Whenever the security of gas supplies is at stake, the shared EU mantra calls for “diversification”. We cry wolf, and the wolf happens to be Russian. The more we cry wolf, however, the more we import volumes of Russian gas. It could just be that when it comes to buying, prices prevail over policies and that in the UE a gas market with transparent prices is finally emerging.
Security since 1973 has been mostly viewed as a consumer issue, i.e. in terms of having access to the needed supplies at reasonable terms. Diversification of the producers meant in this context avoiding the potential political risk and unilateral price-setting connected with having a single or dominant supplier. Are those issues still controlling?
The political risk first. Traditionally, the fear that supplies could be used as a political weapon to force via blackmail or otherwise the policy choices of the importer. Would that be possible in the current environment? Perhaps not impossible, but to say the least hard. Russia’s revenues are largely dependent on natural resources (hydrocarbons) and Russia remembers the economic crisis that followed the major plummeting of oil prices. Less resource revenue means less revenue available for public spending, including welfare and other social amenities. In other words, Russia is no longer (if it ever had been) free not to sell. The security of being supplied becomes balanced by the exporter’s need for supply security.
Next, pricing. The EU gas market has consistently evolved mainly via gas hubs towards transparency and gas -to-gas pricing. It is still far from being as liquid as the oil market; but also thanks to LNG it is narrowing the gap. LNG via hub pricing (and assuming material spare capacity exists) becomes a sort of price security against our assumed dependency. The market situation has evolved so that long-term pipeline gas (from wherever) has become the price taker; and spot gas and LNG the price makers. The dominant supplier does not and cannot practice unilateral price-setting.
Two caveats before we fall into over-optimism. Political and price risks, it may be argued, go (relatively) away to the extent (and only to the extent) that we have alternative suppliers available; and that we have enough infrastructural capacity to accommodate alternative supplies.
Alternative suppliers. In perspective they all bear a potential risk. And the risk has nothing or little to do with a political or pricing risk. Let us call it, for the sake of the argument, a “geological” risk; i.e. the availability in future of volumes of gas for export. Here at least as far as pipeline gas is concerned the future looks cloudy. Norway at current prices may run into a reserve replacement issue; Algeria (net of potential production issues) plans a gas-based internal development that may not leave much for export; Libya has issues with maintaining production, and replacement looks for the time being impracticable. Add the agony of Groningen and the declining of EU production, and a shortfall in pipeline supply may materialize in a not too distant future. Only Russia, amidst our current exporters, seems to retain spare production and potential for an increase. All others seem to be declining. Natural gas consumption in the EU is not projected to very significantly ramp up. But diversification may be mandated not by the necessities of consumption, but by the need to replace volumes of existing imports. Seen through the lens of what we have improperly defined the geological risk, the gas pipeline paradox is that it mandates to diversify from and substitute for non Russian gas.
Can LNG make up for the shortfall? The issue could be argued at length. All we can venture saying is that for the time being LNG comes to EU spot and that spot LNG goes where price takes it. When Asian prices go down we get more; and vice-versa. Assuming you want security over a minimum flow of volumes, then the dear old pipeline remains the only way to inextricably link a production site to a specific market territory. In discussing diversification, this should be taken into some account.
Now for infrastructure. Or, if you prefer, redundancy. Instead of dressing security with geopolitics, try to consider it as a function of your ability to take out insurance. Insurance is a matter of degree of risk; and of the money you need to cover it. If you want to insure against the temperature falling below 0 in northern Italy for two consecutive weeks in May, to have available the gas in case necessary for heating you will have to build up and fill a tremendous storage capacity. If you settle for no later than mid-March, the required investment will be fractional. Likewise if you want to insure against a whole winter without supplies from Russia, or settle instead for just two weeks. If you want to insure against Algeria shutting down exports from 2021 on, you should better hurry to build new import infrastructure; if you want instead to protect against a shutdown in 10 years, a new pipeline can wait.
We may need to diversify to replace what is declining; or we may do it to increase our security. Where security becomes a synonym for the ability to switch producer and/or to resort to storage or some other available spare capacity so as to avoid in terms of available gas the consequences of major disruptions, be they of a technical, political or whatever nature. Adding security means investing in the cure of the market’s pathologies; and spending money that it would not be necessary to spend should pathologies not arise.
How much security you get, i.e. from which pathologies you want to get insured, is finally a function of how much you are ready to invest in redundancies. You can approach it as a cost/benefit, or a risk management exercise, or otherwise. Always keeping in mind, however, that investing in redundancies is not as a rule a market practice; and that therefore some public help (be it through financing, or a guaranteed tariff, or other) may be required (and as a rule is). And also that, one way or another, the cost of the redundancy will end up in the price of the commodity to the final consumer. The greater the security, the higher the (relative) price of natural gas.
Security may be a geopolitical issue; but as to its costs may the taxpayer beware.