The EU is shifting towards LNG in response to declining Russian imports, but the strategy presents new challenges.

Following and due to both the reduction of gas flows arriving from Russia starting in the winter of 2021 and the invasion of Ukraine by Russia in February 2022, Europe has set itself the difficult task of drastically reducing imports of Russian gas by replacing it with a series of alternatives (demand reduction, renewables, Natural Gas imported from friendly countries through both existing and timely pipelines and regasification terminals), each of which has both economic and geopolitical implications, which are going in fact to change balances and relationships consolidated for several decades and that seemed so far immutable.

The Ukraine-Russia war highlighted the uncomfortable reality of Europe's historical dependence on Russian gas. Before the war, Russian gas flows to Europe accounted for about 45% of EU gas imports (155 billion cubic meters out of a total of 360 cubic meters). Natural gas is also deeply rooted in the economies of the European Union as it accounts for 23% of primary energy consumption (but 51% in Italy and less than 10% in Poland).

Disruption in European Gas Prices

However, the decision to diversify gas imports and reduce the share of gas imported from Russia has disrupted gas prices. The timing of the reduction in Russian gas imports was another decisive factor as Europe headed into the winter heating season, and there was not enough time to secure gas supplies from other sources. Market uncertainty has pushed gas prices to extreme levels and generated very high levels of volatility. Subsequently, this increased energy costs and pressured European economies and individual consumers.

Undoubtedly, the EU faced considerable challenges in its pursuit of independence from Russian gas, but the impact of the sudden disruption was mitigated largely due to warm winter conditions and the rapid increase in LNG imports, mainly from the United States.

Europe was the top destination for US LNG exports in 2022, accounting for 64% of total exports. France, the UK, Spain, and The Netherlands imported 74% of US LNG exports to Europe, totaling almost 25mcm.

Unexpectedly, events ended up accelerating the decoupling of Europe's dependence on Russian gas and strengthened the role of the United States as the de facto global energy leader. The conflict has brought the energy policy of the United States and Europe closer than ever.

Europe's energy situation today is certainly much better than many feared just a few months ago. But this does not hide the fact that Europe is still paying much more for gas than before 2021, when Russia began to meddle, with actions aimed at disturbing both price dynamics and available volumes, in European energy markets before the full invasion of Ukraine.

Gas prices on the Dutch Title Transfer Facility (or TTF, the European gas benchmark) averaged $5.31/MMBtu in 2017-2020, while today, the short-term price is $9.44/MMBtu, exceeding $17 for delivery in January and February 2024. 

 

Unintended Consequences of Using Gas as a Weapon

These high prices are difficult to absorb because European consumers are still burdened by a frightening cost increase. Believe it or not, Europe has burned more than a trillion dollars worth of natural gas since Russia began using gas exports as a weapon in preparation for the invasion of Ukraine.

Yes, you read that right: the value of gas consumed across the European continent since 2021 is currently $1.12 trillion, and structurally higher prices could see that amount increase by a further $600 billion by the middle of the decade. Europe has spent a decade on gas in just two and a half years, even as consumption has fallen to a 28-year low in response to high gas prices.

First, let’s break down the numbers. Fair warning: this is a simple calculation based on high-level data, so it has a low confidence level and a high margin of error. That said, it gives plenty of food for thought. So, with the health warning duly administered, here goes.

Gas consumption across the continent of Europe – the EU27 plus Norway, the UK, Turkey, Ukraine, and other non-members – dropped 13% to 499 billion cubic metres (bcm) in 2022, two-thirds of which were imported from extra-European countries, mostly by pipe (Algeria, Lybia, Azerbaijan, Russia) and around 30% of such imports using LNG carriers originating mostly from Qatar, Algeria, the US, West Africa, and Russia. 

This was the smallest amount of gas consumed in the region since 1995, with steep year-on-year declines seen in Finland (-48%), Sweden (-30%), Ukraine (-29%), Latvia (-30%) and Denmark (-28%). Gas burn in Germany, Europe’s biggest gas market, fell by 15%.

Month-ahead TTF averaged $38/MMBtu in 2022 and $16/MMBtu in 2021. If we assign these prices to the volume of gas consumed each year, then Europe’s gas consumption can be crudely valued at $673 billion in 2022 and $330 billion in 2021.

EU-only gas demand over the first six months of 2023 fell by 17.7% below the 2017-2022 average. Applying that 17.7% derating factor to continent-wide demand over the same period, pan-European consumption can be estimated at 225 bcm of gas in the first half of this year, when prompt TTF averaged $14.50/MMBtu. Multiplying volume by price puts the value of H1 2023 gas consumption at $117 billion.

Add these figures together, and the total value of gas burned across Europe over the last 30 months comes in at a grand total of $1.12 trillion. This is comparable to the value of gas burned over the preceding decade to 2020 ($1.35 trillion).

For perspective, $1.12 trillion exceeds the GDP of Saudi Arabia and is more than the combined market capitalization of ExxonMobil, Chevron, and Shell. It dwarfs the amount that Europe invested in clean energy over this period ($260 billion in 2021 and $154 billion in 2022, per the IEA), and is more than double the estimated $411 billion cost of post-war reconstruction in Ukraine.

Burning through one trillion dollars’ worth of gas pushed the EU’s trade deficit to a record -€432 billion in 2022. This is a huge macroeconomic drain and a major reversal of recent trends. Gas consumption as a percentage of EU GDP had been declining steadily from around 0.5% in 2014 to hit a low of just 0.2% in 2020, the year of pandemic lockdowns and cratering global energy consumption.

Russia’s pre-war manipulation of European gas markets in 2021 and the wild price gyrations triggered by its full invasion of Ukraine slammed that trend into reverse. As a percentage of GDP, EU gas consumption shot up to 0.9% in 2021 and again to 1.6% in 2022.

In 2022, Europe faced the toughest energy crisis in its modern history. Russia's invasion of Ukraine drove gas prices to all-time highs, with spot prices peaking at nearly €340 per megawatt-hour (MWh) on August 26, 2022, an annual increase of more than 640%. A year later, however, prices have returned to the 2019-2021 average. By June 2023, they were 92% lower than the 2022 peak, although the conflict in Ukraine persisted, and most of the Russian-sourced gas supplies were not restored.

The risks are not entirely dissipated. However, such a rapid return to normality after the crisis was unthinkable just a few years ago. Several factors have contributed to this result; first of all, the increasing flexibility of gas trade, particularly Liquefied Natural Gas (LNG), which has grown rapidly in recent years. From 2011 to 2021, interregional LNG trade grew more than four times faster than pipeline trade. And in 2020, the share of gas sold as LNG exceeded pipeline trade for the first time.

The growth of global LNG trade has significant implications for energy security, as it provides countries with access to a wide range of natural gas supplies and helps reduce dependence on a single source. Europe benefited directly: when the war in Ukraine began at the end of February 2022, it sparked panic over potential gas shortages. By October, however, LNG tankers were lining up at European terminals.

Liquefied natural gas has thus become a geopolitical tool in international relations and energy diplomacy. The Ukraine-Russia war has reshaped the global energy map and brought a new geopolitical dimension to LNG. The LNG market is now almost as influenced by international relations as it is by supply and demand. So, how have recent market events accelerated LNG's role in the tools available to foreign policy and energy diplomacy?

However, these volumes were not sufficient to close the gap, forcing some EU member states to work to diversify their sources of supply further. Italy, France, Germany, and Spain have thus embarked on a campaign to hoard new gas supplies, especially in Africa and the US.

 

How did the United States carry out this rescue mission?

US LNG exports helped Europe during the winter of 2022 and strengthened its role in energy security for its Western allies.

U.S. LNG exports are driven by market forces rather than politics. The U.S. LNG industry is competitive, privately capital-funded, and entrepreneurial-driven. LNG trading is typically based on the laws of supply and demand, and the geopolitical dimension only manifests itself where there are political or geographical considerations. Unlike many producing nations, the role of the U.S. government has been solely to define the regulatory/policy framework and conduct energy diplomacy.

Future prices on natural gas (Henry Hub) in the United States are more competitive than prices in Europe and Asia. The United States benefits from the maturity of the Henry Hub futures market, characterized by price transparency and high liquidity; it is also the only true export-looking gas hub in the world. The daily volume of the Henry Hub futures and options complex averaged 626,839 contracts in April 2022, an increase of 49% compared to April 2021. The futures contract is listed on a monthly basis for the next 12 years, allowing visibility of market expectations for future gas prices. This allows LNG traders and developers to structure financing and hedge their LNG contracts over the long term using the forward price curve.

LNG prices in the United States are crucial in anchoring gas prices and represent a price cap for competing projects abroad. According to S&P Global Commodity Insights, the U.S. contracted, through long-term contracts, about 75% of global LNG capacity in 2022.

While the worst of the crisis seems over, its impact will last for years to come, particularly on gas trade, major import markets, and competitive dynamics among major exporters.

The European gas benchmark, located at the Dutch Title Transfer Facility (TTF), saw gas prices skyrocket the previous month by 500% against Henry Hub Natural Gas futures and the Platts Asian Japan/Korea Marker (JKM), reaching a high of €185/MWh on 23 September 2022. This price difference between Henry Hub compared to destination markets drove U.S. LNG export shipments to Europe instead of Asia (as of September 2023, the landed prices for LNG delivered ex-ship (DES) in northwest Europe (NEW) were back in the $11-12/MMBtu mark or EUR 35-50/MWh).

This energy crisis in Europe has enabled the United States to achieve some key milestones:

• To position America as a reliable and strategic energy ally.
• Loosen Russia's grip on European gas.
• Improve the ability of the United States to claim global energy leadership.

 

Increasing Global Gas Markets

When it comes to global demand for gas, North America is the largest market, with about 26 percent, with the U.S. alone contributing 21 percent. However, unlike Asia Pacific – the second largest market, accounting for 23% of global demand (including more than 9% from China) – North America is a net exporter.

The other major net import region is Europe. It is the world's fifth largest gas market in terms of share of gas consumption (14%) but relies on imports for almost 62% of its demand. South and Central America are also net importers but represent a smaller market, contributing only 4% of global demand. All other regions are net exporters.

In this context, Europe and Asia Pacific represent the most crucial markets for gas exporters. However, there are considerable differences between the two. Asia Pacific is a fast-growing gas market, largely due to the phasing out of coal, particularly in power generation. In contrast, Europe is a mature market that showed only slow growth potential before the war in Ukraine. After the invasion and fallout with its main supplier, Russia, the European market is undergoing structural changes in supply, opening the door to new exporters.

In 2021, 41% of the EU's gas needs were met by Russian gas supplies, with Germany receiving half of those imports. By the end of 2022, that share had fallen to less than 13%. The considerable supply gap resulting from Russia's decision to stop most of its gas deliveries to Europe during the war in Ukraine was mostly filled by Norwegian gas supplies.

Alternatives to replace Russian gas exports to the EU include deliveries from Norway (mainly pipelines but also LNG) or North Africa. Azerbaijan also supplies gas to Southeast Europe and Italy. Of these alternative sources, LNG remains an indispensable supplement for the European Union to replace Russian gas at current consumption levels. This is because pipeline deliveries from Norway, North Africa, and Azerbaijan are limited by gas production and/or pipeline capacity.

In 2022, LNG met 35% of gas demand in the European Union and 40% in Europe, compared to 12% and 20% respectively in the last decade. However, more than half of the volumes purchased in the last 24-36 months are not guaranteed by long-term contracts and are therefore valued at the spot market price – typically, the TTF. It is important to remember that an index was developed for the NEW gas market importing large volumes of mostly pipelined gas into Holland from the North Sea and not an export market like the Henry Hub. This implies a very high overall cost for gas purchases, given the high prices of the last two years and the lack of long-term contracts capable of controlling spot prices. So much so that in the last two and a half years, Europe has spent almost as much as in the previous ten years on gas supplies ($1.12 trillion vs. $1.350 billion, and structurally higher prices could see that amount increase by a further $600 billion by the middle of the decade) even though gas consumption has fallen to a 28-year low in response to high prices.

Moreover, a gigantic debt is linked to gas held in underground storage, which means more pain for consumers and a lasting brake on European industrial productivity. LNG supply at the peak of the market has stifled Europe's energy-intensive industries and reshaped the continent around a high-cost, low-demand energy economy paradigm.

 

Battle Between Petrodollars and Petroyuan

China completed its first purchase of LNG denominated in yuan from TotalEnergies in March 2023. The rise in yuan-denominated trade is part of China's plan to challenge the dominance of the petrodollar system in place since the ‘70s.

Using currencies other than the US dollar in an LNG trade is far from straightforward. Rejecting the dollar exposes both parties to additional costs due to exchange rate risk and currency misalignment, as most exporters transact and structure their projects in dollars. Such moves also complicate hedging strategies. It remains to be seen how this will play out in the long term, as China wields increasing influence as the world's largest LNG buyer.

The current geopolitical tensions over Ukraine have also accelerated the Sino-Russian rapprochement in the energy sector, including in the LNG arena.

LNG trade is increasingly viewed through a geopolitical lens due to its strategic importance for energy security and international relations. While the US appears to be on track considering its trade with Europe, the Russian-Chinese coming together and its impact on LNG trade will be interesting to watch in the near future.

 

Russia's Energy Export Strategy

Even before the start of the Ukrainian conflict, Russia was planning a change in the geography of demand for its gas. With Asia emerging as a growth center and the European market stalling or contracting, Russia aimed to diversify and expand its reach to minimize risks to demand security.

At the heart of this strategy was the expansion of LNG trade. A 2013 law allowed companies other than Gazprom, which has a monopoly on pipeline gas exports, and its subsidiaries to export LNG. In particular, these companies are predominantly controlled or supported by the government.

The transition from pipeline to LNG exports gives Russia more flexibility and potential optimization. By investing in LNG infrastructure, Russia can diversify its natural gas exports away from Europe, a market it has relied on for decades through a pipeline network. With LNG, it can access new markets not related to the existing pipeline infrastructure.

Share of global gas production and consumption by region

In addition, LNG exports provide Russia with greater flexibility in managing its natural gas supply and allow it to respond more quickly to changes in demand. Since LNG can be transported by tanker to different parts of the world, Russia can adjust its exports according to changing market conditions. This gives it greater influence in negotiations with gas-importing countries, increasing Russia's importance and influence in global energy markets, particularly in Asia Pacific.

In 2021, Russia accounted for nearly 8% of global LNG trade, ranking fourth behind Australia (20.9%), Qatar (20.7%) and the United States (18.4%). While in 2021, LNG exports were still reduced compared to Russia's traditional pipeline activities (LNG exports accounted for 17% of total Russian gas exports), Russia was expected to add increased LNG capacity by 2026. These plans, however, are now undermined by sanctions, which limit access to the necessary technology and capital.

 

Competition between LNG Exporters

The Ukrainian conflict has created a severe gas supply shortage in Europe and simultaneously provided an opportunity for LNG exporters, especially the big three: Australia, Qatar, and the United States, which account for 60% of global LNG trade. The fourth largest exporter of LNG, Russia, holds less than half the market share of each of the top three exporters.

Europe has a well-established infrastructure for LNG receiving terminals, with others planned in response to the Ukrainian conflict, making it an attractive market for LNG exporters. The region is set to become a major new LNG import destination.

LNG export capacity by country (billion cubic meters) – dark blue: existing capacity; Light blue: additional capacity 2022-26

Interestingly, while most of the Russian pipeline's gas supply to the EU was disrupted following the outbreak of war, LNG deliveries from Russia to the EU continued, even increasing by almost 22% in 2022 compared to 2021. However, Russia's role in the European LNG market will depend on its ability to expand its LNG export capacity, the potential for sanctions on such trade, and increasing competition from other, more powerful exporters.

The Big Three have greatly expanded their LNG export capacity, and competition is fierce between them. The Australian government sums up the intensity of this competition: "The opportunity for Australia is huge, but so is the appetite of our competitors to snatch it from us".

Given its position, Australia has focused on the Asia-Pacific region, unlike Qatar and the United States, which have aimed for a broader market reach. Based on the size of reserves and production costs, Qatar has a clear advantage over its closest competitors and is well-positioned to benefit from any growth in LNG demand in both Europe and Asia. Qatar typically sells its LNG on long-term contracts. The competitive advantage of American LNG includes not only its geographical location, which allows the United States to competitively supply both the European and Asian markets, but also the flexibility of its contractual LNG arrangements, especially the flexibility of the destination, which allows buyers to divert cargoes to the more profitable LNG market.

In Europe, competition is likely to intensify between Qatar and the United States, which has expanded its market presence at the expense of the Russian gas delivered by pipeline. Europe is currently Qatar's second largest market after Asia-Pacific, albeit with a much smaller share. However, it could become a more significant market for Qatar's LNG due to ongoing geopolitical tensions. In November 2022, QatarEnergy, Qatar's national energy company, signed two long-term agreements with ConocoPhillips to supply Germany with up to 2.72 billion cubic meters (bcm) of LNG from 2026, for 15 years, marking the first long-term supply of LNG to Germany.

Europe is also an important market for the United States, ranking second after Asia-Pacific and accounting for 32% of total US LNG exports in 2021. In April 2023, the US supplied 50% of the EU's total LNG imports, exceeding supplies from the Middle East, Africa, and Russia combined.

In the process, increased global export capacity and competition will likely cause the two crucial regional markets – Europe and Asia – to become increasingly interconnected and prices more correlated.

 

Scenarios

For decades, Russia has been Europe's largest supplier, and Europe has been Russia's most important market. The breakdown of this relationship has had major implications for both sides, with Europe looking for alternative supplies and Russia looking for alternative buyers. However, both have been pursuing these goals for years: the war in Ukraine accelerated the process. Both sides have found the primary solution in LNG, which gives consumers and producers flexibility that the pipeline cannot provide.

The importance of LNG in the globalization of international gas trade and in connecting production with consumption centers with limited access to gas transported via pipelines is indisputable. LNG helps integrate regional gas markets (mainly interconnected via pipelines) into a global one. We are already witnessing the emergence of a key ingredient needed to support the ever-growing network of LNG cargoes connecting more remote supply and demand centers.

The war in Ukraine has highlighted the importance of LNG in improving the security of supply. A prime example is Germany's decision to build its first LNG import terminals in 2022.

In 2012, the International Energy Agency (IEA) famously predicted a golden age for gas. After the war in Ukraine, the same agency argued that this long-awaited golden age was ending before it had a chance to fully materialize. However, the intensified dynamics in the post-war period indicate the opposite, at least for LNG, which is currently experiencing a golden age.

That said, the amount of gas that Europe consumes (around 500 bcm/y) is still very large, and securing imports by alternative routes other than piped gas from Russia, mainly through additional LNG imports, is both costly and complex. The only way to avoid another spike in prices and excess volatility is to reduce gas demand by around 15% overall. Failure to cut gas demand by 55 billion cu m (bcm) could put Europe at substantial risk from a rebound in Asian demand or reductions in Russian imports. In the wake of the Ukraine war, McKinsey research found that, a complete cessation of imports from Russia could remove 25 bcm of supply in Europe, and a recovery in Asian LNG demand could absorb 35 bcm of supply, while a cold winter in 2023 could boost demand by 15 bcm.

The analysis shows that 57% of EU manufacturers would not be able to further reduce gas consumption while maintaining production over the next two years, indicating that further gas rationing measures could substantially impact the EU economy.

Even if Europe achieves the ‘RePowerEU’ goals of reducing gas consumption and improving energy efficiency in buildings and industry, gas price volatility and potential supply disruptions still pose risks to many sectors of the economy, the analysis shows. McKinsey projects that Europe may need to delay the phase-out of coal, extend the lifetime of nuclear power plants, and accelerate the expansion of renewable energy sources (RES) to reduce reliance on natural gas as a baseload. It also found that ongoing supply chain disruptions, slow permitting processes and a lack of skilled labor for renewable installation could impede the required pace of RES development in Europe.

There is little bandwidth further to reduce Europe’s gas demand without substantial economic damage. If the EU achieves all its gas-savings measures, this could see a 24% reduction in consumption, yet other potential factors, such as more competition from Asia, could reduce Europe’s supply by an even greater amount. The many variables at play will produce significant uncertainty, and Europe’s businesses may need to prepare to mitigate these risks. This may require businesses to consider diversifying their energy sourcing and managing demand, investing in natural gas substitutes or storage, and closely monitoring movements in the energy market.

If Europe can sustain and accelerate several gas-demand reduction measures, the market will likely remain balanced without significant price spikes in the coming years. Europe could drive substantial gas demand reduction by accelerating industrial-electrification measures like fuel-switching and build-out of RES and through longer lifetime extensions of nuclear and coal.

 

Natural Gas Markets today

European gas markets currently see a very limited risk of supply shortage for the short term or even for the coming winter, judging by the convergence of European and Asian spot prices for winter gas delivery and long-term/oil-indexed LNG prices.

This is because stocks are about to fill up well before winter, and consumption remains below normal in the long term, thanks mainly to investments to improve consumer efficiency and caution but also to a decline (final destruction?) in demand from heavy industry.

A year ago, spot gas prices in the Dutch TTF price hub and spot cargoes in Northeast Asia were approaching record prices of more than $75 per million British thermal units (mmBtU). Many Asian importers, particularly in Japan and South Korea, have been protected from these extreme price swings with long-term supply contracts starting with crude oil (mainly Brent) that only rose to around $17.5 per mmBtu last year (although even this was a historically high value given that even after the immediate closure of all nuclear power plants following the 2011 Fukushima accident when Japan had to increase its share of LNG imports essentially overnight dramatically, prices never went beyond $20/mmBtu).

Now that we've passed the mid-year point 2023, markets look pretty relaxed for next winter. European spot gas prices are just above $8-9/mmBtu as inventories are plentiful, providing a higher supply of LNG to Asia, where spot prices are slightly above $10-11/mmBtu, which is tolerable even for consumers.

Gas delivery prices in Europe for winter 2023/24 are also "only" around $15/mmBtu. Historically, it is an expensive value, but a very different prospect from what consumers faced last year – and it is even lower than in the months before the 2021 war in Ukraine, when Russia was still supplying relatively normal gas volumes to the EU. Moreover, it is not much more than the long-term Asian oil-indexed contracts, which are currently mostly estimated at around $13/mmBtu, and at an average spot/winter TTF price of $12/mmBtu, the overall gas price levels in the EU are now slightly cheaper than the average price of the long-term contract indexed to Asian oil.

While the immediate effects of last year's supply shock have subsided in recent months, the structural changes that emerged in 2022 will persist for years and should be considered by policymakers and market participants.

In particular, securing LNG supplies will require policy-makers, in close coordination with private actors, to facilitate the development of innovative commercial offers, new supply mechanisms, and new cooperation frameworks, taking into account the growing need for flexibility of supply.

Beyond the increasing complexity of the security of gas supply in both the short and long term, gas decarbonization and the wider energy system will require the deployment and gradual scale-up of low-emission gases, including the storage of low-emission gases and the use of low-emission liquefied gases in the international maritime sector.

 

Conclusions

The LNG market is today at a critical juncture. The uncertain outlook has significantly affected pricing and contract terms and widened the gap between buyer and seller aspirations. With the volume of contracts signed at the highest peak in over a decade in 2022, the opportunities are there – but the ongoing volatility is challenging to navigate.

Many LNG buyers face the challenge of ensuring LNG supply security while keeping their procurement costs competitive and contractual terms flexible. Simultaneously, the terms in LNG sale and purchase agreements (SPAs) also evolve as LNG trading increases.

In this article, we have gone through, inter alia, the evolving nature of LNG contracts and buyer-seller behaviors influenced by market dynamics. Pricing structures vary based on contract terms, raising questions about procurement processes. Getting procurement right has long-term economic and operational benefits, and we discussed the typical questions LNG buyers address with a particular focus on European ones.

The choice partly desired and partly suffered, to eliminate Russian gas from the European context has thus had an effect not only on our gas and electricity bills but also on the industrial fabric of our country and continent. Without cheap gas, industries close or are forced to move to where the cost of energy is lower (the United States in primis), with worrying effects on the industrial future and economic growth.

A possible solution to this permanent destruction of gas demand and the consequent European industrial sector remains once again in the ability to provide cheap energy through long-term contracts with reliable partners and price formulas that can avoid speculation and excessive volatility.

The EU accounts for 70% of the European gas market.

Russia has historically exercised strong control over the structuring and pricing of energy exports in support of its strategic plans. But after the outbreak of war, the situation degenerated into a geoeconomic stalemate, and the energy lever was taken to an extreme level. Russia violated contractual agreements and reduced gas exports to the EU by 75%. The EU perceived the disruption of pipeline deliveries as an attempt at blackmail to inflict significant economic damage. The Kremlin denied these allegations, although later, in September 2022, it announced that "Russia will not fully resume its gas supplies to Europe until the West lifts sanctions against Moscow."

Even in benign markets, wholesale prices swing strongly away from annual averages on a daily, weekly, and seasonal basis. Benchmark TTF is a useful proxy for European wholesale gas, but prices vary significantly across the continent, particularly in semi-isolated markets such as the Iberian peninsula. A more accurate estimate of the value of volumetric consumption would require a more robust methodology and more granular data that correlates price movements with consumption over shorter time intervals. The extent and pace of wholesale price pass-through to households, businesses, and industrial consumers must also be considered.

China, a gas market of 379 billion cubic meters (just 4.5% smaller than the EU's market as a whole in 2021), accounts for 41% of total regional demand. Economics Legislation Committee: 10/11/2022

Unlike oil, for which more than three-quarters of production is traded between regions in a global market, most of the gas produced is consumed locally.

Between 2011 and 2021, natural gas was the fastest-growing fossil fuel, with consumption increasing at an average annual rate of 2.2% compared to 0.1% and 0.7% for crude oil and coal, respectively.

In May 2023, gas storage levels in the EU were 21% higher than in May 2022 and more than 18% higher than the 2011-21 average.

 

Frequently Asked Questions 

1. How are European countries diversifying their natural gas supply sources to enhance energy security?

The EU has doubled down on its strategy to diversify away from gas in its entirety by accelerating the energy transition and the deployment of renewable energy sources, but still cannot do without gas. 

On one hand, imports of Russian gas via pipeline have already become much less significant for the European market since at least the winter of 2021. The flow of Russian gas averaged 60mmcm/d in the period from Jan 1 – May 20 2023, amounting to 8.5bcm during this period. This compares with 40bcm in 2022 and 59bcm in 2021 over the same period, implying 79 per cent and 86 per cent declines, respectively. 

If the current rate continues for the rest of 2023, then total imports to Europe (EU27 plus UK) from Russia via pipeline will be approximately 22 bcm for 2023, down from 63 bcm in 2022 and 142 bcm in 2021. As a result of this decline, imports of Azeri gas (via TAP) are now running at 50 per cent of the level of Russian gas, a marked change from the time when Alexander Medvedev, a previous Head of GazpromExport, questioned Azerbaijan’s ability to fill the TAP pipeline to Europe, claiming that it hardly had enough gas to ‘light a barbecue’. 

Meanwhile imports from North Africa into southern Europe are now at or above Russian flows to Europe in most months, and they are, in turn, dwarfed by imports from Norway, which have been as high as 340mmcm/d (equivalent to 124bcma). Perhaps even more importantly, though, the send-out of LNG into the European market had averaged almost 450mmcm/d between Jan 1 – May 20 2023, seven times more than the amount of pipeline gas Europe received from Russia in the same period and higher than the levels seen coming from Russia in the equivalent periods in 2019/20 or 2020/21 when Russia was the largest single gas supplier to Europe.

On the other hand, in the near term, new gas means new infrastructure. You cannot use Russian infrastructure to import non-Russian gas, so new infrastructure must be built to compensate for the loss of Russian gas. And, net of the return to full capacity of the Algerian gas pipelines and some other upgrades (TAP?), the substitute immediately available can only be LNG, and the new infrastructure, to be available immediately, can only be floating, therefore, ready and transportable. And so Europe quickly purchased a dozen regasification plants (of which four are in Germany and two in the Netherlands and Italy), most of which were already in operation in 2023.

This is how the emergency was faced. And in the medium term? 

Gas, for example, from the Eastern Mediterranean and other production sites will perhaps be connected by a pipe to make the volumes safer (ships attracted by the price can always sail elsewhere; the tube remains where it is.) 

Here, we need to go back to meeting demand and decarbonisation. At the point of production, the forecast is that the new liquefaction capacity under construction in exporting countries as early as 2024 should (even excluding Russia from Western markets altogether) bring supply and demand back into balance. 

A new fixed infrastructure that can be amortized over twenty years and rigidly directed in a Europe determined to decarbonize would therefore, not make much sense. And so, in principle, let us forget the pipeline from Cyprus. The reserves of the Eastern Mediterranean will end up traveling by sea, also to avoid handing themselves over to a single buyer and making a continuous profession of decarbonizing virtue. Given the goal of a 20% reduction in consumption, even the new ones that are now in operation could prove redundant.

Europe is committed to halving gas consumption over the next decade, but China announces its doubling. This should dictate the rule for medium-term infrastructure. It must be mobile to have the possibility of reselling it to those who practice energy policies other than those made in Brussels and flexible, in the sense of being convertible to receive other commodities (ammonia, hydrogen, etc.) than methane. Flexibility will not be free (in terms of adaptation/conversion investments); but the Germans, speaking of their new regasification terminals, still consider it a viable solution. 

Then, in the long run, Europe will still maintain relatively high gas consumption, but it will focus on maintaining the gas network and the progressive introduction of "other" gases into the network. Here, the theme will be the form of the fruition of energy. Gas (think hydrogen) is consumed in the boiler in the form of gas or used for the generation and power supply of the electric boiler. Electrons and molecules compete with each other. The outcomes could decide the future of the national network. But let us not be naïve on this; it will not happen any time soon.

 

2. What is the outlook for the future of Russian gas exports to Europe, considering factors such as competition, regulatory changes, and geopolitical tensions?

When considering possible scenarios for Russian pipeline gas exports to Europe, several physical, contractual, and political factors must be considered. 

Infrastructure

It is very unlikely that flows through Nord Stream 1 or 2 will recommence soon or that Yamal Europe will be used for Russian gas exports. Therefore, the two available routes are via Ukraine and Turkey (the latter using one pipe on the TurkStream route). This limits the likely available capacity should European customers ever consider increasing purchases of Russian gas. The maximum available level would be around 75 bcma, which would be only possible in a benign political post-war scenario. 

Gazprom’s Sales Strategy and Long-Term Contracts (LTCs)

The second key issue is Gazprom’s sales strategy and resolving issues around long-term contracts (LTCs) with European customers. There are currently three types of LTC – those that have been canceled, those under legal review, and those that continue to function. 

The latter covers flows of around 24-25 bcma at the contracted level, although there is flexibility around this level, while the contracts under legal review contain volumes of 80 bcma. The return of any of these volumes would be subject to significant legal debate and judgment, but even if the contracts are ultimately ruled to have expired or been terminated, some of the flows could be returned via the spot or short-term traded market. 

Geopolitics

Geopolitics will also play a role. The question of the acceptability of Russian gas in Europe will no doubt be driven by the outcome of the war in Ukraine and by the moral stance taken by individual European countries in its aftermath. 

Impact of Russian LNG Imports

Volumes from the Yamal LNG project have increased sharply thanks to the attraction of premium prices in Europe, and they now account for 50 percent of the total current volumes of Russian gas delivered to the continent. 

While a debate about the future of Russian LNG imports is ongoing, direct sanctions are unlikely, and therefore, it can be assumed that flows continue at their current levels. In addition, sanctions would have little impact on prices because Russian LNG would be redirected to the global market, and Europe would receive alternative supplies to balance any loss. The removal or addition of pipeline flows from Russia to Europe makes a significant difference as they alter the overall global supply-demand balance. 

During 2022, a key concern within the EU and the global gas market was how the market might cope with a complete shut-off of Russian gas pipeline exports to Europe if a ban was implemented on Gazprom sales. For most of the year, the market was very stretched, and gas demand rationing in Europe might be needed if Russian gas disappeared completely or if a cold winter caused a spike in demand. 

In addition, the economic impact of higher gas prices, which peaked at over $90/mmbtu in August 2022 and averaged over $40/mmbtu for the year as a whole, also prompted the question as to whether European politicians and companies might be tempted to concede to some of Gazprom’s demands (for example on rouble payments) to increase imports and lower prices. 

The politics of the situation suggested that while the Ukraine war continued, this would not be an acceptable outcome, but questions were being asked about how long the EU, or individual member states, would be prepared to take the economic pain. Six months into 2023, a completely different set of questions can now be asked: is Russian gas that important to the EU and wider Europe anymore? 

Would it matter if volumes went to zero sooner rather than later, either by Russian or EU design? 

Will Russian gas ever have a significant role in Western markets again? 

Russia’s invasion of Ukraine sent a supply shock through the LNG industry as Russian piped gas exports into the European market reduced and increased Europe’s reliance on LNG, mostly sourced from the US and Qatar: a severe shift from the 2020 LNG oversupply caused by the Covid pandemic’s demand destruction. 

Organic supply growth remains limited for the next two years, and the volumes from the under-construction projects are not expected to hit the market until the second half of this decade.

This makes the near-term market “finely balanced,” any supply disruptions or demand upsides could cause significant price volatility and allow Russian gas to flow into Europe as long as it is competitively priced. To this end, the Russian government is ready to cut prices for its natural gas exports outside the former Soviet Union for 2024-26. Russia relies heavily on oil and natural gas sales, which account for around a third of federal budget revenues, while the government has been discussing budget plans for the next three years. 

Moscow plans to increase budget spending by 25.8% to 36.6 trillion roubles ($383 billion) in 2024, with hefty increases in military and social spending expected ahead of a March presidential election. According to the forecast presented by the economy ministry, Russia's gas exports to countries outside the ex-Soviet Union are now seen at $434.6 per 1,000 cubic metres in 2023 (ca. $11.87/MMBTU), at $321.7 in 2024 ($8.79/MMBTU), $308.3 in 2025 ($8.42/MMBTU) and $296 in 2026 ($8.09/MMBTU) – in line with international prices of LNG delivered into Europe.

LNG year-on-year supply growth will then average 40 mmtpa annually from 2026 to 2028, helping the global market to rebalance, which is predicted to bring prices down and, therefore, ultimately push out any remaining Russian gas volumes which will be entirely redirected towards Asia as pipeline connections and new LNG productions are scheduled to come online at about the same time. This will improve gas affordability, facilitate LNG availability for Europe, and enable a rebounding demand in Asia.

Having said that, it is impossible to ignore what the impact of the political situation on energy markets and gas flows could be, both in terms of geopolitical reactions and in terms of broader EU strategy after the end of the Russia-Ukraine conflict. We can consider three possible outcomes and their consequential implications for gas markets. 

Firstly, an absolute victory for Russia would likely end gas exports to Europe. It seems inconceivable that the EU and its member states could conceive of buying energy from a country that had conquered a near neighbor after an unprovoked assault. So, this scenario would seem to point to zero Russian gas flows to Europe, especially as Europe has already made significant progress toward replacing Russian gas with alternative supplies. 

The only possible exception might be countries that have adopted a more neutral or even pro-Russian stance and who receive gas via TurkStream (Hungary might be one example), although significant political pressure would likely be exerted to prevent this.

Absolute victory for Ukraine seems unlikely, but if it were to occur, it might offer some small possibility of a return of Russian gas to Europe. A defeated Russia might be keen to generate extra revenues in 

a post-war world, either to make reparations or to reinvigorate its economy, while a magnanimous Ukraine and EU might be prepared to encourage Russia back into a commercial arrangement that could lead to political rapprochement. Alternatively, both sides could be so antagonistic after a bitter war that no transit or sales agreement is possible. 

The armistice agreement scenario would involve a commitment to stop the fighting but would be unlikely to resolve the political drivers of the conflict. It would likely see the freezing of the front lines and an end to combat, preventing further Russian advances into Ukrainian territory but also stopping counter-offensives and leaving Russian troops in areas of Ukraine that they already hold. 

This would leave many political and economic disputes to be resolved between the two sides, with minimal trade being likely. This would be an unsatisfactory outcome for both sides and lead to the preservation of the status quo at the time of agreement. The implications for the gas market would likely be similar, namely the continuation of flows at or around current levels, with less risk of a fall to zero but equally little real hope of a significant rebound.

The political settlement scenario would involve signing a peace treaty and a more durable end to the fighting. At least some of the core political issues would be resolved and could cover concerns such as the geopolitical position of Ukraine, reparations and reconstruction, resumption of bilateral trade, and the return of some or all Russian-occupied Ukrainian territory. This more concrete agreement to end hostilities could have a more positive outcome on gas flows to Europe. It is very unlikely that the EU and any of its member states would want to find themselves as exposed to Russian gas as they were before February 2022. However, it is conceivable that a more balanced import strategy could still see pipeline flows increase from current levels, and this is explored in our gas market modeling and scenario analysis.

In summary, Russian gas matters more before 2026 than after. This conclusion crucially depends on the assumption that an armada of new LNG capacity (around 171 bcma, more than enough to cover the pre-war level of Russia pipeline and LNG deliveries to Europe) will be delivered by 2026 and that Europe will continue its aggressive policy to roll out renewables in the power sector. Any delays in LNG capacity addition or upgrading renewables in Europe will further shift the date when Russian gas will become less important.

There is no likelihood of any increase in Russian gas exports to Europe. If anything, the most likely short-term risk is that flows through Ukraine are halted either by military activity, further sanctions, or the expiry of the transit contract at the end of 2024. However, depending on the ultimate outcome of the war, some rebound in volumes cannot be excluded, although it is highly unlikely that they would return to their former pre-war levels. 

 

3. What strategies are European countries employing to enhance energy security through developing LNG infrastructure and promoting alternative gas supply routes?

Market volatility in the past two years has significantly affected LNG pricing, contracts, and buyer and seller behaviors. High spot prices during 2022 were prompted by European buyers who were forced to scramble for volumes to compensate for the drop-off in Russian gas supply. Expensive supply drove several emerging buyers towards alternative fuels (such as LPG, oil, coal, and Hydrogen) and established buyers to favor long-term contracts, and the unprecedented fall in spot prices in 2023 has only added to the dilemma. 

The near-term LNG market appears ‘finely balanced’ before a wave of under-construction supply comes online during 2026-28. The outlook for the LNG market beyond 2028 depends on the level of liquefaction project Final Investment Decisions (FIDs) within the next 1-2 years, as well as the pace of energy transition and several dynamic supply-demand-related factors. 

This uncertain market outlook has widened the gap between buyer and seller aspirations on LNG sale and purchase agreements (SPAs) contract terms. European buyers took a greater share of the spot market, but most were reluctant to commit to long-term deals as they kept decarbonization targets in focus. Asian buyers accounted for almost a third of last year's long-term contracts.

The pricing structures of these contracts have varied greatly based on the terms, tenor, and start date of new deals. This raises key questions for buyers around the best-suited LNG procurement process in the current environment, for example, tenders vs bilateral negotiations. 

As well as the pros and cons and the expected timelines. Buyers must be well prepared before engaging suppliers and negotiating in this sellers’ market. 

Many LNG buyers face the challenge of ensuring LNG supply security while keeping their procurement costs competitive and contractual terms flexible. Simultaneously, the terms in LNG SPAs evolve as LNG trading increases. These complexities and the uncertainty in market dynamics hinder the decision-making process amongst many buyer organizations and raise several questions, especially in some emerging Asian markets. Buyers of LNG need to be cognizant of the LNG market dynamics and contracting trends:

With all this said, one other important political factor is the EU’s energy strategy and the new balance that has been established between energy security and environmental necessity. The EU had already 

committed to accelerating the decarbonization of its energy system before the war, with the publication of the Fit for 55 strategies highlighting a focus on increasing the use of renewable energy, reducing the use of hydrocarbons (especially coal), developing the use of hydrogen in hard-to-decarbonize sectors, and encouraging the construction of infrastructure to facilitate the energy transition. 

Following the Ukraine war outbreak, the EU effectively doubled down on this strategy by launching its REPowerEU targets, emphasizing the need to move away from hydrocarbons faster for energy security and environmental objectives. A quicker decarbonization could allow the bloc to reduce its dependence on Russia’s oil, gas, and coal at an accelerated pace by increasing the targets for renewables and other forms of decarbonized energy.

This acceleration has potentially significant consequences for gas overall, but particularly for the import of Russian gas, which is targeted to reach zero before the end of the current decade. Questions have been asked about the realistic targets in the REPowerEU document, with some (such as the growth in hydrogen demand) appearing completely impossible to achieve. Nevertheless, the direction of travel has been set, and the implications for gas imports are that they would surely decline in this scenario, even if EU gas production also falls. 

In a scenario with falling gas imports, supply from Russia would presumably be the first on the list for removal, at least from a political standpoint. Again, it should be reiterated that the targets are not forecasts, and the actual outcome could be rather different – indeed, I would expect gas demand in Europe by 2030 to be much higher than what was forecasted by the EU – and as a result, the outlook for Russian gas imports could also be higher. Nevertheless, the downside risk for Russian gas is clear and has been part of Gazprom’s analysis for some years.

 

4. What is the outlook for developing small-scale LNG infrastructure in Europe to serve niche markets and decentralized consumption?

Since LNG development began in the 1960s, the size of the facilities has continued to grow due to the significant economies of scale at work. However, new environmental (related to low polluting emissions of natural gas), economic, and security of supply challenges have recently revived interest in small-scale installations. 

Its size (SSLNG) refers to facilities producing less than 1 Mpta of LNG and having storage capacities of less than 30,000 m3 ) compared to conventional LNG (where liquefaction usually reaches between 5 and 8 Mtpa). This new market is in full-swing expansion and could represent nearly 100 Mtpa by 2030, according to Engie projections (a quarter for electricity generation, a third for marine fuel, and about 40% for road fuel oil). 

Small-scale LNG (liquefied natural gas) is a form of LNG designed for smaller-scale applications such as local power generation, industrial processes, and transportation fuel. It is usually produced in smaller volumes than traditional LNG, typically with a capacity of up to 10,000 cubic meters per day. Small-scale LNG is typically more expensive than traditional LNG due to its smaller-scale production, but the convenience of its production and use can often make it a viable option for businesses or individual consumers.

The benefits of small-scale LNG are, inter alia:

Lower Carbon Footprint

Small-scale LNG operations can help reduce the carbon footprint of traditional LNG production and distribution methods, making them more efficient and environmentally friendly. 

Lower Cost of Delivery

Small-scale LNG provides greater flexibility and lower delivery costs than large-scale LNG operations. This makes it an attractive option for many businesses and, industries and remote communities. 

Improved Safety

Small-scale LNG operations are considered safer due to their smaller size, making them less likely to cause serious accidents. 

Reduced Infrastructure Requirements

Small-scale LNG operations require less infrastructure than large-scale LNG operations, making them more cost-effective and easier to install. 

Increased Accessibility

Small-scale LNG operations are often more accessible and provide greater flexibility than large-scale LNG operations, making them an attractive option for many businesses and industries.

Most LNG that is unloaded at Europe’s LNG import terminals is still regasified at the import terminal and sent into a natural gas pipeline network in gaseous form. “Small–scale LNG” is a generic name to cover activities where LNG that is unloaded at an import terminal leaves the terminal still in its liquefied form – importantly, these activities are usually not regulated in Europe. Therefore, SSLNG service providers can apply negotiated prices rather than the regulated EU pricing. These activities are: 

Bunkering

Smaller quantities of LNG are reloaded onto LNG-fuelled ships. As stringent environmental regulations are imposed on the maritime sector – notably the 0.5% sulfur cap adopted by the International Maritime Organization (IMO) – an increasing number of ships are using LNG as a fuel. Bunkering LNG vessels are smaller than traditional large-scale LNG vessels and are sometimes able to access inland waterways (which have lower water depths that do not allow for large LNG Carriers to navigate) to expand the geographic availability of small-scale LNG onshore or inland (such as along the Danube). 

Truck transportation

LNG is transported by trucks from LNG terminals with truck loading bays. LNG is trucked:

For use by industrial consumers who are not connected to a natural gas network
Power generation in isolated areas
Supply source to a satellite regasification plant that injects gas into a local network
Supply LNG fuelling stations. LNG has the potential to replace heavy fuel oil and diesel in heavy-duty vehicles at a more competitive price and with a 20-30% lower carbon impact

Rail transportation

Transportation of LNG by rail car is still in its infancy in Europe. Like trucks, transportation of LNG by railcars offers a means to expand the availability of LNG geographically. Rail loading services commenced at the Zeebrugge import terminal in Belgium in September 2020. 

This evolution is qualitative because SSLNG projects are not simple miniature replicas of classic LNG projects. On the contrary, it is a transformation of the basic structure of the current gas sector, with the emergence of a new market with its own rules, technologies, and associated business models. 

For example, modular design and scalable projects make it possible to overcome the lack of economies of scale: the size of the installations are modulable. SSLNG can thus easily be scaled up in the event of growing needs, representing an Investment flexibility highly valued by operators. While traditional LNG is intended for reliquefication to be introduced into distribution networks, SSLNG infrastructures use gas still in its liquid form, destined for two main markets: transmission and power generation in isolated areas or areas not connected to the gas distribution network. 

The economic interest is explained above all by the flexibility offered by these installations and the desire to reduce the risks associated with the volatility of natural gas prices. The SSLNG is widely used for clipping peak consumption and smoothing fluctuations in the short term of consumption. This flexibility, coupled with the multiplication of installations, is also one of the main arguments used by some countries such as Japan, Turkey, or India in favor of SSLNG as an instrument for managing energy dependence since this allows the consumer country to no longer depend on specific suppliers, as is often the case in large LNG projects. 

In addition, the SSLNG infrastructure expands the LNG market, particularly in the transport sectors, maritime (mainly in Northern Europe at the moment), and road (mainly in China), which are the main outlets for the production of SSLNG. Regarding non-fuel uses, the SSLNG makes it possible to supply natural gas to micro consumer networks, as they exist in Poland, Sweden or Spain, where the LNG is transported by truck before being regasified to be injected into microgrids of distribution (isolated communities, industrial consumer pools, etc.). 

SSLNG is also proving relevant for supplying energy to areas without access to electricity (between 15 and 20% of the world's population), in particular through the installation of LNG to Power, developed in Asia (Philippines, Indonesia, Burma), in the Mediterranean basin (Gibraltar, Malta, Sardinia) or in Latin America. Also, SSLNG makes it possible to envisage the development of isolated and small gas resources (stranded) in areas not connected to gas networks, including industrialized countries such as Canada and the United States. 

BioLNG (liquefaction of gas from the methanization of organic, industrial, or agriculture) is also a potentially important channel for the development of SSLNG infrastructure, like the liquefaction stations commissioned in recent years in Lidköping, Sweden, in Skogn in Norway or Northern Ireland. A French player stands out in this market: Cryopur (supplier of Northern Ireland plant technology), which offers an innovative liquefaction solution to combine the purification and liquefaction of biogas.

The small-scale LNG market in Europe has grown by approximately 5% per year over the last ten years and is predicted to grow by a further 17% between 2020 and 2025 – driven by price competitiveness compared to oil, incremental, small-scale infrastructure, and environmental advantages. LNG truck loading is the fastest-growing segment of the small-scale LNG segment. The number of LNG trucks in Europe has increased from approximately 1,500 in 2016 to approximately 15,000 in 2020, and there are now about 300 LNG fuelling stations in operation in Europe. 

As of July 2023, 19 European LNG terminals offer truck loading services, and truck loading infrastructure is being developed in several other European terminals. Small-scale LNG service contracts remain diversified, with different participants offering different contractual structures. However, as the sector grows, we are beginning to see some harmonization across small-scale LNG service contracts. Truck loading services can be contracted on a short-term or long-term basis. In May 2021, GIIGNL published the first edition of Safety Measures for Truck Loading, Unloading, and Road Transport of LNG – another step towards harmonization of the LNG truck loading sector.