How feasible is Europe’s plan to reduce reliance on Russian gas?
Europe’s “REPowerEU” plan is extraordinarily ambitious. We highlight the plan’s five main targets and the challenges ahead.
Russia currently supplies Europe with 35-40% of its gas needs. The war in Ukraine has highlighted the urgent need for Europe to diversify its sources of gas, as well as the longer term goal of transitioning to clean sources of energy.
In late March, the EU signed a major deal with the US regarding liquified natural gas (LNG). The agreement provides a framework for the US to supply the EU with natural gas equivalent to around 10% of the gas it currently gets from Russia by the end of the year.
The long-term plan is for the US and international partners to provide about 50 billion cubic metres of gas (Bcm) per year to the EU. This is on top of the 22Bcm it currently supplies on an annual basis and the 37Bcm it plans to supply by the end of the year.
This is all part of an initiative – REPowerEU – which is designed to reduce European imports of Russian gas by two-thirds over the next year (equating to around 100Bcm per year).
The REPowerEU plan is incredibly ambitious. Here, we set out five of its targets, and the challenges ahead.
Target 1: Import an extra 50Bcm of LNG from alternative sources
Even before the invasion of Ukraine, Europe had been phasing out Russian gas and importing more LNG. The problem is, the US can only do so much in terms of supply, and Europe is competing with other countries for imported LNG cargoes.
The global LNG market is currently around 400 million tonnes per annum (mtpa, or 560Bcm). It is forecast to grow by at least 20 – 25mtpa over the next decade, as key markets such as China and India grow their LNG import capacity.
Another stumbling block is that LNG is – as the name suggests – liquid and to be used it needs to be turned into gas again. This is a process called “regasification”, and Europe has very little spare LNG regasification capacity.
European LNG imports have already nearly doubled since Q1 2021 to as much as 16Bcf/day (billion cubic feet) in February 2022. This is close to the ‘theoretical capacity’ of 20Bcf/day.
Unfortunately, ‘theoretical capacity’ does not mean the European market has access to the gas. For example, Spain and Portugal have around 7Bcf/day of combined capacity. But pipeline capacity to the rest of Europe is closer to 4Bcf/day so it’s impossible to feed all of this additional gas into the markets that need it, such as Germany or Austria.
The good news is that Europe is planning a further build-out of its LNG import capacity; the bad news is that construction hasn’t started yet.
Target 2: Increase non-Russian pipeline imports by 10Bcm
So if shipping more LNG isn’t a silver bullet, what about increasing supply via existing pipelines? This will prove very difficult without further field development. Producing fields are running at full capacity right now.
Around 3.5Bcf/day comes from Algeria, where operator Sonatrach has the Tinrhert expansion project under construction. This will bring on another 0.4Bcf/day of supply; however, no other major gas field expansions are planned.
Norway and the UK combined currently supply Europe with around 15Bcf/day of production. But like Algeria, field development has been extremely limited in the last few years.
Target 3: Reduce natural gas demand by 20Bcm by increasing renewable power generation
In our opinion, focusing on renewables is the most logical and sustainable solution. However, it’s a long-term solution, not one that will provide enough capacity to substitute 20Bcm of gas by 2023.
From a cost perspective, even with the recent increases in raw material costs, renewable power generation through wind and solar is already significantly cheaper than both CCGT and coal fired power generation. With the recent increases in both gas and electricity prices, the cost relative argument is unquestionable.
But capital expenditure in renewable power generation is running significantly below what is required to meet existing 2030/2050 targets. The same goes for the associated investment required for transmission and distribution networks.
The main obstacle to getting more renewable power generation onstream is not political will or investment returns, it is the problem with logistics and the movement of equipment from factory to project site.
This is because of lockdowns of major Chinese cities due to a re-emergence of Covid-19, supply from the chip industry still being constrained, and the availability of cargo ship and container capacity remaining very disrupted.
The equipment providers and renewable developers are hoping that 2023 should start to see these supply chain constraints ease. Again, this is not a quick fix.
Target 4: Use energy efficiency measures to reduce demand by 15Bcm
The first three targets we’ve outlined all largely cover the supply side, but what about demand? Could measures like turning down the thermostat and installing heat pumps make an impact?
Gas is used to heat around 35% of the EU’s commercial and residential buildings. We have no doubt that the current high gas and electricity prices are causing some temporary and permanent demand destruction.
On the temporary side, many industries – notably fertiliser and cement manufacturing - are announcing short-term plant closures due to elevated gas prices.
Meanwhile, recent analysis from Bloomberg suggests a 1.75 degree Fahrenheit thermostat reduction could reduce Europe’s annual residential and commercial demand by 10% (or around 14Bcm).
Where viable, heat pumps are an effective way to reduce overall gas consumption. The EU aims to expedite their adoption in households, with a goal of growing the EU market by at least 10 million units over the next five years. We estimate that this will contribute to around 1.5 – 2.0Bcm of the demand substitution away from natural gas.
The biggest stumbling block for the residential (and commercial) consumer remains the upfront cost, which is still over twice that of a conventional boiler. We expect the relative cost to improve over the next five to ten years as volumes ramp up.
Target 5: Rebuild storage to 80% of capacity by November
Finally, the REPowerEu plan contains a target to replenish storage capacity to 80% by 1 November 2022, and up to 90% in all subsequent years.
This is a somewhat odd one, because it essentially stipulates that market participants (utilities/storage operators) must buy gas in the market at any cost, during the summer, to avoid another winter spike.
Currently, European gas storage levels are around 25% below normal, but above the lows seen in 2018.
US natural gas producers to benefit
To conclude then, there really are no easy answers for Europe when it comes to substituting natural gas. Europe is now very reliant on imported LNG volumes to meet its energy needs and the REPowerEU action plan will speed up the move towards new, lower risk suppliers.
The US is poised to be at the forefront of this. It has a significant resource base in the Appalachian, Texas and Permian regions which offers it the potential to emerge as a big exporter of natural gas. The majority of this gas is likely to feed into the European markets.
Forward prices for gas contracts in the US have already risen from under $3.00/Mcf two years ago to $3.50-$4.00/Mcf now. We think long-term pricing could continue to move upward as the US becomes an increasingly important global supplier of gas.
US companies best placed to benefit from this higher demand and pricing will be those with a low cost resource base and easy access to US LNG export facilities.