Despite moving away from Russian natural gas, Europe has managed to fill up its gas storage facilities. However, the energy crisis is not over. A simulation shows what will happen next.
In mid-October, some slow-moving metal domes appeared off the Spanish coast. These were tankers that had loaded liquefied natural gas (LNG) and were waiting to be unloaded at the heavily frequented gas liquefaction plants.
There, the fuel is converted into gas and transported across the continent. The Iberian Peninsula may have the largest installations in Europe, but there are also large crowds elsewhere.
According to the data provider Kpler, the amount of LNG off the European coast has risen from 140,000 tons in August to 1.2 million tons now.
At least the crews can enjoy the mild weather, as temperatures across Europe are unusually warm for the time of year: Southern Spain is still 30 degrees Celsius.
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The combination of plentiful gas and warm weather lowering demand for gas is a nightmare for Vladimir Putin and has led some optimists to proclaim the end of Europe’s energy crisis.
For months, Russia has tried to divide Europe and weaken support for Ukraine, first by demanding that the gas be paid for in rubles. Then by drastically reducing gas supplies through Nord Stream, its main pipeline to Europe, and finally by closing the pipeline indefinitely.
However, Europe has managed to fill up its gas storage facilities by paying excessive prices. As a result, gas prices fell from $100 in August to $32 per million British heat units. At the same time, global oil benchmark Brent is well below the $139 peak in March at $96 a barrel.
However, the energy crisis in Europe is far from over. Prices will rise again as cold spells set in and other LNG buyers, particularly from Asia, compete for the cargo.
Russia, which has suffered military setbacks, could further increase the pressure. Putin’s options for action include stopping all gas supplies to Europe or destroying the infrastructure.
Such measures – or the use of a tactical nuclear weapon – would trigger further waves of sanctions from the West. To understand how the energy war might play out, The Economist worked with experts from Rystad Energy, an energy research firm. Our analysis suggests that complacency is dangerous. Things could get very bad very quickly.
We went through three scenarios. Even the first, not implying a deterioration in relations, is far from pleasant. It assumes that the Nord Stream pipeline will remain closed.
Europe is also believed to impose an embargo on Russian crude and ban national insurance companies, which cover 90 percent of the world’s shipping market, from insuring ships carrying Russian oil, with one major exception.
Non-Western buyers willing to pay a maximum price for Russian oil set by the US and EU will be allowed to buy European insurance.
For Europe, this scenario means a crisis, but not a catastrophe. The supply cuts will leave the continent short of 84 billion cubic meters of Russian gas by the end of 2022, or 17 percent of normal annual consumption.
Higher LNG imports have already plugged some of that hole, a smaller part is offset by greater pipeline supplies from Azerbaijan and Norway, and another part by painful but voluntary consumption restrictions.
Our simulation shows that – even if the winter gets very cold and demand increases by 25 billion cubic meters – European storage should be sufficient until the summer of 2023, especially since LNG imports could then continue to increase.
In this scenario, governments would not have to ration gas. However, Europe will have to pay dearly for it. According to McKinsey’s Namit Sharma, another consultancy, high prices have already caused energy-intensive industries such as aluminum and ammonia to be shut down.
If Nord Stream stays closed for all of next year, Europe’s energy deficit will widen and require even more severe consumption restrictions. Research firm Gavekal estimates that a 1 percent drop in energy consumption in Germany or Italy reduces GDP by 0.5 to 1 percent.
It is difficult to estimate what costs Russia would incur in this scenario. Russian pipeline exports to Europe have now fallen by four-fifths and cannot easily be sold elsewhere.
Russia’s pipeline to China, the only viable alternative, is too small for large volumes of gas flows. However, the price would be much higher for the amount Russia could sell.
In theory, the EU’s dual oil embargoes combined with a price cap pose a greater threat to Russia’s oil exports, the country’s main source of income.
But, like the market, we believe the price cap will be lifted and Russia will find buyers for the many barrels of oil it cannot sell in Europe. Western governments are calling for a loosely regulated price cap of around $60 a barrel.
Since our baseline scenario assumes world prices will remain below $90, this would not have a material impact on the price of Russian oil, which is currently trading at a 20-30 percent discount.
This explains why, in such a scenario, Russia would still take $169 billion in oil shipments in 2023, little less than the $179 billion it took in in 2021.
Russia and other market participants still have to bear the increased transaction costs caused by longer tanker trips, smuggling and other difficulties. Europe pays a proud price. Importing Russian oil barrels by sea cost Europe $90 billion in 2021. In 2023, it would cost $116 billion to replace those supplies.
In our second scenario, which we call “escalation,” Russia throws a few grenades. As a first step, Russia is closing one of the two remaining open pipelines that run through Ukraine, causing Europe to lose another 10-12 billion cubic meters of gas per year.
The Russian leadership would invoke a pretext (e.g. that a “leak” prevented flow through the Nord Stream pipeline). After all, gas monopoly Gazprom still wants to be seen as a contract-abiding supplier, at least outside the West, explains Anne-Sophie Corbeau, a formerly with British oil giant BP.
This first intervention would come as no surprise to traders, many of whom have already cut Ukrainian gas supplies. But traders would be stunned if Russia subsequently halted its LNG supplies to Europe – the next step in this scenario.
These deliveries, with a volume of 20 billion cubic meters a year, which make up half of Russia’s annual export volume, have hardly been taken into account so far.
Russia would not want to phase them out entirely, if only because it would drive up the global market price, which in turn would hurt friendly countries like India and Pakistan who have to compete with Europe for cargo. We therefore assume that Russia would supply these countries at a preferential price.
In this scenario, the West counters by enforcing its oil price cap with more bite, potentially threatening Western violators with severe penalties, tightening controls, and lowering the price cap.
To counter the retaliation, Russia is persuading OPEC and its allies, a group of 23 countries that produce 40 percent of the world’s crude, to cut their monthly production target by 1 million barrels a day, on top of a 2 million cut already made in October barrels per day.
Rystad’s model assumes that Russia will pay fewer bloody tolls at the end of this dispute. That’s partly because the tighter price cap gives non-Western countries more incentive to build an alternative oil trading system.
Giovanni Serio of trading firm Vitol says tankers owned by the G7 countries are already being bought up by non-Western players, often from Asia and the Middle East.
China and India, which have so far bought up most of the surplus stocks of Russian oil, are likely to be able to insure their ships themselves.
Other countries could take advantage of this “black market” in which Russian oil is transported on tankers with transponders disabled and transhipped from one ship to another on the high seas or mixed with other commodities and thus cannot be traced.
While Russia would see its gas revenues fall, its oil revenues remained relatively stable. According to our calculations, the country’s oil exports would fall by 2 million barrels per day in both 2023 and 2024 compared to 2021 levels, forcing Russia to cut its production by more than 1.5 million barrels per day.
The tightening of the market would push Brent oil prices into the triple digits and demand would fall only slightly. This would allow Russia to compensate for the missing volumes.
Its oil export earnings would remain remarkably steady at $170 billion in 2023, before falling to $150 billion the following year. Europe, on the other hand, would face additional costs of several billion dollars.
Our third (“extreme”) scenario assumes that Russia, faced with devastating losses on the battlefield, no longer cares about money or the goodwill of its allies, but instead opts for all-out energy warfare.
It begins with the closure of TurkStream, the remaining gas link to Europe. The pipeline mainly serves Russia-friendly countries such as Hungary and Turkey. However, with TurkStream shutting down, Europe would be missing another 15 billion cubic meters per year.
Then Russia decides to destroy the European gas import infrastructure. That possibility, once unthinkable, has become less likely following last month’s bombing of the Nord Stream pipeline by saboteurs.
In our extreme scenario, we assume that Russia manages to stop gas flows through Norway’s two largest pipelines, which would cost Europe another 55 billion cubic meters per year. This would be a major intervention. The pipelines are far from Russia and western countries could see this as an attack on NATO.
Aside from the potential military ramifications, we anticipate that Western powers would respond with “consequential sanctions,” threatening non-Western individuals or firms trading Russian oil with measures such as losing access to American dollars.
This would force banks and insurers worldwide to pull out of business with Russia, making the embargoes far more effective. The Kremlin retaliates by convincing OPEC to cut its production by another 1 million barrels a day.
He is also curbing exports through the CPC, a pipeline that carries 1.2 million barrels a day of mostly Kazakh oil but ends in Russia’s port of Novorossiysk, where the fuel is loaded onto ships. The US is attempting to bring down the price of oil by sourcing more oil from its strategic reserve.
However, the reserve is not unlimited, explains Jason Bordoff, an energy expert under Barack Obama. After months of being fleeced, it is already at its lowest level since 1984. So we assume that OPEC could wait, first cutting production and then increasing it when the strategic reserve is exhausted.
At the end of all this back and forth, Russia would win a Pyrrhic victory. Its oil exports, bought only on the black market, would drop to 3 million barrels a day or less for years to come.
Despite the huge global supply gap, Brent prices rise to “only” $186 a barrel before falling to $151 in 2024 as oil demand plummets. Russia’s oil revenues fall permanently to $90 billion or less.
Europe is threatened with a huge bottleneck. To replace Russian oil, it will have to spend $250 billion in 2023 and $200 billion in 2024. Annual gas import costs are nearly $1 trillion, nearly double our baseline scenario, although incoming gas volumes are much smaller.
Replacing the lost gas is proving impossible. Our simulation suggests that European storage, which was empty in November 2023, would remain empty throughout 2024.
European solidarity would almost certainly collapse, adding to the continent’s misery. A recent simulation conducted by Germany’s Economy Ministry examined what would happen if, in February next year, electric utilities in the south of the country received 50 percent less gas than usual, many French nuclear reactors remained shut down (like this year) and coal-fired power plants went out. They concluded that the EU would have to spread 91 hours of power outages among its members.
Germany, panicking, could decide to cut electricity exports to France or halt gas supplies to the Czech Republic and Slovakia. The UK, which has little storage capacity but large gas needs, would be particularly hard hit.
This look into the future has its limits. It focuses only on the energy war and does not take into account the situation on the battlefield and the economic conflicts in a broader context.
Big unknowns, from the weather to the resilience of Ukraine’s military, could make all the difference. And no one knows what might trigger the transition from one scenario to the next, if only because it depends on what’s on Putin’s mind.
Still, the simulation teaches two clear lessons. One is that eight months into the energy conflict, Russia has more opportunities for escalation than the West.
Russia has already shut down its main gas supply route to Europe, but the euro area is in dire need of whatever it can get, so a loss of the remaining gas would still have devastating consequences.
And whatever energy Europe buys from others, it must continue to pass through nodes and hubs that, at worst, Russia could seek to destroy.
The other lesson is that embargoes will not drain Russia’s treasury, at least until Europe is prepared to endure much greater pain.
The less Russian fuel can get onto the market, the more Europe will have to pay to replace it – while rising energy prices keep the Kremlin’s losses contained. Only when oil prices can no longer rise without curbing demand will Russia really suffer.
The article first appeared in The Economist under the title “Europe’s energy crisis is very far from over” and was translated by Andrea Schleipen.
*The feature “Europe’s energy crisis is far from over” is published by The Economist. Contact the person responsible here.