How Russian-Ukraine Reflects the Gas Crisis in EU

Mr. Tatsuya TAREZAWA

Good day.  I’m Tatsuya Terazawa, Chairman and CEO of the IEEJ – the Institute of Energy Economics Japan.

Today, the world is focusing on the developments in Ukraine. I will look at the situation through the lens of energy policies.

President Putin has chosen the most effective timing to maximize his leverage that he has over the energy supply. The world was already facing an energy crisis even before President Putin triggered the crisis in Ukraine. These supply and demand for the energy market was extremely tight and the price was soaring in every segment of the energy market.  Especially bad for the natural gas market for Europe and the LNG market worldwide, reaching record high levels every before the crisis in Ukraine.  

The timing was even worse for our European friends – winter time is certainly a high demand season for gas in Europe. The level of inventory in Europe prior to the crisis in Ukraine was extremely low, much lower than the historical level. Europe depends on gas for heating to survive the winter. Europe depends 46% of its gas demand on imports from Russia. So, this is hard to say – but I would assume that President Putin is calculating that the West, in particular Europe cannot afford to impose sanctions to stop imports or energy especially gas and oil from Russia.

So, it is one thing – bad timing – but we have to look beyond bad timing. I would have to say that there are serious weaknesses or vulnerabilities in energy markets – in particular for gas and LNG, and these weaknesses are being exploited by President Putin.  

What are those inefficiencies or weaknesses?

First, we simply do not have sufficient spare capacity for gas and LNG. Even in normal times because the fixed cost of investment is very high for gas in particular LNG.  The Spare capacity for gas and LNG was kept at the very low level even in normal times.  But in recent years, the pressure from the shareholders and for the governments to decarbonize has led to under-investment in gas and LNG related projects – very serious under-investment.  While we have less investment for gas and LNG, the demand for LNG has grown substantially in the past 2 years.  It was driven by the stronger than expected economic recovery under the pandemic Covid 19, the cold winter globally led to more demand. And, ironically the weak wind flow in Europe led to less power generation through wind turbines and leading to more demand for gas. The trend, the momentum and movement towards decarbonization has led many countries including China to make the shift from coal to gas, which resulted in much more demand for gas.

So, we have the combination of very depressed investment in gas and LNG, and we had a dramatic increase in the demand for gas and LNG which led to the energy crisis, in particular the gas crisis even before the situation in Ukraine got worse.

The second weakness – is that the level of inventory for gas and LNG is very low, even in normal times because the cost of storage is so expensive that the level of inventory has been kept at a very low level, in normal times. While we do have strategic reserves for crude oil – the U.S. Japan and other countries, there is not a system for strategic reserves for gas and LNG.  

Since I know more about the data for Japan – in Japan we have a strategic reserve, but the government and private sector for crude oil that can support 240 days of demand for crude oil in Japan.  But our inventory for LNG in Japan can only support about 21 days – 3 weeks of demand in Japan. I understand that because of the historically low level of inventory in Europe, the inventory of gas in Europe can only support about 3 weeks of gas demand in Europe. So, compared with Japan’s case – 240 days of reserves available for crude oil, for gas and LNG, it may just be 3 weeks.  So, the capability of the gas market or the LNG market to respond to contingencies has been very very much limited.

The third weakness is more specific to Europe. As I said, Europe depends 46% of its gas demand on imports from Russia. It depends on 25% of its oil imports from Russia too. So just hypothetically, if the 46% is gone, the gas supply is gone – Europe would have to scramble to get the replacement for LNG imports from somewhere else.  But, for the reasons I explained because of very limited spare capacity for gas and LNG, it would be extremely hard to find any meaningful LNG replacement to fill the gap of 46% of LNG.  I was suprised to find that even if they can secure LNG, Germany does not have a single LNG importing facility in Germany. Germany in particular, but also most parts of Europe have been depending upon gas transportation through pipelines. Typically, gas through pipelines is much cheaper than LNG. So, it is natural that Europe depends on pipeline transport of gas.

In the good old days – the North Sea region surrounded by Norway, Holland – produced substantial natural gas internally to support the gas demand in Europe, and the pipelines helped a lot. But as the production of natural gas from that region – the North Sea surrounding area -gradually slowed down, Europe had to depend more and more on gas imports from Russia. That is the reason why Germany planned to construct the controversial Nordstream II pipeline connecting Russia and Germany, for that reason.  So, if we did not have this crisis in Ukraine,

the European dependence on Russia for gas could have been much higher than 46% for that Nordstream II pipeline.

Just to compare the situation between Europe and Japan – Japan does not have the luxury of having access to cheaper gas through pipelines – Japan is an island nation and we do not have any pipeline connections. We have to important gas via LNG with is more expensive – we have to pay the cost for that. As a result, we were able to diversify our sources of LNG from all over the world – not just Russia — Qatar, Australia, Indonesia, Malaysia, the U.S. and so on. So, Japan’s’ dependence on LNG imports from Russia is less than 10%. Japan’s dependence for Russian LNG is less than 10% – – for Europe 46%. That demonstrates how vulnerable Europe is vis-a-vis the gas imports from Russia. These structural weaknesses or vulnerabilities must be addressed.  Unfortunately, if we do not rectify these insufficiencies and weaknesses, I would have to consider that President Putin would be tempted to exploit these weaknesses and vulnerabilities in the future, again and again and again – until he fulfills his ambitions. I don’t know how far that will go.

I think that these developments – the two crises – the energy crisis, and the crisis in Ukraine is a wakeup call for us to deal with the structural weaknesses of the energy systems.

What should we be doing?

One of the simple responses – is to ensure to continue to have sufficient investment to make sure we have sufficient capacity for natural gas and LNG. We would have to find that expansion capacity outside of Russia. The U.S. can be an ideal place to expand that capacity. The U.S. shale gas has the potential to provide the scale to be able to stabilize the global supply and demand for gas. And the supply of U.S. LNG produced form shale gas is quite stable, reliable, and quite flexible.

In addition, we need to have investment so that the LNG receiving capacity in Europe can be strengthened. In order to realize these investments, we have to put into place the right set of policies to make these investments possible. Unfortunately, if we look into the existing policies, many policies are counterproductive or even hindering investment into natural gas and LNG.

Here are 5 or 6 examples:

First, a number of multilateral financial institutions, like the Asian Development Bank and others are now restricting financing to all fossil fuels related projects, including gas. This initiative has been led by the current U.S. administration.

Second, is that the U.S. together with many leading European countries are now demanding that all international public financial support for fossil fuel projects including gas should be stopped.

These kinds of demands would make investment for the upstream extremely more difficult.

Third, to expand capacity in the U.S., we need to construct more pipelines and more exporting facilities in the U.S., but these would require permits, authorizations, and licenses, and this process has been very time consuming and expensive, but this process is getting worse and worse.  Last week, FERC (Federal Energy Regulatory Commission) – the U.S. regulatory body – added more roadblocks for this process.  So, it is very very difficult to expand capacity for pipelines and exporting facilities in the United States because of those procedural difficulties.  

The fourth example of policy is led by the Europeans – the EU.  The EU is now in the process of developing a mechanism to categorize financing into sustainable finance, and the others – not sustainable finance. They call this taxonomy. The recent draft for that proposal would only allow a very limited scope for gas related projects to be identified as sustainable.  All the upstream investment in gas and LNG or the LNG receiving facilities would not be recognized as being sustainable according to their proposal. This categorization would certainly discourage investment and financing into related projects, especially when the European players are involved.

Fifth is signaling – it’s not policy as narrowly defined, but messages sent from governments can influence the flow for investments and financing. In the past several years in particular, many governments – the U.S. and European governments – have been sending messages to discourage investment in gas and other fossil fuel related projects. A same message, kind of a negative message has been sent by international institutions including the IEA – the International Energy Agency. But in order to ensure sufficient investment, we need to change the messages sent out from the governments and from institutions like the IEA.

As you may know, President Biden has asked the Emir – the leader of Qatar – to expand the production of gas and to expand the export to Europe.  But to the best of my knowledge, President Biden has not asked a similar question to U.S. domestic producers of gas or exporters LNG. If President Biden can make a similar request to the U.S. domestic producers and exporters of LNG, just as he requested the Emir of Qatar it can send a strong message that a policy is being transformed. I wish it would come out, but as of now, it has not come out yet.

Finally, it’s not just about the government. The private sector is also leading a campaign to discourage or limit financing or investment in fossil fuel related projects, including gas. These initiatives are led by the leading European financial institutions, participated by some U.S. financial institutions. These policies and initiatives largely driven by the desire to address the global climate issue are well intentioned but facing the reality I strongly believe these policies and initiatives should be changed.

In the recent days, I have had chances to talk to some European friends.

The lessons they are getting from this crisis in Ukraine is – it was a great mistake to have depended too much on fossil fuels – natural gas – they need to get away from the use of fossil fuels and will have to accelerate the process of decarbonization. And they would have to accelerate the introduction of renewable energies. I fully agree with need to the accelerate the introduction of renewable energies. But I strongly believe too that it would be a great mistake to depend solely on renewable energies to solve all the problems immediately. The transformation of the energy system will take decades. The transition process is very long.  Without addressing the weakness or vulnerabilities that I just described, we will be facing a number of contingencies and challenges, and energy and geopolitical crises during that transition period.

While we should be promoting renewable energies – we should do other things as well.

One of the options is, in my view is to revisit nuclear power.  With more nuclear power generation, we can reduce our dependence on fossil fuels without emitting CO2.  After the Fukushima nuclear accident in 2011, the construction of new nuclear power plants has slowed down everywhere in the world.  In the face of this reality, and even before this realty President Macron decided to change his policy to restart the construction of nuclear power plants. He made that decision in November, before all the crises.  But now that we are facing this crisis, I would strongly believe that other countries, and other governments should rethink using nuclear power as an option, especially for Eastern Europe countries which are more dependent on gas from Russia.  This would include Germany – Germany has the plan to shut down all the nuclear power plants by the end of this year (2022).  Facing the current situation and the very tight market, I would have to think it would be wise for them to reconsider their schedule of phasing out nuclear for Germany.

What about coal?  Coal is probably the most unpopular energy source these days. In fact, the UK is planning to phase out all the remaining coal fired power plants by the end of 2024.  Germany with a new coalition government is now aiming to retire all the remaining coal fired power plants by 2030.  But retirement of coal fired power plants translate almost directly to increased demand for gas. I’m not quite sure – I don’t believe – that unless we fix other vulnerabilities of the gas and LNG market, phasing out of the coal fired power plants, the schedule of that will have to be revisited, in my view. Furthermore, if we can introduce new technologies like ammonia or biomass to be co-fired with coal in the existing coal fired power plants, we can continue to use the existing coal fired plants by reducing the emission of CO2 and also reducing our reliance, our dependence on fossil fuel.

In summary – I think it is a wakeup call that while we need to address the current crisis in Ukraine, we need to completely address the weaknesses and vulnerabilities of our energy markets, especially with regard to gas energy.  But we have to look into other areas of energy – renewable, nuclear, and coal as well. We will have to have a very comprehensive set of policy changes to address the weaknesses that we are now being exposed to.  

We have been too complacent in the past decades. The younger generation people have no knowledge about the first or second oil crisis. Most of them believe that energy is cheap and readily available. But we have now learned the lesson again, that is not the case. We would have to think about energy security. We would have to think about the stability of the energy market – the global climate issue is very important, but we cannot only look at the global climate issue, we need to incorporate the energy security concern, and the concern for the stabilization for the energy markets, and we would have to put into place our geopolitical concerns into the equation so that we can formulate a comprehensive set of policies in a very strategic manner.  This will have to come from the highest level, and also not a single country can solve this global issue.

It has to be done by Japan, it has to be done by the U.S., it has to be done by European countries, China, and has to be done by other Asian and other countries. This is a global challenge, and this requires a global and comprehensive strategic response.

Mr. ZHANG Daqian

First of all – a great presentation from Mr. Terazawa. Even if we hold different opinions on the independent what we call climate change, we can still agree to disagree on a few things.

Nuclear energy may be our last resource even if though we have Chernobyl and Fukushima, and the nuclear waste it may have on the larger biologic system, It is still not that obvious, but we have no other way to keep the welfare of the people while doing the energy transition. That is to say to use the nuclear energy.

I notice that in the latest taxonomy that Mr. Terazawa has mentioned, they have put nuclear energy to the ones that are getting green financing bonuses. And I think there a great start for shifts into a more clear energy structure, but there is still a lot that needs to be done.  Every though we agree that gas is one of the fossil fuels, but it is cleaner than coal and other kind of fossil fuels.

I only understand the situation in China – which is that we have been cutting down the use of coal in about last decade or so. But the effects and changes have not been very fast. It’s just moving gradually at pace, and some say that we may not reach our carbon neutrality goal if we keep up like this.  

Last year, China has come through a lot of change, especially in terms of carbon markets which has just come in. I co-wrote the annual report of CBCGDF analysis on how China’s carbon market is doing. And I say that with enough MRBs and the expansion to other industries, we are now only covering the electricity and manufacturing industries – we were to cover the airlines and transportation, I believe there is still a long way we can go in terms of carbon offset and the transition of infrastructure.

The climate change must be dealt with even at the cost of some financial insecurities.  The best we can do is to minimize the damage. It is just a way of how we can do it.  If we don’t, there will be countries that will be flooded like Philippines, and the coastal areas of China. So, the important issue then is not to change how the top-down approach that each country is thinking, but ours is the down-to-up approaches how we can facilitate green innovations and technologies and the promotion of nuclear energy and the like.

Prayers go to all the people in Ukraine.  China has been juggling between those two countries for a long time.  Just like China always did – we haven’t announced anything that is pro-Russia or pro-Ukraine. I guess we will have to wait and see how we will take our sides.

Original Chinese Article: https://mp.weixin.qq.com/s/Q0hoeyWyOaY6seOO3j7omA 

Translator: Stan

Editor: Stan    

Contact: V10@cbcgdf.org; +8617319454776

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