Russia’s invasion of Ukraine triggered a shift in European electricity generation sources and forced governments to rethink long-term energy policy.
The European Union is now on the right track to sharply reduce its dependence on Russian gas before eliminating it altogether. Yet with coal and nuclear phasing out across Europe – Germany will shut down its remaining reactors in December and phase out all coal by 2030 – natural gas was set to play a key role in the energy transition .
Russian gas flows account for around 40% of all European imports. And there are doubts about the future of gas as an intermediate generation fuel between high-carbon fuels and green energy.
In recent months, coal – the most carbon-intensive fuel – has undergone a so-called “renaissance” period to cope with the reduction in gas availability. The European Commission has said that coal consumption could increase by around 5% compared to previous expectations over the next five to ten years. However, this could only be a short-term solution.
Glenn Rickson, head of European energy analysis at S&P Global Commodity Insights, expects gas production to play “a leading and leading role in setting prices in markets.” electricity companies for many years to come”.
That said, the events of the past few months will inevitably have a profound impact on the European energy sector.
short term solution
LNG has proven to be an effective substitute for Gazprom’s missing volumes even before the start of the Ukrainian invasion, as Russian imports to Europe have already been well below historical averages in January and most of February .
LNG deliveries in April hit a record high for a single month, with aggregate imports into Europe and Turkey equivalent to 15.995 billion m3 of natural gas, according to data from S&P Global.
LNG supply is likely to help meet European demand in the short term, particularly to fill gas storages which have remained well below historical averages so far this year.
Europe sources LNG from several markets, with the majority coming from the United States. Qatar, Algeria, Nigeria and Russia were also among the top suppliers so far this year.
But sourcing LNG on the spot market is not a medium-term solution, and certainly not a long-term one. Europe has been able to secure its supplies in part because Asian demand is generally subdued at this time of year and is expected to surge in July before peaking through the winter.
For LNG to become a key part of a solution to phase out Russian gas, Europe needs to agree on long-term contracts. This could be difficult as European buyers are more constrained – unlike their Asian counterparts – and can only offer offers for a limited period due to local energy transition regulations.
However, Europe is certainly counting on more LNG in the long term and investing heavily in new infrastructure. Germany, for example, approved in early May the acceleration of the construction of two LNG terminals. Unlike France, the Netherlands and Italy, Germany does not have LNG terminals.
Russia sending more pipeline east, when the west stops buying, could leave more LNG available to be directed to Europe, but where exactly the supply will be shipped will of course also depend on arbitration prices.
In theory, Russian volumes currently sold through the TurkStream-2 pipeline to Europe – currently at 16bcm/yr – could be delivered to Turkey for re-export to Europe and elsewhere, according to oil and gas strategist Nadia Kazakova Russian at Renaissance Energy Advisors. Increased Russian exports to Turkey could release some LNG cargoes, which Ankara buys on the spot market.
Russian gas exports to China are expected to increase to around 16 bcm in 2022 from 10 bcm in 2021. By 2025, exports will reach 38 bcm under a 30-year contract with the Chinese CNPC.
Additionally, in February, Russia signed an additional 10bcm/yr contract to deliver gas from its Sakhalin gas fields to China, although the pipeline extension has yet to be built and commissioned.
In addition, Russia could potentially deliver 30 Gm3/year of gas from the fields of Western Siberia to China via Mongolia.
“However, this project would require a new 4,000 km pipeline. Russia and China have yet to agree on prices. Also, a transit agreement should be signed between Russia and Mongolia,” Kazakova said.
In any case, while Russian gas will replace – and displace – some LNG deliveries, the Chinese government may want to limit Russia’s share of total gas imports in order to maintain a diversified portfolio of gas suppliers, added Kazakova.
New World Scenario
Russia’s invasion of Ukraine forced the European Union to drastically alter its energy strategy, with S&P Global changing its long-term forecast accordingly. Analysts expect green hydrogen – both locally produced and imported – to play a key role in reducing gas demand in Europe’s power sector.
“Notably, the European Commission has doubled its climate ambition through its REPower EU strategy, which focuses on reducing Europe’s dependence on Russian gas, but inevitably has wider implications for natural gas in the electricity sector in general, regardless of the country of origin,” said Rickson of S&P Global.
Previously, phasing out fossil fuels from power generation ticked the decarbonization box. Today, the Russian-Ukrainian war and related gas flow disruption issues also mean that a move away from gas also ticks the boxes for security of supply and affordability.
In the long-term European electricity forecast published in March, analysts at S&P Global presented two scenarios for European electricity markets until 2050. A reference case, which is essentially the “outlook for pre-Ukrainian invasion” and “a case of the New World”, where the analysts examined the implications of Europe’s transition away from gas.
In “the case of the New World,” analysts have seen a greater deployment of renewables, as well as an accelerating push for hydrogen power plants to replace gas units as backup capacity. This is expected to happen faster and to a greater extent, as opposed to the “pre-invasion” outlook.
In this new scenario, relentless gas capacity in Western Europe grows from around 160 GW currently installed to around 80 GW by 2035 and 12 GW by 2050. That’s around 22 GW and 4 GW below of our baseline scenario, respectively.
S&P Global analysts previously expected gas demand for power to rise through 2027 due to nuclear and coal plant shutdowns. The new assumption is that gas demand for electricity in Western Europe will fall by 10 billion m3/year by 2027 compared to the level of 2021, and will fall further to around 25 billion m3/year by 2050. .
Gas and electricity prices have already been well above the levels seen in previous years due to the lower availability of French nuclear power and low gas stocks in Europe. The invasion of Ukraine only exacerbated the already tense situation.
One of the results was that the market began to pay more attention to ignition spreads – a margin for power plants that use gas as a fuel to generate electricity. Clean spark spread is a margin that includes carbon allowance costs.
“Spark spreads are a hot topic at the moment as the focus is on the profitability of gas-fired power plants,” said an Italy-based power trader.
Indeed, strong and frequent price fluctuations lead to extreme variations in margins, even on a daily basis. For example in Germany, which is particularly dependent on Russian gas and therefore more vulnerable to price spikes, spark spreads have been seen to swing from positive to negative several times over the course of a month.
To provide the market with greater insight, S&P Global will launch new peak load spark gap calculations for the German and UK electricity markets, and base load spark gap calculations and peak for France and the Netherlands on June 1. Deviations will be calculated for gas power plants with efficiencies of 45%, 50% and 60%.
Several market sources have highlighted the need for visibility of peak load margins in addition to base load.
“These are not the CCGT fleet loads that run during base load hours, the lots will just spike due to lower efficiency as they age…Day to day prices are very cheap due to lower demand. The overnight demand is not massively large. Overnight stays dilute the price,” said a UK-based electricity trader.
According to Tim Greenwood, sales manager for energy derivatives at the European Energy Exchange, spread trading is generally becoming more important for market participants, whether it is spreads between commodities such as electricity and gas or location spreads.
“Spreads are very important for the development of our electricity and gas markets. It’s actually quite logical. In some markets, it is the same trader who has the mandate to hedge gas purchases, hedge power generation and hedge carbon offsets,” Greenwood said, adding that price swings have caused the shift. from most trade to cleared markets and away from non-cleared bilateral trade. .
“In addition, trading participants are much more sensitive to their cash and collateral management and appreciate, for example, the cross-margining capability between our power and gas futures,” Greenwood said.
It’s fair to say that gas trading will also be important in the long term, even if the focus is on sustainable energy, including hydrogen, Greenwood added.
While clean energy will certainly replace carbon-intensive fuels in the long term, Europe must inevitably stick to ‘old-fashioned’ natural gas for now, as long as it remains committed to achieving its ambitious climate goals.