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How does the EU expect to replace Russian gas supplies and how will this turn out?

Pipe dreams

The determining factors that traditionally affect the gas market are the price and the control effects that arise from the suppliers of this energy carrier. Despite the fact that Russia used to form the lower part of the gas price supply and was doing so for decades, the European Union has made a strategic decision to reduce the degree of energy dependence on both Russia and any other oligopoly suppliers. How did it turn out for the Europeans and what's next?

Strategy and reality

Как в ЕС рассчитывают заместить поставки российского газа и чем это обернется? The loss of the main cheap gas source has placed a heavy burden primarily on the shoulders of relatively energy-intensive industrial enterprises and has become the price that Europe has to pay for severing energy ties with Russia. If earlier even small inflation values in European countries were mainly monetary in nature in the context of stimulating demand, now, for the first time in a long time, Europe has faced accelerated inflation rates from the side of rising supply costs.

These losses are of a conscious nature, since tight binding to Russian, Algerian and Norwegian pipeline supplies has potential risks of non-market forms of control. You can't say that about liquefied natural gas (LNG). LNG suppliers freely redirect cargo to those markets where they are offered the best price without significant regard to politics. The ball here is ruled mainly by commercial interest. Of course, if we talk about ways of trading LNG, energy experts and officials are aware of the consequences of an imbalance in the markets (for example, when news is released, the forecast of which did not coincide with the published official data) and the subsequent movement of the asset price in one direction or another in search of a new balance of supply and demand for it.

At the same time, despite this imbalance and the loss in price, a significant decrease in the share of pipeline gas (and its replacement with LNG) is for Europe, on the one hand, a consequence of the aging of Norwegian fields and the possible closure of the Groningen field in the Netherlands, and on the other hand, an important element in the long—term strategy of green transition. This is due to the need to form a gas market in a form as close as possible to a conditional perfect competition, that is, a consumer market, where the consumer dictates the price.

Such a market configuration is most convenient for Europeans to position gas as a transition bridge to renewable energy sources (RES) or, more precisely, as a reserve capacity to cover failures in the power generation of wind turbines and solar panels. It is the consumer market, according to the strategic plans of the Europeans, that will make gas constantly available and a fairly cheap resource that closes the "holes" of renewable energy.

But this is all a strategy, and the period of possible interception of LNG initiatives from pipeline gas will not come soon. Of course, a pipeline is a big-ticket item. Its condition needs to be maintained, and a road should be laid along the pipe so that any point is accessible for diagnosis and repair. The maintenance of compressor stations also costs a considerable amount.

But it can be stated at the moment that pipeline gas is about a quarter cheaper than liquefied gas. And this is an objectively determined difference, because in the context of the current and medium-term cost structure, it is impossible to make gas transported by sea, undergoing first liquefaction and then regasification, cost less than fuel that simply goes through the pipe.

Answering the question whether LNG can really compete with pipeline gas from Gazprom or other sources, in the near future it is necessary, on the one hand, to estimate the total consumption of natural gas in Europe, and on the other hand, to pay attention to what price LNG is actually traded, viz., whether it is the price of long-term contracts, which are three to four times cheaper than on the stock exchange.

In 2019, the gas consumption volume in Europe made 560 billion cubic meters (the same consumption volume was recorded for 2021). Of these, just under 200 billion came from Russia via gas pipelines and 21 billion as LNG. About 170 billion cubic meters of Europe were produced in the North Sea, including from Norway — 120 billion cubic meters. Another 170 billion fell on exports from other countries — by gas pipelines and in the form of LNG. In particular, Qatar supplied 32.7 billion cubic meters of LNG, Algeria — 30 billion by pipeline and LNG, the United States — 17.7 billion LNG, Nigeria — 15.7 billion LNG.

It’s not just a matter of price

According to a number of experts, it is expected that in the near future the main role in global LNG supplies will be played by the USA, Australia, Qatar. By some estimates, Russia may also become one of the main LNG suppliers to the European continent. Despite the fact that American liquefied natural gas is already taking its place in Europe, the growth of supplies at the current stage, in fact, reduces the competitiveness of the European economy. In significant volumes, LNG will not be able to compete on price, since Russia and Norway offer gas at a lower cost. In the USA, for example, there is a large part of the subsidy laid in gas production, delivery and liquefaction. The real cost comes out about 300 — 350 dollars. If we add to this US$ 200 of all the other costs they incurred, then the price of American LNG at which they have to sell it will be in the region of US$ 500 — US$ 600. At the same time, the average gas price from Gazprom for Europe under a long-term contract for the specified period was US$270 - US$280.

In general, the complete replacement of Russian pipeline gas supplies to Europe with liquefied gas is unpromising. Then suppliers would have to abandon the Asian market, where, in addition to attractive prices, they have obligations under contracts.

Besides, it's not just about the price. If it is necessary to sharply increase the volume of supplies in the conditions of RES power generation fluctuations, LNG will not be able to quickly satisfy the request. At best, consumers will have to wait two weeks for delivery, and Norway and Gazprom can satisfy the request as quickly as possible.

Therefore, given the impossibility of complete decarbonization and the need to use reserve capacity (the one which would maintain overall energy flexibility), pipeline gas will retain its niche in the European market.

To provide flexible energy, partial decarbonization, coal-fired power plants are poorly suited. Their thermal efficiency declines and maintenance costs increase when they operate under a flexible peak mode. In addition, higher carbon dioxide emissions from coal plants nullify the main RES advantage — clean energy.

Batteries can compensate for hourly fluctuations in demand, but they are much more expensive than gas generation. While this cost may decline over time, it is unlikely that batteries will become an economically viable option to balance weekly, monthly or off-season differences in supply and demand. In terms of reserves, a coal pile or gas from storage stores energy thousands of times cheaper than a lithium storage device.

The loss of the relative share of the European pipeline gas market does not entail any serious strategic consequences for Russia. First, there is an Asian direction ("The Power of Siberia" plus LNG), and second, the remaining volumes of gas can be used to produce hydrogen as the basis of future energy. If we talk about the climate agenda, the Russian government will seek global recognition of nuclear energy as carbon-free and meeting climate goals.

Given the world leadership in the field of nuclear energy and possible successes in the field of controlled thermonuclear fusion, Russia in the foreseeable future will can set trends in global energy and create a highly efficient modern industry.

Vitaly DEMIROV, BISR analyst.