The first shipments of U.S. shale gas have been sailing into Europe - first to Norway, then to Portugal and most recently to the UK - in what some foreign policy and energy experts see as the start of a potentially game changing transformation of the European energy market. Europe is the biggest importer of natural gas in the world, and the European Union sees natural gas as the key contributor to its transition to a lower carbon world over the next two decades. The problem is that the E.U. relies for much of its gas on an unreliable source. Russia currently provides about a third of Europe’s gas and has used its hold on the European market as a political tool on repeated occasions.
Dependence on Russia
Not surprisingly, E.U. member states have sought not only to diversify their existing energy mix but also to increase their sources of gas to reduce their dependence on Russia. A number of member states, including Latvia, Lithuania, Estonia, Finland and Slovakia, are fully reliant on Russia for gas. Bulgaria, Hungary, Slovenia and Greece are dependent on Russia for more than two-thirds of their gas while Poland relies on Russia for more than half. Russian gas also accounts for 46% of national gas consumption in Germany, Moscow’s biggest single E.U. gas customer and the largest E.U. consumer of gas, one that accounts for nearly a fifth of the total annual gas demand of the 28 member states. The E.U. has become addicted to Russian gas and has been trying hard to kick the habit - all the more so since the escalation of tensions between Russia and Ukraine, as approximately 40% of Russian gas transits to the rest of the E.U. through Ukraine. Russia has used gas as a political weapon on multiple occasions, halting supplies to Ukraine in the so-called gas wars of 2006 and 2009. On one occasion, a Russian gas shutdown led to a cut off of all Russian gas to Europe for two weeks in the middle of January, leaving many millions of inhabitants in the cold. European governments were forced to declare national states of emergency, shut down factories and scramble for alternative fuels. Following the Russian annexation of Crimea and at the height of the 2014 Ukraine crisis, concerns mounted in Europe over the threat of politically motivated disruptions of Russian gas supplies, especially those passing through Ukraine, disruptions that would cause severe and widespread blackouts throughout the E.U. This prompted the European Commission under its president Jean-Claude Juncker to put energy security at the top of the E.U.’s agenda, triggering the move to create an Energy Union in Europe to counter the threat of Russian political blackmail. Stress tests were also carried out in 2014 by 38 European countries, including all E.U. members, simulating two energy supply scenarios for a period of one or six months. These scenarios included a complete shut down of Russian gas imports to the E.U. and a disruption of gas imports through the Ukraine transit hub. The tests showed that a prolonged supply disruption would have a substantial impact on the E.U., given that gas accounts for around one quarter of the E.U. energy mix and one third of this is imported from Russia. But the report also confirmed that if all countries cooperated with each other, consumers would remain supplied even in the event of a six-month gas disruption. However, the trouble in the case of gas supplies is that, unlike oil or coal, it is not possible to bring large quantities of gas to where it is needed if the corresponding infrastructure is not in place.
The decline in E.U. production and the lack of internal networks
The irony is that Europe already has extensive and underused import and storage infrastructure developed during the last decades when the E.U. grossly overestimated its gas demand. Indeed, Europe’s track record for forecasting gas demand is poor. The so-called 2009 “Ten year Network Development Plan” foresaw an 8% increase in gas demand from 2010 to 2013. Demand, in fact, declined by 14%. Considerable uncertainty remains on future demand levels, with projections ranging from a 38% increase in consumption by 2035 in the Eurogas “base case” projection to a further 25% decline in gas consumption in European Commission scenarios in which efficiency, renewables and emission targets are met. Studies have also shown that the capacity of the import pipelines from Russia, Norway, Algeria and Libya alone, at 422 billion cubic meters (bcm) would be sufficient to more than satisfy current E.U. gas import requirements (255 bcm). In addition, several member states have already installed a total of 183 bcm of liquefied natural gas (LNG) import infrastructure. As a result of the excessive size of gas infrastructure relative to actual E.U. demand, the utilization rate of import pipelines is only 58% and 32% for LNG terminals. The issue is therefore clearly not an insufficient level of infrastructure but one of insufficient intra-E.U. networks. Indeed, 95% of the E.U.’s LNG import infrastructure is based in Western Europe, and there is not enough internal gas transmission infrastructure to connect LNG terminals to Central and Eastern European countries, many with no access to LNG supply. They are thus all the more dependent on Russia. At the same time, even assuming a stagnant or declining outlook for E.U. gas demand, the EU’s vulnerability to gas import disruption is set to continue for multiple reasons. European domestic gas production is rapidly declining. The U.K.’s gas production volume has been steadily falling since 2010, largely as a result of rapid depletion of North Sea resources. Norway, an important and traditionally secure supplier of gas to the E.U., also faces dwindling North Sea resources, while the Netherlands has also seen a sharp drop in gas production. This downturn has accelerated following the decision in 2015 to impose a cap on Europe’s largest gas field, Groningen, because of more frequent and powerful earthquakes resulting from the extraction activities. Fierce and continued public and environmental opposition to fracking across Europe is unlikely to release this potentially vast gas resource, unlike in the, U.S., where fracking has revolutionized the oil and gas industry. Moreover, popular and political opposition to expanding further nuclear power in the E.U. has left natural gas as the most credible energy source for Europe’s transition to a lower carbon future , this despite opposition from environmentalists and Green parties arguing that the European Commission should focus less on gas and more on renewables and energy efficiency to meet its long term climate targets and reduce dependence on foreign supplies. But as Miguel Arias Cañete, the E.U. Commissioner for Climate Action and Energy, pointed out when he unveiled the Commission’s latest sustainable energy security package: “We are still far too vulnerable to major disruption of gas supplies. And the political tensions on our borders are a sharp reminder that this problem will not just go away.” Indeed, the E.U. remains vulnerable not just to Russia but to other key suppliers that could interrupt their flow of gas for geopolitical or technical reasons. Algeria, for example, which has been a reliable and secure supplier, could cut supplies in the event of unpredictable regional political turbulence. The Maghreb country is also expected to become a net energy importer by 2030 due to rising domestic demand driven by population growth, and that could further squeeze gas supplies to Europe. Elsewhere, Azerbaijan has faced growing domestic discontent, while Turkmenistan has the Taliban along its 750 km long border with Afghanistan. In the Middle East, terrorists and extremists have targeted oil and gas infrastructure provoking inevitable supply disruptions. The E.U. thus needs to adapt to a changing and increasingly troubling landscape of geopolitical risk. In the case of gas supplies, Russia clearly remains the number one issue not just because of the scale of its exports to the E.U. but because of the heightened and continued tensions over Ukraine and Moscow’s intervention in the Syrian conflict. These problems underline the strong geopolitical symbolism of the recent arrival of the first shipments of U.S. LNG to European shores, an arrival prompted by the massive ramp up in American shale oil and gas production that led to Washington’s decision to lift its 40-year ban on U.S. oil and gas exports.
The arrival of U.S. shale and Gazprom's response
These initial shipments to European refineries by Ineos, a privately owned multinational chemicals company based in Switzerland, are not going to make a significant difference in E.U. gas supply requirements, at least not at this early stage. Nonetheless, as Jim Ratcliffe, the founder and chairman of Ineos, claims, these shipments mark a strategically important development for both his company and Europe. After his first shipment arrived in Norway at the end of March 2016, Mr. Ratcliffe noted that “shale economics revitalized U.S. manufacturing and for the first time ever, Europe can access this essential energy and raw material source too.” His company has chartered a fleet of purpose-built vessels which it claims will create “a virtual pipeline across the Atlantic.” There is still considerable debate over the extent of the impact U.S. gas exports to Europe will have in changing the current balance of E.U.-Russia energy transactions. Some estimates suggest that the U.S. could match Russian exports to Europe within 10 years. Wood Mackensie, the energy consulting firm, has projected that 55% of U.S. LNG volumes, or about 32 million tons per year, will be sent to Europe by 2020. Others are less bullish. They believe the impact on Europe will be felt very gradually as U.S. LNG will probably go initially to markets in Asia and Latin America where LNG spot prices tend to be higher. However, most experts tend to concur that LNG from the U.S. will probably be one of the most, if not the most, important single developments to transform the future of the LNG market by making it truly global. By providing a major source of competing gas supply on the market, U.S. LNG exports to the E.U. and elsewhere should make gas pricing much more competitive and put pressure on Gazprom, the giant Russian state-owned gas monopoly, to adapt and lower the prices it charges to its European customers if it wants to maintain its market share. Gazprom is hardly going to sit back and accept the loss of its best customers; it has already accepted the U.S. LNG challenge by announcing a few months ago that it intends to ramp up gas exports to Europe to record levels. The Russian group’s strategy is to retain a market share of at least 30% in Europe between now and 2035. Gazprom’s deputy chairman Alexander Medvedev also said 12 months ago that imports of North American gas to Europe would be “limited,” as the cost of U.S. LNG is expected to be higher over the next five years than forward prices at the UK’s National Balancing Point (NBP) hub, Europe’s long established spot traded natural gas market. The Russian gas group certainly has considerable market power to undercut competing sources to preserve its market share, especially since its pipeline gas has in the past been relatively cheaper than LNG imports, although prices have been converging. Russia has also sought to expand its pipeline connections to Europe to secure more buyers on longer term contracts and in so doing, its critics argue, to continue to control and manipulate the market more for political rather than purely economic reasons.
The gas pipeline game
It is highly questionable whether most of the big pipeline projects advanced by Moscow in recent years make viable commercial sense given that E.U. gas consumption is most likely going to remain flat or even drop between now and 2030 (as a result of the transition to a low carbon economy). But commercial merits have never weighed that much in the geopolitics of Russian gas. Moscow, for example, is now reviving with Ankara the Turk Stream pipeline project that is intended to replace the abandoned South Stream pipeline to Bulgaria and bring Russian gas along part of the now scrapped South Stream route, then crossing the Black Sea to Turkey and on to the E.U. border. Such a pipeline would enable Russia to compete directly in the southeastern European market with the so-called Southern Gas Corridor, one of the E.U.’s flagship pipeline projects that will cost an estimated $45 billion and is designed to bring Caspian gas to Europe to reduce reliance on Russia. Significantly, Turk Stream would not only help increase Russia’s gas export capacity but bypass Ukraine, thus depriving Kiev of one of its principal sources of diplomatic leverage in its ongoing conflict with Moscow. An even better example of Moscow’s transparent attempts to use gas as a divisive political tool to manipulate the European energy market and more broadly destabilize the E.U. is the controversial Nord Stream II pipeline project. A consortium of western companies including Eon, Engie, OMV, Shell and Wintershall has now decided not to participate in this project designed to double the capacity of the existing Nord Stream sub-sea pipeline that brings Russian gas to Germany and bypasses Ukraine. But Gazprom and Moscow are still planning to press ahead, even though the existing pipeline is operating at 50% capacity. The Polish government is vehemently opposed to the project, as are a number of other E.U. central and eastern European member states such as the Czech Republic, Estonia, Croatia, Hungary, Lithuania, Latvia, Romania and Slovakia. Writing recently in the Financial Times, Konrad Szymanski, Poland’s minister for European affairs, noted that the economic arguments for Nord Stream II were always questionable, especially considering the overcapacity on existing supply transit routes from Russia to the E.U. “Given Europe’s considerable dependence on Russian gas and the damage the project would cause to the Ukrainian economy (which is subsidized by the E.U.), the political motivations behind it seem obvious,” he said, adding that the project increasingly looked like a Trojan horse designed to destabilize the Ukrainian economy and poison political relations inside the E.U. He also criticized the European Commission’s ambiguous and contradictory position by not clearly opposing the project in spite of the E.U.’s sanctions against Russia following the annexation of Crimea. “The E.U. cannot continue to offer financial support to Ukraine, maintain sanctions against Russia and call for a resilient energy union while at the same time collaborating on Nord Stream II with Gazprom,” he wrote. Nord Stream II has thus turned into yet another test of European unity and of the credibility of E.U. institutions. It has once again exposed the fundamental weaknesses of an E.U. system that has increasingly become a dysfunctional mess with the differing and competing priorities of member states undermining the wider union. In the case of energy and the flagship Energy Union, differing priorities and vested interests have made it all the more difficult for the E.U. to ensure the energy security that goes along with the natural gas transition it is seeking towards a lower carbon world. As Mr. Szymanski pointed out: “Promoting the economic interests of certain countries at the expense of the security and stability of others is no way for the E.U. to escape the crisis it finds itself in. Nor is it likely to imbue disillusioned citizens with renewed faith in European institutions."