Europe Facing “Dual Challenge” in Response to the Energy Crunch

November 07, 2022

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Europe is now plagued by a war-induced energy crunch. The explosions of Nord Stream 1 and 2 pipelines in late September, which triggered substantial gas leaks, added more uncertainty to Europe’s energy landscape, as the hopes of shortly repairing the pipelines were dashed.

 

1. The EU slashes gas imports from Russia.

As one of the world’s major natural gas exporters, Russia exported 201.7 billion cubic meters of natural gas via pipelines and 39.6 billion cubic meters of liquefied natural gas (LNG) in 2021, far outstripping those exported by the U.S., Qatar and Norway. In the same year, the EU imported 155 billion cubic meters of natural gas from Russia, accounting for approximately 45% of its total gas imports and 40% of the total consumption. The EU also depends on Russia for approximately 27% of its oil imports and nearly half of its coal imports.

 

Following the outbreak of the Russia-Ukraine conflict, the whole of EU condemned Russia’s strike against Ukraine. To undercut Russia’s economic base for initiating a war, the U.S. and the Europe launched a barrage of sanctions against Russia. Accordingly, one significant move was to reduce Europe’s reliance on Russian energy, specifically, cutting gas imports from Russia by two-thirds this year, ending gas imports from Russia by 2027, and ending all fossil fuel imports from Russia by 2030.

 

Instead of just sitting around, Russia chose to weaponize its natural gas supply. As a case in point, in late March this year, Putin signed a “ruble settlement order” for natural gas transactions. Subsequently, Russia successively cut off gas supplies to Poland, Bulgaria and Finland, claiming they have failed to pay for gas in rubles. On September 2, Russian energy giant Gazprom announced the suspension of natural gas supplies to the EU via the Nord Stream 1 pipeline for an indefinite period. The announcement came just after the G7 countries agreed to impose a price cap on Russian oil and gas exports.

 

Thereupon, driven by multiple factors, Russia’s natural gas exports to Europe slipped sharply. According to the International Energy Agency (IEA), exports of Russian natural gas via pipelines to the EU and the UK during the first seven months of this year fell by nearly 40% compared to the same period last year. Russia’s share of the EU’s natural gas imports tumbled from 36% last October to just 9% a year later, according to data from Wood Mackenzie, a US research firm.

 

 

2. Europe is expected to get through this winter.

As Russian imports collapsed, Europe snapped up LNG as a replacement. Together, Europe and the UK imported almost 68% more LNG from sources other than Russia from March to September of this year, as compared to the same period in 2021. Nevertheless, consequences began to unfold. After the scramble, LNG was in short supply. As a result, European benchmark prices for gas have fallen sharply since peaking in late August but are still 265% higher than those a year ago.

 

Winter is coming, and Europe will face the gravest energy crisis since World War II. For many countries, the hopes of both profitable businesses and residential warmth will surely be disappointing. Still, according to the current inventories and supply capacity of natural gas, Europe should be able to scrape through this winter. Here is why.

 

First of all, as of October 10, Europe’s natural gas inventories rose to 91.35%, substantially higher than the five-year average and way above the November target of 80%. That is to say, even if Russia continues to cut its gas supply, these inventories will function as a buffer and help Europe through winter.

 

Secondly, the Natural Gas Interconnector Greece–Bulgaria initiated commercial operation in early October. This 182-kilometer pipeline commences with an initial capacity of 3 billion cubic meters of gas per year, predicted to expand to 5 billion cubic meters a year in the future. Accordingly, this pipeline, which can fully meet Bulgaria’s natural gas needs, is expected to ameliorate the energy landscape of Europe.

 

Thirdly, this winter may well be a warm one. According to a data model provided by the Copernicus Climate Change Service, temperatures probably will be significantly above normal during the peak heating season from December to February. There’s a 50%-60% probability that the UK, much of the Mediterranean coast and parts of Central Europe will see well-above-average temperatures. The rest of the continent has a 40%-50% chance of significantly exceeding historical averages. A mild winter could help Europe realize its target of a 15% cut in natural gas consumption.

 

Nonetheless, weather forecasts prove frequently unreliable. According to another forecast source, if calculated based on heating degree days (HDD), this winter, temperatures in Europe will be slightly lower than the average level of the past 10 years, which means this winter may be colder than last year. At any rate, the natural gas that Europe has imported from the U.S. and the Middle East should roughly make up the two-thirds of Russian gas imports it plans to cut. The remainder of the gas supply gap can also be filled if residents of European countries turn down the heating or air conditioner temperatures by two to three degrees Celsius.

 

 

3. The gas crunch may continue into the future.

For Europe, energy woes are nowhere near the end. The International Monetary Fund (IMF) warned in a report that Europe’s energy crisis was not “a transitory shock,” and while the upcoming winter would be challenging, “winter 2023 will likely be worse.” This warning should be taken seriously. The sufficiency of Europe’s current gas inventories is buttressed by Russian gas supplies. Once Putin resolves to shut down the gas pipelines through Ukraine to Europe and the TurkStream gas pipeline, the energy landscape of Europe will get tougher.

 

Until Europe discovers a way to address its gas demand once and for all, it will be leaving its energy security to fate. If the coming winter turns out to be a harsh one, gas inventories will fall short of the heating demand. The gas shortage could plague Europe to worsening degrees over the years to come.

 

To avoid this slippery slope, the EU has introduced a series of energy policies in recent months, including setting a price cap, levying additional tax on energy producers, creating the European Hydrogen Bank, and stepping up support for electric vehicles. Some member states such as Germany and France have announced plans to nationalize utility companies, set power price standards, and earmarked funds as consumer subsidies.

 

Moreover, in an attempt to diversify their energy mix while mulling measures to cut demand and save energy, European countries are sourcing new exporters of natural gas and LNG. For example, Germany and Norway are considering building a hydrogen pipeline between the two countries to make European countries less dependent on Russian energy.

 

At the moment, finding alternatives to Russian gas is growing increasingly critical; however, the crux of the matter is not whether Europe can defuse the gas crisis precipitated by Russia’s countermeasure to choke off gas supplies, but how soon. Regardless of the solution to the gas crunch, it will take time. To illustrate the point, let us imagine that Europe imports natural gas mainly via pipelines, rather than offshore floating LNG terminals. As natural gas imports via pipelines plunge, Europe would lack sufficient LNG regasification terminals for making up the shortfall from Russia, and building new wharves and regasification terminals would require two years. This is one of the biggest challenges facing the continent.

 

According to a report, the current prices of natural gas futures in Europe are eight times higher than those in the US benchmark, and they may plateau at a higher level than the pre-crisis level over the next two to four years. Some analysts predict that European prices will stabilize at about 2.5 times the US prices by 2026.

 

 

4. Europe must iron out internal kinks before addressing the energy crisis.

Granted, Europe’s energy crisis is closely linked to many external headwinds, but the winter gas crunch had already harassed the continent more than once approximately two years prior to the outbreak of the Russia-Ukraine conflict. The energy crisis was already looming several months before Russia sent troops to Ukraine. The war merely exacerbated an existing crisis.

 

Today’s energy crisis may be largely attributed to the EU’s green-policy hubris. For an extended period, while the EU has been slashing the use of fossil fuels and restricting oil and gas exploitation, it has retained a soft spot for Russian gas. Having been living off this largess from the East, they were unprepared for any potential crisis. Overconfident in their green policy, they possessed no reliable contingency plans. According to one estimate, the shale gas and coalbed methane in Germany could meet the country’s energy demand over the next 10 years or more. However, the European countries such as Germany, France and the UK have legislated against the use of hydraulic fracturing for the extraction of natural gas out of fears of implications such as earthquakes and environmental pollution. Over the past decade, natural gas production in Europe has halved.

 

Even so, some European powerhouses have pledged to remove coal and nuclear power from their energy mixes. In May of 2022, the European Commission unveiled the REPowerEU plan, aiming to fast-track EU’s green transformation and prioritize renewable energy sources such as solar power. Nonetheless, the expansion of renewables is too slow to compensate for the loss of conventional capacities, especially in seasons marked by less wind and sunlight. According to a Wood Mackenzie report published in April, one of the key lessons drawn from the current energy crisis is that the energy transition needs to be focused on cutting demand first, rather than supply. Curtailing supply while demand remains strong is a recipe for crisis.

 

In addition, the EU has been phasing out long-term natural gas supply contracts, which is also a contributor to the crisis. The Germany-Qatar deadlock on the LNG deal in March represents the consequences of the long-term contract ban. Germany did not agree to Qatar’s demand to sign deals for a duration of at least 20 years, as it viewed this time frame as contradicting its plan to slash carbon emissions.

 

Understandably, the EU wishes to avoid purchasing natural gas at fixed prices. Still, energy companies need to be assured of the stability of expected returns, as they must invest a great deal in building natural gas production and transportation facilities, and short-term contracts cannot guarantee such stability. If European countries stand by their guns, the stability of the gas supply would be undermined.

 

In early October, OPEC+ announced a major oil production cut of 2 million barrels per day starting in November. Meanwhile, given that China’s economy is on the fast track to recovery and the Russia-Ukraine war is grinding to a stalemate, a solution to the global natural gas crunch will remain elusive. Spiking natural gas prices will continue in Europe, filtering down to businesses and consumers and eventually leading to an economic downturn, growing unemployment, and declines in real personal income. The price spike will also allow right-wing forces in more countries to gain ground and throw European politics off balance. By that time, Eurosceptics will cavil over “safeguarding national interests rather than EU interests” to the detriment of unified decision-making and the bloc’s response to the energy crisis.

 

The road ahead is beset with brambles. Is Europe ready to beat a path?

 

 

 

This article is from the October issue of TI Observer (TIO), which is a monthly publication devoted to bringing China and the rest of the world closer together by facilitating mutual understanding and promoting exchanges of views. If you are interested in knowing more about the September issue, please click here:

http://www.taiheinstitute.org/Content/2022/10-31/1615423550.html

 

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