For the energy industry, the steadily worsening Russia-Ukraine conflict is an illustration of an experiment gone horribly wrong. Deep business ties can often be the harbinger of stability even between regions or nations with steep political and socio-economic differences. The ties are eventually expected to become so strong that those other differences pale in comparison. The European Union perhaps symbolizes the most successful example of that experiment, where once warring nations have come together under a giant umbrella with shared goals, and today enjoy borderless trade and movement. But that very EU is at the receiving end of a similar attempt gone awry. Deepening dependence on natural resource-rich Russia over the past several decades to feed a large chunk of its energy needs means that European policymakers are now scrambling to find alternative sources of supply sufficient to fill the gap as they seek to shun Russian volumes to isolate the nation for its invasion. With all sides digging in, and the geopolitical crisis steadily taking a turn for the worse, any move to punish Russia will mean that Europe must first feel the pain.
And the pain is only set to get worse. As the EU, and more broadly the West, tighten their sanctions to choke off cash flows by halting purchases of Russian oil and natural gas – a key source of revenue for the nation – Moscow retaliated by halting sales to Bulgaria and Poland, purportedly for refusing to pay in rubles. Finland became the latest nation to get caught in the crossfire, as Russia cut off electricity supplies to its northwestern neighbor, again citing issues with payments. As the block was just adjusting to the new reality, Ukraine declared force majeure on deliveries via a key pipeline that runs through its territory, which shipped up to a third of Europe’s gas supplies from Russia. It cited an inability to ensure operational and technical security at the gas measuring point in the Luhansk region. Volumes can be diverted to another trunkline connecting Russia and Europe – the Sudzha pipeline – but that, too, runs through Ukraine. These examples clearly show that the threat of disruptions spreading more widely across the region is real, as new developments unfold on a near real-time basis. All this clearly demonstrates that natural gas, and the broader energy industry, has become a key weapon in the ongoing crisis – which in itself is becoming much bigger than a conflict just between Russia and Ukraine, engulfing Europe and looking set to spread much wider, as historians and risk analysts had warned.
Volatility remains the only constant
Amid the worsening uncertainty, the Dutch Title Transfer Facility (TTF) and Japan Korea Market (JKM) prices, and now the US benchmark Henry Hub, have surged in the midst of the injection season, worsened by limited supply and low storage inventories in the US. The market nervousness about more Russian supplies being disrupted is driving the surge as they currently meet about 40% of Europe’s gas demand. As a result, the LNG market is expected to remain elevated given its tightness even before Russia invaded Ukraine. Over the last few months, western Europe’s import capacity has reached over 100% as a response to the deficit that we see in the market. Most of this incremental supply is getting shipped from the US. So far this year, the US has accounted for roughly 65% of Europe’s LNG imports, doubling from last year’s average of 30%.
LNG production to double through 2030
The need for more LNG is turning even more bullish on a steady stream of new near-term developments. Given the current need in Europe – and the EU deal with the US that will look to source 50 billion cubic meters (Bcm) of LNG over the next 10 years – will enable many of these US projects to move forward in the near term. Only about 11-12% of total US dry gas production ends up being exported as LNG, but we expect this share to double by 2030, with planned US projects stacking up over the next decade. Rystad Energy had a bullish outlook even before the war, expecting an increased need for natural gas in the energy mix that would trigger a stronger wave of final investment decisions for new projects. From an export standpoint, incremental production won’t necessarily be able to contribute to LNG production in 2023 and 2024 before a new wave of LNG projects enter the market.
This year, the US will see a ramp up of new capacity, but that will level out over the next two years. An increase in exports is unlikely before 2025-2026 unless some planned projects choose to move ahead faster this year. In addition, the US natural gas industry is crippled in the short term with supply chain bottlenecks and midstream constraints. Availability of frac crews, rigs, and other products have reigned in drilling and completions activity levels in the short term, but these constraints should ease in the medium term as US ramps up its LNG exports.
We expect to see gas continue to play a vital role in both global energy security and energy transition – now and in the long term – but LNG alone will not manage to meet all of Europe’s demand needs in the coming years.
Clear targets towards ES & ET
The energy transition story and the speed at which renewables take over remain surrounded by uncertainty. The EU has identified clear targets and strategy towards independence – but not just independence from Russia. Brussels has proposed to expedite plans to move towards energy transition through ambitious targets over the next decades.
The EU has announced some plans to diversify supplies and reduce demand because that is the only way that it can move away from Russia entirely – either reduce told demand for gas or find new supply sources. In the short term, the region has proposed some targets, increasing LNG by adding 50 Bcm this year through 2030 compared to 2021. The proposal includes getting an additional 10 Bcm of gas from pipeline diversification through non-Russian sources as well as targets for biogas on the supply side. On the demand side, the EU proposes to increase efficiency, add more heat pumps to electrify the residential use of gas and accelerate the buildout of renewable energy, all of which can support the market in becoming less reliant on Russia. Hydrogen will be an important contributor, but more so in the long run. Current market volatility in Europe will expedite the adoption of green hydrogen, regardless of the significant costs and investments required. Although these plans are ambitious and some of the measures on the demand side are a bit speculative, it shows the ways and the roadmaps of how to diversify and reduce reliance on gas in general.
One consequence of the war is that we expect the energy transition will have to happen at a quicker pace for Europe to reduce its reliance on Russia. That means carbon neutrality and emission reduction goals can go much quicker now – both of which will have a significant impact on Europe’s power mix and its long-term supply and demand outlook. Prior to the war, demand for natural gas in Europe was still considered to be a few years away from anticipated peak levels, but we could now actually see demand peak as early as next year. Most of our downward revisions are an outcome of reduced demand in the power and industrial sectors. Driven by high gas prices and expectations of quicker electrification, Europe will continue to rely on LNG to offset declining domestic production. In addition, we expect that coal and nuclear will continue to be phased out rapidly as we shift to cleaner-burning gas in order to find a balance in the path towards energy transition. Policy targets are not likely to be scrapped so this is probably where we see some middle ground between energy security, via natural gas and LNG, and energy transition. We expect to see a stronger decline in coal’s share in the power mix and further additions of wind and solar in the long run, primarily driven by expectations of increased investments in renewables going forward.
Energy transition vs energy security… or is it?
The ongoing crisis in Europe has thrust new energy – and policies that promote it – into the spotlight. France is choosing to double down on its primary source of “clean” generation through nuclear power. The United Kingdom plans to bring online eight new nuclear reactors to boost production. Belgium is deciding to extend the service-life of its nuclear reactors by another decade. Finally, the region’s heavyweight Germany has promised to triple its renewable energy build-out by 2030, with new auctions, permitting and legal rules to guide its transition. Governments have acted urgently to keep retail electricity prices in check and ensure gas storage is ready for the coming winter, but also to reduce their reliance on Russian gas.
One could argue that countries enacting policies to promote cleaner generation is an act of energy security. In many ways, it is, as they seek to reduce exposure to supply disruptions triggered by geopolitical uncertainty. Others argue that clean energy has momentum on its side and was only waiting for an appropriate event to trigger a pivotal shift towards a more complete and enduring transition. We would argue it is a combination of the two. The events unfolding in Ukraine and Europe have most certainly sped the process in which clean energy can find a way onto power grids, but we also argue that the transition was born out of a necessity for security.
In this instance, the case for energy security started at the end of 2021, months before Russian forces invaded Ukraine. European electricity markets saw prices reach unprecedented levels as the average cost to deliver power rose by more than 200% in Germany, France, Spain, the UK and the Nordics. The volatility in gas prices left these countries at the mercy of Moscow, raising questions about the wisdom of tying reliance of power supply to Russia over the long term. This is especially true as renewable energy penetration began to reach levels that were able to stabilize electricity prices before the crisis in Ukraine.
A transition to a clean energy economy will have lasting benefits. Not only from an environmental perspective, but also from a financial point of view. Additional solar and wind generation will stabilize loads on the grid and, despite being a form of “intermittent” energy, will lower electricity prices in the long term. Countries with aggressive clean energy targets will reap the benefits as more capacity is installed. In addition, storage will be crucial for grids to fully decarbonize. This is bound to be a slow process, but investors and governments are pushing developers for a step up in renewables generation. However, countries that wish to rapidly transform their grid to cleaner energy will need to be strategic in their approach as it could lead to a mere switch from being at the mercy of one superpower to another.
As mentioned in the previous REview, it would be naive to assume that a global energy system based on clean energy would be impervious to geopolitical events, but it remains to be seen whether this new paradigm will reduce or increase security risks in the long run. What is clear is that in the short term the globe is heading towards dependence on several petrostates over dependence on a single country, China.
China is the world leader in terms of energy material processing and equipment manufacturing. The solar industry may be the most egregious case. Polysilicon is the initial feedstock to produce PV panels, and 82% of global polysilicon capacity is situated in China. The second step is to convert the polysilicon to ingots and then wafers, with China controlling 98% of this process – so even if a panel sources its polysilicon from Germany or its final assembly occurs in Malaysia, almost all panels have to go through China. On the battery side, the story is no different. China has more than two-thirds of the world's lithium processing, 90% of its cathode production and 82% of its anode production.
The effects of the renewable supply chain’s overreliance on a single economy have already been apparent. Last year, new polysilicon plant construction in China was slowed due to Covid-19 and industrial output was limited by the Chinese government due to a shortage in coal that led to electricity shortages. As a result, demand for polysilicon outstripped supply and prices tripled in a matter of months, sending shockwaves through the global solar industry and threatening developers’ ability to meet project pipelines.
There is no intrinsic reason for China’s dominance of energy metal processing as this can be located anywhere, but Chinese manufacturers have achieved economies of scale that outcompete any potential new entrant. If nations want to de-risk their energy systems while transitioning to a low carbon economy, they will have to act and incentivize other supply chain options – but the road ahead for those will be arduous.
The US has tried for years to foster a robust domestic panel supply chain through punitive policies towards overseas imports, but to no avail. More recently, the US Department of Commerce launched a probe on Southeast Asian imports on fears that Chinese panel manufacturers are using cheap raw materials while outsourcing cell and panel assembly processes to that region in a bid to circumvent sanctions on China. Chinese panel manufacturers, fearful of potential tariffs, have canceled almost every supply contract. With 85% of last year’s imports coming from Southeast Asia, developers and EPCs are scrambling to get a hold of the solar equipment they need for their projects, as 64% of the solar installations in 2022 are at serious risk of delay or cancellation. Countries across the globe may need to sacrifice the pace of their energy transition in the short term to ensure a more secure energy system in the future.
What about hydrogen?
The case for green hydrogen has never been stronger than today. Green hydrogen, which uses clean energy sources such as solar and wind as a feedstock for electrolyzation, has become the obvious choice as countries not only continue to build out and rapidly expand solar and wind generation, but also since this approach has clear advantages over its top competitor, blue hydrogen. Blue hydrogen is produced from natural gas through steam methane reforming and has long been considered one of the more cost competitive forms of hydrogen in the market. However, both blue and gray hydrogen have seen a rise of over 70% in prices in the space of just a few months. Blue and gray hydrogen have now seen production costs of over $11 per kilo, approximately $7 per kilo higher than a green hydrogen project that was recently awarded in an auction in the Iberian Peninsula. The issue of prices as well as reducing the reliance on Russian gas has provided an exceptionally good incentive for developers and governments to consider green hydrogen.
In conclusion, while renewable energy is growing, we do not expect any immediate collapse in gas for power. The energy transition will require an ambitious energy infrastructure plan – whereby gas is expected to capture some market share from coal in the medium term, but where renewables will eventually come out on top. Fuel price volatility caused by the Russian invasion is expediting the energy transition, but nations should be wary of trading their energy security from the hands of one nation to the other. Even as the share of renewables in the global energy system expands at a fast pace, companies and nations must continue to invest in oil, gas and LNG production long into the future to ensure sufficient supply through all phases of the transition.
Senior Vice President of Oil Markets, Head of Americas Research
Vice President of North America Gas Markets Research
Analyst, Renewables Research
(The data and forecasts contained in this column are Rystad Energy’s and the opinions are of the authors.)
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