There’s not enough gas to go around
Will war-rattled Europe deprive emerging Asia of winter fuel and food?
They say that those who lack resources become resourceful. With an almighty global tussle brewing over scarce supplies of natural gas, the term ‘resourceful’ is about to take on new meaning. This summer, rich European nations will go head-to-head with poorer emerging Asian economies, with the highest bidder taking the spoils. This is an annual event that Asia usually wins — but the stakes are much higher this year.
In ‘normal’ times, China, Japan, South Korea, Taiwan and other major importing nations instruct their gas buyers to outbid others to buy enough liquefied natural gas (LNG) in the spot market cover their winter needs. Cargoes follow the money and flow east.
Only when Asia has had its fill does Europe get a look-in. This is because Asia doesn’t have much gas storage capacity to lean on, and privately-held European companies must obey the laws of free market economics; they won’t willingly incur costs that they can’t pass onto consumers. A state mandate to buy LNG at any cost – as China declared in September – usually wins out.
This summer will be a bit different. Gas buyers in the EU will scramble to refill European gas storage facilities to meet an imminent new EU mandate of 90% full by 1 October. This is a considerable undertaking when considered with a parallel effort to reduce EU imports of Russian gas by as much as two-thirds this year.
The semi-fungible molecule
One of the many differences between oil and gas, as explored previously in Energy Flux, is that crude is fully fungible and globally commoditised while gas is still only half way there. Sanctioned Russian oil will in most cases find a home in China, India or other importing countries motivated purely by price and indifferent to Western opposition to Russia’s invasion of Ukraine.
Russian pipeline gas, on the other hand, can’t be rerouted to other destinations. Russian gas flowing through pipelines that land in Europe is either lifted by European buyers, or it is shut in. It can’t be piped to China because the infrastructure does not exist. Same goes for re-exporting it as LNG: this is simply not an option.
Europe’s decision to shun Russian gas therefore has global implications. This article dissects the many economic, infrastructure and market constraints to placating the EU’s newfound zeal to do away with Russian gas – and then asks whether enough consideration is being given to what would happen if these constraints are magically overcome. It finishes with links to some useful resources when studying these issues and the many articles, papers and studies I’ve been reading this week on related topics.
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Starting from a low base
While restocking gas stores to 90% by October is pretty unambitious in times of plenty, doing so with minimal or no flows from Russia is another question entirely – particularly when Europe’s depleted gas stocks are at the bottom of the five-year average for this time of year.
With 288 TWh of gas in storage, EU stocks are only 26% full. To hit 90% requires injecting 999.7 TWh of gas into storage over the next six months or so. This equates to roughly 102 billion cubic metres (Bcm) of natural gas, or ~80 million tonnes of LNG. Of course, not all of this will come from LNG, but it is the supply source with greatest scope for ramp-up.
The EU Commission has set a target to import an extra 50 Bcm (39 mt) of LNG this year from global suppliers as part of its effort to end EU dependence on Russian gas. In addition, it hopes to pipe in a further 10 Bcm from Azerbaijan, Algeria and Norway.
The world’s supply of LNG grew by 21 mt (6%) in 2021 to hit 380 mt and could increase by a further 25 mt this year, according to Shell. Europe cannot expect to receive all of that incremental supply. China’s LNG demand alone grew by 12 mt in 2021 and further growth is expected in 2022.
So, the EU would have to lure cargoes from other parts of the world to meet its 50 Bcm / 39 mt LNG import target – and even then, would still be only half way towards hitting the 90% gas restocking target due 1 October. Pipeline supplies almost certainly cannot bridge that gap, with or without Russian imports.
Doing business with the enemy
There is still widespread uncertainty over the dependability of wartime Russian gas flows into Europe, which is keeping prices sky-high. Exports rose after the Ukraine invasion due to Gazprom’s contractual terms that incentivise buyers to take more oil-indexed gas when spot prices exceed futures prices.
This is a self-correcting mechanism. The post-invasion surge in Russian gas flows took some heat out of hub prices, quelling demand from EU gas buyers for Gazprom’s oil-indexed gas.
Russian exports duly dipped by 9% on Thursday, and the Mallnow exit point on the Yamal-Europe pipeline once again entered reverse flow mode as buyer side nominations “slanted towards spot purchases over contractual nominations”, Rystad Energy said on Thursday, adding:
“This will likely exacerbate restocking demand later in the year, especially if the EU hopes to keep to its goal of refilling 90% of its storage by 1 October.”
Carrots, sticks and collateral risk
Restocking when prices are extremely elevated and volatile will come at enormous cost to gas buyers, traders and ultimately consumers. The economics of storage work only when there is an adequate summer-winter spread of at least €2 or €3 per MWh. There is no market incentive to inject expensive gas for withdrawal later when forward prices are trading lower, so some costs or risks will probably have to be socialised.
Does this mean some form of subsidy, soft loan or other state support, a hefty penalty for failure – or both? We shall see, but the cost implications are utterly mind-boggling no matter how the pain is spread around. Month-ahead TTF is currently trading at €102/MWh, which implies a cost of around €88 billion to achieve 90% replenishment.
Trading gas at these elevated prices is challenging due to diminishing market liquidity and heightened collateral risk, an issue flagged by the European Federation of Energy Traders this week. The EFET reportedly asked governments and central banks for “time-limited emergency liquidity support to ensure that wholesale gas and power markets continued to function”.
It is conceivable that a firm EU obligation to refill gas stocks, underpinned by substantial penalties and incentives, drives demand and prices on EU gas hubs even higher than they are today. This could create the required summer-winter spread and pull LNG cargoes out of Asia and into EU terminals.
This raises more thorny questions:
Does the EU have sufficient regasification capacity to absorb this amount of LNG?
Which European consumers will be able to afford to burn gas bought during a bidding war and priced to cover storage costs?
How will Asian economies cope if they are deprived of winter LNG?
EU27 regasification capacity currently stands at 156 Bcm. The region imported 77 Bcm of LNG in 2021, and terminal utilisation rate was about 50%, so there would seem to be plenty of spare capacity to import an extra 50 Bcm.
Unfortunately, regasification and storage capacity are unevenly distributed geographically. Most regas terminals are in Spain and Portugal, but main storage capacity is located outside the Iberian peninsula.
Spain has very limited pipeline capacity with France, or for that matter with eastern and southern Europe – the areas that rely most heavily on Russian gas. One way around this would be for the UK to act as a ‘land bridge’: import more LNG and re-export it to north-west Europe via pipeline.
European industry has been hit hard by elevated energy costs, which have hobbled productivity and shuttered factories in various economic segments since last autumn. Destroyed demand will not return quickly, or ever if wholesale energy prices are double or triple today’s rate come next winter.
And then there is the small question of combatting fuel poverty and keeping homes warm. A multi-billion deployment of fossil fuel subsidies across the EU may be required next winter to avert widespread hardship and hypothermia. This would coincide with world leaders convening in Egypt for the COP27 climate talks that will inevitably seek to build on last year’s COP26 commitment to phase out “inefficient” coal, oil and gas subsidies.
What about Asia?
The question of affordability will be particularly acute across the developing world. Global energy markets are extremely tight and an aggressive push by European LNG buyers to outbid Asian rivals will inflict economic misery on the poorest sectors of society while pushing up emissions. This means lots more coal and even diesel burn in Europe, Asia and other regions, worsening air quality and adding to the bloated inventory of planet-warming gases in the earth’s atmosphere.
As explored in last week’s newsletter, this goes beyond energy and emissions. Gas is the principal feedstock for ammonia production that in turn is used to make fertiliser. War in Ukraine has prompted fertiliser export bans, and major producers of grain are banning exports in anticipation of shortages.
The tragic reality facing Europe is that every molecule of Russian gas that it replaces with non-Russian sources exacerbates the shortages and price spikes facing global energy, agriculture and food markets. The Arab Spring uprising was triggered by comparatively modest incursions on ordinary people’s finances and living standards.
The EU Commission has a laser-like focus on the task at hand: securing as many (gaseous) winter energy resources for its citizens as possible while sending as few euros as possible back to the Kremlin. While this is understandable, it appears to be motivated by emotion as much as logic – which explains why the otherwise largely rational executive body is nailing its colours to the mast of energy fantasy.
In short: Europe is in a dismal energy situation. Correcting years of mis-steps in a matter of months means exporting Europe’s misery to the rest of the world. This is the reality of an energy crisis. When there’s not enough to go round, amicable and diplomatic solutions only go so far. Buckle up for a fierce energy bidding war.
Seb Kennedy | Energy Flux | 18th March 2022
Postscript: Bridge to nowhere?
The immediate crisis facing Europe and the world makes it hard to focus on longer-term horizons, but decisions being made now will inevitably have a huge impact on the trajectory of the energy transition. Normally I would place equal focus on short and long-term trade-offs, but for now I will dwell only briefly on the latter.
Outwardly at least, the clear message from Brussels is that the EU’s reliance on Russian natural gas is in rapid and terminal decline. Germany is taking it a step further, saying gas will have no role in Germany’s energy transition:
These statements are being made at a time of extreme political anxiety. They are designed to exude defiance towards Moscow. Whether they constitute a paradigmatic shift in thinking is open to debate. A sudden war-invoked rush of blood to the head might also explain the renewed conviction in influential parts of the EU towards renewables and the electrification of heat and transport.
Will this last? Time will tell. In the meantime, Europe faces much more pressing issues. Resolving the winter gas supply situation could push the world into a prolonged period of structurally higher prices and periodic shortages in some markets. This could ultimately feed back into reduced demand for ‘unburnably expensive’ gas. I’ll be watching closely.
What I’ve been reading this week
There are not enough BTUs – Viscosity Redux (I wrote my article and headline before reading this excellent article – great minds, I guess 😇)
Practical realities and implications of REpowerEU – OIES
Economic Warfare & Energy Security – Reserve Report
Why doubling down on the Green Deal is the best strategy – IISD
Energy Security and Decarbonization in Response to Russian Aggression – Breakthrough Institute
Which Gas Will Europe Import Now? The Choice Matters to the Climate – RMI
European natural gas imports – Bruegel
Interactive dashboard of EU gas storage levels – ENTSOG
Payments to Russia for fossil fuels – CREA