From Australia to the US, from the Middle East to the Mediterranean, new projects are being planned to bring natural gas to the European market. This supports the EU’s goal to create a competitive integrated European gas market. But will there be enough demand for all that gas, Energy Post’s editor-in-chief Karel Beckman wonders? And what role do our policymakers want gas to play in the low-carbon economy?

For many years the European gas sector complained that gas did not get enough attention from EU policymakers.

Today, the reverse is true. Gas is the talk of the town in energy policymaking circles in Brussels. As an illustration: in the European Commission’s State of the Energy Union report, which came out in November, and which is at the heart of EU energy policy, gas is mentioned 42 times (excluding “greenhouse gas”), renewables 23 times, oil 1 time and coal not once. Environmental groups are even complaining that gas is getting too much attention.

One turning point which led to this reversal in policy priorities was the Russian invasion of the Crimea in 2014. This prompted the European Commission, at the urging of the European Council, to come up with a new energy security strategy, mainly aimed at reducing dependence on Russian gas.

“This is one of the fundamental stories in the global energy picture the next ten years and beyond”

In reality, though, the EU has been working quietly for many years on reforming the European gas market. The goal is to create a competitive integrated market, based on gas hubs with spot-based pricing, to reduce the importance of long-term oil-indexed contracts with which Gazprom and other major suppliers used to control the market. As part of this process the EU has introduced many crucial market reforms, such as third party access requirements for pipelines and storages, the removal of destination clauses from contracts and ownership unbundling rules for transmission and generation activities. The Crimean crisis only gave more urgency to this project.

Plowing ahead

Today the EU is still plowing ahead with its gas market reform. In particular, it is making efforts to connect formerly isolated East and South East European markets with each other and with the rest of Europe, through key infrastructure projects, including interconnectors and new LNG terminals, as well as new cooperation agreements. The European Commission is also turning its attention to LNG and gas storage, for which it will introduce – for the first time – a European-wide strategy next year. In addition, the Competition directorate of the Commission is still pursuing its anti-trust case against Gazprom.

So policy is marching on. Nevertheless, there is still great uncertainty as to how the European gas market will develop in the coming years: whether it will grow or shrink, who the main new suppliers will be, how prices will be set, what new pipelines or LNG terminals need to be built  – and even whether the transition to a competitive market will succeed.

One major uncertain factor is how European gas demand will evolve, particularly in the light of the EU’s climate and renewables policies. Over the past few years Europe’s gas consumtion has fallen precipitously, as illustrated in this graph from a report of international consultancy E3G:

At the same time, prices have halved over the last four years to a low of just over $6 per mmbtu at the end of November 2015:

The price of Russian gas at the German border has dropped from around $11/mmBtu to around $6.50 in July 2015:

The reasons for these downward trends are well known: the economic crisis in combination with competition from renewables, cheap coal and energy efficiency. (Warm weather is usually not mentioned; it would be interesting to know what the effects of climate change on European gas demand will be.)

New projects

In spite of the lacklustre market, projects to bring new gas to Europe are springing up all over the world. At a recent Energy and Economic Summit organised by the Atlantic Council in Istanbul, optimism about the future prospects of gas, both for Europe and globally, prevailed.

Most experts expect to see a globally integrated, competitive gas market emerging over the coming years, similar to – but independent of – the global oil market. Europe will be just one part of this. They base this belief on the rapid expansion of LNG supplies, from the US and elsewhere. “LNG is changing the way gas is sold and priced in the world”, said Jason Bordoff, Director of the Center on Global Energy Policy at Columbia University in the US. “This is one of the fundamental stories in the global energy picture the next ten years and beyond.”

LNG has given gas “a global reach”, Amos Hochstein, Special Envoy and Coordinator for International Energy Affairs at the US State Department, concurred. “Gas is becoming a competitive commodity in its own right. That’s a really big deal for gas.”

“The Kurdistan Region of Iraq (KRG) will be able to supply enough gas to satisfy the entire Turkish demand for the next 50 years”

It is above all the expected wave of LNG exports from the US, on the back of the shale gas revolution, which is expected to transform international markets. In January 2016, frontrunner Cheniere Energy will export the first cargo of LNG from the continental US from its Sabine Pass terminal. Subsequently the company will start up a new production train every six months until mid-2019.

Together these seven trains will account for almost half of the 65 million tonnes (88 billion cubic metres) per year of LNG export capacity under construction in the US. This is more than the entire annual consumption of Germany, which was around 70 bcm in 2014. The US supplies will come on top of new LNG supplies from Australia and other countries.

Andrew Walker, the new VP Strategy for Cheniere Europe, said in Istanbul that  US exports “will rebalance the power in the industry. They will move power away from current suppliers and improve energy security in Europe. They will also increase the power of the consumer.”

Cheniere’s LNG supplies have already been sold under long-term contracts to companies including BG Group (now owned by Shell), Koreas Gas Copr and GAIL India. They can find their way to Europe or Asia, whichever market offers the best conditions.

Gas from Kurdistan

But LNG will not be the only new source of gas for Europe. New pipeline projects are being planned and undertaken as well. The planned Nord Stream 2 pipeline from Russia will not offer additional gas. But the TANAP-TAP project will. This consists of three pipelines – one from Azerbaijan to Turkey, one through Turkey (TANAP) and one from Turkey via Greece to Italy (TAP). In 2020, 16 bcm of gas is expected to reach Italy through this route. In 2030, this should be 26 bcm.

These are still fairly modest numbers. Nord Stream 2, for example, will have a capacity of 55 bcm. Italian gas consumption was 57 bcm in 2014.  But the story may not end there. Other countries are also gearing up to supply gas to Turkey and beyond into Europe. Iran is potentially the biggest supplier, although experts in Istanbul agreed that it will take considerable time before Iran will be able to export gas to Europe.

“Coal can’t simply move to renewables in the same scale and volume”

Another new supplier of gas to Europe, whose projects are much further advanced, is the Kurdistan Region of Iraq (KRG). Tony Hayward, Chairman of the independent oil and gas company Genel Energy (and former CEO of BP), told the audience in Istanbul that the KRG will “become a major gas exporter, first to Turkey, then to Europe.”

Hayward, whose company is active in the KRG, said  the “industry has discovered very large gas resources in the region, in excess of 850 bcm. And in my view there is a lot more to come.” Genel operates two major fields in the region with 300 to 400 bcm of proven reserves. These will become the “anchor fields” for the first phase of the KRG’s export efforts, said Hayward. In the early 2020’s, the KRG should be exporting more than 20 bcm to Turkey.

Turkey last year used some 49 bcm of gas, most of which it had to import from Russia. According to Hayward, the KRG will in the future be able to supply enough gas “to satisfy the entire Turkish demand for the next 50 years. It will allow Turkey to diversify its sources of gas away from Russia and Iran.” The KRG can supply gas at much lower cost than Russia and Iran, Hayward said. “It will be a completely transforming step to both Turkey and the Kurdistan Region. Far more strategic than the KRG’s oil exports.”

Consensus forecast

If we add potential new supplies from the Eastern Mediterranean, where ENI’s newly discovered Zohr field alone could reach 20-30 bcm of production per year, with many more fields in the region being developed and yet to be discovered, the question becomes whether the European market may not become oversupplied.

In fact it already is. The utilisation of European LNG import terminals has declined steadily over the last decade:

In 2013 LNG import capacity in the EU was five times as high as imports:

Pipeline imports show a similar picture, with roughly twice as much capacity as needed:

But most suppliers believe this situation will not last. They point out that domestic gas production in the EU, e.g. in the Netherlands and the UK, is declining steadily, leading to higher import needs. In addition, they expect demand to go up.

In 2014 EU gas consumption was 485 bcm (-10% compared to 2013), of which 265 bcm was produced domestically (Norway included) and 230 bcm imported. Domestic production is expected to fall to some 206 bcm in 2035. This is a reasonably safe prediction (if no shale gas enters the picture).

“In our energy sector pathway, natural gas becomes a high-carbon energy source in 10 years”

Conversely, for EU gas demand, optimistic projections abound. According to a presentation from Sergei Komlev, Head of Contract Structuring and Price Formation at Gazprom Export, at the Flame conference in April 2015, the “consensus forecast” is that EU demand will grow by around 30% to 632 bcm in 2035. This would mean that the EU would need to import 426 bcm around 2035, i.e. 196 bcm more than in 2014. This would justify many of the new projects with gas destined for the European market.

Komlev and other analysts base their prediction of higher demand on various factors: an increase of gas in power generation at the expense of coal (as climate measures and the reform of the EU Emission Trading System kick in), an increase in small-scale combined heat and power plants (particularly in Germany), and more use of LNG in bunkering and road transport.

At the Atlantic Council Summit in Istanbul, Denis Simonneau, Director of European and International Relations at the French gas giant Engie (formerly GDF Suez), also showed himself optimistic about the prospects of the EU gas market. “Europe is a difficult market for us at the moment, yes. But we expect domestic production to decline and demand to increase. Coal is facing a difficult situation. Many investors do not want to invest in coal anymore. Nuclear also faces difficulties.”

No guarantees

Yet there are no guarantees of course that this will happen. There are dozens of projections of future gas demand, showing a wide range of numbers. The projections from the European Commission are actually at the low end of the spectrum, as can be seen in this chart from E3G:

Komlev of Gazprom Export looked at a much wider range of projections, resulting in a higher average, but also with a very wide range of outcomes:

Such projections are essentially useless. For all anyone knows they may all be wrong. The expected expansion of renewables in the EU may choke off gas demand growth altogether. The growth in electric transport could preclude any growth in natural gas based transport.

Some observers are convinced that natural gas is the ideal “transition fuel”. As Amos Hochstein of the US State Department put it in Istanbul: “Natural gas can be that transition fuel. After all it’s about climate policy, not renewables policy. Coal can’t simply move to renewables in the same scale and volume.”

Ian MacDonald, VP Europe, Eurasia and the Middle East at Chevron Exploration & Production, likewise claimed that “gas is an extremely important transit fuel”.

But Laszo Varro, Head of the Gas, Coal and Power Division of the International Energy Agency (IEA) noted  that “in our energy sector pathway, natural gas becomes a high-carbon energy source in 10 years.” He observed that a lot of people are promoting natural gas as a “low-carbon source”, but “unfortunately by 2020 this is not the case anymore.”

Hedging bets

Assuming that gas demand will not decline much further (2015 is already seeing a small rebound), an equally important question is who will win the battle for the European market.

Andrew Walker of Cheniere Energy declared that his company can deliver gas to Europe at prices of $7-8/mmbtu (and in Asia for $8-9). That is to say, from new projects. Existing “trains”, however, will supply gas at marginal cost if necessary, said Walker. “Then you are talking about $2 on top of the Henry Hub price [the US trading hub], which is around $2.20”, i.e. some $4.20/mmbtu. That is considerably lower than current gas prices in Europe.

“There are strong cultural attitudes that hinder the development of liberalised markets and there are still too many incumbent or dominant companies that want to protect their current revenue streams”

This is a dilemma for Gazprom of course, but the company has already indicated that it will defend its market position if necessary by offering lower prices.

Denis Simonneau of Engie (formerly GDF Suez), which is part of the Gazprom-led consortium that is planning to build Nord Stream 2, made it clear in Istanbul that his company is hedging its bets. “We believe in different ways. We are part of the US LNG export effort. We are also part of Nord Stream 2. And we are supporting the Southern Corridor [i.e. gas supplies from Azerbaijan and other countries in the Middle East and Central Asia].”

He said he expected the European market to become “the dumping market of the future”.

Quiet revolution

There is yet another uncertainty around the future European gas market. Despite the EU’s dogged efforts to create an integrated competitive market, based on trading hubs which can source from diverse suppliers, there is still no guarantee that this project will succeed.

Certainly a lot of progress has been made. As Colin Harrison and Zuzana Princova of consultancy IPA Advisory pointed out in a recent paper, Central and Eastern European countries have become a lot less dependent on Russia in the past few years. Gas supplies to this region of Europe are increasingly coming from western Europe, thanks to increased “reverse flow” capabilities. Prices across the continent are converging. They call this a “quiet revolution”.

According to Harrison and Princova, Eastern Europe is becoming a gas hub of its own:

But it is too soon yet to claim victory. In a recent study, the Evolution of European Traded-gas Hubs, Patrick Heather of the Oxford Institute for Energy Studies (OIES) comes to the rather disappointing conclusion that at this moment only the NBP hub in the UK and the TTF in the Netherlands are functioning properly. He bases his analysis on criteria such as the number of active market participants, the number of traded products, traded volumes and – the most important one – the “churn rate” (the multiple of traded volume to actual physical throughput).

The results of Heather’s investigation are summarised in the following table (the abbrevations on the left hand side refer to the various hubs in Europe):

Heather points out that although the “European Commission is very keen to see the process of liberalisation completed across all of the Member States so that there will be, one day, a Single Energy Market”, this is by no means the case yet: “Thus far though, it is evident that in many countries there is not the political will to carry out this vision. There are also in many cases strong cultural attitudes that hinder the development of liberalised markets; and finally, there are still too many incumbent or dominant companies that want to protect their current revenue streams.”

He concludes that in gas “the EU’s vision for a single energy market is still many years off”.

Heather’s point about “political will” may be the most important factor of all, in a much broader sense than with regard to gas hubs only. What do policymakers in the end want the share of gas to be may determine to a large extent what it will be.

The EU is certainly pursuing policies to create a competitive European gas market. But it has not answered the question what role it wants gas to play in the fuel mix.

The case of Lithuania: LNG terminal as strategic asset – and economic driver

Although the utilisation rate of Europe’s LNG terminals is very low at the moment, on average around 20%, some would argue that these terminals also serve a strategic function, namely to increase security of supply. In addition, by simply being there and offering a potential route to market, they have a downward effect on pipeline import prices.

This is the position of the Lithuanian government. The Lithuanian Minister of Energy, Rokas Masiulis, said in Istanbul that when his country decided to build the terminal at Klaipéda, which is now in operation, they did not look at the cost at all. “For us it was a no-brainer. We were 100% dependent on Russia and paid the highest prices in Europe. Many smart people told us we should build only a small terminal, but we went ahead and built a big one.”

As far as Masiulis is concerned, the project has already proved its worth: “We received a 20% discount from Gazrpom in 2013, before the terminal started, then another 23% discount. Our gas prices are now the third lowest in Europe.”

The Lithuanian government has enacted a law that stipulates that 20% of gas imported into the country must come from LNG, to ensure that the terminal will always have a minimum utilisation. Statoil supplies the LNG under a long-term contract.

Masiulis noted that although Klaipéda was intended to end Russian energy dominance in Lithuania, it is also having the effect of stimulating other economic activities. “We now see many other options. We are looking at small-scale LNG projects for ships in the Baltic Sea and for use in trucks. We have found that delivering LNG to remote inland areas costs about the same as transport by pipeline. We expect that in 2020 half of the gas sold in Lithuania will be in gas molecules and half in small-scale LNG.”

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