The staggering cost of Europe’s current gas imports is threatening to destroy any lingering hopes of a post-coronavirus (COVID-19) economic recovery and will saddle governments with higher debts and businesses and consumers with higher taxes and crippling energy costs.
Europe’s immediate response to Russia’s invasion of Ukraine and the Kremlin’s cut in pipeline gas exports has been to pay whatever it takes to bring in LNG as an alternative.
On global gas markets, Platts LNG Japan/Korea Marker (JKM) Futures reached $55 per mmBtu on September 8, compared with $8 a year ago, meaning that futures for LNG are now seven times what they were in September 2021.
This price is only set to rise more because of a shortage of tankers, higher chartering rates and limited gas supplies, S&PGlobal said,
Meanwhile, JKM’s daily physical assessment reached $71.01 on August 25, the highest level since March 7, when the benchmark hit a record $84.76. Furthermore, this is still a $20 discount to Europe’s TTF benchmark.
These spot and future prices contrast with estimates for current long-term contract price put at $16, according to Reuters.
However, Reuters warned that given the preponderance of long-term, oil-linked contracts in Asia, Europe will probably not be able to buy draw as much LNG from Asian markets as it wants, no matter what price it can pay.
Where does the gas come from?
If Russia’s piped gas has fallen from 40% to 9% of supplies in nearly six months, where is the replacement gas coming from? So far, Europe has bought up gas quickly and aggressively, managing to fill its storages to 82% of capacity ahead of the coming winter.
Europe has increased imports from the US and Qatar, with LNG rising by 63% in the first eight months of 2022 to 85.3mn tonnes, equivalent to 400mn cubic metres per day, as the continent uses up all regasification and cross-border pipeline capacity.
However, the nature of the global market means that Europe is not as able to block Russian gas imports as it wants.
Gas is a fungible commodity, meaning that gas from one production plant or tanker is exactly the same as any other gas, unlike oil, which has several different grades.
This means that Russia has been able to reorientate its LNG exports and still send them into world markets.
This has created the situation where Europe is still buying gas whose availability is facilitated by Russian exports to China. The gas does not need to physically move from Russia to China to Europe, although this could happen, but a series of swap deals means that gas from Russia is effectively reflagged as Chinese.
This practice, dubbed gas leakage, means that the Kremlin can get round Europe’s gas sanctions, while European buyers can access the gas they want, although at a far higher price than for pipeline gas from Russia.
For example, Sakhalin-2 LNG plant on Russia’s Pacific Coast has sold at tender several cargoes of LNG to China at half the current spot price, Bloomberg reported.
In turn, China can then resell gas to gas-hungry buyers in Europe, Japan and South Korea, which have all stopped buying spot LNG since Russia’s invasion of Ukraine.
China has seen its LNG imports rise by 60% in 2022, according to research firm Kpler, while gas consumption has fallen because of slower economic growth.
Beijing is now selling this gas surplus – bought from US, Australian or Asian producers – in the form of LNG cargoes to Europe. The Nikkei reported that more than 4mn tonnes of Chinese LNG has probably been resold to Europe, making up 7% of Europe’s imports in the first half of the year.
This means that European and Asian buyers have been unable to shut out Russia from the global market, and can only buy up LNG cargoes from Asia or the US because Russian LNG is freeing up new cargoes for sale.
So, Europe has been purchasing Russian LNG via China – while pretending like it is highly successful in its campaign to decouple from Moscow.
The frantic purchasing has creating a tight global market, which pushes up prices. LNG tankers are now waiting laden at anchor, Bloomberg reported, as Europe’s utilities are now paying to store LNG in tankers offshore as extra storage for winter, as the continent’s gas storage tanks are now full. Kpler said 1.4mn tonnes of LNG was floating offshore on September 2, the most in two years.
Freight rates for LNG tankers are growing, and the tanker market is now sold out for winter as energy majors are refusing to release their vessels as they typically do at the end of summer.
A crucial issues is Europe’s LNG import capacity, especially if some tankers are hanging around offshore waiting for space.
The EU has 169bn cubic metres of annual LNG import capacity, according to the Economist Intelligence Unit, while it imported 98 bcm in 2021. However, Russian pipelines supplied 153 bcm in 2021, meaning that the unused 71 bcm in Europe could not come anywhere near replacing Russian supplies.
Countries are pushing ahead with new terminals, such as Germany, but this will take years to materialise, meaning that LNG cannot replace Russian gas in the short term
If Europe cannot just buy LNG at any price, as it cannot regasify it fast enough, what else can be done to meet gas demand?
Europe’s energy prices are now at levels that could scarcely have been thinkable only six months ago, with gas futures hitting €238 per MWh on 6 September, eight times the levels seen 12 months ago.
Electricity prices also reached record levels at the end of August, mainly driven by the close connection between gas and power wholesale prices. Put simply, if wholesale gas prices go up, then so do power prices.
Russia’s invasion of Ukraine, and Moscow’s reduction of gas supplies to Europe – NordStream 2 was abandoned by Germany, while NordStream 1 has now been shut down by the Russians, meaning that Europe is desperate for gas from alternative sources, and has been willing to pay almost anything this year in order to meet demand and to build up a reserve ahead of the coming winter.
In bid to control gas costs, European Commission President Ursula von der Leyen proposed this week to place a cap on the price paid for Russian gas, which was suggested by media at €50 per MWh.
“We must cut Russia's revenues, which Putin uses to finance this atrocious war against Ukraine,” she said.
She said that at the beginning of the war in February, Russia's pipeline gas accounted for 40% of all gas imported by the EU. Today this had fallen to 9% of gas imports.
Her comments form part of what the EU has dubbed an “emergency intervention” into the EU’s power market.
As well as a Russian price cap, von der Leyen outlined several more ways to counter what she terms as the Kremlin’s “manipulation” of the gas market. These include: reducing peak power demand; a cap on windfall revenues generated by low-cost power production, principally renewables; a tax on surplus profits made by fossil fuel companies and more money made available to support utilities and power supplies companies.
These five issues are set to discussed by EU energy ministers as in an effort to reduce the cost of energy for Europe’s consumers.
Some governments have already proposed putting in place energy saving drives, such as turning off lights in public buildings, or taxing both fossil fuel and renewable firms in a bid to redistribute fund to hard-hit consumers.
France and Poland have both suggested that they would favour a cap on the price that could be paid to Russia, while Germany is more cautious.
Other options include breaking the link between gas and power prices, which would hopefully see a fall in electricity costs.
However, speed is of the essence, and cobbling together a package of reforms will take weeks. The formal Energy Council meeting is due in October, while von der Leyen will make a State of the European Union speech later in September.
Nevertheless, she firmly placed the blame for the current energy crisis on the Russian government, accusing it of weaponising energy as part of its invasion of Ukraine.
Such a view is shared by Sergiy Makogon, CEO of Gas Transmission System Operator of Ukraine (GTSOU), who highlighted that Europe has enough supply routes to source gas, but that it is Gazprom that has shut down gas supplies.
Meanwhile, Germany and has put forward a €45bn funding package to subsidise the cost of gas.
In the UK, which is not vulnerable to any Russian physical supply cut in terms of actual volumes, but is highly exposed to high wholesale prices, new Prime Minister Liz Truss said that her new government would borrow the cash to support energy bills, with the amount of being suggested at up to GBP130bn ($150.5bn).
Where this money comes from is a major question. Germany has proposed taxes on fossil fuel production and gas imports, while the UK is refusing to introduce any new taxes, suggesting that the support will be funded by borrowing.
Ultimately, the economic impact of high LNG prices and the cost of intervention measures means that the economic impact will be enormous, with gas-intensive industries cutting back activity and energy skyrocketing for both domestic and industrial users. Steel, fertiliser and other energy-intensive industries are set for a wave of closures and reduced output.
Coal is also making a comeback, with the fuel accounting for 33% of Germany’s power so far this year, up from 17% in 2021. Gas’ share of the power mix fell from 18% to 12%, the Financial Times reported.
All this comes as Germany will continue to close its last three remaining reactors in December.
This high-price environment is creating considerable financial and economic risk for LNG traders, gas producers and government. While gas producers and utility companies are able to rake in high profits at the current time, the face new taxation and pricing caps from governments eager to rein in what seems to be runaway prices.
Meanwhile, Russia’s invasion of Ukraine continues, and global gas markets are continuing the painful process of forging new trading patterns and managing ballooning prices while also meeting demand.