Never Say Never

To begin with, there are no objective, economically driven reasons for rejecting Russian gas. Reliable and flexible pipeline gas flows from Russia ensured a balanced filling of the European gas market compensated for the discretionary nature of LNG supplies. They maintained competition in this market by influencing the price level.

The initiative to refuse Russian natural gas came not from its buyers, but from Euro-institutions. This “voluntary” initiative was endorsed by the European Council in the form of the REPowerEU strategy document dated March 8, 2022. The buyers, who until the last moment remained interested in multi-year contracts with the Russian Federation, were forced to submit to the pressure of the authorities and abandon these contracts under various pretexts. This document is worth reading in order to realize that it was not V. Putin who cut off natural gas supplies to Europe, as European politicians precariously claim.

Since in the process of implementing the REPowerEU strategy there were risks of energy shortages and rising energy prices, in an effort to deprive “the Putin regime” of revenues from gas exports to Europe, the EU decided to hedge against the loss of significant volumes of gas from Russia.

On August 5, 2022, the Council of Europe approved an initiative for an overall reduction of natural gas consumption in the EU. It took advantage of the events in Ukraine to solve another problem on the climate agenda along the way. In other words, it was about reducing the EU’s dependence on fossil fuels in the form of natural gas, regardless of its source.

Under the August 5 initiative, the Council of Europe approved a decision to reduce natural gas demand by at least 15% in the winter period from August 1, 2022 to March 31, 2023, compared to the average consumption over the last 5 years. The new decision dated March 28, 2023 extended the fifteen percent reduction initiative for 12 months, from April 1, 2023 to March 31, 2024, compared to the five-year average, from April 1, 2017 to March 31, 2022. On March 4, 2024, the Council of Europe extended the initiative for another year, until March 31, 2025. The reduction in demand should also be at least 15% relative to the average over the last 5 years. While reducing demand is voluntary and EU countries are free to choose how they do it, reduction targets are mandatory. And what is surprising is that both initiatives, coming from politicians far removed from the gas industry, were successfully implemented.

Let’s start with the anti-natural gas initiative. From August 2022 to December 2023, the EU reduced consumption by 18% compared to the five-year average, amounting to a whopping 100 billion cubic meters (bcm) in absolute terms. The demand reduction has already exceeded the required 15%, with consumption even lower than planned.

The results of the gas demand reduction for all of Europe (including Turkey) were no less impressive. Gas consumption in 2023 collapsed to where it was a decade ago, 452 billion cubic meters, which was 19% below 2021 levels. In comparison, between 2021 and 2023, EU natural gas consumption fell to 330 billion cubic meters. It is noteworthy that this drop is not only due to the European solidarity factor, but also to economic factors. No commitments to reduce gas consumption have been made by non-EU countries. The largest significant decreases in consumption over the past two years were recorded in Germany (–17.6 bcm), Italy (–14.4 bcm), Great Britain (–14.2 bcm), the Netherlands (–10.9 bcm), Turkey (–9.7 bcm), France (–8.6 bcm), and Spain (–4.8 bcm).

Against the backdrop of a record decline in natural gas consumption, the EU has achieved a significant reduction in its dependence on Russian natural gas supplies. While Russia’s share in pipeline and liquefied gas imports amounted to 45% of all gas supplies to the EU in 2021, in 2022 it fell to 22%, and in 2023 to 15%. There’s not much time left until the complete elimination, which should happen by 2027.

It would be a mistake to believe that achieving such a stunning result has been painless for the EU. Among the associated challenges were ultra-high energy prices in 2022-2023. According to Eurostat, due to high natural gas prices, despite lower natural gas imports, Europe paid an additional 185 billion euros from February 2022 through October 2023 compared to 2021. One of the side effects of high prices was the pressure on the budgets of European countries, due to the additional funds required to compensate for the losses of local consumers.

Another negative effect of abandoning Russian gas is its mass substitution by coal. According to McCloskey’s calculations, the EU’s rejection of Russian gas will cost the European energy sector an additional 185 million tons of coal consumption by 2030.

However, the most serious sacrifice was the virtual destruction of the European gas chemical industry. Due to high energy prices, other energy-intensive industries have suffered as well. According to the German statistics service Destatis, from February 2022 to December 2023, the production index of the country’s energy-intensive industries plunged by more than 20% and that of the chemical industry by 24%. As a result, Europe experienced low rates of economic growth and the beginning of the processes of industrial collapse, or more simply, deindustrialization. The worst off is German industry, which has been in free-fall mode since the start of the energy crisis – with the country’s GDP falling by 0.3% in 2023.

Notably, the EC considers the removal of energy-intensive “dirty” production outside Europe an acceptable result. According to the EC, this has been the dominant trend over the past few decades and has only been further extended. Optimism prevails in thinking about the consequences of a break with Russian energy resources.

The European Commission notes that the situation on the European gas market stabilized at the beginning of 2024. After two years, prices have gained resilience, although they are still above pre-crisis levels. The price forecast for this year is even better. Europe has happily survived two autumn and winter heating seasons without Russian gas and with no cataclysms. Gas reserves in storage at the end of the heating season are at a record high. With a requirement to have 50% on March 1, the stock level at the end of March 2024 was just under 60%. There is no shortage of gas suppliers in the market. For example, at the February tender for the collective purchase of gas by EU countries through the European Energy Platform, supply exceeded demand three-fold. Seventeen suppliers announced their readiness to supply almost 100 billion cubic meters of gas, which is nearly three times more than required. The USA became the world’s largest exporter in 2023. Seven LNG plants in the USA exported 116 million tons globally, mostly to Europe. American LNG has completely replaced the niche previously occupied by pipeline gas from Russia. Russia’s budget revenues from natural gas exports have fallen sharply.

Inspired by this success, the European Commission decided to move forward and get rid of the remaining volumes of natural gas from Russia completely. Thus, EU Energy Commissioner Kadri Simson said the European Commission will continue to pressure the EU countries in this direction. She also said the EC is working on a tool that would allow European countries to reject Russian supplies without imposing sanctions on pipeline gas. The EC, according to Simson, “is not interested in extending Ukrainian gas transit,” the volume of which amounted to 14.7 billion cubic meters last year.

However, reducing to zero the remaining 17% share of pipeline gas supplies and 13% share of LNG will not be easy. The famous Vilfredo Pareto Principle comes to mind – an empirical rule, according to which “20% of efforts produce 80% of the result, and the other 80% of efforts produce only 20% of the result.”

The reason for the difficulties in implementing the course of complete elimination of gas purchases from Russia by 2027 is not so much the lack of sufficient volumes of gas from alternative sources as the lack of transportation infrastructure for such substitution. For example, Austria, Hungary, Moldova, Slovakia, Czechia, Slovakia, and Italy continue to receive Russian gas via Ukraine. The cessation of such transit threatens the energy security of these countries.

Even with the availability of substitute volumes of Russian gas, abandoning Ukrainian transit would require a change in supply logistics. These additional capacities could possibly be created over time. In any outcome, this will lead to higher prices and transportation costs, which will be an additional burden for these EU countries. The losses will be especially significant when trying to import through Germany, as the German authorities have recently unilaterally adopted a law on gas export tax.

Interestingly, the Euro-institutions, focused on solving geopolitical problems, are not in a hurry, unlike the gas business, to find solutions to the problems of the countries importing Russian gas, which arise in the case of breaking relations with Russia.

Thus, more than half of Russian gas transiting Ukraine ends up in Austria. Austrian Energy Minister Leonore Gewessler said that her country should prepare a withdrawal from the Russian gas supply contracts concluded by the OMV concern. In June 2018, OMV signed an agreement to extend the existing contract to Austria from 2028 to 2040. The contract is based on the take-or-pay principle, meaning that OMV is obliged to pay even if it does not actually take the gas. Therefore, OMV is not in a hurry to give up Russian supplies, saying that in order to give up gas from Russia, the relevant regulatory framework should be created first. The share of Russian natural gas in Austria’s energy mix reached 98% in December 2023.

Italy, according to Environment and Energy Security Minister Gilberto Pichetto-Fratin, is not afraid of problems associated with the termination of Russian gas transit. Russian gas is not critical for Italy, even if the country is hit by severe cold weather, the official said. The Minister explained that Italy has consistently reduced its dependence on Russian gas: in 2021 it was 38% of consumption, in 2022 it was reduced to 18%, and in 2023 it was reduced to 4%, thus playing a minimal role. Indeed, Gazprom has traditionally supplied the country with 20-22 billion cubic meters of gas per year. Exports fell to 11 bcm in 2022 and to 2.6 bcm in 2023.

Nevertheless, ENI head Claudio De Scalzi, who previously said that the country could easily do without and completely get rid of Russian gas as early as 2025, admitted in a recent interview that Italy is still dependent on Russian gas, despite the decline in Italian imports and consumption of blue fuel from Russia. “We have not yet completely replaced all Russian gas from other sources, but as a result of the fall in consumption and the unfortunate increase in coal use, the gas that we now import from Russia is more than enough,” the head of the Italian energy company commented on the results of 2023 to the Italian newspaper La Stampa. “If China increases consumption tomorrow, prices will go up. However, at this stage, China, which accounts for 25-30% of the gas market, is not in a phase of strong consumption growth,” Claudio de Scalzi added.

Neither France, nor Spain, nor Germany can completely exclude LNG supplies from Russia. The latter continues to buy LNG from Belgium and the Netherlands, which receive LNG from Russia. As a result of this dependence, the ban on LNG purchases from Russia was not included in the EU’s 13th package of sanctions.

Although Europe’s natural gas consumption appears to have peaked, there is no reason to believe that the decline in demand will continue to spiral downward as it has over the past two years. Most likely, it will be a smoother process stretching over many years with its own intervals of growth and decline. The Institute for Energy Economics and Financial Analysis (IEEFA) estimates that gas demand in Europe (including Turkey) will continue to decline by 2030 to less than 400 bcm, down from 443 bcm in 2023. Meanwhile, the need for LNG imports is estimated to be less than 100 million tons per year in 2030, according to the Institute’s report.

The most important shifts over the past two years have occurred in the industrial sector, where the fall in demand has become precipitous. Nevertheless, it can be said with all certainty that the decline has already reached its bottom. As economic growth recovers and prices remain at current levels, demand in this sector should be expected to recover.

The least predictable component of gas demand in Europe is the utility sector, as natural gas demand is determined here by a variable combination of weather factors. Two years of warm weather had allowed Europe to survive two winters unscathed, fostering confidence that this would always be the case. However, already in the winter of 2023-2024, sustained abnormal cold temperatures were observed in the Nordic countries. They did not affect gas consumption in Europe, as it is insignificant in these countries. For some reason not quite understood, the Scandinavian frosts did not come to Northwest Europe. If that were to happen, two weeks of such Arctic cold would completely empty the storage facilities in Europe.

Demand projections in the utilities sector cannot ignore research by climatologists, according to which the accelerated melting of glaciers in Greenland will slow down the current that drives the Gulf Stream. Europe could lose its mild climate as a result of the Gulf Stream’s rerouting. Models predicting the onset of climate change do not rule out that this process could begin as early as 2025.

The consumption of natural gas in the electricity generation sector is also influenced by weather factors, such as wind strength, number of sunny and rainy days. In 2023, the strong performance of wind turbines contributed to a 21% reduction in gas demand in Europe’s power generation sector.

However, renewable energy of wind and the sun belongs to the category of unmanageable energy sources and therefore needs to be stabilized. Natural gas and renewables are doomed to exist together for many years, during which gas-fired power plants will promptly take on the function of providing reliability of the entire power grid. And that drives demand for natural gas. With this in mind, the UK government in 2024 abandoned the commitment to have only carbon-free generation by 2035 and allowed new gas-fired power stations to be built in the 2030s.

An important driver of gas demand will be the plans announced by European countries to completely abandon coal, the consumption of which has increased in Europe after the rejection of Russian natural gas. Thus, Italy intends to abandon coal power by the end of 2025. Gas-fired generation should replace coal-fired generation. Italy has approved 3.4 GW of gas-fired generation over the past two years. Germany has more ambitious plans to replace coal-fired power plants with gas-fired ones. The “green” government of Germany plans to build 10 GW of new gas-fired power plants.

Shell released a forecast in early 2024 that global LNG consumption will grow by 50% to 625-685 million tons by 2040. Of them, approximately 400 million tons of LNG will be exported. However, the company did not risk naming the capacity of the liquefaction projects that will be commissioned by then, citing that their commissioning dates may change.

There is no doubt that the European market will be balanced in terms of natural gas supplies for the next couple of years – of course, if the logistical problems in Europe are solved. This is driven by the commissioning of liquefaction plants with a total capacity of up to 80 million tons in 2025-2027, primarily in Qatar, the USA, and Australia. The estimate of such an additional global gas supply from this third wave of liquefied natural gas projects was made by Shell before the USA announced its moratorium on approving new LNG projects and may therefore be an overestimate.

Uncertainty about the balance of the global natural gas market after 2027 is even greater. The fact is that the moratorium on export licenses is not only due to the negative attitude of US Democrats towards investment in fossil fuels, but also due to the risk that the supply of natural gas in the US domestic market will lag behind demand due to the implementation of numerous export projects. Much of the growth in US gas production hinges on a single shale formation, the Permian Basin. There are other shale formations in the USA, but they have long since come off the natural gas production shelf. A surge in gas production in the Permian Basin, which is derived from oil production there, could deplete the province before 2030. American oil and gas will not be able to compensate for the falling Permian field production by increasing it in other fields.

Protective measures may be taken by the US government due to the fact that the demand for gas-fired generation to replace coal-fired generation and increased energy demand from electric vehicles is growing rapidly in the country. During the summer peak in US electricity demand in 2023, the share of gas in the electricity generation mix rose to 45%. In July-August 2021, it was 40%. The suspension of new LNG export licenses in the USA has moved up to half of the currently known LNG projects into the gray zone. With the increased cost of money and falling LNG prices, the likelihood of their launch is getting closer and closer to zero.

Qatari projects, which are particularly ambitious, also face serious challenges. Thus, QatarEnergy announced plans to expand its liquefied natural gas production to 142 million tons per year. While there are no problems with the resource base of the projects, the volume of signed long-term contracts, without which the refineries’ projects cannot receive long-term financing, so far covers only a part of the planned additional liquefaction capacity. The growth of interest rates is inevitable when the investment rating of oil and gas companies is downgraded.

It should also be kept in mind that Qatar does not consider Europe as a target market, but bets on long-term contracts tied to oil prices with China, India, and growing Asia. Europe, on the other hand, has rejected such long-term contracts. Shell predicts that China will increase its liquefied natural gas purchases by 50% to about 90 million tons per year by 2040. At the same time, the capacity of LNG-receiving terminals in China will increase by 80 million tons in 2024-2025 alone. In 2024-2025, the cumulative capacity of gas-fired TPPs in China will be comparable to the installed capacity of gas-fired power plants in Great Britain, i.e., about 40 GW (with the existing capacity of 121 GW). In other words, China can actually absorb all of the additional LNG supply.

If we look at the traditional pipeline gas suppliers to Europe, none of them, apart from Russia, is able to increase supplies. Although Norwegian gas supplies may increase slightly in 2024 due to reduced repairs, gas production has already reached a plateau. Not only are there no growth prospects for the next five years, there is a recession at the end of the decade. Algeria is limited in production. It is itself increasing domestic consumption of this resource, so there is no surplus for Europe.

The only way to guarantee Europe’s energy supply is to resume natural gas supplies from Russia through the surviving branch of Nord Stream-2, the Yamal-Europe pipeline, and the preservation of the Ukrainian transportation corridor.

As I have already mentioned, the main purpose of the Russian gas boycott is not to increase the reliability of natural gas supplies to the European market, but to cause Russia unacceptable economic damage and the collapse of its political structure due to public destabilization and loss of confidence in the government. By early 2024, it became clear that these plans had failed. The sanctions caused the opposite reaction to the expected and led to political consolidation in Russia. The results of the presidential election in March 2024, in which V. Putin received 87% of the vote with a record turnout of 77%, are an undeniable example of this.

In such a context, the EU’s rejection of gas from Russia is an equally obvious example of economic masochism. So far, the EU has persisted in its geopolitical aspirations. Therefore, we cannot rule out the possibility that the EU will manage to get rid of it completely, as planned by 2027, at the expense of internal problems aggravation. The energy war with Russia has already cost Europeans dearly. Much of the sacrifices associated with it were borne by Germany, which voluntarily destroyed entire sectors of its own industry. But other participants in the war on Russian gas have had to make sacrifices as well. Great Britain has also fallen into recession. There is no visible potential for post-covid growth due to high interest rates and debt burdens in the eurozone and other countries. In the end, the political ambitions of European leaders will again be paid for by ordinary EU citizens.

The USA and Western Europe are geopolitical partners. But economically, they are competitors. This explains the degree of reliability of the USA as a supplier of natural gas to the EU. If there is a threat of rising domestic natural gas prices or even a suspicion of such a threat that undermines the competitiveness of the US economy, restrictions on LNG exports would be imminent. This measure will also ensure the profitability of LNG supplies due to higher export prices.

There is a clear asymmetry in Russia-EU relations on gas. According to the statements of President V. Putin, “Russia has never done anything for political reasons in the issue of gas supplies and is not going to do so.” In gas relations, in contrast to the United States, Russia has for many years ensured the competitiveness of the European economy. The acknowledgment of these realities by European elites will lead to the return of natural gas from Russia to the European market.

Zuhreddin Zuhreddinov
Independent Expert Oil, Gas and Energy (Uzbekistan)