EU Becomes More Resilient as Accepting The New Reality

• EU’s reaction to adversity – more LNG and energy conservation
•         LNG industry to spur the downsizing O&G Investments 
•  Reducing the overdependence on Russia rather than the over-reliance on fossil fuels
•       Low price indicating LNG supply chain choke points
• The extortionate EU stockpiling game plan
•       ‘Contango’ or ‘backwardation’ – ‘speed versus cost’ approach
• Energy model crisis driving a shift in the EU energy paradigm
•      Energy crisis put a spoke in the energy transition wheel

A series of political and economic miscalculations have been carried out for the last 14 years by EU and despite the countries in the Old Continent were caught off guard in the beginning of 2022, today EU is more prepared for the winter in comparison to the last 5 years(excl. 2019) owning to a combination of multiple right decisions and a pinch of good luck. The reaction to adversity is EU’s ticket to success, or in simple words - Energy efficiency, Energy saving, Energy security, LNG.           

Given the fact, that more than half of the EU total primary energy supply is reliant on fossil fuels, it is understandable that when one of these energy commodities is in turmoil, this will unquestionably spur the consumption of the other substitutes, one of which is namely coal. In this regard, we must give all due credit to the LNG as it emerged on the EU market as a true lifesaver, which acted together with the European Commission energy-saving initiatives RepowerEU and took the burden off, which under other circumstances, would’ve boosted the coal usage. Having said that, coal-plants experienced slight renaissance which would have been much more striking if it was not for the LNG. On top of this, Europe not only managed to keep its head above the waters but also to get by with lower carbon emissions if we consider LNG to be with 50% and 25% less C02 than coal and oil respectively; this would definitely not be the case if the LNG alternative was not available.

The ‘convenient’ EU energy policy of prioritizing the import of cheap Russian gas led us to this mathematical statement through the years, namely Russian PNG + Renewables (=)resulted in significantly more LNG and moderate usage of Coal.

LNG sector to be the torchbearer for new O&G Investments

The LNG supply chain has been through its biggest stress test in terms of its production, shipping, and distribution, more notably the LNG infrastructure in the Old Continent, which is meant to absorb the LNG influx. The eye-watering year-on-year EU LNG demand surged by more than 60%, whereas the global LNG demand may rise 5% in 2022 to about 400 million tonnes, compared to 380 million tonnes in 2021.

The Effects of the Fossil Fuel Divestment | Source: IEA

In the last couple of years the fossil fuels investments faced a decline with an overall investment in 2022 down to $630 billion(26% less than pre-Covid levels) in order to meet the goals of the Paris agreement, however, on the flip side the power sector spending on renewables is expected to exceed $1.4 trillion(according to IEA) in 2022, or accounting for almost 60% of the global energy investment(out of USD 2.4 trillion), which is really unfortunate since the renewables are not quite ready for the ‘Prime time’, whereas fossil fuels are still the ‘workhorse’ supporting more than 60% of the EU energy consumption.     

A Steady Increase for O&G Investments, Still Lower than pre-Covid Period | Source: Rystad Energy

As the LNG industry is ‘going long’ this could help out to spur the downsizing O&G investments with more gas to be produced in order to keep the liquefaction facilities full for many years to come. As a matter of fact, financing into new LNG infrastructure is expected to register about $50 billion annually.

• Expectations for the next decade is that the surge in US LNG exports could jack up the overall US natural gas production by adding more 280Bcm to the already existing production output.

         Europe’s Triple-E approach: energy-saving, energy efficiency, energy security

For many years, the EU has been determined to solve the over-reliance on fossil fuels, whereas the solution for this energy riddle is actually in reducing the overdependence on Russia as an incumbent PNG Supplier. After this 50 years-long deep-rooted dependency on Russian pipeline gas, one of the end-goals of the EU ‘Fit-for-55’ plan by 2025, would be to cut EU Russian gas consumption by 32BCM, in addition to the plan for reducing electricity and gas demand by 15%, replace approximately 20BCM with Green energy, 35BCM with Biomethane production and to replace 21BCM of gas with wind and solar energy in the next decade. Lately, there has been much public criticism and scepticism towards the energy efficiency and energy saving countermeasures taken by the EU governing body, although let us not forget that energy rationalization plan is something UK has already overcome in 1974 amid the miner's strike and massive inflation.

Very diligently Europe accepted the energy saving through a gas rationing plan so as to curtail the unnecessary storage UGS withdrawals, backed by continuous LNG and PNG flows, in addition to the agreed voluntary natural gas consumption reduction target of 15% this winter.  

It could be argued that the lower consumption comes at a dear cost, primarily due to the high exposure of imported NG to the extortionate TTF. Some big EU industry companies look out for "downsizing", notably BASF in China as part of a cost-cutting strategies, along with it come the fears for a looming recession. Despite that one could say the countermeasures undertaken by EU give more breathing space, any excessive step would cause demand destruction and industrial relocation, something completely not desirable amid the looming EU recession.

UGS facilities can no longer be considered as a 'safe haven for lower priced gas'

In the year 2022, we've come across not only record-breaking gas prices but also events turning the gas trading pattern upside down, as a result the UGS facilities can no longer be considered as a 'safe haven for lower priced gas' during the off-peak season. The reduced PNG flows and the fears for gasless winter acted as an impetus for filling up the UGSs without any delay in a way that the chronological order of summer low season and winter peak season pricing has been reversed.

Reversed Gas Trading Pattern | Source: Trading Economics

Diametrically opposite to the traditional seasonal arbitrage, the new EU stockpiling policy pushed countries hustling to make up the difference for the disrupted Russian supplies, and altogether aggregated such a vast amount which in fact propped up the LNG spot prices sky-high following an impulsive buying tendency. This brings us to the well-known fundamental law of supply and demand, where as a consequence, after UGS were filled up, the flimsy demand triggered an abrupt fall of the main European gas price index TTF. In light of this, it comes quite naturally that in Q4 Europe found itself in a situation, in which it had already injected natural gas into the gas storages at an extortionate price, whereas the global gas prices have registered unprecedented discount afterwards(below 34EUR/MWh EOD price TTF). The extremely low price indicated for some LNG supply chain choke points on top of the mild weather and full UGSs.

Main factors for having downward pressure on the TTF gas price :

·       Mild weather conditions along with low consumption rate

·       Slowed down industrial demand

·       Maxed out regasification plants and infrastructure choke points

·       Full underground gas storage facilities(above 95% on average)

·       Fears for looming recession in the Old continent and the European Commission intentions for capping prices on TTF joint purchases

EU Stored Gas Purchase Price | Source: Reuters

All in all, the European gas storage is currently filled with extortionate gas(over $50Bln UGS natural gas ), which in event of being withdrawn could drive a price surge. However, no gas owner would release it on the market with the current price level, but rather would wait for more profitable times(summer-winter spread to be above the gas storage market value) at a later stage, thus capturing a greater netback, otherwise this would be clearly non-economical and restrictive on the stored assets capitalization. In the end, we got ourselves at a time of full UGS with expensive NG and no ability to take advantage of the low-cost LNG. If the withdrawals of the UGS were not regulated, any attempt to cash-out the stored NG would very likely revert the current ‘contango’ situation into a ‘backwardation’ – ‘speed versus cost’ approach.

EU putting the pedal to the metal in preferring promptness than cost-effectiveness

After the 2022 Q3, with the beginning of the new Gas year, natural gas market entered back into the normal situation with upward sloping forward curve(contango), which is quite the opposite of what was the summer market sentiment with anticipation of tightness in supply amid booming demand for aggressive injections in the UGSs, when the spot cargoes were traded higher than the forward dated cargoes(spot LNG prices have averaged 170% of LSPA contract-based LNG prices) and risk premium on the futures heavily eroded, representing strong bearish headwinds. European Buyers dilemma was speed versus cost with charter rates above 400 000 $/day. With the consideration of the rising geopolitical tensions, there was hardly a commodity which did not behave in the same way(i.e., Copper, Zinc, ‘Brent’ Crude oil etc.). The overall attitude, back then, was deliberate on securing sufficient energy inflows(prompt outright cargoes), propping up the spot price above the forward one or basically saying the market is determined to pay more for units right now, which all ended up with a contango for the Q4, when all storages remain almost full. All this giving us the feeling that the bargaining power is in the hands of the LNG Buyers in a fairly loose market with brimming UGS, shrinking prices and diminishing demand.

European countries will have to turn their back to the contemporary energy transition paradigm

The EU energy paradigm has bet big on the electrification and renewables for supplying 100% of electricity demand, adamantly overlooking the vital part of “base load”(nukes and fossil fuels) in the EU’s energy policy framework. Nevertheless, all this has gone through a ‘model crisis’ and has the potential to turn into a ‘model revolution’, reflecting the Thomas Kuhn's paradigm theory.

Germany serves as an example for an energy transition front-runner that revives the coal plants by 6.9 gigawatts of coal and 1.9 gigawatts of lignite capacity to boost supplies, extending the lifetime of its nukes and putting on a fast track the LNG import terminals in defiance of their energy-transition goals.

It should be noted that in Germany new legislative changes were developed, all this facilitating the LNG FIDs, cutting the lead time and project development in general. As a consequence, 4 FSRU will be online for less than 2 years, while 2 more permanent facilities are in process; and this is the same country which has not been considering the LNG as part of their energy roadmap for the last 14 years.

Energy crisis to solidify and strengthen the LNG Infrastructure in EU

Energy transition took precedence over energy security in the last two decades. In that case, the pivotal decision will be if energy security is to move side-by-side with energy transition insomuch that they work together as 'flesh and blood’ for a more resilient, diverse, and environmentally sustainable energy system.

LNG Regas Terminals Construction with a Horizon of 2 Years | Source: EIA

Energy crisis put a spoke in the energy transition wheel, at least in a short run but will speed up even more the achievement of EU 2050 Goals by strengthening and solidifying the LNG infrastructure in EU, where all particularly vital additional LNG quantities will be processed by the upcoming LNG regas facilities, but also by expanding the internal energy infrastructure – interconnectors, pipelines and UGSs.

One of the positive takeaways of the current situation in 2022 is the change and transition into new energy solutions and approaches. Although LNG has been part of the energy policy on a national level only, it has not been clearly included in any of the general principles of the EU Energy policy. By convention, Germany has always been signifying the EU’s ‘state-of-mind’, and a year ago it has been rather conservative towards ‘fossil-fuels’(even the low-carbon ones). What happens now is that Germany and Netherlands turn back to fast-frack 'near-shore' solutions, serving as a role-model for other EU Countries. (e.g., for an unprecedently short period Gasunie achieved Agreement with Exmar for Eemshaven in 3 months only)

In a nutshell, by the end of this year about 20BCM of EU LNG Capacity will come online (e.g., Netherlands, Germany, and Finland(SSLNG)), and 44BCM more in 2023. It is beyond any doubts that any prompt regas solution would be impossible without involving a great number of the floating platforms (FSRU).

Existing and Planned FSRU Terminals | Source: S&P Global Commodity Insights data

In view of the regas and pipelines bottlenecks, the floating regas units are considered to have a good fit amidst the disrupted gas flows in the current stormy market conditions, by flattening out the asymmetrical regas bottlenecks. Further to this, more than 80%(44BCM out of 51BCM) of the LNG gas infrastructure planned to be commissioned in 2023 will be in the form of Floating Storage and Regasification Units, thus almost every single cubic meter of liquefied natural gas will processed by a floating platform, due to the lower permits and lead time required as opposed to the onshore permanent sites.

Emerging 'predatory behaviour' out of the relative balance between consolidation and fragmentation of the LNG Market

The current energy crisis brought up more of the short-term and high-priced surplus, thereby prompting Buyers to opt for shorter alternatives. As a consequence, the LNG market reaches a point of fragmentation and tilting the balance of Spot<>LSPA contracts with 30% and 70% respectively. As a concept, the 'market fragmentation' comes along with higher short-term volatility but greater market efficiency.

The shortage of sufficient natural gas flows exerted influence on the duration and flexibility of the cargo contracts. Before the Russian pipeline gas flow to be cut off, by convention, the contract structure was 80%/20% in favour of LSPAs. After the third quarter of the year, approximately 50%(250 bcm) of the current global energy trade could be deemed contractually flexible - this should tell us how more fragmented LNG market has become, increasing the competitive pressure on Spot cargoes and creating new opportunities for regions and Buyers to compete for attracting vessels(though costing an arm and a leg) which under other circumstances, would have been destined to the default LSPA locations. This gives us the big picture of market conditions where Long-term Buyers are re-selling their own LNG as outright cargoes to Europe at a greater netback -  notably, China (CNOOC) reselling their LSPA cargoes to Europe – (estimated at about 10 bcm).

Potential Spot Contracts Scaling up | Source: S&P Global Analytics

For better or worse, a good deal of the current LSPA’s is expected to expire over the coming years and more liquefaction capacity is expected to be commissioned, which will only intensify the Shipper's ADP design. Moreover, if the market players fail to bind the incrementing LNG Demand with LSPAs, this niche will be filled with uncontracted(Spot) cargoes, with liquidity being spread across. Given the fact there is a tendency of increasing, the more spot deals we get, the more exposed to short-term market volatility we are, without any opportunities to develop scale advantages, bringing along more risk and uncertainty, hampering the longer-term energy risk management planning, essentially undermining the long-term supply chain and security of supply. Although, whatever comes with great risk for Buyers, comes with great rewards for the Sellers such as the windfall profits earned in 2022 attributable to the above-mentioned prevailing share of the extortionate spot cargoes.

Transforming the traditional gas supply pattern into a multi-source and multi-directional transmission network as natural gas is not meant to flow from the East only

While gasping for more LNG inflows, at the end of Q3, Europe has its back to the wall, already satiated its storage facilities with exorbitantly priced natural gas, without having any clear move available to absorb more from the ‘low-hanging fruit’. In order European Union economy to embrace LNG as a viable alternative, some formidable hurdles may need to be overcome. In modern Europe, the share of the natural gas in the total primary energy supply TPES is below 30%, for some countries it slightly below 40%Netherlands for others such as Germany is below 30%(second to Oil only). The immense significance of natural gas(second largest energy source) for the proper and cost-effective functioning of the European economy has been guaranteed by 5 main pipelines and the perspective of a sixth one – Nord Stream 2. As a consequence, the EU high-capacity infrastructure is more concentrated in the regions adjacent to the pipelines last destination - Central and NW Europe, prioritizing the gas supply direction from the East. On its way for energy ‘de-russification’, Europe will need to reverse the established flow from west to east. This comes to be a temporary solution until a more robust, evenly distributed and multi-directional infrastructure is built, while changing this paradigm will help to better utilize the LNG Terminals on the EU west coast(France, Spain) and sending it forward to the remote regions without such a vast regasification capacity and UGS capacity.

Despite the high spirits, the greatest caveat of all is poised to be the insufficient intra-EU gas pipelines and unevenly distributed LNG Import locations(shortage of high-capacity connections with the LNG Import terminals), where this ‘choke-point’ still persists. Interestingly, only the countries with LNG Import terminals had discount on the natural gas prices(notably TTF, PVB etc.), where countries like France benefitted from prices way below the prices in Germany which just until recently did not hold any LNG terminals.

More than 50% of the LNG carriers are unloading in UK, France, and Spain as being the countries with largest regasification capacity. Moreover, the LNG Terminals in NWE is better integrated with the pipeline systems spanning across major load centres and UGS facilities compared to the other regions in Europe(the insubstantial gas connection between French and Spanish grids provides a noteworthy example). In addition, the Iberian Peninsula is very poorly connected to the rest of the continent, despite the fact that 40% of the EU Regas capacity is located there.

EU in an effort to keep the ball rolling on their way to catch up with the infrastructure deficit

Due to the fundamental differences of the PNG supplies compared to the LNG supply chain, in case of emergency, the former comes with greater promptness* and efficiency** as opposed to the LNG cargoes.

*Even prompt spot cargoes are requiring at least 15-20 days of voyage time to reach Europe, e.g. even for the spot-lifting regions with proximity advantage such as Qatar and US)

**No BOG loss generated, only methane slippage for PNG

As European countries became conscious of their deep necessity of a more robust intra-EU gas network, a handful projects came to a completion or have been proposed:

The SWE region is confronted with tight bottleneck situation. Having said that, Portugal, France, and Spain are looking ahead to build the Barcelona-Marseille pipeline BarMar – unfortunately, it will not be fully functional earlier than 2025 in order to provide the desired energy security. Thus, Spain will remain on the periphery of the EU energy map for a bit longer.

In Central Europe, the only one Interconnection point between Germany and France at Obergailbach(maximum capacity – 100GWh/day or approx. 2.5BCM/annum) is used as an act of solidarity, reversing the flows in west direction; Poland-Lithuania (GIPL) 500km Interconnector is another project of common interest fortifying the energy infrastructure and gas market integration with 2.4BCM per annum. In addition to this, the Poland-Slovakia interconnector is also set to be operational this year, carrying approx. 5BCM per year.

In Eastern Europe, new 3BCM of inter-country capacity has been added in 2022 via the Bulgaria-Greece Interconnector ICGB. Any additional similar infrastructure will bring in favourable effect for the pricing and competitiveness in the regional energy markets and individual countries.  

Trans-Balkan Pipeline Usage Prior to TurkStream Commissioning | Source: Natural Gas World

New project aims in recovering the usage and reversing the flow of the Trans-Balkan corridor(south-to-north), which in the olden days happened to be the major source of natural gas supplies for the countries in the Balkan region(south direction gas flow), although with the commencement of TurkStream the former was technically phased out. As a consequence of the new project, outlying regions will be connected with the regas plants in Greece(via Trans-Balkan pipeline and ICGB), which in turn will be carrying LNG-sourced and PNG-sourced gas flows in north direction, towards Ukraine. To illustrate this point, in December Moldova carried out a test purchase of a meagre amount(4.3MCM) of natural gas, bearing in mind that the actual capacity of the Trans-Balkan pipeline is approx. 20BCM.

EU might need to ‘fight the battle’ more than once

In 2022, the line of actions undertaken by the European energy industry on first thought could be deemed a winning hand, though in the long run one could see it more as a 'great Pyrrhic victory'. With that being said, it should be kept in sight that in the next injection season supposedly no Russian Pipeline gas will be used for UGS replenishing. Added to this, the lack of EU large-scale long-term SPAs together with the severe intra-EU gas network choke points, coming on top of the highly vulnerable and extortionate TTF benchmark along with the fragile TTF-JKM price spread, all this could make luring more LNG cargoes damagingly expensive or rather impossible to repeat.