In March this year, the European Commission presented a plan to reduce by two-thirds its reliance on Russian gas in 2022 in response to the war in Ukraine. Natural gas is the dominant source of energy for European households and constituted 21.5% of EU's primary energy consumption last year. The EU imported ~44% of its natural gas (25% of oil and 40% of hard coal imports) from Russia in 2021 highlighting the bloc's reliance on Russian energy and explaining policymakers' exigency to quickly reduce Russian exposure.
In retaliation to various European sanctions, Russia has been cutting off gas supply to the EU. Pipeline natural gas exports to Europe have been falling since H2-2021 and are now down almost 70% y/y. This gas shortage is exerting tremendous pressure on European households in the form of high inflation. Euro area inflation rate touched 10% y/y in September, the highest on record, due in large part to energy prices. Europe is facing substantial gas shortages and strategic measures are being planned to replace Russian gas.
The European Commission announced the REPower EU plan in May 2022 where it laid down concrete steps to reduce reliance on Russian gas.
REPower EU plan:
As part of REPower EU plan, the European Union plans to implement 1) energy savings, 2) diversify energy sourcing and 3) increase renewable energy generation to balance the demand and supply of energy in the bloc.
Within energy saving, the EU is encouraging citizens to reduce energy consumption through behavioral changes. Fiscal measures including VAT cuts for energy efficient heating and home appliance systems will be implemented. EU member states have pledged to reduce gas demand by 15% (compared to past five-year average) by March 2023. This is likely to be achieved through fuel switching, gas auctions between companies and awareness campaigns.
Within diversification of energy sourcing, the EU has established an energy platform for the common purchase of gas, liquified natural gas (LNG) and hydrogen on behalf of member states. A big clout of energy importing countries will aid the EU to negotiate better prices from suppliers. Demand pooling and collective international outreach to hydrogen and gas partners are other planned measures.
Within renewable energy generation, the EU plans to enhance capacity generation in order to power 45% of its energy needs from renewables by 2030. This will mean doubling solar energy generation capacity by 2025 and creating more wind energy capacity as well.
What has been achieved so far?
Energy saving:
As per Eurostat, the EU's energy consumption peaked in 2006 and has been declining since then indicating that the region is on the right track.
EU energy consumption (million tonnes of oil equivalent, Mtoe)
Extracted from Energy saving and demand reduction, published by the European Parliament, September 2022
The Energy Efficiency Directive set the goal to reduce EU's energy consumption by 20% in 2020. The EU exceeded this goal by 5.4% for final energy consumption. Despite post COVID-19 demand rebound, the bloc's fossil fuel consumption in 2021 was 5% below 2019 levels and followed 12% contraction in 2020. These statistics indicate that the EU does have the capability and intention to reduce energy consumption.
Diversification of natural gas and overall energy sourcing:
EU's gas consumption totaled 412 billion cubic meter (bcm) in 2021 of which domestic production stood at ~51 bcm and imports stood at roughly 342 bcm (83% of gas consumption). The rest was met by stored gas reserves and domestic production.
EU's gas consumption has risen in the past few years as countries have been shifting away from coal to decarbonize energy production.
Source: Eurostat
On the production side, domestic output has been falling since 2010 largely led by diminishing production in Netherlands' Groningen gas field. Earthquakes associated to production drilling forced the government to curtail activity. The Dutch government has set an output quota of 3.9 bcm for the year starting 1 October 2022, down significantly from 54 bcm in 2013.
EU natural gas production (bcm):
Source: Statista
Natural gas imports:
Natural gas imports have therefore picked up from 344 bcm in 2014 to 440 in 2019.
Of the EU's roughly 342 bcm gas imports in 2021, Russia supplied 43.5%, Norway 23.6%, Algeria 12.6% and the US 6.6%. Going forward, the EU is likely to raise gas imports from other nations.
Since March, global LNG exports to the EU rose 75% y/y as the bloc sought to diversify gas imports away from Russia. This is largely driven by the increase in imports from the US to 39 bcm in H1-2022 compared to 34 bcm in all of 2021. In June 2022, the EU signed deals with Egypt, Israel and Azerbaijan to import natural gas. Azeri gas imports are estimated to rise from 8.1 bcm in 2021 to 12 bcm in 2022.
European nations have also been preparing alternate routes to import gas. Germany could receive pipeline gas from the UK, Denmark, Norway and the Netherlands. Norway has been raising domestic gas production to improve supplies to Europe.
Gas storage:
Since the war, the EU set a goal to fill gas storage till 80% by November 1 and so far the bloc has exceeded the target by ~10%. Reuters tracks storage data
here. Notwithstanding, storage gas is meant for peak demand and not everyday use. Full storage would supply gas for at most three months.
Renewable energy generation:
Renewable energy overtook fossil fuels in generating electricity for the first time on record in the EU in 2020. Renewables (led by solar and wind) generated 38% of electricity compared to fossil fuels at 37%. The EU plans to source 45% of its overall energy mix from renewables by 2030 up from 40% as per previous plans.
Research by energy think tank Embers indicates that while previously the EU was replacing coal energy with renewables, the recent gas shortage will push nations to replace gas with renewables while reneging on some coal and nuclear energy reduction targets going forward.
Change in EU electricity generation (annual average in tera watt hours):
For instance, the UK is raising domestic oil and gas production by lifting the fracking ban. In Germany, floating LNG terminals are being secured and onshore LNG import capacity is being built. Across other countries, coal and nuclear power plants are being readied. Germany for instance was earlier planning to phase out nuclear power generation by end-2022. It is now considering keeping three plants running.
What do official estimates suggest?
The European Commission estimates that it would be able to replace 50 bcm of Russian pipeline gas with LNG by the end of 2022, 13.5 bcm with non-Russian pipeline gas and biomethane and 38 bcm with renewables and energy saving. The IMF's estimates also suggest that the EU in theory could reduce by two-thirds its reliance on Russian gas through non-Russian gas pipeline imports, LNG imports and fuel switching by July 2023.
However, potential hurdles do exist including uncertainty of gas supply in the current environment and challenges faced by countries and firms in switching energy sources. There are also transmission constraints that prevent gas transportation from alternative sources leaving countries heavily reliant on Russia including CEE, Germany and Italy highly vulnerable.
Therefore, while a 60-70% reduction in Russian gas supply is manageable for now, a longer-term complete shut off particularly during peak winter months is likely to require demand rationing.
Countries most at risk of energy shortage:
The IMF expects the EU to manage a 70% decline in Russian gas through alternative energy sources and lower consumption. However, managing a total shut-off of Russian gas supply will be more difficult and in extreme scenarios Central and Eastern Europe (CEE) could face between 15 and 40% consumption shortage.
European countries' reliance on Russian gas in 2021
Source: European Union Agency for the Cooperation of Energy Regulators
A full-scale shutoff in Russian gas could cut GDP growth by 6% in CEE as per IMF estimates. The impact on Austria, Germany and Italy would depend on government policy response while the impact on other European countries would be moderate.
The war in Ukraine is forcing several countries to rethink and replan their energy dependencies on Russia. While the EU's goals to extricate itself from Russia are headed in the right direction, there is nevertheless high probability of energy shortage in countries most reliant on Russian gas over the next few years.
