Energy Monitor April
Group Economics
Commodity Research
A Russian marriage of convenience
4 April 2014
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European gas prices under pressure due to weak demand and high inventories
Stronger European call for less dependency on Russian energy…
… but near-term alternatives result in (too) difficult moral quandaries for EU politicians
Extension of renewable energy is of some (expensive) help, but only in the longer term
Figure 1: TTF gas price trend (in EUR/MWh)
28,00
27,00
26,00
25,00
24,00
23,00
22,00
21,00
20,00
01-jan 11-jan 21-jan 31-jan 10-feb 20-feb 02-mrt 12-mrt 22-mrt 01-apr
TTF gas price
Source: ABN AMRO Group Economics, Thomson Reuters
3
Figure 2: EU gas imports from Russia (x mln m )
6.000
5.500
5.000
4.500
4.000
3.500
3.000
2.500
2.000
2011
2012
2013
EU Monthly gasimport from Russia
Source: ABN AMRO Group Economics, IEA
2014
European gas price stuck in downward trend
The conflict between Russia, Ukraine and Western countries only had a shortlived impact on European gas prices. In our previous Energy Monitor
(‘Balancing on geopolitical territory’), we indicated that European spot prices
found support due to the unrest in Ukraine. Future prices were hardly affected.
This was a first sign that the market was confident that the conflict would not
have a dramatic effect on Russian gas deliveries to Europe. The impact on the
spot market was limited to an appreciation of only 10%. In the weeks
thereafter, the rally was unwound. In fact, TTF gas prices even declined
further, reaching a low of EUR 20.00/MWh, the lowest point since the end of
2010. Also in the future markets the downward trend remained intact. The 12month TTF future price , after some sideways trading in December and
January, declined by 10% in February and March. This resulted in the lowest
price since July 2013. The drop in both spot and future markets are the result
of weak demand for gas following mild weather conditions, in combination with
large supplies (figure 1). These inventories will increase even further now
spring officially started. Only when temperatures become so high that demand
for cooling will increase, a price effect could occur. Interruptions in gas
deliveries from Russia to Europe if the current conflict intensifies, might lead to
price developments we are not taking into account here.
Call for less dependency on Russian energy
As a result of the conflict regarding the Russian annexation of Crimea and the
imposed sanctions against Russia, the call to reduce Europe’s dependency on
Russian energy came to the fore again. Recently, European leaders decided
in Brussels to look for alternatives. Against this background, a trans-Atlantic
trade deal with the US might be arranged. In 2013, 30% of the gas supply in
Europe came from Russia. This is equal to some 57.400 million cubic meter of
gas (source IEA). Especially countries in Central- and South-Europe are very
dependent on the relatively cheap, Russian gas. Remarkable is the request of
four Central-European countries to President Obama to make it easier for
European companies to get permission to export Liquefied Natural Gas (LNG)
from the US to Europe. The Visegrad 4 (Czech Republic, Poland, Slovakia
and Hungary) want to further diversify its energy mix, but even more
important, more diversification in their energy suppliers. As a result, the
Visegrad 4 would become less vulnerable to the possible capriciousness of
one supplier. The request was remarkable as in the past few years, gas
deliveries from Russia to Poland and Slovakia increased significantly. These
higher imports in Poland and Slovakia contributed to the fact that gas prices in
Europe maintained their downward trend. The rise of gas imports occurred
even despite the lessons learned during the 2009 conflict between Russia and
Ukraine. That conflict did affect the gas deliveries to Europe substantially.
Are there alternatives?
In the search for alternatives for Russian energy we will not focus on oil
and coal. Russian oil and coal are relatively easy to replace with oil from
the Middle East and coal from the US. Therefore the only effect to be
2
Energy Monitor April - A Russian marriage of convenience
Table 1: ABN AMRO oil and gas price forecast
(Oil prices in USD/barrel, Gas prices in USD/mmBtu)
Price
Q2 2014
Q3 2014
Q4 2014
2014*
2015*
Brent
100
95
100
100
95
95
90
95
95
90
4.25
4.00
4.25
4.25
4.75
WTI
NG**
Source: ABN AMRO Group Economics
* year average ** Natural Gas Henry Hub
(Please see our Quarterly Commodity Outlook for details
regarding our longer term forecast)
Figure 3: Global LNG exports per country (in %)
Others
22%
Qatar
32%
Algeria
5%
Trinidad
6%
Indonesia
8% Nigeria
Australia
9%
Malaysia
10%
8%
Source: International Gas Union, ABN AMRO Group
Economics
Figure 4: Global LNG imports per country (in %)
Others
20%
Japan
37%
UK
4%
Taiwan
5%
India
6%
Spain
6%
China
6%
South
Korea
16%
Source: International Gas Union, ABN AMRO Group
Economics
4 April 2014
expected is a small rise in transportation costs. The biggest challenge will
be replacing, or at least reducing, gas imports from Russia. Many
professional market participants buy their Russian gas on the futures
markets and committed themselves to buying Russian gas via long-term
contracts (> 10 year). This in itself means that a rapid drop in dependency
on Russian gas is not very likely. Russia, in turn, is strongly dependent on
gas sales to Europe, which makes it very unlikely that it will reduce or even
stop the gas flows to Europe. From a European perspective, there is an
interest in maintaining these long-term contracts as the financial safety
allows Russia to invest large amounts in gas pipeline infrastructure. By
reducing such contracts, the quality of gas infrastructure will be put on the
line. The question politicians should raise is whether such a drop in quality
is desirable. Nevertheless, politicians are currently looking into alternatives
that, in the end, could be used to reduce the dependency on Russian gas.
LNG: frozen gas from another continent
Replacing Russian gas by other types of gas seems the most logical
solution. Shale gas could be one of the possibilities. However, as long as
there is no test drilling done in Europe, it is impossible to know whether that
would be an economic sound decision. In the Netherlands, the government
recently even ruled out the possibility to raise gas production. An increase
of gas imports from the UK and/or Norway is only possible for a very small
amount of gas. Therefore, the most obvious alternative in gas is LNG, a
methane that becomes liquid when it is cooled to minus 162 degrees
Celsius and therefore can be easily transported by ship over large
distances. Nevertheless, a rapid switch to LNG is not very likely for several
reasons.
The first reason is infrastructure. Currently, there is a global LNG
production capacity of 281 MT (which is similar to about 387.628 million
cubic meter). Almost 70% of this volume is tied up in long-term contracts.
The remaining part of 116.288 million cubic meter, is traded at the spot
market. In 2012, Asian clients were good for 72% of spot trading. This
percentage is expected to have risen further in 2013, and this trend may
not stop here. Japan is with 87.3 MT by far the largest importer of LNG,
after the closure of most nuclear power plants following the Fukushima
disaster. Even if Europe succeeded in buying a large share of the needed
gas volume on the LNG spot market, it would quickly run into the next
problem. The number of LNG terminals in Europe is limited. Several
terminals are being built (France, Poland, Italy and Spain) and existing
terminals have some spare capacity. However, whether that is enough to
cope with a fast rise in LNG demand can be questioned. Furthermore, the
infrastructure to transport LNG further into Europe is not optimal.
Besides infrastructure, there is the argument of pricing. Last year, Poland
reached an agreement with Qatar for the delivery of LNG. In their drive to
diversify suppliers, Poland was willing to pay over 30% more for LNG than
it would have paid for Russian gas. LNG is significantly more expensive
than Russian gas, due to the costs of liquifidation, transportation and
conversion back to gas. Most LNG contracts are closed for several years.
Therefore, the available volume at the spot market is limited. A huge
increase in demand at the spot market would automatically lead to a jump
in prices. At this moment, it is forbidden in the US to export fossil fuels.
Nevertheless, there are more and more voices pleading for legalisation of
US exports to stronger benefit from current gas and oil supplies. At this
moment, a few permissions are given to export a limited amount of LNG to
Europe. If the US would be willing to increase its LNG exports significantly,
this would go hand in hand with higher costs. Although US gas prices are
3
Energy Monitor April - A Russian marriage of convenience
Figure 5: Coal prices (ARA) and carbon allowances
(x tonne)
140
20
18
120
16
100
circa 50% lower than European prices, US prices would be increased with
the costs of transport and transformation. Nevertheless, LNG suppliers will
prefer to sell their LNG in Asia, as this is more lucrative. More than 50% of
the yearly-traded volume LNG is imported by Japan and South Korea.
Demand in Asia for LNG is high, and still rising, even despite high
transportation costs. If the US decides to increase its LNG exports, Europe
will have to reach into its pocket to prevent all LNG to be shipped to Asia.
14
12
80
10
60
8
6
40
4
20
0
2010
4 April 2014
2
0
2011
Coal (ARA) l.a.
2012
2013
2014
Carbon allowance r.a.
Source: Thomson Reuters, ABN AMRO Group Economics
Coal: an alternative due to large inventories and low carbon price
Coal could be another alternative for Russian gas. Coal production in
Europe is substantial and the proven reserves are gigantic. The coal price
has been in a downward trend for several years. Moreover, there is a
possibility of further increasing the already significant coal imports from the
US. As a result of the use of shale gas in the US, the domestic industry
changed its focus to coal exports. Now that the US dollar is relatively weak
and prices of coal and carbon are very low, importing coal from the US
becomes interesting for European utilities. However, the main question is,
how much extra capacity can be handled in existing coal plants. As a result
of low coal and carbon prices, several gas plants were switched off and
most coal plants are fully in operation. Building new coal plants would take
many years.
The burning of coal has one other great disadvantage: a further rise in
carbon emissions. This would not only be a reversal of the trend seen in
previous years. It would also make it almost impossible to reach the
ambitious carbon-reduction targets. Therefore, coal is an easy, but less
desirable alternative for Russian gas.
The prices of carbon allowances are extremely low. The huge overcapacity
in allowances (mostly provided for free) resulted in a drop in prices. During
the second quarter of 2013, the price even dropped to a low of EUR
4.29/tonne. Hope for a stricter policy, comments by German Chancellor
Merkel, and the agreement of a back-loading plan to reduce the
outstanding number of allowances triggered a price rally towards EUR
7/tonne. Nevertheless, due to the lack of further measures, investors lost
faith and pushed prices back to a low of EUR 4s/tonne. To make things
clear: to make the Emission Trading Scheme (ETS) actually work and to
reduce carbon emissions, carbon allowance prices should appreciate to
levels between EUR 30-40/tonne. Up til then, the use of coal remains
financially interesting for European industry
Nuclear energy in downward trend
Nuclear energy is a method of energy generation which does not result in
carbon emission. It is therefore considered a form of clean energy.
Nevertheless, nuclear energy clearly involves extra risks. The risk of a similar
earthquake and tsunami as in Fukushima, Japan, in 2011 is extremely small.
But still, the risk of a nuclear disaster is present, with all possible
consequences. As a result of the Fukushima disaster, Germany, Belgium and
Switzerland decided to phase out the use of nuclear energy. In March 2011,
the federal government in Germany decided to reverse its decision to extend
the duration of nuclear plants. Furthermore, eight nuclear plants were closed
immediately and the energy production at the remaining nine nuclear plants
will be reduced gradually. At this moment, there are 151 operational nuclear
power plants in Europe. These power plants have a total net capacity of
roughly 140.000 MW. France has, by far, the largest capacity (over 63.000
MW) and the most nuclear power plants (58). There is some capacity
available after recent closures, but this is limited. On top of that, restarting
these nuclear power plants would be against the current public opinion and
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Energy Monitor April - A Russian marriage of convenience
Figure 4: Number of operational nuclear power
plants in Europe
70
60
50
40
30
20
10
0
UK
Ukraine
Switzerland
Sweden
Spain
Slovenia
Slovakia
Romania
Netherlands
Hungary
Germany
France
Finland
Czech Rep.
Bulgaria
Belgium
Nuclear powerplants Europe in operation
Source: European Nuclear Society (ENS), ABN AMRO Group
Economics
4 April 2014
less desirable from a social perspective.
Renewable energy: slow and not economic without subsidy
Renewable energy is often seen as the alternative for energy imports. Also in
the discussion about reducing Europe’s energy dependency on Russia, many
people see renewable energy as the ultimate solution, especially for power
generation. In recent years, we made great progress. Solar energy capacity
has been rising for many years. Wind energy sees strong growth too, but this
growth strongly depends on subsidies. Replacing Russian gas imports by
renewable energy seems therefore not realistic. The long lead time of projects
makes it impossible to generate enough extra capacity of renewable energy to
make gas imports unnecessary. The average lead time for an offshore wind
park is five to seven years. Given the huge amount of subsidy that is currently
necessary to create capacity of wind energy, much more money is needed to
create even more capacity. That would result in a jump of the wind energy
cost price. All in all, extra capacity in renewable energy will not result in an
energy volume that is sufficient to replace Russian gas, in terms of quantity as
well as costs.
Enough alternatives, but not for now
To summarize, there are enough alternatives for Russian gas. However, all
alternatives come with a burden. LNG’s limited availability makes it expensive.
On top of that, there is a lack of infrastructure. Coal supplies are immense,
making coal a cheap alternative. However, an increase in the use of coal
would interfere with European carbon reduction targets. Expanding nuclear
energy is possible, but from a social perspective undesirable. Finally,
expanding the capacity of renewable energy further in the very near term is
not possible. As a result, Europe faces a moral-political dilemma. Apart from
the legal consequences of breaking long-term contracts for gas deliveries, it is
possible to reduce the dependency on Russian gas in the near term.
However, there is a price tag attached to that. It is either expensive, dirty, or
risky. We do not believe that European leaders will make radical choices in
the current circumstances. This also explains why European leaders are
careful in imposing sanctions on Russia. To focus on energy efficiency and
invest more in innovation on behalf of renewable energy (increase
performance, develop storage of solar- and wind-energy, as well as reducing
the usage of rare metals such as lithium and indium) seem the most logical
solutions to reduce Russian gas imports. Up til then, it seems that Europe is
stuck in a marriage of convenience when it comes to an important part of our
energy supply.
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Energy Monitor April - A Russian marriage of convenience
4 April 2014
Group Economics | Commodity Research
Hans van Cleef
Senior Energy Economist
tel: +31 (0) 20 343 4679
hans.van.cleef@nl.abnamro.com
Group Economics
Commodity Research team
Marijke Zewuster (Head)
tel: +31 20 383 0518
marijke.zewuster@nl.abnamro.com
Hans van Cleef (Energy)
tel: +31 20 343 4679
hans.van.cleef@nl.abnamro.com
Casper Burgering (Ferrous, Base metals)
Georgette Boele (Precious metals)
tel: +31 20 383 2693
tel: +31 20 629 7789
casper.burgering@nl.abnamro.com
georgette.boele@nl.abnamro.com
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