The continent has been at the centre of a supply and demand crisis since last year, placing the security and flexibility of gas supply as well as its role in the energy transition top of the EU’s agenda.
Wood Mackenzie, a Verisk business released the Europe Gas: 5 things to look out for in 2022 report yesterday, highlighting key areas to watch which will shape the European and global gas markets for decades to come.
1. The start-up of the controversial Nord Stream 2 pipeline bringing Russian gas to Germany might now be past 1Q22, meaning limited additional Russian supplies through the winter period, if any.
At normal weather conditions and with low Russian imports, European storage inventories will dropbelow 15 billion m3 by the end of March – a record low.
Prices will eventually come down as spring approaches, but requirements to refill storage facilities will be high at 20 - 25 billion m3 more than this year.
Kateryna Filippenko, Principal Analyst, European gas research, said:
Without additional Russian imports, the ability to refill depleted storage and to avoid a repeat of last year’s crisis will be limited
But Gazprom has so far been reluctant to make more gas available on the existing routes and the start-up of Nord Stream 2 remains the big unknown as Gazprom navigates regulatory approvals
Cold weather in Europe could exacerbate the situation further, adding up to 10 billion m3 to gas demand through the rest of the winter, pushing storage levels to zero unless more Russian gas is supplied, and Europe may have to tap into cushion gas to balance the market
Normal winter weather, including in Asia, and visibility on Nord Stream 2 commissioning would push prices down, although demand for storage (and high carbon costs) will maintain prices above $15 mmbtu
2. Over the last 2 years the importance of gas storage in Europe has been demonstrated to the full.
In 2020, storage was able to absorb a large excess in supply whereas in 2021, extremely high gas pricing discouraged the injection of gas through summer leaving the region with historically low inventories for the winter.
Graham Freedman, principal analyst, European gas research, said:
Exceptionally cold weather in the Northern Hemisphere could again leave Europe with a supply deficit
Questions are being raised about the importance of having gas storage in the overall mix of sources, and how storage operators and owners should be rewarded in the future
A new EU strategic storage policy will require an overhaul of regulations which significantly vary from country to country
Places such as Italy and Hungary already have well-established strategies to supply the market in the event of a supply shortage, others do not
Therefore, a framework is required to ensure consistency across the industry
3. In the last decade, Europe has been moving away from long-term oil-linked contracts towards hub pricing and spot market.
But the current crisis has shown that this path can have drawbacks – security and affordability of supply foremost among those which could impact the region.
About 49 billion m3 of import contracts into Europe will expire this year.
Out of these, 21 billion m3 will be Russian piped contracts.
Some of these will not be extended such as PGNIG’s 10 billion m3 contract with Gazprom as Poland moves away from Russian gas.
Penny Leake, Research Analyst, European gas research, said:
With the possible start-up of Nord Stream 2, we may see some new long-term contracts signed along the pipeline’s route
Potential concerns over the long-term exposure to Russia, coupled with the crisis-driven worries over supply security and diversification, may push more players towards LNG contracting
Both oil-indexed and Henry Hub plus long-term LNG contracts will be at a considerable discount to local spot prices through to 2025/6, making them an attractive option for European players
But negotiations over the prices and structures of these contracts will be complicated
Utility companies will need to commit to a long-term duration contract if they are to take advantage of the current spot price premium, which could prove risky
4.The energy crisis has drawn attention to the importance of domestic production and the prospect of Europe requiring gas for decades to come.
Record prices pushed gas producers to prioritise gas developments that can provide immediate flexibility, and the prospect of tight gas market in the coming years may revive investments into new gas supply options.
Conner McKinney, Research Associate, European gas research said:
Some operators may see this time as ‘now or never’ for their projects, particularly inspired by the possibility of high prices. Temporary tax packages offered in Norway last year will encourage more FIDs including King Lear, Asterix, Dvalin North and Linnorm
Maximising flexible production through increased permits for Troll and Oseberg will also be a focus and some operators may prioritise gas sales over gas reinjection, like Equinor at Gina Krog
While new FIDs are more uncertain due to ESG pressures in the UK, the sustained market tightness expected over the next few years may impact decision-making in other parts of Europe
In Romania, progress towards FID for the giant Neptun Deep project has been delayed since 2019, not least by fiscal and regulatory deterioration
It has the potential to produce more than 6 billion m3 a year at plateau and transform Romania to a net gas exporter, but for this to materialise, fiscal and regulatory improvements are required
The prolonged prospect of high prices could further encourage Romania’s government to speed up change
5. At the end of last year, the European Commission published a new EU taxonomy proposal classifying efficient unabated gas-fired power plants as transitional investments, which could be a moment of truth for the global gas industry.
Expert advisers have until 21 January to provide feedback which may result in changes to the proposed text.
Claire Spencer, Research Associate, European gas research, stated:
As it stands, financial and non-financial investors will be able to increase their corporate ‘green scoring’ by investing in gas, including outside Europe, disclosure will be key
Other countries developing similar taxonomies would be emboldened to include gas too, particularly in Asian markets where coal still dominates
However, the EU recognition of gas power plants as a transitional investment is no panacea for the gas industry
Wood Mackenzie predicts that gas prices will need to come down to accommodate increased investment in gas use.
The proposed CO2 emission cap of 270 Gr. per kWh for facilities that have a construction permit by 2030, alongside the commitment to use at least 30% of renewable or low carbon gas by 2026 and 100% by 2035, means that the use of conventional natural gas would need to reduce over time if a gas-fired power plant is to be classified as transitional.
The use of unabated natural gas in the EU is set to decline, even if the EU classifies investments in gas-fired plants as transitional investments.