Europe is at the centre of an economic and geopolitical storm. Since last September, the prices of electricity and natural gas have steadily increased. EU natural gas prices soared to a new record high of €180 per megawatt-hour on the 21st of December, underpinned by a double-whammy of cold weather forecasts in late December and fears of supply disruptions. If compared to an average of €20 per megawatt-hour in mid-June, the December figures represent a 900% increase. In the second half of December, however, dozens of US LNG cargoes were redirected from Asia toward Europe as prices soared there: at least 15 U.S. cargoes were headed toward the continent. After the announce gas prices have immediately started to sink to €70 per megawatt-hour on the 31th of December. Europe is attracting more supplies as Asia’s biggest buyers are opting to use their inventories this winter instead of procuring more. Milder weather forecast for much of mainland Europe will curb energy demand, while there was also uncertainty over the impact of the fast-spreading omicron. However, the prices reduction was just temporary. On the 4th of January, gas prices surged at almost €100 per megawatt-hour after the Yamal-Europe pipeline – which normally delivers gas from Siberia to Europe – was sending flows from Germany to Poland for the 15th successive day. Moreover, flows of sea-borne liquefied natural gas (LNG) to Europe accelerated at the end of last year, but might recede again as Asian LNG prices are back above European spot prices.
Dutch Title Transfer Facility (TTF) Natural Gas (€/Mwh)
Source: The ICE
The gas and electricity markets are still heavily linked, and rising gas prices have meant, in turn, increasing prices on natural gas and electricity for household with, in some respects, worrisome inflationary pressures.
What are the root causes and which consequences could this lead to?
When approaching the winter, Europe acknowledged to have the lowest gas reserves since 2013. The filling rate in September 2021 was barely 77% when compared to 95% in 2020.
Europe’s gas storage filling levels
Source: AGSI
Other factors include the surge in global – especially Asian – demand due to the economic recovery, an unusually cold spring in northern Europe, poor Brazilian hydroelectric production, and reduced gas production in Norway and Russia. The completion of the Power of Siberia gas pipeline has further complicated the picture for European gas demand. This important pipeline has connected Russian natural gas production with one of the fastest growing energy consuming-markets in the world: China. The Power of Siberia pipeline, inaugurated by Gazprom in 2019, has helped Beijing to diversify its suppliers and reduce the costs of gas imports; however, this could have serious consequences for Europe. For months, Russia’s Gazprom has only delivered the volumes it was contractually bound to provide, and not a single molecule more. An unusual behaviour compared to the past. However, the Chinese demand of Russian natural gas do not directly compete with the European demand. Gas wells that supply the European market are different and independent from the ones producing for the Chinese market. Until the Russian natural gas grid is fully integrated and the Power of Siberia 2, which is a project expected to connect the Yamal gas fields (the same which supply Europe) with China, becomes a reality.
These regional imbalances have turned into an unprecedented global energy crisis because of a structural imbalance: insufficient natural gas supply. Since 2014, global investments in new oil&gas wells research and development have plummeted. Just as global investments were starting to recover, a game changer event revolutionized the energy market: the Paris Agreement, which marked the end of the fossil era. On the one hand, oil companies have drastically reduced their investments and their time horizon concentrating few resources in those operations that are sure to make profits within a few years. The European Investment Bank (EIB) itself has embraced the energy transition and it is progressively phasing out fossil investments from the Bank’s portfolio, becoming the de facto European Climate Bank. Meanwhile, however, investments in renewables have not been sufficient to cope with the rising demand for energy worldwide, especially in Europe. Moreover, electricity pricing relies on a marginal price mechanism: electricity’s hourly price is decided by the source which, at that hour, the grid cannot do without. Simply put, renewable energy only sets the price of electricity when it is so abundant that it saturates the market. And that is, typically, at those times when demand for electricity is low and prices would be equally low. Therefore, the kingmaker for pricing are still fossil fuels and, in particular, natural gas.
Additional data is crucial to understand Europe’s situation. The EU produces 39% of its energy, importing the remaining 61%. The energy mix is made up by petroleum (36%), natural gas (22%), renewable energy (15%), and nuclear energy (13%). In particular, Europe is highly dependent on Russia for natural gas imports, which account for 41% of its overall natural gas imports.
The geopolitical struggle for European gas
On the 13th of December, natural gas prices soared by 11% when German Foreign Minister Annalena Baerbock said construction for the Nord Stream 2 pipeline could not be allowed in its current form because it did not comply with EU laws. In particular, in mid-November, the Bundesnetzagentur suspended the certification process, citing non-compliance issues with the EU’s gas directive. The German regulator could only approve the pipeline if the operator was “organised according to German law”. The new gas pipeline is not consistent with the EU’s diversifying energy strategy set to reduce costs and dependency from a single supplier. Nord Stream has a total annual capacity of 55 billion m3 of gas, and the addition of Nord Stream 2 is expected to double this capacity to a total of 110 billion m3. Moreover, the US strongly opposes the project, although the Biden administration decided in July 2021 to lift sanctions to the companies involved in the project in a bid to improve the relations with Germany and Russia. Notwithstanding, a bill is under consideration of the US Senate to reinstate the sanctions lifted. The infrastructure project will also have an impact on EU-Ukraine relations: it will weaken the Ukrainian position, since the new pipeline will make the gas transiting through Ukraine no more essential, ultimately reducing the transit fees that are crucial for the Ukrainian economy (over $3 billion in 2020).
Furthermore, natural gas prices have picked up amid the rising tensions between Russia and the EU and US over a potential Russian offensive against Ukraine.
EU supply security
Soon after the second Russia-Ukraine gas crisis of 2009, the EU enacted several reforms aimed at reducing dependency on a single supplier. In 2010, the new EU regulation on security of gas supplies included new standards, a solidarity mechanism in case of emergency, and the requirement for each member state to rely on three different sources of gas supply. In 2014, the adoption of the European Energy Security Strategy accelerated the creation of international interconnections among member countries in order to create a full-fledged integrated market. Furthermore, the creation of a single market, the diversification of supply sources, and the increase in strategic reserves in European countries have contributed to reducing risks in the event of an external shock.
Pipelines and corridors
To cut natural gas prices, increase strategic autonomy, and differentiate supply sources, the European Union has fostered and also funded the construction of gas pipelines that connect southern European countries with North Africa. The EU is currently connected to the southern Mediterranean through three main gas pipelines reaching Italy (the Green Stream, the Trans-Med and the Trans Adriatic Pipeline) and two reaching Spain (the Medgaz and the Maghreb-Europe gas pipeline). In addition, the EU has found financed main gas corridors which, if completed, will boost diversification capacity for EU member countries.
These corridors are:
- The ‘NSI West Gas’: new gas pipelines intended to increase gas transit in the north-south direction in Western Europe, further diversifying the sources of supply and increasing short-term gas deliverability.
- The ‘NSI East Gas’: new pipelines between and within the Baltic Sea, the Adriatic Sea, the Aegean Sea, the Eastern Mediterranean, and the Black Sea, intended to strengthen supply security.
- The Southern Gas Corridor (‘SGC’): for the transmission of gas from the Caspian Basin, Central Asia, the Middle East, and the eastern Mediterranean Basin to the EU.
- The ‘BEMIP Gas’: Infrastructure aimed at connecting the three Baltic States and Finland to the EU gas network and end their dependency on a single supplier.
The entry into operations of the Trans Adriatic Pipeline (TAP), which is supplying Italy and Europe from the Azeri Gas Field, connecting with TANAP pipeline in Turkey, is flowing to Europe additional 7.5 billion m3 of gas, resulting in a 10% reduction of natural gas costs in Italy, and partially compensating the overall price increase.
The new TEN-E regulation
On the 15th of December, a new provisional agreement between the Council and the European Parliament on the TEN-E network (Trans European Network – Energy) was reached to dictate new rules for cross-border energy projects. In particular, the new Regulation will support the EU’s climate objectives and the green deal. The revision of the TEN-E network regulation is crucial because it will introduce two key points:
- The EU will end support for new natural gas and oil projects and introduce mandatory sustainability criteria for all projects.
- It will allow a transitional period until the 31st of December 2029, for dedicated hydrogen assets converted from natural gas to be used to transport or store a pre-defined blend of hydrogen with natural gas or biomethane. Eligibility for EU financial assistance for such projects will end on the 31st of December 2027.
The Commission has highlighted some key projects and corridors that will promote interconnections and interoperability across Member States.
The priority electricity corridors are:
- North-South electricity interconnections in Western Europe (‘NSI West Electricity’), with the main purpose to end isolation of Ireland, and to ensure the necessary onshore prolongations of offshore grids for renewable energy.
- North-South electricity interconnections in Central Eastern and South Eastern Europe (‘NSI East Electricity’), aimed especially at ending the isolation of Cyprus.
- Baltic Energy Market Interconnection Plan in electricity (‘BEMIP Electricity’): interconnections between Member States and internal lines in the Baltic region, to foster market integration while integrating growing shares of renewable energy in the region.
Other offshore electricity corridors will be crucial to transport electricity and hydrogen from the offshore fields (wind or solar offshore plants) to the coasts. The main individuated corridors are: the Northern Seas offshore grids (‘NSOG’), the Baltic Energy Market Interconnection Plan offshore grids (‘BEMIP offshore’), South and West offshore grids, South and East offshore grids and the Atlantic offshore grids.
Moreover, the Commission has endorsed the priority corridors for hydrogen and electrolysers which will be created through the repurposing of existing gas infrastructure (such as the aforementioned gas corridors), enabling the emergence of an integrated hydrogen backbone, connecting EU countries and addressing their specific infrastructure need for hydrogen. The final goal is the emergence of an EU-wide network for hydrogen transport, ultimately contributing to the sustainability of the EU energy system.
The main individuated corridors are the HI West, the HI East and the Baltic Energy Market Interconnection Plan in hydrogen (BEMIP Hydrogen).
The new proposed regulation tries to find a balance between the imperative of accelerating the green transition and scaling up the bulk of green-related investments whilst ensuring Europe’s energy security. In this sense, natural gas will necessarily play a role as a transitional source of energy, less pollutant of carbon and oil, and fundamental to ensure competitive energy prices for households and companies. To reduce the gap of €260 billion yearly in green investments and meet the 2050 carbon neutrality targets, new sustainable investments emerge as a major priority, with a strong support needed from the private sector. But, in the short-term, green energy investments cannot cope alone with rising demand and prices, and natural gas is the least harmful among the fossil energy sources. This has also been confirmed by the possible inclusion of natural gas in the EU Taxonomy, which indicated what kind of infrastructure and energy investments will be allowed in the next decades: natural gas and nuclear energy will probably be on the list.
The EU’s actions to contain rising prices
Since late October, EU Energy Ministers agreed on the urgent need to tackle rising prices and to do so in a coordinated manner in order to reduce the financial burden on households and companies struggling to recover from the COVID-19 crisis. On the 13th of October 2021, the Commission released a a 'toolbox' of measures that the EU and member states can use to address the immediate impact of price increases. It includes emergency income support for households, state aid for companies, and targeted tax reductions. Finally, on the 15th of December 2021, the Commission issued new proposals to decarbonise gas markets, promote hydrogen, and reduce methane emissions. These proposals include initiatives to improve the gas system’s resilience and strengthen the existing security of supply provisions (including joint natural gas reserves and common purchases of natural gas), as requested by member states and as announced in the communication and toolbox on energy prices that had already been released.
The recently released EU Global Gateway will be a crucial enabler for a further diversification of the EU’s energy supplies. The €300 billion EU Strategy will also support the green transformation on the way to achieving the Sustainable Development Goals and commitments bound to the Paris Agreement. It will promote green technology exchanges and reinforce energy security. Financing new interconnections, in particular with the Southern shore of the Mediterranean, is key to ensuring the diversification of energy supplies and scaling up renewable energy availability for Europe. In the next few years, Brussels will require an increasing amount of renewable electricity to cope with soaring demand that will also be needed to realize the EU Hydrogen Strategy and ensure the decarbonization of the European economy by 2050.
The energy crisis in Europe confirms that the historical dependence on few energy suppliers is no longer sustainable for EU Member States. The path to decarbonisation and the transition towards a green energy system is crucial to ensure the fuel Europe needs to feed its economic recovery amid the Covid-19 crisis. Coordination is the buzzword for member states for a rapid and smooth solution of the current energy crises and to lower soaring inflationary pressures. Energy is vital for the European economy and the green transition, if correctly embraced, could transform the European energy landscape for the better.
