The replacement of Russian gas in the European energy mix could be challenging in the short term, which will keep gas prices high, but is feasible in the medium term, Fitch Ratings says. The search for alternatives has accelerated due to the Ukrainian crisis and related European sanctions that may lead to supply disruptions or even a complete supply cut-off. The European Commission’s (EC) policy package aims to reduce dependence on Russian gas by two-thirds by year-end.
Europe imports about 60% of its gas demand according to BP’s Statistical Review of World Energy, with Russia supplying about a third of European gas consumption; 152 billion cubic metres (bcm) by pipeline and 17bcm as liquefied natural gas (LNG). The dependence on Russian gas varies by country, with Germany and Italy importing the highest volumes.
The EC’s REPowerEU package proposes to replace about 100bcm of Russian gas by year-end with 50bcm from additional LNG supplies from elsewhere, with the rest coming from wind and solar expansion, energy savings and diversification of pipeline gas sources.
The EU has sizeable LNG import capacity of about 157bcm a year, according to the EC, of which only 80bcm was used in 2021, leaving room for additional volumes. However, most LNG import terminals are concentrated in Spain, Portugal, France and Italy with limited existing pipeline infrastructure to deliver gas to Germany and some Central and Eastern European countries that are most dependent on Russian pipeline gas.
However, around two-thirds of global LNG supplies are already contracted, leaving limited room to increase supplies to Europe, unless it offers higher prices. Recently higher LNG netbacks in Europe compared to China made shipments to Europe more competitive. We expect the LNG market to remain tight in the next two years, with Europe competing with Asia for LNG flows, keeping prices high, and more production capacity coming onstream only in the medium term.
The US has recently agreed to supply an additional 15bcm of LNG to the EU within a year (having exported 22bcm to the EU in 2021, according to the EC). Since a significant part of US LNG exports go to Asia, competitive European prices may encourage the redirection of greater volumes. US final investment decisions (FIDs) constitute over two-thirds of global FIDs for new LNG capacity waiting for approvals in the short term, yet developers will have to overcome a pre-existing Biden administration slow-down of approvals. We expect those projects to be approved, given LNG demand growth, but it may take three to four years before developers start exporting gas.
We believe the EU plan is feasible in the medium term, if proposed increases in LNG capacity materialise, while competitive gas prices in Europe keep redirecting LNG from Asia, on the top of additional pipeline supply from Algeria, and growing renewables and energy efficiency. This is likely to result in sustained high gas prices.
The IEA, using similar steps to those outlined in the EU plan, estimates that EU gas imports from Russia can be reduced by 50-80bcm within a year. The upper end of the range that assumes all fuel-switching options for power generation (mainly to coal) are fully exercised.
The European market’s resilience would be tested in the event of a full near-term supply cut-off by Russia but the impact would depend on its duration. Russia’s ability to redirect gas volumes earmarked for Europe is limited, which may deter it from unilateral long-term supply stoppages. Russia only exported 3.9bcm of gas by pipeline and 6.9bcm as LNG to China in 2020.
Source: Fitch Ratings