What is the future of natural gas in Europe?

by Michael Akerib, Rusconsult

Gas consumption has seen a major increase in its use for the production of electricity in both Europe and the US as it is a less polluting fuel than coal while having a higher efficiency. The International Energy Agency forecasts an annual increase in demand of 1.5% in the next ten to twenty years.

This increased use may, however, well put consuming countries, and the European Union in particular, into a higher dependency ratio - of up to 80% - with regards to its suppliers, since gas extraction is geographically concentrated in a limited number of countries some of which have dwindling resources or require considerable investments to maintain their present production levels, or both. Russia's estimate is that investments of the order of 300 billion dollars will be required over the next 20 years to meet demand. In the case of Russia, large investments to maintain an archaic pipeline system are also required.

Should these large investments not be made, supplies will be reduced and Russia would most likely increase prices to maintain its revenue flow.

Europe's natural gas suppliers are Norway, Russia, Central Asia and North Africa. Supplies from Iran are out of the question for the moment. Europe's dependency might induce its suppliers to select its clients on the basis of a political agenda.

The world's leading gas producers are Russia, the United States, Canada, Iran and Norway. Several European countries are now proceeding with exploratory drillings but results are so far unavailable.

Europe's environmental concerns will no doubt lead to a reduced demand, of up to one-third by 2030 according to some forecasts, while the opposite will be true for Asia. Competition between the two continents for adequate supply will increasingly weigh on suppliers' decisions with regard to the building of transport routes from Russia, Central Asia or the Gulf. These routes are significantly longer and therefore more expensive to reach the Asian markets than Europe. However, China's massive foreign exchange reserves enable it to finance the building of gas pipelines over large distances and difficult terrain but the availability of Australian gas may not require them to make this outlay.

China has also struck deals with foreign companies that will be drilling in China for shale gas. The government has set a target of producing 50% of its gas requirements.

Another issue that is a cause of worry is the possibility of the creation of a gas producer's cartel but that is unlikely as long as the market is dominated by long-term contracts and that producers and consumers have little flexibility in view of their link through the fixed structure that is a pipeline. Further, the interests of the gas producers are far from being homogeneous.

The readiness of some consumers to invest in the necessary re-gasification terminals - and the assumption that corresponding liquefaction investments in developing countries will follow in uncertain markets where a five-year lead time maybe perceived as too long - to receive LNG (Liquified Natural Gas) reduces the dependence on the closest supplier which is Russia. It has, as an added advantage, the fact that LNG prices are not automatically indexed on oil prices.

Price-wise, the indexation of the price of natural gas to that of oil, which is the case at present, has its limits as in case of a strong increase in the price of oil, which every pundit has been forecasting for the last half a dozen years, nuclear energy could become an even more attractive alternative than at present. More particularly, the cost of energy produced by a nuclear power station remains essentially unchanged over long periods of time, the risks being at a different level - safety and availability of uranium.

An increase in Europe's reliance on nuclear power would lessen its dependence on Russian gas.
Investments in renewable energies remain small and therefore any impact these sources can have in a period of gas shortage remains marginal.

Improvements in energy productivity would obviously have a major impact in gas imports in consuming countries. So would the discovery of major gas fields on the Old Continent, although production may be delayed by ecological fears of contamination of the aquifers. Russia would be the country most negatively affected as it is proceeding to develop fields that are difficult, and thus costly, to operate. Thus, the Shtokman project, in the Arctic, for instance, has been postponed.
An incitement for consuming countries to obtain a stability of supplies consists in allowing suppliers to acquire local companies and thus integrate downstream in what is sometimes the most profitable end of the industry. However, he European Energy Charter regulates sales of infrastructure to non-EU companies. This has not stopped Russia's Gazprom from acquiring a portfolio of companies and planning a major expansion downstream even though Russia, just like Venezuela, restricts foreign investment in their own infrastructure. Whether this will continue if demand drops remains to be seen.

Political uncertainty is one more parameter to be taken into account in a developing market in which decisions on very large investments have to be made in situations of great uncertainty.