Decarbonising European gas: value chain impact
What will the impact of gas decarbonisation be on asset values and different market players across the value chain, over the next decade and out to 2050?
June 3, 2019
Decarbonisation of the European gas market will involve very large scale investment across the supply chain, regardless of the pathway via which it is achieved. European energy companies are in a strong position to lead a gas market transition, just as they are currently doing in the power sector.
Gas decarbonisation will require major changes in infrastructure, business models & regulatory frameworks. It will also result in structural changes to the value and risk profiles of existing gas assets.
But decarbonisation brings substantial growth opportunities for companies that are positioned for change. The challenge is that the growth areas going forward may be very different to those of last two decades.
Today we focus on:
- how the European gas value chain may be impacted by decarbonisation
- what this means for the key categories of market players (producers, network owners, suppliers & midstream flex assets).
We do this with the aim of identifying both risk mitigation actions and growth opportunities for the players involved.
How decarbonisation pathways impact the gas value chain
In last week’s article we set out 3 potential pathways that the European gas market could follow toward decarbonisation (2020s to 2050s). All of these pathways involved structural changes in the gas supply chain by the mid 2030s. A quick recap:
- Gas transition: Steady transition to large scale hydrogen networks by 2050s. Transition supported by ‘blending’ of hydrogen (& potentially bio-methane) in existing networks across 2020s-30s. Large scale methane reformation into hydrogen at European border entry points by the 2050s.
- Steady displacement: Gas retains a structural role, but with a changing/shrinking footprint. From the mid 2030s gas starts to be displaced by electrification of power/heat/industry (by default). By 2050s, fragmented & localised gas networks are focused on flex backup in the power sector & hard to reach areas of heat/industry.
- Rapid displacement: Electrification broadly displaces gas from the energy mix by the 2050s. Displacement from the power sector across 2020s-40s (by electricity storage) & heat/industry across 2030s-50s. The residual role of gas is focused on smaller scale local applications (e.g. biogas), with progressive closure of gas T&D networks.
So what could these different pathways mean for infrastructure & companies across the European gas value chain? In Table 1 we summarise the potential impact.
Table 1: Value chain impact of 3 decarbonisation pathways
||Value chain impact
| Gas Transition
||Headline: Extensive but managed infrastructure & business model transition
- Blending of hydrogen & bio-methane supports: (i) continued usage of existing gas infrastructure (2020s to 2040s) & (ii) the role of gas as a transition fuel e.g. displacing coal & lignite across 2020s
- Existing producer supply chains (e.g. Russia/Norway/LNG) may continue to deliver methane to European borders for reforming to hydrogen
- Steady transition to hydrogen networks & infrastructure across 2030s-50s, requiring large scale new investment (from production to burner tip)
- Adaption/upgrade of some existing midstream infrastructure (e.g. storage, regas terminals) to support hydrogen networks
| Steady displacement
||Headline: Time for ‘fast movers’ to adapt (or exit) as new role of gas defined
- Relatively high utilisation of existing methane infrastructure into 2030s, before displacement by electrification gathers pace in power, heat & industry
- Steady decline in gas demand & asset utilisation from mid 2030s, with networks & infrastructure becoming more localised/fragmented
- Flexibility/peaking role of gas infrastructure increases over time as utilisation falls e.g. to support peaking flex in the power sector
- Asset risk/return profiles change as gas evolves into ‘peaking’ role, with associated changes in regulatory, ownership and business models
- Significant retirement of existing methane supply chain infrastructure by 2050s
| Rapid displacement
||Headline: Industry wide disruption to asset values & business models
- Gas infrastructure utilisation starts to decline from late 2020s with a more limited role of gas as a transition fuel
- Peaking flex role of gas in the power sector diminishes with rapid electricity storage evolution in 2030s & 40s
- Large decline in gas infrastructure utilisation across 2040s-50s
- Broad based redundancy of existing methane supply chain infrastructure by 2050s, including stranding of existing assets
Source: Timera Energy
Balancing the 30 year horizon with the 10 year one
At first glance, the impact of these pathways seems to be a major threat to existing gas asset portfolios & business models. But there are some important considerations to balance against this.
Under all three pathways gas could well see somewhat of a resurgence across the next 5 years. There are two key drivers behind this:
- Coal & nuclear closures: Substantial volumes of coal, lignite and nuclear capacity face regulatory driven closure over the next decade, much of this over the next 5 years (e.g. Germany 25GW). This is set to increase the load factors of existing gas-fired plants & therefore gas demand.
- Low prices: Large volumes of new LNG supply (2019-21) are pushing down European hub prices. This is causing coal to gas switching in the power sector. But it may also induce other demand side response.
In the ‘Gas transition’ and ‘Steady displacement’ pathways there is also a genuine role for gas as a transition fuel well into the 2030s. The EU’s current top priority is driving coal out of the energy mix. A number of countries are in parallel closing nuclear plants (despite dubious emissions logic). In the absence of blistering electricity storage technology evolution, gas will be needed to plug the capacity gap. Beyond that, a combination of biogas & hydrogen from electrolysis may be a longer term necessity.
The ‘Gas transition’ scenario would likely be a very favourable outcome for European energy companies prepared for change. As a result we think this is the path which will garner the greatest industry support. If momentum builds behind blending of hydrogen & biomethane in the early 2020s, this may support both:
- Use of existing networks & infrastructure well into 2030s, with increasing blending of hydrogen and biomethane
- Very large scale investment in hydrogen production and network infrastructure (& the potential for European companies to lead a global roll out of hydrogen).
Hydrogen production via steam reformation could even actually support European gas demand, given energy required in the conversion process (and to capture CO2) results in a conversion efficiency of some 75 to 80%.
Impact on different players
Next we summarise the potential impact on players across the gas value chain. This draws in part on material from Jonathan Stern’s recent paper on gas decarbonisation.
- LNG producers & aggregators selling into Europe
- will need to watch the potential for declining demand from 2030s
- but they have the potential to sell elsewhere e.g. Asia/Lat America (at least temporarily)
- Pipeline linked producers (e.g. Russia, Norway, North Africa)
- More exposed to European demand decline (& tougher prospects for signing LTCs)
- Strong incentives to carve out a role in hydrogen reformation supply chain
- Substantial opportunities to develop hydrogen production infrastructure
- Both LNG & pipeline producers have incentives to locate hydrogen production at European borders (e.g. regas terminals, pipeline entry points) to preserve existing methane supply chains to the border
Transmission and Distribution Network Owners
- Face key risk of erosion of network utilisation
- Network location and decarbonisation pathway important in defining value impact
- Blending of hydrogen & bio-methane important to support utilisation in 2020s-30s (incentives aligned with producers here)
- Transition to different regulatory & ownership structures likely as existing network utilisation declines
- Opportunities to develop new hydrogen (& bio-methane) networks, but new regulatory, commercial & investment structures required to support this
- Easier to adapt gas supplier business models than other parts of the supply chain
- Issues arise where suppliers own assets/infrastructure that suffer from falling utilisation, which may lead to increasing asset divestment momentum (& the contracting of replacement flexibility)
- Strong diversification logic in electricity supply chain presence
- Trading businesses will need to evolve with the market, but are relatively well placed to do so (e.g. in supporting flex/peaking role of gas + potentially establishing hydrogen markets), albeit replacement markets may be more fragmented and less liquid than the current pan-European hub market
Midstream gas and power assets:
- European midstream asset owners (e.g. regas & storage) & gas-fired power plant owners are already adapting to changing market conditions & lower utilisation
- Transition to ‘peaking’ role of these assets is likely to continue through 2020s-30s
- As a result, substantial change of ownership likely over 2020s-30s as assets transition to owners with appetite & skill set to manage ‘peaking’ risk/return profiles
- Substantial opportunities for new investment in hydrogen (& bio-methane) midstream infrastructure as well as conversion of suitable existing assets (e.g. storage, regas)
- There could also be big opportunities in CC(U)S both for hydrogen production and power plants.
Conclusions on how to approach gas decarbonisation
The impact of gas decarbonisation on gas portfolios can be broadly split in two categories:
- Impact on value and risk of existing assets
- Growth opportunities in the development of new assets & markets
Both need to be approached in a pragmatic way that reflects the uncertainty and timescales involved, using a structured analytical framework.
In our view, the best way to approach this is for companies to develop their own in-house decarbonisation ‘pathways’. These can then be used to analyse & even quantify the impacts of decarbonisation, e.g. by understanding upper and lower bounds on asset value and risk. They can also be used to target lobbying for appropriate policy support.
Doing nothing because decarbonisation is too far off is not really an option anymore. Whatever decarbonisation pathway and timeline you subscribe to, it will involve structural changes in business models, asset values & ownership structures. These are set to commence through 2020s and accelerate in the 2030s.
A consistent framework for analysing risk & opportunities and the readiness & flexibility to act on this are likely to be key to successfully navigating the transition.