss of supply.
There is potential for volume throughout to fall further by the end of 2024 or possibly sooner, considering the recent Ukraine incursion in the Kursk region. However, the metering point at Sudzha has remained intact and supply remains stable. Although lower Russian flow to Europe has been observed, the UK has been less affected by Russian flow curtailment as it only made up 4% historically, however the interconnection to Europe and the ability to export gas flow has meant the same impact to prices have been felt here too.
In turn these higher prices needed to incentivise gas being sent to European and UK markets, have put pressure on many businesses, both on a commercial and industrial scale, whilst also affecting the residential sector. Higher prices have brought a level of demand destruction, with both gas and power users being more conscious of their usage as to negate the effect on their bottom line.
Some businesses and energy intensive users have unfortunately gone into administration due to the higher costs and inflation, and consequently would factor into the overall demand picture. With the energy crisis being a catalyst for users being more aware of energy efficiency and prices, the demand appetite could be impacted going forwards, both commercially and for the residential sector.
Interestingly, an increase in gas demand has been observed with a rebound in industrial operations since the height of the crisis. Preliminary data from IEA (International Energy Agency) indicated an increase of roughly 15% YoY for Winter 2023 - 2024 relating to European industrial demand.
As an outcome of higher prices, along with the EU Commission reduction targets, could we conclude that these are the only reasons for demand destruction in 2023?
Mild Winter...
For the last two winters, the UK has experienced milder temperatures, dampening the overall demand requirement. Compared with the five winters spanning from Winter-17, temperatures have increased on average around 0.6 Degrees Celsius, which have contributed to less demand being put on to the system. If we turn to European temperatures, nearly a 0.7 Degrees Celsius increase has also been in the same period.
Renewables...
Although demand remains strong, a decrease in reliance on gas fired generation could also be seen as a contributing factor over the past number of years, as expansion of renewable assets is advancing, lessening fossil fuel demand. Of course, this comes with the limiting nature of intermittent supply sources. Nonetheless, the ambitions for Net Zero combined with the European Commission's REPowerEU plan, we could continue to see demand destruction coming from fossil fuels as a source. The UK Power Mix chart demonstrates how renewables are taking a growing share of the UK's energy mix, however, to reiterate, due to their intermittency they cannot be relied on wholeheartedly.
It is important to mention that despite a decreasing dependency on fossil fuels, gas will still play a pivotal role in strategic goals aimed at achieving Net Zero and will help boost energy security. There will continue to be demand coming from fossil fuel-based electricity generating assets, although we could see this demand diminish over time as greener alternatives increase.
Returning nuclear assets on French fleet...
The recent decrease in gas demand can also be attributed to the reduced use of gas for electricity generation, stemming from the recovery of French nuclear exports after a significant decline a few years ago. In 2023, gas-fired electricity production across Pan-Europe reached a five-year low on 353 TWh, falling nearly 20% from 2022 levels, likely influenced by the increased output from the French nuclear fleet.
Looking forward...
In summary, a reduction in natural gas demand has been recorded, and the causes are not solely driven by price, as detailed in this blog. Although gas demand in Europe and the UK has declined, there has been a rebound with industrial operations increasing supported by the fertiliser, refining, and petrochemical industries. However, it is important to note that this increase remains significantly below pre-energy-crisis levels. Looking ahead, the key question will be how gas demand evolves in all sectors, with prices and dynamics changing due to ongoing market and policy shifts, as well as the global economic situation.
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