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Where is Future EU Gas Demand Going? Implications for Russian and US LNG Exports to Europe

Europe Fears Cuts In Natural Gas From Russia

A new E3G Briefing Paper calls into question official EU projections regarding EU gas demand, which raises important questions about the economic viability of new gas import infrastructure – both pipelines and especially LNG terminals – and, by extension, about gas supply diversification efforts to enhance overall EU energy security. The following chart shows that projecting future gas demand has become an exercise in downward revisions. E3G points out:

“Projections of what gas demand will be in 2015 have decreased by 23% over the past 10 years – and the Commission is still forecasting 2015 gas demand to be more than 20% higher than the actual 2014 levels.”

European Commission: EU27 Gas Demand Forecasts (Mtoe)

roman eur1

Source: E3G

EU gas demand is actually now 23 percent below its 2010 peak and threatening to revisit the 1995 lows.

EU Gas Demand (Mtoe)

roman eur2Source: Eurostat, Eurogas, Sandbag, E3G via E3G

E3G views the changes in the gas demand picture as a result of “structural shifts to the European economy, changing consumption patterns and significant progress on energy efficiency.” What makes the underlying study particularly interesting is that it distinguishes between countries in which gas demand occurs. Unsurprisingly, not all countries are equal: “Gas demand is not evenly spread across the EU. Germany, the UK and Italy consume more than half the EU’s gas demand, and three quarters of the EU’s total gas consumption comes from only six western European countries: Germany, UK, Italy, France, Netherlands and Spain. (…) Only 7% of gas demand comes from countries highly exposed to Russian imports (i.e. Share of Russian imports as in total gas consumption is more than two thirds: Bulgaria, Estonia, Czech Republic, Greece, Finland, Hungary, Latvia, Lithuania, Slovakia, Slovenia). (…) Just 12% of gas demand comes from seven Central and Eastern European countries (Bulgaria, Czech Republic, Hungary, Poland, Romania, Slovakia, Slovenia).”

Importantly, the first category of importing countries – in Western Europe – features common policies that emphasize the widespread deployment of renewables as well as, to various degrees, energy efficiency programs. That allows for the study’s authors to conclude that EU gas demand on aggregate is likely to further decrease in the future. Here, it is important to note that gas demand is falling and is seen to fall further across major sectors of the respective economies such as power, industry and residential.

All this will have significant implications for infrastructure projects. In this respect, the E3G study warns specifically of the “risk of misevaluating future gas demand”: “The wrong diagnosis on EU energy security will lead to the wrong cure. An expectation of rising demand has led the EU’s energy security strategy to focus on accessing new sources of gas, rather than on alternative approaches such as demand reduction or strengthening internal connections. (…) Overinvestment in gas infrastructure can also create ‘lock in’ to levels of gas consumption that are in conflict with the EU’s decarbonisation goals.”

This warning is very telling indeed. While the study nicely identifies the good long-term structural reasons for the downwardly revised EU gas demand picture, at the same time it appears to display a bias against natural gas as integral for getting to a low carbon economy. The E3G report also seems to de-emphasize the fact that the most vulnerable – in terms of energy supply security – countries, which depend heavily on Russian natural gas for heating are located in Central and Eastern Europe. In fact, a Climate Action Network (CAN) Europe position paper from April 2015 pointed out just that: “ The current security of supply concern, (…) is first and foremost a heating issue. Indeed, 61% of EU imported gas is used in buildings.” The problem here is not Western Europe but Eastern Europe with its old inventory of buildings – often severely lacking Western energy efficiency standards. To fix this reality will require substantial investments in an often budget-constrained environment.

Thus, Europe viewed ideally as a community based on solidarity put in place a EU energy security strategy focusing on the diversification of the gas supply away from one monopolistic supply center in addition to enhancing interconnections (EU Energy Union) between countries in multiple respects. Note, diversification often just means to substitute old supply corridors for new supply corridors without necessarily replacing supply volumes one-to-one let alone increase said supply volumes.

However, the E3G study raises issues for potential infrastructure projects like new LNG import terminals intended to serve – from an energy security perspective – Southeastern Europe. In this context, there is no shortage of politicians calling on the US to allow future LNG exports in order to support US allies in the region – a region, which has traditionally been ‘underserved’ in terms of its energy needs. Obviously, the US government will have no say in this matter. These decisions will be made exclusively by the private sector based on pure economic considerations and ‘animal spirits’.

Lastly, to make an overarching point with regard to US LNG exports, LNG exports may turn out not to be the ‘jackpot’ for most exporters as previously anticipated. Consider the latest IEA Medium-Term Gas Market Report, which suggests in its five-year projections of natural gas demand, supply and trade developments with respect to the high-priced and therefore most desirable Asian natural gas (LNG) market that overall “weaker gas demand in Asia, where persistently high gas prices until very recently caused consumers to switch to other options”, is cutting into global demand.

IEA Executive Director Maria van der Hoeven expanded in her remarks on that: “One of the key – and largely unexpected – developments of 2014 was weak Asian demand. (…) Indeed, the belief that Asia will take whatever quantity of gas at whatever price is no longer a given. The experience of the past two years has opened the gas industry’s eyes to a harsh reality: in a world of very cheap coal and falling costs for renewables, it was difficult for gas to compete.”

Consequently, according to the IEA the long-term outlook for gas has become more uncertain – especially in Asia where “a few Asian countries have decided to move ahead with plans to expand coal-fired power generation instead of gas-fired generation.” Interestingly, the IEA Medium-Term Gas Market Report – seemingly diametrically opposed to the E3G study – views Europe as an important outlet for global LNG supplies citing a declining trend in domestic production and “a moderate recovery in demand.” “As a result, European gas import requirements are set to increase by almost one-third between 2014 and 2020,” the IEA report says.

roman eur3

Source: IEA

Russia, however, has already started proactively pursuing a strategy of ‘gas infrastructure divestment’ from Ukraine by rearranging its future portfolio of ‘transit countries’. Russia’s state-controlled energy giant Gazprom is taking first steps to expand the Nord Stream gas pipeline beneath the Baltic Sea and to add a new outlet for Russian natural gas with a new Turkish Stream pipeline through the Black Sea.

Both projects have to be perceived as not primarily intended to increase the supply of natural gas to the EU but rather following in Saudi Arabia’s footsteps in the oil market to maintain market share in the crucial European gas market as the traditionally only low marginal cost natural gas producer/supplier next door. Note, Russia could meet a future increase in EU gas demand pretty handily provided that by that time enough pipeline capacity is available. But in the meantime, Russia will comfortably price more expensive global LNG supplies – due to seaborne transportation costs – out of its core European market.

In sum, US LNG exports may only end up on the European market as likely more expensive spot cargoes and/or from Asia diverted LNG, or only if European governments make a conscious decision to opt for US or global LNG supplies instead of piped Russian natural gas out of energy security considerations trumping the pure economics of the trade – as long as there is no other piped alternative from the immediate neighborhood around the Eastern Mediterranean or the Caspian basin. An indication that this is the direction into which European governments are moving would be the sprouting of LNG import terminals along the Southern flank of Europe (for more information on the prospects for that and LNG terminals in Europe, read Breaking Energy here). US energy special envoy Amos Hochstein has repeatedly urged Southeastern European governments “to build new gas links and focus on smaller projects (…) rather than blockbuster pipeline deals,” as reported by Reuters. Back in January 2015, Hochstein outlined at an event at the Atlantic Council’s Global Energy Center the US energy diplomacy priorities for 2015. On this occasion, he stressed the criticality of a LNG facility in Croatia on the Adriatic Sea.

As outlined above, Russia is not going to stand idly by while the EU is openly pursuing the marginalization of Russia as main gas supplier to Europe. Thus, Russia/Gazprom is actively taking steps to reposition itself by trying to preserve its European gas market share for the future. Overall, the European gas market is poised to become a fascinating battleground – a tug of war between geopolitics, the transition to a low carbon economy, and gas market price signals.

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