Impending Shortfall

Despite continuing reductions to supply, short-term efforts have largely succeeded, with high gas storage levels - above 95% in early November - an unexpected abundance of LNG carrier vessels waiting offshore Europe to restock terminals, and mild weather expected for the winter. The process has not been cheap, costing an estimated US$50bn, but security of supply has been achieved for the coming months.

However, the problem has not gone away, merely shuffled to the back of the metaphorical mind while other concerns like oil sanctions and gas price caps take centre stage. Supplying the 2023-24 winter will be just as challenging, if not more so.

Last week, the European Commission confirmed its intermediate gas targets to reach the 90% gas storage target expected by 1 November 2023. Intermediate targets for February, May, July and September 2023 have all been set on an individual basis, but of note is an EU aggregate average target of at least 45% storage on 1 February, with expectations of 55% storage capacity needing to refill if winter is not colder than average (it shouldn’t be, according to meteorologists).

Winter’s Impacts

With the Russian withdrawal from gas supply leaving a hole in the supply chain of 110bcm, equivalent to 83Mtpa of LNG, sourcing sufficient gas will continue to be a challenge. Europe typically consumes 50%-70% of its ~1100TWh (76Mt) gas storage capacity each winter. However, that is under ‘normal’ circumstances, one that assumes a sufficient gas supply – a supply that is currently lacking.

Over the three months of winter, Russia’s shortfall will mean consumption of an additional 22Mt from the storage capacity—effectively, Europe should expect to consume an additional 20% from its storage this winter, all other things being equal—putting total consumption expectations at nearly 75% of its total storage, or 57Mt, on top of its inflated supply requirements.

In 2023, replacing Russia’s gas supply will require imports of around 83Mt of LNG. The US has largely stepped up in 2022, supplying its European allies with an additional 29Mt of LNG in 2022, and it can be presumed that barring any major domestic disasters that supply will continue.

Some 7.5Mt total could come through the new Baltic Pipe from Norway, and perhaps another 10Mt from increased flows through Azerbaijan’s pipeline. Norway could supply roughly 4Mt with the restart of Hammerfest LNG, combining to make a total of 21.5Mt. With US supply, 50Mt of supply replacement looks feasible.

The equivalent of 32Mt of gas is effectively being saved through the implementation of gas usage cuts between November 2022 and March 2023, pushing Europe to scrape over the line. Next year, however, is not so certain, as the painful impacts of these gas restrictions bite industrial and retail users alike.

Unfortunately, natural disasters have cut supply from the 22Mtpa Nigeria LNG and Malaysia’s 9.8Mtpa MLNG Dua for an unknown period – potentially the entire year, given the wide-ranging and challenging nature of the disasters. While Malaysia does not directly supply Europe, increased pressure on the Asian market will drive higher prices through competition for supply.

The Worst-Case Scenario

The worst-case scenario requires only two major events: Russia cuts off the tattered remainder of its gas flows into Europe via Ukraine, worth around 25Mt of LNG annually, and China returns to the major growth paradigm of yesteryear, once more vacuuming up every scrap of spot LNG to fuel its power stations, estimated at an additional 12Mt of LNG consumed.

Between the two the LNG trade would be trying to supply another 10% of the global market with no lead time, a near-impossible prospect. Fortunately, neither scenario is particularly likely, with the Chinese government set on its covid-Zero policy and the Russian economy in dire need of cash despite its ongoing war.

The European Commission is wary of a cut-off of the last of the Russian gas, which represents the larger of the two risks. The potential 25Mt shortfall represents around 8.4% of Europe’s gas needs (compared to 2021), or 1.7% of total energy requirement. Such a shortfall, while not exactly spelling doom for the continent, would significantly curtail usage in the coldest periods next winter, and potentially requiring the return of gas usage cuts.

The Cost of Doing Business

Finally, all of these hypotheticals also fail to mention one significant stumbling block. Supply is difficult, but manageable. It is also likely to be extremely expensive, returning to prices in the US$50/MMBtu range from its current lull around US$30/MMBtu.

Historical gas prices have lingered in the US$8-12/MMBtu range, and 2022 has seen a massive spike in LNG prices due to shortages of supply that cannot really be avoided – the liquefaction capacity simply doesn’t exist.

The cost of replacing the supply of gas will depend heavily on competition from Asia and ensuring a sufficient security of the LNG supply. AME forecasts an AME European Composite Gas price of US$47/MMBtu, which would cost the European market US$191bn if its full LNG replacement was bought entirely on the spot market. More likely, the figure will be closer to US$60bn.

The European governments will be able to obtain the required gas supply if no further major disruptions emerge. The purchase of this gas supply will be expensive and continue to underpin continued high gas prices in the region. The high price for gas will continue to encourage imports into the continent, but Russia’s involvement in the continent will be cast out in favour of closer allies like the US.