A Bad Year for Gas

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This will go down as the year natural gas fell off the cliff towards obscurity. Things look okay at the moment, with high-but-not-insane prices keeping exporters fat, and a few small long-term LNG supply deals keeping them happy. But the abrupt break in voluminous Russian pipeline gas flows to Europe that were highly profitable for Russia and relatively cheap for Europe is a wound that will not heal. Europe is replacing only a small fraction of its Russian pipeline gas purchases with contract LNG — or other gas — and any incremental Russian gas sales to China won’t come close to making up lost volumes to Europe. Gas importing nations outside Europe have developed deep doubts about the prudence of relying on LNG as more than a marginal fuel, given the year’s astronomic spot prices. The now undeniable relative cheapness of solar and wind power caps the case against gas.

The threats to natural gas’s future have been evident since the Ukraine conflict began. Now the evidence of realized damage is starting to pile in — although failure to focus on huge differences in Russian pipeline gas volumes and the LNG and other new supplies coming to Europe has obscured that to a degree.

Europe filled gas storage to unexpectedly high levels this summer, bringing EU spot gas and LNG prices down by more than half recently — albeit to levels still more than twice pre-crisis rates. This has been deemed a success in Europe. But governments are still having to spend billions of euros on subsidies for gas-dependent industries and households, and only staunch objections from cash-flush Germany have kept most EU countries from agreeing to a ceiling on prices at which Europe would import LNG. The Financial Times nonetheless examined Germany’s “broken business model” last week, querying whether the country could “reinvent itself” without cheap Russian gas. Europe is already in recession, or soon will be, most economists agree.

Global Gas Disruption

The restocking that brought these bare-bones benefits to Europe came through a combination of, first, beggar-thy-neighbor purchasing that drove global LNG prices to heights that buyers in South Asia, Latin America and other places couldn’t or wouldn’t match; and second, luck: China’s economy was struggling under the Zero Covid-19 policy and a housing finance crisis that left Chinese LNG importers not merely out of the spot market as purchasers, but willing to resell big term-contract volumes to Europe.

One near-term result of this disruption of global gas markets was less gas and more coal burning in Asia. Another was a huge boost for energy efficiency in Europe. And most importantly, solar and wind generation became the cheapest new form of electricity practically everywhere, including the US. In many places, new-built renewables facilities now provide cheaper electricity than existing gas-fired power plants, and they account for 90% of all new generating capacity globally. The International Energy Agency just boosted its projection for renewables expansion over the next five years by 30%, to 2,400 gigawatts, and this is probably still an undershot.

In volume terms, the Russians haven’t come out well either. Monopoly pipeline gas exporter Gazprom is projected to see sales down by nearly half this year, to 100 billion cubic meters from 185 Bcm in 2021, in its major export markets the EU, China and Turkey.

Russian gas flows to China rose in line with a long-scheduled buildup in contract volumes. Prices are indexed to oil, and so rose this year by hugely less than spot-LNG. In any case, Chinese import volumes — while not broken out by Gazprom — are roughly 10% of the amount Europe took in 2021. Europe, in contrast, had for years pushed Gazprom into gas-hub-related pricing, so it likely paid as much or more to Gazprom for the reduced volumes it bought as it would have for higher volumes before the war.

Scenario Thinking

Various scenarios can be imagined for how this will play out over the years. A few things, though, are already clear. One is that Europe will get off substantial reliance on gas faster than it would have done had cheap Russian gas continued. New LNG import infrastructure in Germany and elsewhere has led to suggestions that gas imports would go on for longer. However, even if Germany completes the full 22 Bcm/yr of LNG import capacity expected by end-2023, it won’t come close to replacing just the 55 Bcm/yr capacity of the two new, or nearly new, Nord Stream systems Russia had just built.

Three of four pipes in that system have been blown up, and probably won’t be repaired. Then there’s the even greater capacity Russia has to push gas into Europe via Turkey, Poland and Ukraine itself. If you try hard, it’s possible to imagine Russia using some of that capacity for post-war gas sales into Europe, but not for long or in anything like pre-war volumes.

What Europe will end up with is lower energy demand overall due to intense conservation efforts, and a more rapid buildout of solar, wind and battery-storage — as laid out initially in the RePowerEU plan adopted immediately after Russia invaded Ukraine. Initial evidence suggests the EU’s wind goals may be overly ambitious, but solar might outperform even that plan’s ambitious targets. Europe’s generating system is on a fast track to renewables, the remaining puzzle is industrial gas use. However, if power and space heating move quickly off gas, satisfying industrial needs with natural gas itself looks a lot simpler for the years until a solution emerges.

Russian Downsizing

Russia’s gas industry is unlikely to come out of this without permanent downsizing, as well. Gazprom and other Russian LNG exporters hope to sell more into China, India and Turkey — the same countries seen as rescuing Russia’s oil industry. However, replacing roughly 150 Bcm/yr of pre-war gas sales to Europe is hugely harder than finding new oil customers. Chinese gas demand is projected to fall by 1.3%-1.4% this year, and LNG imports have tumbled by more than 20%. Chinese analysts expect little, if any, recovery in 2023. Coal now and solar, wind and batteries as quickly as possible is where China looks to be headed — not towards gas.

India’s government last week authorized LNG gas purchases for next summer. That made a gas-friendly sounding headline, but the LNG would feed existing plants that have, at most, provided around 3% of the country’s electricity.

Qatar could be looked at as one of the few winners in this. It recently announced a new 27-year contract into China and a 15-year deal into Germany from its 32 million ton North Field East (NFE) LNG project. But measured against Gazprom’s prewar pipeline gas sales, the volumes are modest. The German deal with Qatar, plus three long-term, low-volume deals for US supply, add up to less than 8.7 Bcm/yr of gas (6.275 million tons of LNG), not quite 6% of the volume it bought from Russia in 2021.

Equally worrisome for the long-term is the harsh light the Chinese deal, in particular, casts on the challenges the international gas industry will face as the transition progresses. Qatar’s NFE deals are price-linked to oil. That looks great right now, but it becomes a highly uncertain proposition as you look out towards the 2054 expiration date. Consider that oil use will be falling through most of that period and may be quite small — perhaps negligible — by mid-century.

Who knows what oil prices will do over that unprecedented phaseout period? Will China really want gas by that time anyway? Or is that long contract duration mainly an attempt to give the parties grounds for a lawsuit or arbitration action when the gas music stops? Pick your scenario. No really one knows.

For more coverage of the Ukraine crisis, visit Ukraine Crisis: Energy Impact

Sarah Miller is a former editor of Petroleum Intelligence Weekly, World Gas Intelligence and Energy Compass.

Gas Demand, LNG Demand, Ukraine Crisis
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