European gas market: winter outlook
The world is focused on Europe’s ability to survive the coming winter without Russian gas. This article sets out analysis that quantifies Europe’s winter gas supply safety buffer, assuming all goes well.
A harsh lesson of 2022 is it is dangerous to assume all goes well. So our analysis also focuses on the impact of 4 key risk factors that could erode Europe’s safety buffer:
- A shortfall of policy targeted demand reductions
- A cold winter
- Diversion of LNG supply from Europe e.g. in case of a cold Asian winter
- Loss of remaining Russian supply volumes.
It is very unlikely that Europeans will freeze this winter due to gas supply cuts. But the risk factors above could cause further extreme market volatility and a requirement for heavy handed government intervention to reduce demand.
Last week’s sabotage of both Nordstream pipelines also creates an increasingly challenging gas supply environment in 2023.
What happened last winter?
It is useful to start with 2021 as context for the challenges across the winter ahead. Chart 1 shows a breakdown of supply & demand balance across last winter and the ‘End of Winter’ (EoW) storage inventory.
Chart 1: Winter 2021-22 supply vs demand
Source: Timera Energy
Europe entered last winter with low storage levels. This was due to a combination of (i) Gazprom drawing down its within Europe storage inventories and (ii) limited LNG import volumes (given strong Asian demand).
Europe benefited from a mild winter in both Europe and Asia and higher nominated Russian flows in March through Poland & Ukraine. This saw ‘end of winter’ (EoW) storage balances back within the 5 year range by March.
An optimistic scenario for this winter
We start by setting out an optimistic scenario summarised in Chart 2 and then challenge how this could go wrong.
Chart 2: Optimistic scenario for Winter 2022-23 supply & demand balance
Source: Timera Energy
Let’s consider each of Europe’s key supply sources one at a time.
Storage: Storage volume mandates mean that Europe enters winter 2022 with 9 bcm more gas inventory than last year. That is a big help.
Domestic production: This is relatively flat year on year. Lower Dutch output from Groningen should be offset by stronger Norwegian flows.
Non-Russian pipeline: Also relatively flat with little potential upside from TAP or Algeria (given there is no return in the sight for the Tarifa route).
Russian pipeline: Sabotage of Nordstream 1 & 2 means the best case scenario for Russian flows is likely to be a continuation of the current ~6 bcm through Ukraine plus ~13 bcm via Turkey.
LNG: A best case outcome involves (i) Europe continuing to attract enough LNG volumes to maximise throughput given available regas capacity and (ii) new FSRUs coming online across the winter that could allow up to 7bcm of additional import volumes (e.g. 4bcm in Netherlands, 2 bcm in Germany) vs current regas levels.
The demand side of our optimistic scenario assumes that Europe achieves its 15% demand reduction target (with winter demand of approx. 282 bcm).
If this optimistic scenario comes to pass then Europe should have ample gas to make it through winter, with an estimated ‘end of winter’ storage inventory buffer of around 55 bcm.
How could things go wrong?
Table 1 summarises the potential impact of the 4 key risk factors that could erode that 55 bcm storage buffer.
|Volume at risk
|Demand reduction shortfall
|• The EU has announced a 15% winter demand reduction policy target (approx. 50 bcm)
• How this will be achieved in practice across member states is far from clear
• Power sector (~20% of demand) reductions will be very difficult because Europe has a parallel power crisis and gas fired generation is required to keep the lights on
• Residential & commercial (~55% of demand) reductions are also challenging given increasingly widespread implementation of consumer price caps (eroding incentives to cut demand)
• Industrial sector (~25% of demand) will need to bear the brunt of reductions; some of this is happening already e.g. via fuel switching & shut ins, but price response alone is unlikely to be enough
• Europe’s winter buffer depends on these demand reductions being effectively implemented
|• Weather is the variable beyond anyone’s control and could account for a 20 bcm increase in demand
• Most of this is likely to come via the residential & commercial sectors (where increases are hard to restrict)
|• Markets are currently priced for Europe to attract maximum LNG volumes (e.g. reflected by >10 $/mmbtu premium of TTF over the DES NW Europe LNG price)
• However a very cold winter in Asia (alongside any economic recovery in China) could significantly increase Asian demand (e.g. as for the Jan 2021 spike)
• A battle between Europe & Asia for available LNG would likely drive an upwards price spiral and European import volumes could be eroded (via Asian cargo diversions)
|• Russia may try and place further pressure on Europe via cutting Ukraine route flows to zero (6 bcm impact)
• The risk of this increased last week with Gazprom threatening Naftogaz with sanctions if they pursue an arbitration case targeting repayment of transit fees
• There is also an additional 13 bcm of supply routed via Turkey at risk, although reductions here are less likely
Getting through winter… and 2023
If one or more of these risk factors plays out to erode Europe’s storage buffer, it is demand that will need to react to balance the market and avoid outright supply cuts.
That would likely mean more extreme price volatility and heavy handed intervention in the form of mandated rationing of gas. This could be a very ugly outcome for European industrials.
The good news is that Russia looks close to having played its last card in terms of gas leverage over Europe. However Europe’s challenges will not disappear with the daffodils next spring.
Europe was able to fill its storages in 2022 due to healthy Russian supply volumes across the first half of the year. Nordstream sabotage means that Europe will now likely need to make up an additional 40 bcm of gas in 2023 to cover reduced Russian flows.
That volume cannot be met by incremental LNG alone. Europe will not have enough regas capacity (even if it could attract enough additional cargoes). That means further demand reductions are required next year.
The 2023 challenge will also depend on storage inventories coming out of this winter. We’ll be tracking progress through the winter both via our feature articles and snapshots.