12 Jan 2023
The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.
In the face of declining Russian gas exports, it appears Europe may have managed to store enough gas reserves to see out this winter at least. Our global energy analyst Michael Rae explains the complexities of the Liquified Natural Gas (LNG) market and how Europe will manage its current and future energy needs.
There is still some Russian gas supply flowing through Ukraine to Austria, Hungary and Italy, and it should be noted that further cuts to supply would not cause the same initial shock, and this would have less of an effect. Also, it could be argued that Russia may not want to cut further as this would impact supplies to countries such as Serbia, Macedonia and Hungary – a consequence which, for political reasons, it may try to avoid.
The energy deficit has been filled by LNG imports. However, LNG projects are large-scale and capital-intensive, and as such cannot suddenly be brought online. Around 20% of LNG can be bought on the spot market, where it can be traded for immediate delivery; much of the supply for this year was procured in this fashion. The remainder can be bought in the form of long-term contracts, which contain break fees. However, rising gas prices covered the costs of the break fees and hence Europe was able to purchase significant amounts via this route as well. There were of course losers in this transaction. These were the countries that were unable to compete with Europe’s superior purchasing power, and suffered power outages as a result.
Another big factor in this equation is that China has effectively stepped out of the market. It has a greatly reduced energy requirement on previous years due to a succession of COVID lockdowns and, unlike Western Europe, it has the ability to rely solely on coal – leaving stocks of LNG available to be bought by Europe. Due to this combination of factors, Europe has increased its market share by 50% this year. The region has, however, paid a premium to secure these volumes.
Some European Union (EU) countries have managed to make significant energy savings. For example, Germany’s savings on gas consumption in its industrials sector this year has been equal to the entire annual gas consumption of Austria.
The EU’s goal was to reach 80% storage by the start of the cold season, a target it has surpassed thanks to an unusually mild autumn. In fact, storage reached 95% capacity, which caused the pendulum to swing the other way, towards a supply glut. This has thrown up a few interesting anomalies. For example, the UK has limited storage facilities but substantial re-gas capacity and consequently was able to supply France and Belgium with both gas and power, compensating for France’s underperforming nuclear power sector. The Iberian region also has significant re-gas capacity. (Re-gasification is the process of heating the liquefied gas and turning it back into gas to be used as fuel, for cooking and heating, etc.) All-in-all this is good news, as it shows the European power system is working as it should – communication between the members, balancing out the supply.
A recent report from ENTSO-E1 (European Network of Transmission System Operators for Electricity), which is tasked with facilitating cooperation between national energy transmission system operators to achieve European energy goals, laid out the risk preparedness of the region by testing various potential scenarios and sensitivities. It identified uncertainties around nuclear availability in France, Sweden and Finland as well as the coal supply in Germany and Poland.
The modelling by ENTSO-E suggests if there were an unusually harsh cold snap every European country would be undersupplied by around 10%, and in this scenario it would become necessary to ration power. However, given the high stock levels at the beginning of the season, this would not come into play before February.
The report concludes Northern Europe is more vulnerable than Southern Europe and the most exposed countries are Finland, Latvia, Lithuania and Estonia.
The LNG market is delicately balanced. On one side of the scales you have the demand for LNG. This is made up of a number of building blocks – Europe’s increased needs (to refill inventories ahead of the 2023/24 winter), Asia’s needs as the countries come out of lockdowns and resume a more normal growth cycle, and the possibility that Russia will cut supplies even further, taking its share out of the market.
On the other side of the scales, you have supply. Unusually high disruption to the existing LNG complex took place in 2022. Facilities in Nigeria, Australia, Norway and Freeport in the US suffered outages this year, which may be less of a feature in 2023. In addition, several new LNG projects will come online in 2023, increasing the overall supply. Finally, there is the unknowable quantity of the weather – whether it is mild or cold will greatly affect storage levels at the end of the current winter. Even with all of this, the demand outweighs the supply. In the short term, the scales can only really balance if China continues to plug the gap by using coal rather than LNG. But longer term Europe has shown good progress on managing demand to the level of gas supply available.
As discussed in our example above, some significant energy savings have been made, notably in the German industrials sector. Both the UK and the Iberian region have surpluses of LNG, but no efficient way of getting it to areas which need it more, such as France and Germany. As a result, Europe is materially expanding its re-gas capacity with 28 new re-gas terminals planned, half of these floating facilities. Once these come online, over the next three years, it will achieve an increase in capacity of around 50% for 15 countries. Over the longer term the EU is trying to accelerate its rollout of renewable energy facilities and to work on energy efficiencies. The targets are ambitious – Europe already being relatively well furnished in this area. The EU is targeting 45% renewable energy penetration by 2030 – which would require roughly what has been achieved over the past 25 years to be achieved again in the coming eight years.
Gas prices have come down from their dizzying highs over the summer, when Europe was paying a premium to fill storage units in preparation for winter. Whilst it is not possible to rule out further large price rises, it would likely require an unfortunate combination of further Russian supply cuts and a sustained harsh cold snap. Prices are still high, the sharp peak over summer 2022 was already from a relatively high basis level compared to recent history, so the drop is likely to be gradual and over a long period of time.
The crisis is delayed for now, and is managed for the medium term. Whether it is completely averted depends on Europe’s ability to action its ambitions for reduced consumption and ramping up its renewable energy sector at an accelerated speed.
1 ‘ENTSO-E Winter Outlook – 2022-2023, Summer 2022 review’, ENTSO-E Vision, 2022.
By Michael Rae
The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.