Europe’s Gas Conundrum

Originally published at Project-Syndicate | May 6th, 2022

If Europe is willing to pay the price of expensive LNG imports, it could severely undermine Russia’s ability to earn hard currency via gas exports to finance the war in Ukraine. But this would carry high costs for Europe, too.

BRUSSELS – In a matter of months, the European Union has reduced its dependence on Russian oil so much that it is now ready to impose an embargo. European Commission President Ursula von der Leyen has announced a plan to ban Russian crude oil imports to most of the EU in the next six months, and refined oil products by the end of the year. But to have a meaningful impact on Russia’s budget, Europe must also end its dependency on Russian gas. This will prove much more difficult to achieve

Europe has managed to reduce its need for Russian oil quickly for a couple of reasons. Oil can easily be delivered by tanker, not just pipelines, and it is relatively easy to find new supplies on the world market. The problem is that it is also relatively easy to find enough new buyers – and Russia has plenty – to offset a large part of the losses from an EU embargo.

Gas is different. Europe needs natural gas to provide heat in winter and to serve as feedstock for the world’s largest chemical industry, which accounts for a significant share of EU exports. And certain features of the natural-gas market will make it far more difficult and costlier to find alternatives to Russian supplies than it has been for oil.

For starters, because most natural-gas producers operate on long-term contracts with buyers, there is little spare production capacity outside Russia. While there are spot markets, where one can buy or sell limited quantities of gas, their purpose is to redistribute existing supply or demand across regions, as needed, not to provide additional supply.

Nervous European energy ministers have visited various global gas producers, in the hope of convincing them to increase production. And major gas producers are happy to oblige. But they warn that it takes up to four years to launch new projects, and doing so makes commercial sense only if the customer is willing to sign a 20-year contract.

All of this means that, in the short run, the natural-gas supply is close to fixed. So, the only way to make up for a shortfall of Russian gas is through a combination of energy savings and increased imports.

Here, Europe will confront another challenge. Natural gas is costly to transport and difficult to store. Liquefied natural gas (LNG), which can be shipped, offers the main alternative to piped Russian gas, though it raises challenges of its own.

Once gas has been liquefied and loaded onto a special tanker, a few thousand extra miles of travel make little difference. This is the principal reason why the Asian and European LNG markets are integrated, with prices on the two continents usually moving closely together. Gas spot prices reached very high levels already last autumn, months before Russia invaded Ukraine, because a strong recovery in Asia drove up demand.

Before the war in Ukraine began, Europe was already importing almost as much LNG as piped gas. But if Europe wants to end its dependence on Russian gas, it must vastly increase these LNG imports. This will be costly because it means diverting shipments originally directed to Asia toward Europe. Luckily this will be technically possible owing to a profound asymmetry in LNG trade: It takes far longer to construct liquefaction facilities than to arrange for regasification.

When LNG arrives, importing countries merely have to heat up the liquid in the tankers. Energy specialists frequently point out that many countries do not have enough fixed LNG facilities to increase imports. But floating LNG terminals are also an option, and countries like Germany, France, and Italy are already taking advantage of it, ensuring that they can offload LNG when it arrives.

These flexible gasification facilities, together with a dense network of pipelines connecting most of the EU providers, offer some protection against Russian attempts to pick off individual countries. Europe has already shown solidarity on the issue. When the Russian energy giant Gazprom recently stopped gas deliveries to Poland and Bulgaria, pipelines from Germany and Greece ensured that the two countries got what they needed. The question is whether Europe will show the same resolve when all countries are under pressure.

Liquefaction facilities, on the other hand, are far more difficult to come by and take much longer to construct, because they require giant refrigerators that cool the gas to -160° Celsius. This has two politically important consequences.

Some hope that the United States can provide much-needed LNG to Europe. But the US is currently running its existing liquefaction plants at full capacity, and it would take several years to construct new facilities. As long as America’s export capacity is constrained, redirecting US deliveries from Asia to Europe will do nothing to reduce the excess demand in the combined EU-Asia LNG market. For the US this has the advantage that domestic natural-gas prices have remained much lower than in either Europe or Asia.

The challenge of constructing LNG-liquefaction facilities also significantly raises the costs for Russia to try to export the gas Europe is no longer buying. For a number of years, Russia would be unable to sell the 140 billion cubic meters of natural gas that previously went to Europe each year.

If Europe is willing to pay the price of expensive LNG imports, it could thus severely undermine Russia’s ability to earn hard currency via gas exports. That would put a real dent in Vladimir Putin’s war budget.

Daniel Gros: Is a member of the board and a distinguished fellow at the Centre for European Policy Studies. 

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