We have recently had the opportunity to verify the importance, relevance and dependence of Europe has on natural gas; understood it as a primary energy source to produce electricity for industrial and domestic consumption. Natural gas is the cleanest hydrocarbon used for power generation, with coal being the most polluting, followed by fuel oil and diesel.
In the last six months, there has been an unprecedented sustained rise in electricity prices due to two factors: the high cost of natural gas at European and Asian level and the supply-demand matching model promoted by the European Union which affects practically all the countries of the Union. We will try to analyze each of them:
How can natural gas affect the electricity production mix so much? Well, as we have mentioned, due to the matching system considering natural gas as the most used hydrocarbon for the marginal modulation for immediate electricity production; that is, we use natural gas to cover the peaks in demand that we have throughout the day. We also use it to supply the lack of renewable production when the wind is not blowing, or the sun isn’t shining. Virtually all European countries have adopted natural gas as a source of marginal and modular electricity production due to its ease of starting and stopping power plants. In any case, countries like Germany or Poland still have considerable coal plants in their mix.
Hence, the high consumption of natural gas to cover demand peaks or supply the shortage of renewables, added to the fact that this is currently the most expensive fuel, results that the price of electricity, within the production mix structured in the marginal matching system that we have, is excessively high.
Another factor triggering the price escalation has been the regional price of natural gas or the international price of liquefied natural gas (LNG), and such price increase, has been because of the high demand for natural gas in its post-COVID stage; but that is not the only essential reason. We are going to identify what other reasons are behind the price increase, more geopolitical reasons than purely economic or commercial. And also, what consequences and alternatives are for the future of natural gas and therefore for the guarantee of electricity production in Europe. Let’s look at the 10 most relevant points.
1- Europe consumes 541 Billion cubic meters (BCM) of natural gas per year, according to 2020 data, of which 218 BCM are from internal production, mainly from the Dutch reserves of Gröningen and from the North Sea fields. Another 211 BCM are imported by pipeline and 112 BCM are imported by ship in the form of LNG (equivalent to about 1,300 conventional shipments per year). With these data, we can see how Europe depends on 60% of natural gas imports, so essential to guarantee the security of supply for the electricity production of their countries.
2- The top three countries that sell natural gas to Europe by pipeline are Russia with 167 BCM, Algeria with 21 BCM and Azerbaijan with 14 BCM. Regarding pipeline supply, Russian gas accounts for 79% of such imports while Algeria accounts for 10%. Within the top five countries that export LNG to Europe with methane tankers, we also find Russia and Algeria with 17.2 BCM and 13.9 BCM, respectively. Other relevant countries within the total amount of LNG that reaches Europe are Qatar with 30.2 BCM and the USA with 25.6 BCM.
3- considering the he total consumption of natural gas in Europe, we see how dependent Europe is on Russia by 34% and Algeria by 6.5%. The countries on which Europe depends after Russia and Algeria are Qatar with 5.6% and the USA with 4.7%. It is important to see in the global picture what alliances or alignments each one of the suppliers has in order to understand the general interests of the main players and the risks to which Europe is exposed as an entity dependent on these external agents. At first glance, it may seem that supplies are diversified and balanced, but this is far from the truth.
4- Regarding the large gas pipelines that enter to Europe, we have three that come from Russia. One gets through the Ukraine to reach the Central European countries such as Austria, Hungary, the Czech Republic, etc. and that also has a branch to enter through Greece; another through Belarus that goes to Poland and Germany and a third that enters through the Baltic to supply the region of Germany and Holland. From the East, we have a gas pipeline that enters via Turkey and ends in Italy and that mainly supplies gas from Azerbaijan. And finally we have the gas pipelines in southern Europe that enter from Algeria through Spain and Italy. Here it must be taken into account that two pipelines with Algerian gas arrived in Spain, one that crossed Morocco and entered through Tarifa (Maghreb gas pipeline), which supply has been canceled in November 2021 due to the end of the 25-year contract and another that comes directly from Algeria and enters through Almería (Medgas).
5- Right now, as we have said, the main amount of natural gas depends on Russia and Algeria, two countries aligned in their foreign policies. It must be bear in mind that the gas pipeline that came from Morocco was designed in such a way to satisfy Morocco in exchange for geopolitical stability on the border with Spain and in some way to balance the powers over Western Sahara. It is no coincidence that tensions between Morocco and Algeria have skyrocketed just as the balance provided by the gas pipeline Maghreb is coming to an end. Morocco, a clear ally of the USA, has run out of natural gas – it took part of what was pumped through the tube to Spain – and that is why the USA is jointly studying the export of LNG to Morocco. While Algeria, historically aligned with Russia, does not share the decisions of the USA regarding Western Sahara, has recently put Spain in a bind by choosing to support the Polisario leader during the crisis that occurred in 2021. And finally, if we consider that Turkey has some form of precedent on the gas pipeline that comes from the East, we could consider that practically all the gas imported by gas pipeline to Europe is in the hands of a group of countries that are somehow aligned rather than allied. Russia, in this aspect, has designed a perfect claw effect with respect to gas supply and create some dependence for Europe.
6- Europe, including Turkey, has a reception and regasification capacity of 239 BCM, of which in 2020 used 112 BCM for imports, that is, an utilization factor was 47%. In particular, in Spain there are around 64 BCM of capacity, being the country with the most regasification capacity in Europe. In any case, in 2020 Spain imported only 20.9 BCM, which represents 27% of its capacity. As a first alternative, Europe could focus more efforts on LNG. Importing by ship helps to diversify the supply and make contracting more flexible, which means reducing dependence on a single source.
7- We can observe, coincidentally (or not), that some presumed gray zones in the European continent are connected in some way with commercial conflicts related to hydrocarbon transactions and in particular with natural gas. We have recently seen Belarus vs. Poland; Ukraine vs. Russia; Germany (EU) vs. Russia; Turkey vs. Cyprus; Turkey vs. Israel, Morocco vs. Spain or Algeria vs. Morocco. It is true that these areas of conflict or diplomatic tension or economic guerrilla warfare are maintained and supported by partisan interests as a bargaining chip for something to negotiate or achieve later, such as the maintenance of natural gas contracts and their commercial structure with respect to the term and the prices. We could debate whether it is a gray zone or not, or even if it is in development phase because it does not meet all the requirements, but we will leave this topic for a separate analysis. In any case, the coincidence of the conflicts, in time and location, with the situation of energy dependence that Europe experiences today is still interesting and deserves to be mentioned.
8- Nordstream II (NSII), this gas pipeline is ready to come into operation from the end of summer 2021. The route runs parallel to Nordstream I, which, as we have mentioned, passes through the Baltic and enters to Germany and has a nominal capacity of about 50 BCM. Enough to mitigate current price tensions. In any case, the natural gas would originate from Russia, the same origin as the other three gas pipelines, so the dependency on Russia would increase from a purely mathematical point of view, although it would not be totally true; Russia would increase its export through the NSII but would reduce the flow of the Ukrainian gas pipeline. That way it would make Europe happy and make Ukraine more dependent, weakening it for not having easy access to the natural gas that is currently receiving. In a way, Russia would act in the same way that Algeria has done with Morocco (as stated in point #5) by canceling the flow of natural gas through the Maghreb gas pipeline. The NSII could be part of the possible integrated solution (along with LNG diversification) to mitigate the geopolitical tensions in Europe caused by the supply of natural gas and its dependence on certain countries not aligned with the same European interests, even not being the only solution to the whole problem.
9- Another possible player and great unknown in this geopolitical game could be the natural gas reserves in the eastern Mediterranean. Reserves found mainly in the territorial waters of Israel and Cyprus. Turkey, Greece and Lebanon are also in the area claiming as well as exploring possible new deposits to be discovered. The relevant fact is that the best way to monetize these reserves is to enter a market large enough to guarantee production and the return on the investment of the needed infrastructure. This market could essentially be Europe if we consider that the shared reserves are half European as they are in the territorial waters of Cyprus. The optimal solution would be to produce LNG and sell to terminals in southern Europe or build a gas pipeline to Greece to reach the continent (pipeline gas that has already been planned and commercially granted but now is on the spot since USA has pulled out of the consortium sponsoring it). The problem, as we have seen, is the tension that Turkey exerts on any decision that may be taken regarding the implementation of infrastructures (whether it is an LNG plant or a gas pipeline) in areas of alleged Turkish influence. This causes all projects that could supply more natural gas to Europe to be delayed. Currently the gas reserves remain in the same place, and nothing has been done to reduce Europe’s dependence on imported natural gas. It seems that there are certain conversations between the main players in the region, but it is far from being able to opt for a beneficial solution for Europe. Other countries such as Egypt also have enough reserves to be able to mitigate the effects of dependence on Russia and Algeria, but at this time they have other domestic priorities to solve.
10- And to all this, how much time does natural gas have left? On the one hand, we have sufficient proven reserves for the next 50 years, and with a substantial rate of increase in reserves for many more years. On the other hand, it will continue to be the most viable primary energy source for modular electricity production, mainly due to its storage capacity vs. emissions; until a form of energy storage appears that produces fewer emissions than natural gas and of course being more competitive. To this end, great efforts are being made by main European administrations to have hydrogen as an energy storage vector. In any case, economic competitiveness and technical viability are away from being a reality while we try to sort out the current problem of gas prices and dependency. At the moment the administrations are driving the development of the hydrogen production solution through surplus electricity production from renewables based on subsidies. These levels of injection of public capital, at least on the scale we see today, had not been seen even in the period of development of renewables 15 years ago, so it can be assumed that the development of hydrogen in a viable way could be seen accelerated within 10 years.
On the other hand, we still have the elephant in the room, which is the nuclear energy as primary energy. It is true that it has a long construction time and that it would not solve the problems that we see today immediately, but it could be an alternative for the future and above all, a dissuasive element where Europe could show its vocation for energy independence. Many of the European countries still have space in their production mix to be able to install nuclear reactors to cover their base needs. This solution, complemented by an increase in renewable production facilities, would help not only to reduce emissions but also to substantially reduce the energy dependence that Europe is experiencing today.
It should be noted that while this article was being finalized, South Korea has approved considering natural gas as a green energy for new investments. This is an issue that continues to be debated in Europe; whether to consider nuclear and natural gas as green investments to inject more capital and promote a culture of balanced and competitive energy transition; or on the contrary simply focus on renewables and bet on storage energy vectors such as hydrogen or biogas. Likewise, it is also important to consider the high inflation that in some way determines the difficulty of investing in new projects that are so necessary to alleviate the high electricity costs, but this also gives for another analysis and another article.