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EU plan to slash Russian gas to cause global gas “tug-of-war:” Analysts

11 March 2022 Cristina Brooks

The EU's emergency plan to address a natural gas supply shortage due to tensions with Russia may prove challenging for states obliged to store gas.

The European Commission's REPowerEU communication on 8 March proposed steps to reduce EU consumption of Russian gas by two-thirds this year and completely before 2030, for example through increasing use of electrification, energy efficiency, biomethane, and green hydrogen.

REPowerEU aims to cushion the impact of continued high gas prices on companies and consumers if Russia's war in Ukraine curbs its gas exports to the EU, in particular via Ukrainian pipelines.

Continuing along the lines of an agreement reached with the US last month, the EU will seek alternative gas suppliers to Russia, "ending the EU's overdependence on a single supplier."

But REPowerEU's goals for EU gas markets are not simple. "REPowerEU is an extremely ambitious strategy. Reaching independence from Russian gas by 2030 is extremely challenging," said S&P Global Commodity Insights' Head of EMEA Gas Analytics Adrian Dorsch.

The requirement that states fill gas storage facilites to 90% by 1 October each year would see them buying gas at far above autumn historical average volumes and prices. Legislation on storage will be proposed by April.

In the meantime, states should encourage gas storage operators to stock up by increasing tax rebates and guaranteeing gas suppliers' income under contracts for difference (CFDs), said the EC.

In the current price environment, gas storage buyers are likely to be outbid by gas suppliers willing to pay more, unless the buyers receive state financial support, according to S&P Global Head of EMEA Gas Analytics James Huckstepp.

REPowerEU's goal to obtain 50 billion cubic meters (bcm) of LNG annually is also in doubt given global competition for LNG, said investment management firm AllianceBernstein.

LNG is in high demand in Asia. "Sourcing an additional 50 bcm per year of LNG in the medium-term will require continued high gas prices to incentivize gas demand destruction in Asia. Long-term commitments may be required to secure this gas," said Dorsch.

Explaining further, S&P Global Senior Advisor and Global Gas Strategy Lead Michael Stoppard added: "There will be a three-way tug-of-war for scarce spot LNG supply between Europe, Asia, and Latin America through the year and beyond."

S&P Global Platts Analytics forecasts that if Russian pipeline gas flows continue at current levels, the EU will need to reduce industrial gas demand by at least 10% through the summer to reach REPowerEU targets.

This level of industrial shutdown may not be enough if there is a supply interruption, however, as Russian pipeline gas flows are already 25% below five-year averages. "It will be difficult to reach [the storage target of] 90% with existing Russian flows. If Russian pipeline flows are suspended, or indeed if Russian imports are reduced in 2022 by 66%, then significant shutdowns of industry may be required to ensure storage for the coming winter," said Stoppard.

In a scenario that modeled industrial shutdowns to conserve Russian gas, Aurora Energy Research foresaw interruptions to 1%-3.5% of industry GDP over the coming winter.

Even before the invasion, the EC predicted gas prices would remain high and volatile until at least 2023. "The requirement to have European storages 90% full by the start of winter season will cause a further increase in prices, more than otherwise would have been the case as both Gazprom's gas bought under long term contracts and spot gas will become progressively more expensive," Katja Yafimava, a Senior Research Fellow at the Oxford Institute for Energy Studies Gas Research Programme told Net-Zero Business Daily.

It was "not a given" that states would succeed in reaching the EU's storage goal, she added.

Consumer impacts

High gas prices are being felt by consumers bloc-wide owing to the surge in wholesale gas prices last year, a product of global market tightness and rebounding Asian LNG demand post-lockdowns.

REPowerEU will seek to assist consumers struggling with the high gas and electricity prices. For example, it gives states guidelines on how to roll out windfall taxes on the energy sector and introduce regulated retail prices.

These build on the October guidelines for states looking to use taxes to relieve consumers paying more through energy bills. "Continued high energy prices are likely to increase poverty and affect business competitiveness," according to the communication.

The proposals may be a nod to the Spanish government's February letter urging the EC to protect electricity bill payers through windfall taxes that "claw back" high generator profits and reform markets by decoupling wholesale electricity from gas.

While in October Energy Commissioner Kadri Simson rejected reforms and said energy markets were "sound" and driving renewable energy uptake, the EC's lastest communication promised to "assess options" on market design.

The EC is looking into reforms, such as ways states can legally cap energy prices temporarily and how to distribute subsidies to companies, such as gas utilities forced to buy expensive gas to replace disrupted contracts.

AllianceBernstein expected the REPowerEU windfall taxes to have a minimal impact on German utilities RWE and Uniper as the clawback would only apply to unhedged coal and nuclear power volumes.

However, it suggested the windfall taxes could "backfire" on renewable developers that collected windfall profits on their power sales during the gas price spike.

Securing gas storage

During the gas price crisis last October, Polish climate minister Michał Kurtyka accused Gazprom, the Russian state gas company at the heart of certain Russian-Ukrainian disputes, of pursuing "illegal practices."

In the communication, the EC Commission said it would investigate alleged market manipulation, and noted Gazprom was not filling the storage it operates to the usual level.

The EU's executive has not forgotten storage risks in the proposals. It offered to help states coordinate gas storage refilling and lower-risk contracts through a joint European platform.

Shoring up risks to supplies, each member state will also be required to certify that foreign gas storage operator ownership does not put states at risk of loss of supply.

Speeding renewable deployment for hydrogen

The EC also wants to pick up the pace towards net-zero targeted by its proposed Fit for 55 policy package.

While keeping Fit for 55's 2030 targets for states under the revised Renewable Energy Directive and Energy Efficiency Directive, the EC will roll out a new set of short-term targets using many of the same technologies for the end of 2022.

For example, consumers will also be called upon to participate in EU-wide energy efficiency "by turning down the thermostat for buildings' heating by 1 degree Celsius" and agreeing to the installation of 10 million heat pumps over the next five years, aiming to save gas.

More renewable energy is also needed, as EC's Executive Vice-President for the European Green Deal, Frans Timmermans, noted in a statement. "Let's dash into renewable energy at lightning speed," he said.

Proposals would speed up the Fit for 55 goal of installing 480 GW of wind and 420 GW of solar by 2030, raising the rate of deployment of wind and solar by 20% annually.

REPowerEU also adds 80 GW more renewable energy to allow more green hydrogen. It aims to ramp up green hydrogen production and imports to 20 million metric tons by 2030, nearly quadrupling the Fit for 55 target.

To do this, the EC plans to work with industry to establish a Global European Hydrogen Facility that will boost member states' access to cheap green hydrogen. It will finance electrolyzer manufacturing, while accelerating related regulatory and research projects.

It elaborated on a potential EU-wide scheme to get industry to switch to hydrogen fuel. Such carbon contracts for difference (CCFDs) are already being pursued in the Netherlands, the UK, and Germany.

While the EC claims the plans will "drastically accelerate the clean energy transition" by speeding up the rollout of renewable gases, AllianceBernstein said the new targets for renewable energy are only "marginally higher" overall than those laid out in the Fit for 55 package.

In line with net-zero goals, the EC foresees rolling out more wind power with the help of long-sought-after revisions to permitting and network rules, a sensitive topic for states. Association WindEurope is one of many sector observers who have been pushing for the EC to address permitting and network "bottlenecks."

Biomethane brought to the fore

Larger volumes of biomethane and renewable hydrogen, including both domestic production and imports, are expected to help displace volumes of Russian natural gas.

Within the year, the EC seeks to ramp up biomethane production to replace 3.5 bcm of natural gas.

AllianceBernstein was skeptical of the target: "The EU Commission's expectation of adding approximately 3.5bcm [of natural gas equivalent] in 2022 could be challenging, in our view."

The EC will also target 35 bcm of biomethane production annually in terms of natural gas equivalent by 2030, replacing the more modest Fit for 55 target to produce 17 bcm of gas-equivalent biomethane annually.

"This target should be viewed as aspirational, as it would be close to the equivalent of UK [annual] natural gas production today, and compares to approximately 2 bcm per year [EU] biomethane production today," said Dorsch.

Some green NGOs have said the EC's proposed target to multiply biomethane production by about 10 in less than a decade brings significant sustainability risks, for example of increased carbon from overseas crop imports. "Boosting biogas production will exacerbate the competition for land between food, feed, and fuel, as most biogas plants cannot run only on waste, and require additional energy crops as feedstock," said Celia Nyssens, EEB senior policy officer for agriculture and food systems.

Bioethanol trade body ePure and the European Biogas Association (EBA) praised this goal, but the EBA called for a hike in biomethane targets within the proposed Renewable Energy Directive. The Directive's biofuel targets have already been called ambitious.

Posted 11 March 2022 by Cristina Brooks, Senior Journalist, Climate and Sustainability

This article was published by S&P Global Commodity Insights and not by S&P Global Ratings, which is a separately managed division of S&P Global.


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