The energy crisis has just begun
Europe is in a better position than expected, but it is too early to declare victory in the energy war. Analysis by Justin Thomson, Chief Investment Officer, International Equity at T. Rowe Price
In the summer, wholesale gas prices soared that led to forecasts of blackouts and rationing and fears of extreme cold in private homes. Since then, prices have retraced as most European countries have been able to stockpile gas reserves for the winter.
THE ENERGY WAR BETWEEN EUROPE AND RUSSIA
However, it would be a mistake to think that the energy crisis is over, in many ways it is only just beginning. Following the invasion of Ukraine, Russian President Vladimir Putin sought to use Russia's vast oil and gas reserves as a tool to weaken opposition among Western countries. Since Germany, Italy and other European countries have always depended on cheap Russian energy, there were fears that Russia could inflict enormous economic and social damage, more than the continent could bear.
Turning off the gas taps is a weapon that could only be used once. As the threat became apparent, countries began looking for alternative energy sources. Since the invasion of Ukraine, gas imports from Russia to European Union (EU) countries have dropped significantly, largely offset by a sharp increase in liquefied natural gas (LNG) imports from the United States and Qatar. At one point, there were so many LNG vessels queuing in European ports that spot gas prices went negative for a short time.
At the same time, European countries have announced energy price caps to protect people and businesses from the consequences of the energy crisis. These costly programs stoked public debt but helped prevent social instability and a sharp economic downturn. Gas consumption has also decreased significantly due to soaring prices, warmer weather and the destruction of demand in the industrial sector.
BECAUSE IT'S TOO EARLY TO SING VICTORY
Gas storage facilities in Europe are well stocked compared to previous years and, based on the current rate of demand, the continent is expected to arrive in spring 2023 with 30 billion cubic meters (bcm) – 50bcm of storage remaining – a far better position than could have been imagined just a few months ago. As such, it is unlikely that Europe will face a severe energy crisis next winter, unless there is a surge in demand due to cold weather or a reversal in demand destruction.
However, it is too early to declare victory in the energy war. Although Putin's attempt to use Europe's dependence on Russian gas as a tool for blackmail failed, Europe still faces a major challenge in ensuring that its energy needs are met in the winter of 2023-2024, and beyond. The era of Russia as the main supplier meeting Europe's energy needs is over: it is no longer possible to return to the status quo before the war in Ukraine. Russia would not have sabotaged its Nord Stream pipelines near Germany if it had considered sending gas back to Europe. On the European front, moreover, there is no desire to go back to depending on Russian energy.
THE DIFFICULT DETACHMENT FROM RUSSIA ENERGY
However, the transition from Russian energy will not be easy. Despite declining imports, Russian gas still accounts for more than 40% of Europe's reserves for this winter. Put simply, if Europe has around 50 bcm of gas stored for spring, it will need to re-store a large amount of LNG to arrive safely until spring 2024. At current demand levels, this means that Europe is expected to attract 30% of the global LNG market or 35% of the global spot market after excluding already contracted volumes.
It could be a tall order. This year there has been a 12% increase in LNG imports to Europe from the US, but this growth rate is not sustainable because US production and export capacity are currently at their highest. Even if more US exports are available, the capacity to process LNG in Europe is currently limited. Even if there are plans to build new LNG processing infrastructure in Europe, their completion will likely take several years.
Furthermore, the fact remains that a large part of the LNG imported into Europe last year came from Russia which, due to the sanctions, will not be possible. Global LNG demand is likely to pick up again next year, especially if China starts to ease its "zero Covid" policies. LNG is already very expensive, and prices will likely rise during 2023 as demand grows.
BETWEEN FOSSILS AND RENEWABLES
In the long term, renewable sources will replace Russian imports in meeting European energy needs, but this prospect is still a long way off. Planning, financing and construction of wind and solar farms are the key points of a multi-year process. Installing pipes and other infrastructure to enable households and businesses to use wind and solar energy can take even longer. Supplies of wind turbines and solar panels are also limited due to bottlenecks resulting from restrictive policies in China, as well as delays in permits and financing. Renewable energies are the future, but they cannot represent the only answer to Europe's energy needs in the immediate future.
This implies that fossil fuels will continue to play a central role for some time to come. In the near term, as countries scramble to find alternative sources of gas, we expect high prices and increased volatility. This will come at a huge cost, as governments will have to cope with rising prices while supporting private citizens' rising energy bills. If countries struggle to get all the gas they need, it may be necessary to reduce consumption, but convincing people to use less gas and electricity will not be easy.
We believe that many European countries, but not only, will face a recession this year, largely caused by the energy crisis. It is therefore clear that Russia's invasion of Ukraine will continue to affect energy markets for an extended period. Shutting off gas pipes, even if it was a one-time weapon, will have a macroeconomic impact that will be felt for years to come.
This is a machine translation from Italian language of a post published on Start Magazine at the URL https://www.startmag.it/energia/europa-lunga-crisi-energia/ on Sat, 21 Jan 2023 06:12:21 +0000.