EXPERT Q&A — Europeans are already feeling the cold, even as near-full energy storage capacity and mild weather have worked to avert a full-blown European crisis as early winter approaches.
European energy pressures exacerbated by Russia’s invasion of Ukraine, have forced a reset in energy production and supply. “I don’t believe there was ever a time – to include in the 1970s – when so many consumer nations worked so furiously to identify new producers,” said Cipher Brief Expert and Energy Expert Norm Roule.
We tapped Anna Mikulska, Non-Resident Fellow in Energy Studies at the Center for Energy Studies at Rice University’s Baker Institute, for a deeper dive on what Europe is facing.
EXPERT Q&A
The Cipher Brief: Even with favorable conditions are there still some weaknesses in Europe in the short term?
Anna Mikulska: It’s not an equal distribution for the simple reason that different countries have different storage capabilities. So even though this storage might be full you still need to see how much of the country’s demand is covered by the storage that they have. So Germany has more, Poland has some, but other countries don’t have that much storage. So that could be an issue. The fact that you have full storage doesn’t mean that you can actually sleep soundly if the weather gets cold and if you need to use gas at a higher rate to support it. Because storage in Europe and everywhere is not there to store enough gas to support countries throughout the entire heating season. It’s there to balance the supply and demand and obviously that balance is very tough now to keep.
So favorable conditions are not assured, especially for countries that have less storage. The other thing is lower demand, which exists for two reasons. One is mild weather, which is obviously a favorable condition, but the other one is not so favorable because it is actually demand reduction. I read today that the IEA (International Energy Agency) natural gas team indicating 40 percent reduction in demand year-over-year in gas and energy-intensive industries. This is very significant and definitely not a favorable trend in Europe in terms of its economic performance .
Lastly, it’s great that the weather is giving the Europeans breathing room at the very least; heating is not as expensive as if the weather was cold. But it also means that the storage that’s currently full doesn’t get emptied and that gas that they have ordered in anticipation of winter has nowhere to go. Hence, we see accumulation of LNG cargo, especially around Spain, and Northwestern Europe that doesn’t have anywhere to go, waiting for space to unload. But this is a very expensive exercise. The prices of tankers per day have skyrocketed to almost half a million dollars a day. In addition, this LNG purchased in the summer when the market price was high. If you try to sell it now, you have to accept that you will lose a lot of money on that trade. As a result, is really a very difficult situation where positive and negative intertwine. All in all, right now we see the crisis in Europe lessening because the LNG storage that’s been already ordered has nowhere to go. But both cold weather as well as demand destruction in industry can still affect the Europeans and European economy going forward.
The Cipher Brief: There are a couple of possibilities that could reverse favorable trends, such as an extended cold weather snap across Europe, or more instability in energy markets, or even the potential for sabotage of energy infrastructure. Of those possibilities, which one would you regard as the most important?
Mikulska: At this moment, the European and global gas markets are so tight that any type of issue will reverberate with added strength and impact. All these factors will make things more difficult, like a cold weather snap when you cannot refill storage fast enough and support different countries. That will be definitely problematic. I think what people often don’t take into account when talking about weather is that it’s not only the weather in Europe that can determine how bad the winter will be in Europe in terms of gas supply, but also that weather in Asia can have a significant impact . And this is because there is an arbitrage now in LNG between Asia and Europe. This has not been the case before, but now these markets are connected via global LNG trade.
So if there is a cold weather in Europe, of course there’s going to be increase in the need for more gas. But the market can also tighten even when it’s relatively mild in Europe but there is a cold winter in Asia. That’s going to tie up supplies and it’s going to increase the price and it’s going to make it more difficult for Europe to get whatever gas they need at a reasonable price. And then if cold weather spikes in both these markets, well that can really create a big problem. The other thing is it’s not only natural gas. We know that hydro and nuclear in Europe haven’t been performing well. If that continues, that’s an issue. Wind has been performing well, but what if it doesn’t? And other sources are failing to provide a energy supply, then you need to either turn to coal or natural gas. And coal currently also is in short supply in the global markets.
The Cipher Brief: Are there any other wild cards as you look into early 2023 that could throw a monkey wrench into European plans to sustain their energy supplies?
Mikulska: What I can tell you going forward — depending on how cold the weather in the winter is and how much supply is drawn out of storage – is that this winter could set up Europe for a very difficult winter in 2023-2024. That is connected to the issue of having to fill storage throughout the next non-heating season. By EU law, each country needs to fill up its storage to 90 percent or more by November 1st. It was 80 percent last year, but starting this year it’s 90 percent. Some countries like Germany have actually introduced a law where it’s 95 percent by November 1, 2022.
If storage is really depleted by a cold winter this year, that means that these countries come into the storage filling season with a huge amount of demand. This year they were able to fill up that storage. But this year they were supported still by quite a lot of Russian gas coming from Nord Stream 1. Throughout the first five months of the year, Germany was getting maximum flows via Nord Stream 1. This is not going to be the case the coming year. Hence, it’s going to be so much more difficult to fill that storage. Yes, there are countries like Germany, Italy, the Netherlands, Finland that are bringing in floating storage and regasification units (FSRUs) to help them with acquiring new LNG so they can use LNG to replace Russian gas that was used to fill up storage last year. But the supply of LNG won’t change much in 2023 so this will actually create even more tightness in the global LNG market.
In Europe in particular (though this will reverberate across the world) we might see much higher prices because of the legal imperative that European countries fill up storage. The imperative basically artificially heightens demand and increases prices throughout the year. This is why we have seen those really really high prices in August. Now that the storage is full prices are falling since LNG has nowhere else to go. The combination of mandated storage and lack of typical supply with little additional global LNG coming into the market in 2023 is going to be something we will need to watch.
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The Cipher Brief: Apart from current favorable conditions, it still appears that it will be necessary for the EU and European governments to drive down demand from both consumers and industry, and find ways of boosting domestic energy production. What are your thoughts about driving down demand and also finding domestic ways of at least partially increasing Europe’s own supplies?
Mikulska: They have been trying to drive demand down and we’ve seen that the industrial demand has been really lower, but that creates an issue going forward because it will impact the economy of Europe, particularly heavy industrial centers like Germany. Thus, this is something that the government will watch and they will try to appeal to both individual consumers and industry to curb demand. But they are in a very hard spot because lower demand does not always mean efficiency gains. And, as I have mentioned earlier, demand reduction particularly in industry is problematic. This is really a situation where the Europeans are between a rock and a hard place. And thus what they will try to do is meet demand with other energy sources, including nuclear. France especially is hoping for nuclear to pick up back to much higher supply with the technical difficulties hopefully resolved.
There are also attempts at assuring cooperation between countries, such as France and Germany with regard to supporting each other with electricity and gas flows when needed.
Unfortunately, coal currently is experiencing a revival in Europe and that’s significant. I think Poland has revived a 60-year-old coal power plant to produce electricity when Poland’s electricity market was dangerously close to its maximum capacity. Mothballed coal generation plants have been brought back in different countries, including Germany, Finland, and France. The Netherlands removed the cap that it previously imposed on coal-fired electricity production.
In truth, nobody can give a specific date when it will stop. Everybody is pointing to short term, but what does it mean? Is it going to be 2024, 2025, 2026? And my reading is that we just don’t know how short term it will be until Europe is able to figure things out. In the end, energy security is going to be paramount and soon enough I think it’s going to be not only national or energy security, but also it’s going to be economic security, making sure that your economy is going, that it has a future and companies do not leave for cheaper energy markets. In fact that’s what’s been happening as European governments are trying to think of different ways to decrease energy prices.
The Cipher Brief: The head of the International Energy Agency last week caught the headlines by saying that circumstances right now are creating what he called “the first truly global energy crisis”. What are your thoughts about that?
Mikulska: It really is not looking good. European countries are cutting demand and that impacts their economies. But not only that — the crisis in energy, particularly in natural gas, will have also an impact on food supply. For example, the fertilizer industry has been affected, which has a huge impact on the ability of different countries to support themselves, especially countries in the Global South that do not have money to subsidize agriculture or subsidize the purchase of food. That is on top of the grain crisis resulting from the Ukraine conflict, with Russia not necessarily stable in their commitments to enable sending grain from Ukraine. This is absolutely something that will impact everybody, around the globe.
We are more interconnected that we’ve ever been before, and prices are rising in pretty much every energy source. That can create significant negative externalities for literally every single country. We will see some countries, of course, benefiting. We’ve seen a lot of Middle Eastern countries increasing growth because they are sending out quite a lot of oil, in particular. We’ve also seen U.S. GDP increase and this is partially because of energy exports. But countries that rely on imports will be affected in terms of inflation, global and domestic high energy prices, and domestic issues that could become really severe in economies still recovering after being affected by COVID.
The Cipher Brief: From a Western perspective, the three villains in the overall picture that you’re describing are Russia, OPEC and possibly China. Do you see anything in the actions of those three entities that will either make the situation worse or could improve in 2023 and afterward?
Mikulska: As for Russia, the biggest impact would be the destabilizing effect on world order that Russia’s invasion of Ukraine has caused. In terms of energy, the biggest impact has been that a significant amount of energy supply has been basically taken off the market. In the oil sector that can actually be smaller in terms of volume and potentially shorter-lived, given that at least some of that oil can be moved around to other markets almost immediately.
But for natural gas that’s not the case. Some of that Russian natural gas that has basically disappeared from the market created the tightness that we see currently. Going forward, what would it take for countries in Europe and Western allies to go back to being supplied by Russia? I think Russia has burned a lot of bridges, and it will take much longer than a short term for countries to adjust. There would have to be a very different Russia before countries would think about going back and trading energy with Russia. At the same time, I don’t think there will be the same volumes and the same rate of dependency that we saw before the Russian invasion.
All in all, concerning Russia, Europe really got itself into the position where at least in the short term it will be difficult to change anything. Also, we cannot forget that Russia has been really focusing and targeting energy infrastructure in Ukraine. And that could be problematic.
China is interesting because China actually can, as a huge market demand center, impact other demand centers. For example, China has been sending some of the LNG it bought to Europe, which actually allowed a little bit of breathing room for the Europeans over the summer and this fall. But if Chinese domestic demand picks up then they might not be as willing to send cargoes to Europe. They will be retaining it on their own shores, and that means less LNG on spot markets from which Europe needs to supply itself. We have to remember that there’s actually very little U.S. LNG that actually is contracted for European delivery; most of it will go to China and other places. So, if China decides to restrain exports, that will tighten the market for Europe and create even higher prices potentially.
And China doesn’t work based on market rules. It’s not like with normal trade involving arbitrage where if Europe paid enough Chinese companies would deliver to Europe despite being contracted somewhere else, as it recently happened, for example with Pakistan. China doesn’t have a conventional market-based economy; they are not entirely driven by market principles. Going forward this could become problematic, in particular if China and Russia are drawn closer to each other with China basically the largest demand center for energy and Russia the largest exporter of energy in the world.
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