A laconic calmness: how the EU market is experiencing a reduction in gas supplies

Econs.online published an article by Marcel Salikhov "A laconic calmness: how the EU market is experiencing a reduction in gas supplies."

After a period of record growth in 2022, spot gas prices on the European market returned to the levels of two years ago. Europe has managed to adapt to the reduction in supplies from Russia, but the volatility of gas prices and consumption risks remain.

Spot gas prices for the first time reached a record level of $1,000 per thousand cubic meters in the fall of 2021, by the winter of 2022 they crossed the $2,000 mark, and last fall they broke through the $3,000 mark amid concerns about a possible energy crisis in the EU. However, forecasts that the European Union will face a severe energy crisis during the last winter heating period did not come true: gas prices have been steadily declining since the beginning of 2023 and remained at a fairly low level this summer. In July 2023 the cost of a thousand cubic meters of gas dropped to $290, which is about 10 times lower than the level of the same period in 2022.

At the same time, the decline in prices is taking place amid a decrease in Russian pipeline gas supplies, which now amount to about 2 billion cubic meters per month, which is about 5-6 times less than in 2021. According to our estimates, pipeline gas supplies from Russia to the European Union in 2023 will amount to about 24-26 billion cubic meters compared to 147 billion cubic meters in 2021. Thus, the reduction will exceed 120 billion cubic meters, which is approximately 30% of pan-European consumption.

The drivers of decline

How did the European market manage to adapt so quickly to the reduction in supplies from Russia and how stable is the current price level?

The main reasons for the decline in European gas prices in 2023 are related to several factors. First of all, this is a demand factor. Many consumers began to reduce their consumption of this energy resource in response to the price shock of last year. In 2022, gas consumption in the EU decreased by 13.4%, or 55 billion cubic meters, compared to 2021. The drop in demand was particularly strong in October and November 2022. It was the decline in demand that provided up to 70% of the replacement of Russian pipeline gas supplies to the EU in 2022. (about 73 billion cubic meters), becoming a key factor in reducing the EU's dependence on Russian gas.

The weather also made it possible to offset the reduction in Russian gas supplies. October 2022 and January 2023 were the warmest in Europe in the entire history of observations, and November was the third warmest November in 20 years. And the calendar winter of 2022-2023 turned out to be almost the warmest in several decades, with the exception of the winter of 2019-2020, which also contributed to a decrease in gas consumption by households and utilities.

In addition, structural factors also played a role. A number of the EU industrial enterprises have shifted to other sources of energy resources, including fuel oil and liquefied petroleum gases. Some large manufacturers of chemical products and fertilizers (for example, BASF and Yara) have announced that they will gradually close their production sites in the European Union (but these plans may be revised in the new price conditions). Households, faced with rising bills for electricity and heat, also changed their energy consumption and invested in improving the energy efficiency of housing.

Secondly, it is a supply factor. The increase in the supply of liquefied natural gas allowed to replace up to 30% of the reduction in pipeline supplies from Russia. In the first six months of 2023, European imports of liquefied natural gas increased by 6 million tons to 44 million tons. About two–thirds of the increase was provided by additional supplies from the United States, the rest - mainly supplies from North Africa.

Thus, the EU economy was able to adapt fairly quickly to the reduction in gas supplies from Russia due to a whole set of structural and conjunctural factors. However, this does not mean that the current low prices are guaranteed in the medium term.

We believe that the "new normality" for the European gas market is that the price level will be in the range of $500-600 per thousand cubic meters. This is higher than the "old normality", when prices were $250-300, but significantly lower than the extreme values of last year at $2000-3000.

Changing the geography of deliveries

In the near future, the European market will have to focus on liquefied natural gas, as alternative suppliers of pipeline gas, including Norway, Algeria and Azerbaijan, will not be able to provide an increase in supplies on a significant scale. The two major suppliers of new liquefied natural gas, with the exception of Russia, will be the United States and Qatar in the coming years. It is these two countries that will meet the demand of the European market for additional volumes of gas.

At the same time, the demand for gas in the European Union will continue to decline steadily, but probably at a slower pace due to the fact that the most affordable options for abandoning gas have already been implemented in the last two years. Given the high volatility of the market and geopolitical risks, gas will remain an excessively risky and volatile energy resource for consumers even at a more comfortable level of current prices.