In 2017, Europe imported a record amount of natural gas: Russia’s exports rose by 8 percent, reaching an all-time high; Norwegian pipeline exports reached an all-time high as well, up 7 percent; pipeline imports from North Africa were slightly down, but imports of liquefied natural gas (LNG) rose by 16 percent—but still below their 2011 peak. Higher imports came largely from higher demand. After a decade of almost steady decline, gas demand in Europe has risen three years now—a major reversal. Europe pulled in more gas from most major suppliers since there are no longer any systematic differences in pricing among them. Invariably, the headline take-away is likely that Europe became more dependent on Russian gas, which is true but also beside the point. The real take-away is that demand rose—and that a continent that will rely more on gas needs to remove the final obstacles in the way of a fully functioning internal market.
Higher Demand Drove Imports
From 2004 to 2014, indigenous production and gas demand declined in tandem so Europe’s import needs did not change much. Since 2015, however, production has fallen, while demand has recovered. Through September 2017, demand in the Europe of the Organization for Economic Cooperation and Development (OECD) was up 7.5 percent driven by increases across Europe and Turkey—which, after two years of decline, showed substantial growth. It is this demand growth that drove imports.
From 2004 to 2014, about half the decline in gas consumption came from fuel switching: gas use fell by 21 percent, while total energy use fell by 12 percent (the true extent of fuel switching is greater because some of the decline in energy use came from the transportation sector, where gas use is marginal; so, the market share of gas fell by more in other sectors). From 2014 to 2016, the rebound in gas demand was mostly due to a rising market share: total energy use in Europe grew by just 2 percent, but gas grew by 12 percent.
We do not have the full numbers for 2017 yet, but we can observe a mix of cyclical and structural drivers behind the boom in gas use.
In Spain, just over half the 9 percent rise in gas use came from power, but only because hydroelectric output was at its lowest point since (at least) 1990. Gas rose, but so did coal, while overall power generation was flat. The rest of the rise in gas demand came from industry, courtesy of an improved economy.
In Italy, just over half the increase came from power as well. Hydroelectric power underperformed in Italy, but the country also boosted overall generation and demand (net imports fell). There was also a stronger pull from industry, although absolute gas demand in industry remains far below its levels a decade ago.
In the United Kingdom, gas declined across the board. Gas had received a boost after the government placed a hard floor on carbon prices, which led to significant switching from coal to gas. But after this initial push, gas stabilized and fell in 2017, as renewables, especially wind, grew. Outside power, gas demand was down slightly.
In France, demand grew modestly: it fell in the residential and commercial sectors due to warmer weather, but it grew among large users. In power generation, gas benefited from another weak year for nuclear and, especially, a very low year for hydroelectric power (whose output declined by about a fifth).
In Germany, gas consumption rose by about 5 percent, driven by weather in the residential and commercial sectors; by improved economic activity in industry; and by weaker output from coal (-7 percent) and nuclear (-10 percent) in power, where gas and renewables grew.
In short, we see a mix of drivers across different European countries, some structural, others cyclical. But this is the third year in which European gas demand has risen: after a decade of nearly uninterrupted gloom, the European gas industry might finally cheer at these demand numbers, even if their durability is not clear at this point.
Pipeline Beats LNG—Sort Of
Europe pulled in more gas from Russia, from Norway, and via LNG—with Russia providing a bigger share of that added gas than Norway or LNG. Yet one could also say that Europe imported more gas wherever it could find it—all major supply sources, except North Africa, registered a sharp increase.
Price is a fundamental driver of where Europe draws its gas from, but not the only one. Infrastructure plays a role as well—the United Kingdom has different supply options than, say, Bulgaria. Deliverability is important too, being able to produce enough gas and at the right time; it is often easier to bring in more pipeline gas in short notice than it is to bring more LNG. And many other factors contribute too—which companies are importing the gas, what relationships they have, what contracts are already in place, and so on. So, price matters, yes—but Europe is far from a market where the cheapest gas always wins.
These caveats aside, there are two fundamental pricing realities that shape Europe’s supply mix. First, prices have largely converged over the past few years. A decade ago, Europe had a two-tier pricing system: some gas was priced according to market fundamentals in liquid hubs; and some gas, under long-term contract, was priced in formulae connected to oil. The gap between these prices was often sharp: in 2009, for instance, the price in the United Kingdom, Europe’s oldest hub, was ~40 percent lower than in Germany, whose border price is often used as a proxy for the continent given its diverse supply mix.
These gaps have been compressed, although they still exist. In 2017, those two prices were almost the same, at least on average, but there were still months where they diverged by as much as 20 percent. The gap between the export price earned by Norway and Russia has been similarly shrunk. On average, these two prices were similar in the 2000s but diverged in 2009–2010: in 2010, the average price of Russian gas was 15 percent higher than the average price of Norwegian gas. By 2016, that spread was just 6 percent (these prices are not strictly comparable since they include different delivery points and different end markets).
This compression in spreads has come about due to two changes. First, there has been a shift from oil indexation and toward hub-based pricing in long-term contracts. The International Gas Union estimates that two-thirds of Europe’s gas consumption in 2016 was priced according to market principles, up from 22 percent in 2007. This is largely the result of voluntary changes in pricing strategy or arbitration proceedings that introduced hub-based pricing in oil-indexed contracts and lowered the strength of the relationship between oil and gas prices (so that, at the same oil price, the gas price is lower). The other driving force toward convergence has been the drop in oil prices, which lowered the price of oil-indexed gas.
In other words, there is no longer a systematic divergence in European gas pricing. That said, and this is the second fundamental reality that shapes Europe’s fuel mix, there are sharp differences at the micro-level. As in most gas markets, average prices conceal substantial variations. The price of Qatari gas in Italy, for example, is ~20 percent cheaper than the price of Qatari gas in Spain. As a result, Algerian gas is similarly priced to Qatari gas in Spain but not in Italy, where it is more expensive. These small divergences are the product of contract terms and market forces, and they can shape a country’s supply mix choices in ways that are not obvious when looking merely at continent-wide trends.
But the bottom line is that Europe pulled in more gas from everywhere, because there are no longer systematic differences that would lead buyers, en masse, to prefer one supply source over another.
Looking beyond Russia’s Market Share
The European gas market is often caricatured as a space suffocated by Russian gas, where any additional non-Russian gas brings about major gains in energy security. From that lens, it is easy to see worrying signs—Europe needed more gas in 2017, and it turned, first and foremost, to Russia for that gas. We did not see a battle for market share in Europe, and certainly not one between American and Russian gas; instead, we saw most major suppliers boost exports to meet growing demand.
Importantly, this influx did not push down prices; rather, prices rose to attract more gas. On average, prices at Europe’s two largest hubs, in the United Kingdom and the Netherlands, rose by 25 percent in 2017 relative to 2016 (with a major rally in the fourth quarter). At the German border, through October 2017, prices were up 12 percent. We have yet to see Europe as a grand battleground where major suppliers are undercutting each other to gain market share.
These numbers also show the limit in relying too much on a single number—Russia’s market share in Europe—as a meaningful barometer for European energy security. Europe could have imported less Russian gas by burning more coal or by bidding up the price of LNG cargoes to lure them away from more attractive markets beyond Europe. It is not clear why such an outcome, while reducing Russia’s market share in Europe, would have entailed an improvement in energy security.
Similarly, continent-wide averages conceal areas where improvements in energy security did take place. Europe as a whole has never been overly reliant on Russian gas, and Europe’s supply picture is now more diverse than ever. But there are individual markets that rely too much on Russia; that are not resilient enough to cope with a disruption in Russian supplies; or that lack sufficient competition to put pressure on Russia to cut prices. Several markets, such as Lithuania and Poland, have made progress on that front, chiefly by relying more on LNG in 2017, even though this progress does not show on aggregate statistics.
The bottom line is that Europe’s gas market functions much better than it did a decade ago. It is more open and flexible, and there is more infrastructure, more competition, and more transparency than ever before. Yet the internal market remains incomplete: there are still regulatory barriers that prevent gas from flowing freely across countries; there are price disparities that cannot be explained by transportation costs alone; and, with the exception of the changes brought on by Nord Stream and by a few LNG import terminals, gas in Europe flows more or less as it did years ago.
Europe needs another regulatory push to resolve these obstacles. In some ways, the rising dependence on Russia might serve as a catalyst to see through these changes, although, often, the obsession with Russia’s market share leads Europe to champion projects with doubtful commercial merit (e.g., the Trans-Caspian or East Med pipelines) or leads to arguments that do little to boost energy security (like arguing over the regulatory regime that will govern Nord Stream 2). More auspiciously, one might see growing demand as the true story of 2017. After years of decline, gas is growing again, reaffirming the importance of the fuel for Europe’s energy future and acting as an impetus for the industry and policymakers to finally complete the internal market.
Nikos Tsafos is a senior associate with the Energy and National Security Program at the Center for Strategic and International Studies in Washington, D.C.
Commentary is produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).
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