Most of Europe’s natural gas consumption occurs in three sectors. Firstly, in the residential and commercial/public sectors, mainly for space heating (38 per cent of total EU-27 gas consumption in 2020); secondly, in the heat and electricity generation sector (35 per cent - Such plants may be electricity-only, heat-only, or combined heat and power (CHP)); and thirdly, in the industrial sector, mainly to generate process heat (25 per cent). The remaining 2 per cent was accounted for by other sectors, such as transport and agriculture. The challenge of phasing out the use of natural gas, as part of the energy transition, varies by each of these three sectors.
In the power sector, while output from nuclear power plants is relatively stable, output from renewable sources (primarily wind and solar) varies, and this variation does not always align with variation in electricity demand. In this context, natural gas is used to bridge the gap between supply and demand. The share of gas in EU-27 power generation in 2020 was significant (20 per cent) compared to nuclear (25 per cent), coal (13 per cent), wind (14 per cent), hydro (13 per cent), solar (5 per cent), and other sources, including oil products, peat, waste and biofuels (10 per cent). Over the next decade, gas demand for power generation will be influenced by the expansion of renewable power generation capacity, the phase-out of coal, and national policies on nuclear power generation, but natural gas will retain its balancing role. In the longer term, hydrogen or biogas could take on that balancing role, complemented by large-scale battery technology, if the challenges of cost and scaling up can be overcome.
Given that electric heating is not particularly energy-efficient, the phase-out of gas is likely to involve the deployment of either heat pumps or a switch to hydrogen as a fuel for domestic gas boilers. This is significantly more challenging than the build-out of renewables in the power sector and will therefore take longer. In the industrial sector, using electricity for high-temperature process heat is significantly less energy-efficient that burning a gas, so the phase-out of natural gas could also depend on the development biogas and/or hydrogen.
At a European level, the European Commission has a binding target that 32 per cent of EU gross energy supply comes from renewable sources by 2030, and its May 2022 REPowerEU plan proposed raising that target to 45 per cent, while maintaining the target of climate neutrality by 2050. Such targets imply continued demand for natural gas in the EU beyond 2030, but a complete phase-out of unabated natural gas (i.e., natural gas whose consumption is not accompanied by carbon capture and storage) by 2050. Such targets and timelines reflect the challenges noted above.
The role of Russian gas in European imports and its ongoing phase-out
Given that European gas demand is likely to remain significant into the 2030s, the sources of supply are crucial. The most recent data states EU gas supply for the period January-August 2022 as follows: EU production (28.9 billion cubic metres [bcm]), pipeline imports from Norway (59.5 bcm), pipeline imports from Russia (54.4 bcm), pipeline imports from Algeria & Libya (22.3 bcm), pipeline imports from Azerbaijan (7.4 bcm), pipeline imports from the UK (12.2 bcm), and LNG imports (77.8 bcm). This gives total supply of 262.5 bcm, up from 260.0 bcm in the same period in 2021 – an increase of 2.5 bcm (1 per cent).
Within this 1 per cent year-on-year increase in total supply to the EU, there have been significant changes in supply by source. The most significant was the decline in pipeline imports from Russia, which fell from 98.9 bcm (37 per cent of total supply) in January-August 2021 to 54.4 bcm (21 per cent of total supply) in January-August 2022. With the Nord Stream pipeline no longer in use, the flow of Russian pipeline gas to the EU fell to just 76 million cubic metres per day (mmcm/d) in early September (equivalent to 27.7 bcm per year),and is not expected to increase significantly in the foreseeable future. This implies that the supply of Russian pipeline gas to the EU in the whole of 2022 could be around 65 bcm, down from 142 bcm in 2021 (a 54 per cent year-on-year decrease), and that Russian pipeline flows to the EU in 2023 could be just under 30 bcm (another 54 per cent year-on-year decrease).
On 8 March 2022, following the Russian invasion of Ukraine, the European Commission set out its proposal to reduce EU demand for Russian gas by two-thirds by the end of the year, and to make the EU independent from Russian fossil fuels well before 2030. While that proposal implied that the EU would reduce gas demand and source alternative imports in order to ‘push out’ imports from Russia, Gazprom’s decision to withdraw from European spot markets (supplying only volumes linked to long-term contracts), the cut-off of Gazprom’s European counterparts that are not prepared to pay for gas in Roubles rather than Euros or Dollars, and the closure of major pipelines (Nord Stream and Yamal-Europe) have also substantially impacted the flow of Russian gas to Europe.
With the share of Russian gas in total European supply falling dramatically in 2022 and set to do so again next year, the timing of the final phase-out will depend on the willingness of European companies to continue receiving Russian gas under long-term contracts with Gazprom (some of which are valid into the early 2030s) and Gazprom’s willingness to continue delivering those supplies.
Short-term issues for winter 2022/2023: record prices and proposals for price caps
The curtailment of Russian pipeline gas supplies to the EU in recent months has contributed to European wholesale gas prices reaching record levels. The north-west European benchmark is the front-month contract at the Title Transfer Facility (TTF) trading hub in the Netherlands. The monthly average price of this benchmark between April 2005 and December 2019 ranged from 9 Euros per Megawatt Hour (EUR/MWh) to 32 EUR/MWh, at an average of 20 EUR/MWh. Prices then collapsed during the COVID-19 pandemic in mid-2020, before recovering and surging in the second half of 2021. The Russian invasion of Ukraine added to this price increase momentum, and the monthly average reached 235 EUR/MWh in August 2022 – more than five times higher than in August 2021.
While these record prices have helped to attract record European LNG imports that partially offset the decline in pipeline supply from Russia, they also pose an urgent challenge to the European Commission and national governments as a threat to economic stability and living standards, and caused wholesale electricity prices to rise to exceptionally high levels. In response, the European Commission produced a ‘non-paper’ for discussion at a meeting of EU Energy Ministers on 9 September.
That ‘non-paper’ contains two ideas: the first is a cap on the price paid for gas imported from Russia, to which the Russian government could respond by instructing Gazprom to cease gas supplies to companies that implement the cap. The second idea is for a wholesale price cap for EU member states most affected by a disruption in gas supplies from Russia (the ‘red zone’), where no further supplies can be attracted no matter how high the wholesale price rises. The cap would be set slightly higher than the TTF benchmark, to encourage gas to flow to the affected area. However, this idea would be complex to administer in relation to existing gas supply contracts and trading arrangements, and attempts to distribute gas equitably between member states in ‘red zone’ in the event of a physical shortage.
National governments could also cap retail gas prices paid by household consumers at a level lower than wholesale prices, but those governments would then be liable to cover the difference between the wholesale and retail prices in a form of subsidy. Proposals to tackle the problem of high gas prices causing high electricity prices include capping of the price of gas used for electricity generation and/or ‘ring fencing’ the price of electricity generated from gas separate from the price of electricity generated from other sources (namely renewables and nuclear power), whose costs have not increased in recent months. These proposals raise the challenges of whether such measures would breach existing supply contracts, how to allocate electricity generated from gas and non-gas sources equitably, and how to ensure that the cost savings are passed on to consumers.
How to balance supply and demand in the gas market?
To conclude, Europe currently faces a truly exceptional set of gas market circumstances and national governments are constrained in their ability to influence the supply-demand balance, with limited availability of additional supplies and a reluctance to engage in demand-side rationing beyond the encouragement of voluntary reductions in consumption. These circumstances are generating record gas and electricity prices, to which governments and the European Commission are set to respond with unprecedented market intervention. The complexities and costs of such intervention are substantial, but the social and economic costs of failing to address this challenge are even greater.
With the support of the European Commission's Representation in Italy.
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