Why Norway’s views on energy security should ring alarm bells across Europe

Norway’s energy security would appear to be a done deal, yet the past couple of years have been very challenging for its electricity market. While the rest of Europe struggles with reduced access to gas, it seems strange that a country which produces far more gas than it needs has faced potential electricity shortages and soaring prices. The reason has been unusually dry weather which saw reservoir levels fall to 20-year lows, and while recent wet weather has helped water levels to recover they are still well below average in the critical South Norwegian NO2 electricity region as winter, and the draw-down season, starts. This dry period coincided with the start of new 1.4 GW interconnectors to both Britain and Germany during 2021.

In its annual energy market report, the Government committed to investigating how electricity exports effect Norwegian security of supply and power prices, and to enter into dialogues with the EU and UK about cross-border electricity trading and its impact on security of supply.  It is particularly interesting to note the language used in the report to describe the situation, explicitly linking questionable energy policies in neighbouring countries with Norway’s energy security:

The Norwegian Government has announced a number of measures to address these issues and reduce the adverse impact on consumers. Last month the Energy and Petroleum Minister, Terje Aasland repeated his commitment to developing measures to link exports with reservoir levels, with more details due in the autumn. The proposed measures to strengthen security of supply include:

• A management mechanism to ensure that water is conserved in the reservoirs at low reservoir levels and that exports are limited at such times
• Significant investment in energy efficiency and local production
• Increased budget allocations to the energy authorities to facilitate faster development of offshore wind, more efficient licencing for power grids and new renewable energy, and strengthening the analysis and power market modelling capability within the Water Resources and Energy Directorate (NVE)
• Faster development of the electricity network, reducing the time it takes to develop and license new grid facilities.

Not everyone supports the idea of export restrictions, and the details of the scheme are yet to be announced, but the Government appears to be persuaded that some intervention in this area is warranted, noting that Norway is dependent on the investments made by its neighbours for its energy security.

Studies indicate greater interconnection has reduced Norwegian energy security and raised prices

A study on behalf of the Norwegian Government by independent research firm SINTEF found that prices in Norway in 2020-21 were higher with the interconnectors to Germany and Britain than they would have been without, and that reservoir levels have reduced. These are the exact opposite conditions to the ones expected and hoped for when the interconnectors were commissioned. However, the study also found that the reservoir conditions in Norway during this period have been very unusual by historic standards.

The study also pointed out that forward markets had consistently under-estimated future prices which gave producers an incentive to use water resources sooner rather than later. Expectations though the autumn of 2021 that high prices in Europe would decline over the coming months meant that reservoir levels remained low even when filling rates improved. This coincided with the opening of new interconnectors with GB and Germany, providing more opportunities for Norwegian producers to capture the near term value indicated by the forward markets.

Another study by AFRY Management Consulting and Menon Economics explored different approaches to managing the hydro situation. It studied six measures which could be used to address the problems of low reservoir levels and high consumer prices, and found that:

1. Setting target levels for reservoirs for the end of the filling season would help security of supply but the effect on prices is uncertain – when producers are asked to preserve water levels they increase their market prices so they are displaced by what would normally be more expensive forms of generation, however, when reservoir levels are restored prices fall, so the overall effect over the course of a year is difficult to predict
2. Linking electricity exports with reservoir levels or imposing an export tax would be positive for prices but would have a limited effect on security of supply and would potentially put access to imports at risk
3. Increasing transmission connections between the different Norwegian prize zones would have a positive impact on both water management and prices, but new infrastructure cannot be delivered quickly and there are limited options for new capacity
4. Capping electricity prices would be very negative for security of supply as water levels would not be optimised and exports would increase
5. Subsidising consumers would mitigate the effects of high prices but can be expensive to implement
6. Creating a state-owned electricity company is unlikely to be more effective than simply introducing new regulations

The paper ascribes high prices in the south of Norway to the following factors:

• Power prices on the Continent and in Britain are set by fuel and emissions costs. The war in Ukraine has seen gas prices rise significantly, and while carbon prices rose by a factor of 3 during 2021 they have traded broadly sideways through 2022. However, as gas has become less available in Europe, coal generation has increased and with it the amount of EUAs required
• The situation has been aggravated by drought across Europe which reduced hydro availability and created problems with cooling water for thermal and nuclear power stations and fuel transportation
• Pricing in Norway is influenced by prices on the Continent and Britain, with the degree of influence being driven by the hydrological balance in Norway. In 2021 and 2022, water inflows in southern Norway have been below the average which has created significant price convergence between NO2 and Continental Europe
• In 2021, Norway has connected itself more closely to the power markets in Great Britain and the Continent through the North Sea Link and NordLink cables which also contributed to raising NO2 prices
• Network congestion between the north and south of Norway has isolated the markets, increasing the impact of GB and EU prices on NO2 (as well as in NO1, and to a lesser extent, NO5)
• The extremely high and gradually rising prices and low filling reservoir rates led the Norwegian Government to ask producers to conserve water ahead of summer 2022. This significantly reduced hydro output, causing further price increases.

The authors of the study suggest that since no individual hydro generator has responsibility for security of supply, they do not value the social cost of running out of water highly enough. This leads to the counter-intuitive situation where exports from the south of Norway to other countries continue despite dangerously low reservoir levels. They also point out that Norway contains a large number of reservoirs which operate differently from each other with different purposes and very different filling and emptying dynamics, from rapid diurnal variations to multi-season reservoirs such as Blåsjø. These differences would make it difficult to impose broad targets or restrictions on reservoir/water management.

The most interesting of the measures considered from a non-Norwegian perspective is the idea of linking exports to reservoir levels. There has been increasing political and public support for such an approach, and intuitively it would make sense. However, the study found that while restricting exports would help keep Norwegian power prices down, it would not significantly support security of supply unless there was a radical reduction in exports to all nations other than Sweden (the Nordic markets are tightly integrated). In this case there would be higher water losses in wet years, although that might be a reasonable price to pay for better energy security in dry years.

While export limits are prohibited under both World Trade Organisation and EEA regulations, there are exceptions for measures aimed at preventing product shortages, which would apply to the situation being discussed for Norwegian electricity exports.

My reading of these studies, which admittedly may be flawed, since I had to rely on Google to translate them into English (although I would like to thank Norwegian gas expert Morten Frisch for his help both with market background and ensuring there are no glaring translation-related mis-understandings), is that although the hydrological conditions experienced in Norway during 2021-22 have been highly unusual by historic standards, they were exacerbated by a combination of higher electricity prices in GB and the EU, as well as the increased interconnection with these regions.

This resulted in reservoir levels falling further than would have been the case without these additional interconnectors, and prices in NO2, NO1 and NO5 rising higher than they would otherwise have risen. Restricting exports in such extreme conditions would not be incompatible with international trading rules, and would be to the benefit of Norwegian consumers, however the optimal approach would be to engage with neighbouring countries to develop solutions which are more nuanced than outright export restrictions.

Longer-term, Norway is planning to increase transmission connection between its price zones, although these projects could be further expanded. The possibility of installing pumping capabilities within the same freshwater river / reservoir system should be investigated, which could enable Norway to make better use of electricity imports, particularly at times when domestic demand is low, for example at night-time. The benefits of pumping capabilities should be considered alongside future interconnector investments, potentially linking the projects to ensure that Norway is able to realise more of the benefits of interconnection.

Conflicts of interest are not being well managed

Hogne Hongset, a member of Norway’s Alternative Energy Commission recently wrote to newspaper Dagens Næringsliv pointing out that the very people who wanted to build and open the interconnectors with high priced markets in Britain and Germany benefit from the resulting higher electricity prices in Norway, that is owners of interconnectors and electricity generators. For years, low Norwegian electricity prices conferred a competitive advantage for the economy as a whole, but limited income for generators and transmission owners, however, with prices rising as a result of greater interconnection with more expensive markets, these organisations, many of which are state owned, benefit.

There is, however, a degree of circularity, since high prices require end users, particularly households, to be subsidised by the state, funded in part by the higher income from rising power prices. At the same time, de-carbonisation policies require a significant increase in generation capacity – possibly by as much as 50% – by 2030.

The Alternative Energy Commission (“AEK”) was appointed in May 2022 by Industrial Action, a pressure group linked with the trade unions, which felt that the mandate of the government-appointed Energy Commission was too narrow. AEK issued a report earlier this month which addressed the following questions: How can Norway recreate its historical competitive advantage in the form of lower electricity prices than in the countries with which it competes; and How will Norwegian energy demand develop, and how can the necessary amounts of low carbon electricity best be obtained?

The report points out that when Statnett applied for permits to build the interconnectors with Britain and Germany in 2013, there were strong protests from large industrial companies and industry bodies which warned that these interconnectors would lead to a sharp increase in Norwegian electricity prices.

“AEK mener at strømpriskrisen er skapt av svikt i styringssytemene og mangelfull oppfølging av energilovens intensjoner. Det demokratiske underskuddet har overført beslutningsmakt i viktige økonomiske spørsmål fra folkevalgte organer til aktørene i kraftbransjen / AEK believes that the electricity price crisis has been created by failures in management systems and an inadequate application of the intentions of the Energy Act. A democratic deficit has transferred decision-making power in important economic matters from elected bodies to members of the power industry,”
– Alternative Energy Commission

According to the report’s authors, Norway introduced the world’s most liberal energy law in 1991. Despite its good intentions, the law allowed an “uncontrolled liberalisation” of the entire energy value chain, and subsequent monitoring by politicians and public supervisory bodies has been inadequate. Publicly owned power companies, and system operator Statnett, have collaborated with international companies to build an increasing number of interconnectors to high-price markets in Europe. They go on to say that high and rising prices on the Continent which are causing price contagion in Norway, are due in part to failed energy transition policies, highlighting nuclear closures in Germany, and a failure to properly provide for periods of low wind and solar output.

The AEK believes the interconnector arrangements with the EU and the UK should be re-negotiated along the following lines:

• Norwegian electricity prices should be decoupled from the European electricity price system
• Norway should have full control over the flow of electricity over the interconnectors, with the state controlling the exchange of electricity and the sale of surplus power
• Norway shall have full state control over domestic power sales, and the electricity retailers should be wound up
• Norway should be free to establish a price regime for Norwegian electricity used in Norway
• The water in Norwegian hydropower reservoirs should be managed to ensure Norwegian security of supply and favourable prices for Norwegian electricity customers
• Statnett’s mandate should be changed in accordance with a new organisation of the Norwegian power market, based on revised/new agreements with the EU and the UK

The pro-nationalisation tone is hardly surprising from a body with links to trade unionism, but it is not unreasonable for Norwegians to want their energy resources to be used for their own benefit. It is difficult to argue that Norway has not suffered a detriment due to the opening of the interconnectors with EU nations that have radically different generation mixes and different energy policies. It is also hard to argue that there are not conflicts of interest inherent in Statnett’s role, similar to those identified within National Grid which led to the creation of NG ESO and the planned full separation under the announced NG FSO.

Wetter weather alone will not solve the problem

Looking to the future, electrification will eliminate the current electricity surplus enjoyed by Norway under normal hydrological conditions. The Government has appointed an Energy Commission to consider future energy policy alongside some tactical approaches to the current situation. The Commission had been due to report in December, but this has now been delayed to February.

The Government has expressed ambitions to develop both off-shore and on-shore wind, and to further expand and upgrade the hydropower system. It will also invest in programmes to reduce energy waste. And as with other countries such as the UK, Norway wants to position itself as a leader in emerging green technologies such as hydrogen and carbon capture and storage.

But Norway is right to be mindful of the impact neighbouring countries’ energy policies have on its energy security. Germany, Britain, Denmark, Belgium and the Netherlands (and others not directly connected with Norway) have rapidly increased intermittent renewable generation without being sufficiently mindful of securing sufficient forms of back-up when it isn’t windy or sunny, particularly in winter when cold and still weather often coincide, occasionally across very wide areas for extended periods of time. An excessive reliance on imports presents dangers to all parties – countries with a high proportion of wind power will find themselves competing for electricity in periods of low wind output, while countries such as Norway with other forms of generation will see their prices rise in response to shortages elsewhere, and could see their own energy security being undermined by a Continent-wide energy shortage during still weather.

Norway’s lower weather correlation with its southern neighbours should at least insulate it from having to compete directly for scarce wind power, but it will see increased demands on its hydro resources when wind output is low elsewhere. And, during winter demand peaks, recipients of Norwegian hydropower are unlikely to be able to return power into Norway even when the wind is blowing.

These countries are also seeing reductions in non-intermittent generation capacity – aging coal and nuclear power stations are closing in Britain although some of the closing coal capacity could probably remain open for longer, while Germany is prematurely closing perfectly operable nuclear reactors. In the Netherlands, production from the Groningen gas field has been rapidly reduced in the face of relatively minor seismic activity, and with it gas-fired generation is also declining. Denmark has aggressively built out wind capacity and closed thermal generation, to the extent that while in 2020 wind represented 52% of end user electricity demand, while imports accounted for 22%.

The Norwegian Government is also right that greater co-ordination between nations is needed in the context of cross-border electricity flows. While the prospect of rationing in Norway has declined with the recent wetter weather, the prices paid by end consumers are very high with some receiving subsidies covering up to 90% of their energy bills this winter. As the studies described above show, high prices and low reservoir levels were made worse by the opening of the interconnectors with Britain and Germany last year. It is clearly wrong for taxpayers in one country to subsidise consumers in other countries, but this is exactly what has happened over the past year. It would not therefore be surprising if countries such as Norway became less willing to expose themselves to the negative effects of poor policy choices and inadequate generation investments elsewhere.

Norway is sounding a note of caution, one which should not be overlooked by its power-hungry neighbours.