If Europe is willing to pay the price for expensive LNG imports, it could severely undermine Russia’s ability to earn foreign exchange through gas exports to finance the war in Ukraine. But this would also carry high costs for Europe.
BRUSSELS – In a matter of months, the European Union has so reduced its dependence on Russian oil that it is now ready to impose an embargo. European Commission President Ursula von der Leyen has announced a plan to ban imports of Russian crude oil to most of the EU in the next six months and refined oil products by the end of the year. But to have a significant impact on Russia’s budget, Europe must also end its dependence on Russian gas. This will be much more difficult to achieve.
Europe has managed to rapidly reduce its need for Russian oil for a couple of reasons. Oil can be easily transported by tanker, not just pipelines, and it is relatively easy to find new supplies on the world market. The problem is that it’s also relatively easy to find enough new buyers, and Russia has plenty, to offset a large part of the losses from an EU embargo.
The gas is different. Europe needs natural gas to provide heat in winter and to serve as a feedstock for the world’s largest chemical industry, which accounts for a significant part of EU exports. And certain features of the natural gas market will make it much more difficult and costly to find alternatives to Russian supplies than it has been for oil.
For starters, because most natural gas producers operate under long-term contracts with buyers, little production capacity is available outside of Russia. While spot markets exist, where limited amounts of gas can be bought or sold, their purpose is to redistribute existing supply or demand between regions as needed, not to provide additional supply.
Nervous European energy ministers have visited several global gas producers, hoping to convince them to increase production. And the major gas producers are happy to oblige. But they caution that it takes up to four years to launch new projects, and doing so only makes business sense if the client is willing to sign a 20-year contract.
All of this means that, in the short term, the supply of natural gas is almost fixed. Therefore, the only way to compensate for the shortage of Russian gas is through a combination of energy savings and increased imports.
Here, Europe will face another challenge. Natural gas is expensive to transport and difficult to store. Shippable liquefied natural gas (LNG) offers the main alternative to piped Russian gas, though it poses its own challenges.
Once the gas has been liquefied and loaded into a special tanker, an additional few thousand miles of travel makes little difference. This is the main reason why the Asian and European LNG markets are integrated, and prices on the two continents often move very closely. Spot gas prices already hit very high levels last fall, months before Russia invaded Ukraine, as a strong recovery in Asia boosted demand.
Before the war in Ukraine began, Europe was already importing almost as much LNG as piped gas. But if Europe wants to end its dependence on Russian gas, it must massively increase these LNG imports. This will be costly because it means diverting shipments originally destined for Asia to Europe. Fortunately, this will be technically possible due to a profound asymmetry in the LNG trade: it takes much longer to build liquefaction facilities than it does to organize regasification.
When the LNG arrives, importing countries simply have to heat the liquid in tankers. Energy specialists frequently point out that many countries do not have enough fixed LNG facilities to increase imports. But floating LNG terminals are also an option, and countries like Germany, France and Italy are already taking advantage of it, ensuring they can unload LNG when it arrives.
These flexible gasification facilities, along with a dense network of pipelines connecting most EU suppliers, offer some protection against Russian attempts to eliminate individual countries. Europe has already shown solidarity with the issue. When Russian energy giant Gazprom recently stopped gas deliveries to Poland and Bulgaria, German and Greek pipelines ensured the two countries got what they needed. The question is whether Europe will show the same resolve when all countries are under pressure.
Liquefaction facilities, on the other hand, are much harder to come by and take much longer to build, because they require giant refrigerators that chill the gas to -160° Celsius. This has two politically important consequences.
Some hope that the United States can provide much-needed LNG to Europe. But the United States is currently operating its existing liquefaction plants at full capacity, and it would take several years to build new facilities. As long as US export capacity is constrained, redirecting US deliveries from Asia to Europe will do nothing to reduce excess demand in the combined EU-Asia LNG market. For the US, this has the advantage that domestic natural gas prices have remained much lower than in Europe or Asia.
The challenge of building LNG liquefaction facilities also significantly raises the costs for Russia to try to export gas that Europe no longer buys. For several years, Russia would not be able to sell the 140 billion cubic meters of natural gas that used to go to Europe each year.
If Europe is willing to pay the price for expensive LNG imports, it could severely undermine Russia’s ability to earn foreign exchange through gas exports. That would make a real dent in Vladimir Putin’s war budget.
The author
He is a board member and a distinguished fellow at the Center for European Policy Studies.
Copyright: Project Syndicate 1995 – 2022