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Europe’s next gas crisis – The Business & Financial Times

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Europe can heave a sigh of relief – for now. Thanks to an exceptionally mild winter and a well-designed strategy of supply diversification and consumption-reduction measures, the continent avoided what could have been a catastrophic energy crisis following Russia’s invasion of Ukraine. Its untapped gas-storage capacity is at around 60% – ten percentage points above the historical average for this time of the year – and the benchmark TTF price has fallen more than 85% from its peak last August, from €340 per megawatt hour ($360/MWh) to less than €50/MWh.

But this run of good luck must not lead to complacency. There is a risk of significant repricing in the coming months, which would weigh heavily on firms and households’ energy bills. The tightness in European gas markets will likely become more apparent as summer approaches, possibly pushing prices back toward €100/MWh or even higher. The European Central Bank’s fight against inflation is not over.

As complex as Europe’s energy situation is, it can be understood with some relatively simple arithmetic. Before Russia’s invasion, European natural-gas consumption amounted to just under 500 billion cubic meters per year. Add today’s (unusually high) stockpiled gas, domestic production, and current imports of both natural gas and liquefied natural gas (including from Russia), and you get 440 bcm. Thus, Europe will need to cut consumption or increase LNG imports by 60 bcm to fill the demand-supply gap.

But implementing such a strategy is easier said than done. Although Europe did manage to reduce gas consumption to roughly 430 bcm in 2022 (13% below the 2021 level), the unseasonably warm weather played a key role, and there was substantial cross-country variation. Spain, benefiting from its lack of exposure to Russian gas, cut its consumption only moderately, and France and Italy cut theirs by less than the European average. Germany and the Netherlands, by contrast, cut significantly more, reducing consumption by around 20% compared to 2021.

Assuming that weather patterns return to relative normality next winter, European governments will need to aim to cut consumption by 10% from their 2021 levels to keep the total below 450 bcm. Though the EU set a voluntary target of 15% last year, that would not have been achieved without the anomalously warm weather. A 10% target is much more realistic.

The reduction will come partly from industries such as chemicals, metals, and glass, which use natural gas intensively and will have experienced some scarring from 2022. At the same time, European firms and households will probably maintain the prudent energy-saving practices they have adopted, and mandated consumption caps (such as for residential heating) will likely remain in place. If so, 50 bcm of the 60 bcm gap can likely be filled through consumption cuts.

The remaining 10 bcm will require Europe to import more LNG from global suppliers. According to the International Energy Agency, global LNG production in 2023 is expected to increase by about 23 bcm. But that means Europe will need to seize almost half of the overall increase. And since it will find itself in fierce competition with recovering Asian economies – not least China – the demand for LNG will likely push the TTF price above current levels, probably setting a floor at around €80/MWh.

The situation will get more challenging if imports of Russian natural gas and LNG are halted completely, which remains a distinct possibility. Overall, these shipments currently amount to around 45 bcm (a mere 20% of their pre-war levels). Combined with the 10 bcm shortfall, this loss of supply would create a gap of around 55 bcm, more than twice as much as the expected increase in global LNG supply. And since only a fraction of Russian gas can be diverted away from Europe and sold internationally, the global LNG market would be severely undersupplied. In this scenario, the TTF price would be pushed well above €100/MWh – more than ten times its pre-war price – and governments might need to resort to rationing.

Moreover, even if there was enough global LNG supply, Europe would lack the necessary regasification capacity. It would need to process around 190 bcm in this extreme scenario, but its current capacity is only around 157 bcm (though more facilities are under construction). Of course, if the consumption cuts were lower than 10%, the gas shortages would be significantly higher, creating even more intense upward price pressure.

That said, natural-gas prices in Europe are not likely to exceed €200/MWh for three reasons (beyond the fact that the EU has a €180/MWh price cap). First, high prices last year were partly due to the lack of preparation for such an unprecedented shock. Compared to a year ago, Europe is in a much stronger position to deal with gas shortages. Second, joint purchases of natural gas at the EU level will help control prices, owing to the bloc’s immense negotiating power as the world’s largest single market.

Third, the EU is in the process of introducing its own price benchmark for LNG contracts. Currently, LNG prices in Europe are pegged to the TTF price, which is directly influenced by disruptions to the flow of natural gas to the continent. But the new benchmark will make LNG prices in Europe more responsive to dynamics in the global LNG market than to natural-gas deliveries through pipelines.

Although Russia’s role as a gas supplier to Europe has been reduced substantially, its shipments will remain essential for balancing supply and demand in the European market until new regasification capacity is built, or until alternative energy sources are brought online. LNG is undoubtedly more important in Europe’s energy mix than it was just a few years ago; but there are limits to the relief it can provide. Consumption cuts and solidarity mechanisms (in case of extremely low supply) will remain necessary to avoid an energy crisis next winter.

Edoardo Campanella, Senior Fellow at the Mossavar-Rahmani Center for Business and Government at Harvard Kennedy School, is co-author (with Marta Dassù) of Anglo Nostalgia: The Politics of Emotion in a Fractured West (Oxford University Press, 2019).

Copyright: Project Syndicate, 2023.
www.project-syndicate.org

 



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