The European natural gas market during the energy crisis

The European natural gas market underwent major changes in 2021–2022, both in terms of prices and the supplier structure. After Russia’s invasion of Ukraine, the European Union tried to rid itself quickly of its strong dependence on natural gas supplies from Russia. As a result, imports of natural gas in liquefied form (LNG) increased rapidly and strengthened further. This put pressure on the inadequate gas infrastructure in Europe and raised concerns about whether it would be possible to secure sufficient gas supplies for the operation of industrial firms. The European administration thus put pressure both on industry and households to reduce gas consumption. Thanks to huge savings and milder weather, EU countries managed to get through winter 2022/23 without any major problems, but in the absence of supplies from Russia, the European market will also remain tight in the years ahead.

Published in Global Economic Outlook – May 2023 (pdf, 1.3 MB)

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Introduction

The European natural gas market started to change gradually from about 2010. The last ten years saw structural changes in the global natural gas market amid an ever-increasing excess of supply over demand (due, among other things, to the shale revolution in the USA). Europe had sufficient supplies of pipeline gas from Russia, Norway and Algeria, and more and more LNG, which had not been sold in other parts of the world, was also ending up in Europe. The gas spot prices were thus mainly on a downward trend and were mostly below the prices of standard long-term contracts indexed to the oil price at the time. Therefore, buyers gradually put increasing pressure on traditional suppliers to allow spot market prices of gas (which mainly reflect the current fundamentals in the gas market) to be taken into account in the prices of long-term contracts in addition to the oil price. In the end, most contracts in Europe were decoupled from the price of oil, and the price was derived exclusively from gas market prices, even for long-term contracts. This is described in more detail in GEO 2022/03.

However, the beginning of this decade saw a major turnaround. Global demand for natural gas grew strongly due to its low price and the growing possibility of supplying LNG even to regions far from the extraction sites. Natural gas also became a welcome alternative for reducing CO₂ emissions. Moreover, gas-fired power stations increased in importance as a flexible reserve source for wind and solar power plants, whose production capacity is growing rapidly but which are unstable in terms of output. One-off factors, which were described in more detail in the aforementioned issue of the GEO, also contributed to the strong demand surplus in 2021. The price of natural gas in Europe and Asia thus began to grow strongly in 2021, which also led to strong growth in electricity prices.

At the end of February 2022, the situation on the gas market was further exacerbated by Russia’s military invasion of Ukraine. Supplies of Russian pipeline gas to the EU had already weakened gradually during 2021 due to Russia’s unwillingness to sell gas on the spot market and EU Member States’ unwillingness to conclude new long-term gas import contracts. In 2022, the reduction in Russian pipeline gas supplies to Europe was mainly a reaction to EU sanctions against Russia. European countries thus had to quickly get rid of their strong dependence on Russian gas and began to look for alternative sources. This brought about a rapid change in the structure of natural gas suppliers to Europe (while there were no significant changes in supplier-customer relations in the rest of the world^[1]).

As a result of these factors, LNG imports to Europe have also risen sharply. However, LNG imports were putting initially under considerable pressure the inadequate European gas infrastructure. At the same time, Europe moved from the role of recipient of residual LNG to the opposite, where its increased demand for LNG imports became a driving force behind the growth of global prices of this raw material. There were widespread concerns of an energy crisis in Europe, to which the European administration responded with increased pressure to reduce natural gas consumption across the economy. In the following sections, we will describe in more detail the development of natural gas prices both in the longer term and in the past two years. We will also look at the changes that have occurred in the EU in connection with the reduction of natural gas imports from Russia. Next, we outline the extent of savings that have occurred in Europe both as a result of concerns about gas shortages and due to high gas prices. Finally, we will try to make a rough estimate of the increased costs currently facing European customers due to the previous transition to market prices of natural gas.

Import prices of natural gas to Europe

For the purposes of this article, we will derive prices from Eurostat’s customs statistics. Natural gas is traded in many trading venues and this results in the different prices we can observe for a given period. For example, prices at Europe’s largest trading hub (Title Transfer Facility, TTF) tend to be lower than prices on the Central European exchange (Power Exchange Central Europe, PXE). They may also be spot prices or futures prices with delivery typically in the next month, quarter or year. However, there are also a number of differently defined publicly traded contracts and many contracts whose data are not public. Therefore, we try to use the price derived from Eurostat’s customs statistics in this study. It is calculated on the basis of the declared imported quantity (in hundreds of kg) and the declared value (in euro) and converted to the commonly used unit EUR/MWh. Due to the different physical properties of natural gas imported from different regions (see Table 1), the conversion from weight units to energy content is only indicative. Here, a coefficient of 13.6 kWh/kg was used in the conversion.

Table 1 – Physical characteristics of natural gas

Source: https://www.tzb-info.cz/
Note: density at 20 oC and normal pressure, calorific value at 15 oC and normal pressure.

Chart 1 shows the average import prices of pipeline gas and LNG to the EU from the rest of the world. For comparison, we also included the total average import price of natural gas to Europe, as published by the World Bank (this statistic was previously published by the IMF). 

Chart 1 – Average prices of imported natural gas into the EU27
(EUR/MWh)

Source: Eurostat, World Bank and author’s calculations.
Note: Average import price according to the World Bank brought forward by one month. The grey area is the forecast based on futures contracts.

The average import prices differed from market (exchange) gas prices until around 2010. The majority of imports were based on long-term contracts, indexed to the price of oil. However, in the last decade, with the decline in market gas prices, an ever-increasing share of gas was imported into the EU based on those market prices, leading to a convergence of World Bank data with exchange prices. In the last few years this data series has been practically mirroring the futures contract price for the coming month at the TTF trading hub.

The price of imported LNG was slightly higher than that of pipeline gas and fluctuated more for most of the period under review (see Chart 1). This may be because contract prices for the import of pipeline gas tend to be smoothed by several-month moving averages. Chart 1 also shows the dramatic rise in gas prices that has occurred since early 2021 as a result of the events described above. According to the futures contracts, we can only expect a more marked drop in natural gas prices in 2025, when significant new LNG production capacity should be put into operation (especially in Qatar and the USA).

The prices of imported gas can differ quite significantly across individual EU countries. There was considerable convergence within the EU between 2017 and 2019 alone. Conversely, we see a massive increase in the differences in prices around the European average from 2021 onwards. In this period, the Czech Republic and Spain showed mainly lower import prices. By contrast, import prices in Slovakia, Slovenia and Greece were significantly above the European average (unfortunately, Eurostat does not publish individual data, for example, for Germany). Given the EU’s plan to unify natural gas purchases as much as possible, import prices in individual countries might be expected to converge again in the future.

Imports of pipeline gas from countries outside the EU

Imports of pipeline gas to the EU decreased substantially from around October 2022 onwards. There was already a drop in the amount of pipeline gas imported from Russia^[2] to the EU in 2021 Q4 (see Chart 2) but this decrease was initially offset by increased imports from the UK, Norway and Azerbaijan, while supplies from Algeria were flat, remaining close to their all-time high. However, there was a significant drop in pipeline gas supplies to the EU after the Nord Stream gas pipeline was completely shut down. Italy, Belgium, Spain, Hungary, Greece, Ireland, Bulgaria and Slovakia were among the largest importers of pipeline gas from outside the EU in 2022. We can assume that Germany and Poland would also be on this list, but individual data for these countries is not included in Eurostat’s customs statistics. In the case of other EU countries importing pipeline gas, this involved trade within the EU.

Chart 2 – Amount of imported pipeline gas to the EU by country of origin
(TWh/month)

Source: Eurostat, author’s calculations.

Imports of liquefied natural gas

The amount of LNG imported to the EU has reached record highs since the start of 2022. Imports of LNG from the USA, which have been growing strongly since 2019, accounted for a major share of the total (see Chart 3). However, imports from Russia have also recorded strong growth since 2018. Other important exporters of LNG to the EU include Qatar and Nigeria, while smaller volumes are currently imported from Algeria, Egypt, Trinidad and Tobago, and Norway. Imports from Angola have also grown strongly in recent months.

Chart 3 – Amount of imported LNG to the EU27 by country of origin
(TWh/month)

Source: Eurostat, author’s calculations.

The southern and south western European countries are traditionally the largest importers of LNG in Europe. Spain, France and Italy imported liquefied natural gas as far back as the 1990s, as did Belgium. Later, Portugal, Greece, the Netherlands, Croatia, Lithuania, Finland and Ireland gradually followed suit. Apart from the EU countries, the UK is also currently importing large volumes of LNG, which it can then send via pipeline to north western Europe. Some countries, such as Germany, France and Poland, do not publish data in these statistics.

The strong and growing imports of LNG from Russia is a problem for the EU. Unlike pipeline gas, Russian LNG is not subject to EU sanctions yet. In 2022, the largest importer of Russian LNG was Spain, which has a long-term contract with Russia to import LNG until 2038. Other large importers of LNG from Russia are Belgium and France. LNG exports from Russia to Europe increased by 30% in 2022. Imports to Spain have increased by as much as 84% since the start of the war in Ukraine, when the country reduced its traditional imports from Algeria due to diplomatic disputes. The European administration is putting pressure on Member States to limit LNG imports from Russia as much as possible and not to conclude new contracts. However, this represents another risk in securing sufficient natural gas supplies to Europe in the future.

Savings in 2022

During winter 2022/23, concerns about a critical shortage of natural gas in Europe did not materialise, due mainly to a pronounced drop in consumption. This was recorded for both households and industry. According to the IEA (IEA, 2023c), overall consumption of natural gas in the EU last year fell by a total of 13%, i.e. 55 billion m³ (bcm), compared to 2021. Household and business consumption from the distribution network fell by 28 bcm (17%). Of this, a saving of about 18 bcm can be attributed to a milder winter (with 12% fewer ‘heating degree days’). In addition, an increase in heating efficiency and the transition to alternative fuels brought an estimated saving of 10 bcm. Demand from industry was reduced by about 25 bcm (25%) by limiting production and/or the transition to alternative fuels, especially in gas- and energy-intensive sectors.

Nonetheless, gas consumption in the energy sector remained relatively stable last year. There was no reduction of natural gas consumption in electricity generation despite high growth in gas prices, the drop in total electricity consumption and increased output of coal, solar and wind power plants. This was due to reduced hydro power generation and massive outages at French nuclear power stations, when a large proportion of their reactors had to be shut down due to technical problems. The situation with the French nuclear power plants has partially improved this year, but their outages still pose a risk of increased natural gas consumption in Europe.

Outlook

The International Energy Agency (IEA) has warned that the situation on the global gas market will also remain tight in 2023. The agency reduced its estimate for the potential shortage of natural gas in the EU for 2023 compared to its December estimate (IEA, 2022c) in a crisis scenario from 57 to 40 bcm (due to the milder weather last winter and high LNG supplies). Therefore, European gas stocks are at historically high levels ahead of this year’s replenishment season and according to BloombergNEF, storage capacity will be filled to the required 90% by the end of October 2023. However, according to the current forecast (IEA, 2023a), the market will face a large number of uncertainties and exogenous risks. There is still a need to save gas in Europe. The key points of the IEA’s baseline scenario for the 2023 global gas market are summarised in Box 1.

 

It will not be possible to rely on Russian gas supplies this year. Limited amounts^[3] of Russian gas are still flowing through pipelines via Ukraine and Turkey, but these supplies can be unilaterally interrupted at any time. A large amount of LNG, which is not yet subject to sanctions, is also imported into Europe from Russia^[4]. However, the European administration is putting pressure on private companies to limit these imports too. If there was a ban on imports of Russian LNG, figuring out how to replace this amount from other sources would pose yet another challenge to the EU. 

Future demand from China is still a major unknown. IEA estimates for extreme scenarios of 2023 LNG consumption in China differ by 40 bcm, i.e. 8% of total consumption in Europe. Wood Mackenzie analysts, for example, do not however expect China’s demand for LNG this year to exceed the peak observed in 2021 due to rising domestic natural gas output and continued growth in pipeline gas supplies from Russia. However, lower gas prices will probably awaken the interest of smaller Asian countries in the import of LNG, which will increase competition among customers on the global market.

There are indications that gas consumption in industry is increasing again this year in Europe. This is particularly the case for Spain, the Netherlands and France and has occurred mainly in refineries and petrochemicals where different energy sources can be more easily substituted for one another. This could drive gas prices up again. On the other hand, however, many firms already moved part of their energy-intensive production capacity from Europe to other regions with lower energy prices last year, and it is unlikely that they will return.

The current relatively low gas prices and the high price of emission allowances also lead to increased interest in the use of gas for electricity generation. In Germany, gas-fired power plants with an efficiency of 55% and steam-gas units with an efficiency of 59% are already able to effectively replace older black coal units with an efficiency of 38% or newer black coal power plants with 40% efficiency at current prices (Vobořil, 2023).

Last but not least, there is the risk of climate change, which increases the likelihood of protracted periods of drought. The lack of precipitation thus reduces the production of electricity from hydroelectric power plants, while also leading to a drop in water flow levels. This, on the one hand, limits the transport of coal to coal-fired power plants and on the other hand reduces the amount of available cooling water, which limits the maximum production of thermal power stations. That said, according to meteorologists, for example, this year’s seasonal snow cover in the Alps was the lowest since 2017.

Results of the liberalisation of the European gas market from the perspective of recent developments

It was beneficial for customers to transition to market (exchange) prices at a time when there was an excess of gas on the market. Hošek (2022) discusses, among other things, the benefits and costs for European customers of moving from (long-term) contracts indexed to oil prices to shorter-term contracts whose prices are based solely on market prices of natural gas. He cites an IEA study (Zeniewsky, 2021), which admitted that the liberalisation of the gas market exposed European consumers to greater price volatility, but on the other hand saved them up to EUR 70 billion in gas imports in the past decade. However, the data ends in 2021, in which there was already a strong increase in natural gas market prices. It deprived European consumers of a significant part of their previous savings in a single year. In 2022, tensions on the global natural gas market heightened further, leading to additional strong growth in gas prices. We will therefore now try to estimate how the price of contracts derived from oil prices would develop and whether trading based on market gas prices is still beneficial for the European customer.

It is practically impossible to accurately quantify the hypothetical price of natural gas contracts linked to the price of oil. The main problem is that the details of the previous contracts, indexed to oil prices, are not publicly available. For our purposes, we simulated this price for the period under review using a model of the relationship between average gas prices in the EU and the Brent price. To specify the model and estimate its parameters, we only used the period from 2000 to 2010, when the large majority of contracts for the import of gas to Europe were still based only on the price of oil. The estimated model was then used to simulate hypothetical contract prices linked solely to the oil price in the following period, when price mechanisms were gradually adjusted so that they partially and later fully take into account the market prices of natural gas. We then compared the hypothetical prices calculated with the actual market import prices arising from Eurostat’s customs statistics. The calculation also includes several years of forecasts.

The liberalisation of the European gas market in the last decade led to lower prices for consumers but ...

While our calculations (see Chart 4) are only indicative^[5] and qualitative in nature, we can conclude that savings for European consumers through the liberalisation of the European gas market over the last decade may very quickly disappear (if this has not happened already). Efforts by the European administration for a rapid transition to renewable energy sources lead in the medium term to an increased need for natural gas to fuel reserve gas power plants. Their counterbalancing role cannot yet be effectively replaced on a larger scale by, for example, battery storage or the production of green hydrogen. The unwillingness to conclude longer-term contracts for the import of gas, also stemming from the strategy of transition to renewable energy, will probably lead to higher costs of importing natural gas into the EU as a result of higher market prices of gas, at least during the transition period. The question then is whether the liberalisation of the gas market was not premature and whether the falling price of electricity from renewable sources will be able to offset the higher costs of ensuring the necessary supplies of natural gas to the EU in the transition period.

Chart 4 –  Comparison of gas import costs in Europe
(prices in EUR/MWh, import costs in EUR billions/month – right-hand scale)

Source: Eurostat, author’s calculations.
Note: The hypothetical difference between gas import costs based on current import prices and costs in the case of 100% oil-indexed prices

Conclusion

The natural gas market has become highly globalised in the last decade. This was due to the rapid growth in supply (shale gas output in the USA) combined with the increased availability of LNG virtually anywhere in the world. Regions, which were previously isolated, are now connected, thus fostering natural gas price convergence. At the same time, however, supply or demand shocks in one area have an effect on other regions as well.

Natural gas prices in Europe hit record highs in the context of the outbreak of the conflict in Ukraine. In 2022, Europe therefore became a premium market, attracting massive LNG supplies which were supposed to offset the sharp decrease in pipeline gas exports from Russia to the EU. Strong demand from Europe also pushed LNG spot prices for the Asian market to historical highs. This led to a reduction in price-sensitive demand, especially in emerging Asian economies, and enabled the EU to obtain sufficient LNG supplies in 2022, refill its gas storage facilities and get through winter without any major problems. At the same time, however, there was a substantial and evidently long-term increase in natural gas import costs to the EU.

The global market will remain tight at least until 2025, owing to the decrease in Russian pipeline gas exports. European gas storage facilities remained fuller than usual after this winter and there have been significant savings in consumption, but the risk of limited supplies and extremely high gas prices has not been fully averted yet. More substantial growth in LNG production capacity (especially in the USA and Qatar) is not expected until 2025. The gas market will thus be volatile and sensitive to potential production outages in the coming years. The situation on the gas market is currently calm, but we cannot expect another significant drop in gas prices for the next few years.

Therefore, some of the forecasts regarding the consequences of the liberalisation of the European gas market have materialised. More than ten years ago, Melling (2010) predicted that large monopoly suppliers would regain their market power and the ability to influence the price of natural gas due to renewed growth in global demand. Some large suppliers remain unwilling to supply gas on the basis of short-term contracts and spot prices, as this means increased risk for them. China has recently understood that due to its growing dependence on LNG imports, it is beneficial for it to enter into long-term contracts which guarantee stability of supply and relative price stability. At the same time, it can use price volatility on the spot market to its advantage by redirecting part of its contracted gas back to the international market and meeting domestic demand from other sources (e.g. coal) in the event of a strong price increase. By contrast, it can increase domestic gas consumption if the spot market prices of gas are low. Conversely, the EU is avoiding concluding long-term contracts, which exposes it to the risk of supply shortages and strong price volatility on the spot markets. It will also most likely pay higher prices on average for gas imports than large buyers in other regions of the world (at least in the medium term).

Author: Jan Hošek. The views expressed in this article are those of the author and do not necessarily reflect the official position of the Czech National Bank.

References

Hošek, J. (2023): Developments in the European natural gas market, Global Economic Outlook 03/2022, Czech National Bank

IEA (2022a): Gas Market Report, 2022 Q3, July 2022, https://www.iea.org/reports/gas-market-report-q3-2022

IEA (2022b): Gas Market Report, 2022 Q4, October 2022, https://www.iea.org/reports/gas-market-report-q4-2022

IEA (2022c): How to avoid gas shortages in the European Union in 2023, December 2022, https://www.iea.org/reports/how-to-avoid-gas-shortages-in-the-european-union-in-2023

IEA (2023a): Background note on the natural gas supply-demand balance of the European Union in 2023, February 2023, https://www.iea.org/reports/background-note-on-the-natural-gas-supply-demand-balance-of-the-european-union-in-2023

IEA (2023b): Gas Market Report, 2023 Q1, February 2023, https://www.iea.org/reports/gas-market-report-q1-2023

IEA (2023c): Europe’s energy crisis: What factors drove the record fall in natural gas demand in 2022?, March 2023, https://www.iea.org/commentaries/europe-s-energy-crisis-what-factors-drove-the-record-fall-in-natural-gas-demand-in-2022

Melling, Anthony J. (2010): Natural gas pricing and its future, Carnegie Endowment for International Peace https://carnegieendowment.org/files/gas_pricing_europe.pdf

Vobořil, David (2023): Klesající ceny plynu v Evropě způsobují nahrazování uhlí plynem při výrobě elektřiny, OEnergetice.cz, březen 2023, https://oenergetice.cz/nemecko/klesajici-ceny-plynu-v-evrope-zpusobuji-nahrazovani-uhli-ve-vyrobe-elektriny-plynem

Zeniewsky, Peter (2021): Despite short-term pain, the EU’s liberalised gas markets have brought long-term financial gains, IEA commentary, 22 October 2021. https://www.iea.org/commentaries/despite-short-term-pain-the-eu-s-liberalised-gas-markets-have-brought-long-term-financial-gains

Keywords

Natural gas, LNG, oil indexation

JEL Classification

D40, D43, L10, Q40

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^[1] The exception was China, which started to conclude long-term contracts for the import of LNG on a larger scale, while making favourable purchases on the spot market earlier. The gas purchased on the basis of long-term contracts is then consumed by China itself if the market price is low. If prices are are high, it is returned to the global market (and coal, for example, is used for domestic consumption instead). China is thus increasingly performing a balancing act between global demand and supply in several commodity markets, including LNG.

^[2] The import volumes are drawn from Eurostat’s customs statistics and may in some cases be lower than the actual values, as the customs statistics do not include data for some countries. Nonetheless, the data are sufficient to illustrate the trend.

^[3] According to the European Commission, the share of Russian gas in total EU consumption decreased from 40% in 2021 to less than 10% at the end of 2022.

^[4] While pipeline gas supplies to Europe have decreased dramatically, imports of Russian LNG have increased, accounting for 14% of total LNG imports to the EU last year.

^[5] Chart 4 shows only the import of pipeline gas into the EU27. The results for imported LNG are similar. The total annual figures are lower in absolute value than those given in, for example, Zeniewski (2021). This may be explained by the fact that Eurostat’s customs statistics, from which the data is drawn, indicate smaller import volumes for the EU27, as figures for some big countries are missing. However, their qualitative message is similar.