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Is the European Plan to Reduce Dependence on Russian Gas Feasible?

Published 04/26/2022, 01:24 PM
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By Laura Sanchez

Investing.com - Europe continues to look for viable alternatives to not relying on gas from Russia to meet its energy needs. Russia currently supplies Europe with between 35 and 40% of its gas needs. The war in Ukraine has highlighted the urgent need for Europe to diversify its gas sources, as well as the long-term goal of transitioning to clean energy sources. Meanwhile, the International Monetary Fund (IMF) warns that next winter we will not have enough gas in the region if the supply from that country is cut off.

This raises the question, is Europe's 'REPowerEU' plan to reduce dependence on Russian gas viable? Schroders' team of energy experts - Mark Lacey, global energy and precious metals portfolio manager; Alexander Monk, global renewables analyst; and Felix Odey, the manager's global renewables analyst - discuss the plan's five main objectives and the challenges they pose.

Objective 1: Import an additional 50 billion cubic metres of LNG from alternative sources

Even before the invasion of Ukraine, Europe had been reducing Russian gas consumption and importing more LNG. The problem is that the US cannot offer such an ample 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 560,000 bcm). It is expected to grow by at least 20-25 million tonnes per year over the next decade, as key markets such as China and India increase their LNG import capacity.

Another obstacle is that LNG, as its name suggests, is liquid, and in order to use it, it has to be converted back into gas. This is a process called "regasification", and Europe has very little LNG regasification capacity.

European LNG imports have already almost doubled since the first quarter of 2021 to reach 16Bcf/day (billion cubic feet) in February 2022. This is close to the "theoretical capacity" of 20Bcf/day.

Unfortunately, "theoretical capacity" does not mean that the European market has access to gas. For example, Spain and Portugal have around 7Bcf (billions of cubic feet) of combined capacity per day. But pipeline capacity to the rest of Europe is closer to 4Bcf/day, making it impossible to get all this additional gas to the markets that need it, such as Germany or Austria.

The good news is that Europe is planning a further expansion of its LNG import capacity; the bad news is that construction of the infrastructure for this has not yet started.

Objective 2: Increase non-Russian pipeline imports by 10,000 bcm

If shipping more LNG is not the solution, what about increasing supply through existing pipelines? This will be very difficult without further field development. Producing fields are operating at full capacity at the moment.

Around 3.5Bcf/day comes from Algeria, where the operator Sonatrach has the Tinrhert expansion project under construction. This project will provide a further 0.4Bcf/day of supply; however, no further major gas field expansions are planned.

Norway and the UK together currently supply Europe with about 15Bcf/day of production. But, as in Algeria, field development has been very limited in recent years.

Objective 3: Reduce natural gas demand by 20,000 bcm by increasing renewable energy generation

Focusing on renewables is the most logical and sustainable solution. However, it is a long-term solution, which will not provide enough capacity to replace 20,000 bcm of gas in 2023.

From a cost perspective, even with recent commodity price increases, renewable energy generation from wind and solar is already significantly cheaper than power generation from CCGT (combined cycle) and coal. With recent increases in gas and electricity prices, the cost ratio argument is unassailable.

However, capital expenditure on renewable energy generation is far below what is needed to meet the 2030/2050 targets. The same is true for the associated investment needed for transmission and distribution networks.

The main obstacle to getting more renewable energy generation off the ground is not political will or return on investment, but the problem of logistics and moving equipment from the factory to the project site. This is due to the confinements of major Chinese cities due to the re-emergence of Covid-19, that supply from the chip industry remains limited, and that the availability of cargo ships and container capacity remains severely disrupted.

Equipment suppliers and renewable energy developers expect these supply chain constraints to begin to ease in 2023. Again, this is not a quick fix.

Objective 4: Use energy efficiency measures to reduce demand by 15,000 billion cfm

The first three targets we have addressed largely cover the supply side, but what about the demand side - could measures such as turning down the thermostat or installing heat pumps make a difference?

 Gas is used to heat around 35% of commercial and residential buildings in the EU. There is no doubt that the current high gas  and electricity prices are causing a temporary and permanent destruction of demand.

On the temporary side, many industries - notably fertiliser and cement manufacturing - are announcing short-term plant closures due to high gas prices. Meanwhile, a recent Bloomberg analysis suggests that a 1.75 degree Fahrenheit drop in the thermostat could reduce Europe's annual residential and commercial demand by 10% (or about 14,000 billion cubic metres).

Where feasible, heat pumps are an effective way to reduce overall gas  consumption. The EU wants to accelerate their adoption in households, with the aim of growing the EU market by at least 10 million units in the next five years. We estimate that this will contribute to the substitution of natural gas demand by about 1.5-2.0 billion cfg. The biggest hurdle for the residential (and commercial) consumer remains the initial cost, which is more than double that of a conventional boiler. We expect the relative cost to improve over the next five to ten years as volumes increase.

Objective 5: Replenish storage to 80% of capacity by November

Finally, the REPowerEu plan includes a target to refill storage capacity to 80% by 1 November 2022, and to 90% in all subsequent years. This is a somewhat conventional target, because it essentially stipulates that market participants (utilities/storage operators) must buy gas on the market at any price, during the summer, to avoid another winter peak.

Currently, gas storage levels in Europe are around 25% below normal, but above the lows recorded in 2018.

US natural gas producers will benefit.

In conclusion, there are no easy answers for Europe when it comes to natural gas replacements. Europe now relies heavily on imported LNG volumes to meet its energy needs and the REPowerEU action plan will accelerate the transition to new, lower-risk suppliers.

The United States is poised to lead the way. It has a significant resource base in the Appalachian, Texas and Permian regions that offers the potential to become a major exporter of natural gas. Most of this gas is likely to be destined for European markets.

Forward prices for gas contracts in the US have already risen from below $3.00/Mcf two years ago to $3.50-4.00/Mcf now. We believe that long-term prices could continue to rise as the US becomes an increasingly important global gas supplier.

US companies best placed to benefit from this increased demand and prices will be those with a low-cost resource base and easy access to US LNG export facilities.

 

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