The Fuse

LNG Crucial to Europe’s Energy Security, But Not a Cure-All

by Nick Cunningham | December 22, 2015

The EU has gone to great lengths since the onset of the Ukraine crisis in 2014 to diversify its energy supplies and push back against Russia. At the heart of the discord within Europe is the fact that Russia remains the largest source of imported natural gas for Europe, and also the lowest cost option available. As a result, despite the public pronouncements about diversification, including steps to import LNG, Europe is moving ahead with projects that increase its reliance on Russia’s supply.

Despite the public pronouncements about diversification, including steps to import LNG, Europe is moving ahead with projects that increase its reliance on Russia’s supply.

Against this backdrop, German Chancellor Angela Merkel felt compelled last week to defend the expansion of a major natural gas pipeline from Russia, as more of her European colleagues voiced opposition to the proposed project. “I made clear, along with others, that this is a commercial project; there are private investors,” Merkel said in defense of the Nord Stream expansion at a summit in Brussels. The comments came shortly after European Council President Donald Tusk and Italian Prime Minister Matteo Renzi joined an increasingly vocal bloc of European politicians that oppose the pipeline project over concerns that it will leave the EU at the mercy of Russian energy.

The conflict is illustrative of the competing economic and geopolitical objectives for Europe. German support for more Russian natural gas also highlights the limitations of alternative supplies, as well as the extent to which they are political pursuits. Energy diversification is difficult for European consumers, with LNG likely playing only a narrow role in resolving the EU’s energy security vulnerabilities.

LNG provides benefits…

In the wake of the crisis and violence in Ukraine, the EU stepped up its search for alternative solutions to trim its dependence on imported Russian natural gas. One oft-cited solution to Europe’s energy problem is imported liquefied natural gas (LNG). In July 2015, the European Commission launched a study into the EU’s LNG strategy, which will result in a finalized plan in 2016. The goal of the study is to increase LNG imports in order to displace gas imported from Russia.

In the wake of the crisis and violence in Ukraine, the EU stepped up its search for alternative solutions to trim its dependence on imported Russian natural gas. One oft-cited solution to Europe’s energy problem is imported LNG.

LNG is already having a positive impact in Europe. For instance, Gazprom has started to shift away from long-term oil-indexed contracts and is beginning to offer gas on auction in Europe. These gas sales are more market-oriented and flexible with shorter time horizons. Oil-indexation fell from 74 percent of the market in 2005 to just around one-third today, according to Platts. There are a few reasons for this downturn: the fall in oil prices, which have affected LNG prices; pressure from EU antitrust regulators on Gazprom’s anticompetitive practices for gas sales; flat energy demand in Europe; and finally, new sources of LNG imports.

The option of LNG imports has succeeded in putting downward pressure on natural gas prices in Europe by taking away some monopoly power held by Gazprom. In 2014, Lithuania contracted for a floating regasification terminal, aptly named the “Independence,” providing it with an alternative to gas from Gazprom, for which Lithuania was wholly dependent. The extra spending on the regasification vessel was partially offset by the 23 percent price discount Lithuania’s utility secured from Gazprom. With a buying option from other than Russia, Lithuania was able to cut down on Gazprom’s leverage, and as a result, the company offered the price discount as a concession.

Poland’s concerns over Russian influence in Europe make it arguably one of the most aggressive proponents of LNG.

Poland’s concerns over Russian influence in Europe make it arguably one of the most aggressive proponents of LNG. Poland recently opened an LNG import terminal and pledged “full independence” from Russian gas within a year.

Looming over Europe is the pending startup in early 2016 of the U.S.’ first LNG export terminal in Louisiana by Cheniere Energy. A growing number of American LNG cargoes are expected to land on European shores. In February 2015, a Lithuanian utility signed a memorandum of understanding with Cheniere Energy to purchase LNG.

There is a loud chorus of LNG proponents that have lobbied the U.S. Congress in recent years to open up the floodgates, citing the multiple benefits of providing European allies with security of supply and supporting economic opportunity for the U.S. in ramping up energy exports from the Gulf of Mexico.

But LNG is not a panacea

Despite LNG’s promise, the EU strategy to make LNG a central pillar of energy security will face some significant obstacles.

First, LNG is not always the lowest cost option. Russia’s natural gas shipments via pipeline usually come in lower than imported LNG. That explains the logic behind the Nord Stream 2 expansion, which Chancellor Merkel notes is a “commercial project” with “private investors.”

 Despite LNG’s promise, the EU strategy to make LNG a central pillar of energy security will face some significant obstacles.

The LNG import terminals in Lithuania and Poland were constructed with government subsidies. Other import terminals will only be possible with similar levels of support. Moreover, even while Poland declares gas independence from Russia as it will have soon completed a major import terminal, Poland will likely still opt for Russian gas because of the lower price tag. As the Brookings Institution noted in October, LNG import terminals in Europe may simply amount to “pricey insurance policies.” In other words, they will be a hedge against a potential disruption in supply but not a wholesale replacement for Russian gas.

Second, Gazprom has shown a willingness to further discount gas sales to Europe in order to hold onto market share. So while there could be increased competition from rapidly expanding global LNG supplies, Russia can still hold onto to its market by lowering its prices. Of course, that alone is an achievement for Europe, but it is important to distinguish between price reductions and a massive wave of LNG washing through Europe. The latter seems unlikely.

Third, LNG will still only make up a small share of European energy demand. In 2014, for example, EU gas import capacity via pipeline stood at 490 billion cubic meters per year (bcm/y). Meanwhile, LNG imports sat at just 45 bcm despite the 197 bcm/y of regasification capacity. Europe’s regasification infrastructure is underutilized because of cheaper gas from Russia. At the same time, more than 80 percent of Europe’s LNG import capacity and regasification infrastructure is located in Western Europe–mostly in Spain, the UK, France and Italy–with the rest located in Turkey. The locations of these regasification terminals do not easily serve the gas needs of Eastern Europe.

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LNG to play a marginal role for Europe

Contrary to claims of a silver bullet-style cure-all for Europe’s energy woes, LNG will be but one arrow in the EU’s energy security quiver.

In terms of volume, LNG will play only a marginal role for Europe’s energy mix. Improved gas interconnections that smooth gas trade, Europe’s ongoing push for energy efficiency and renewable energy, stagnant economic growth, and weak energy demand will all loom larger as key determinants of European energy security.

Still, the presence of LNG import terminals provides Europe with more options. That is a significant development by essentially putting a cap on prices for Russian gas, set more or less at the landing price of LNG into Europe. As a result, LNG can temper Moscow’s use of energy as a political weapon. But contrary to claims of a silver bullet-style cure-all for Europe’s energy woes, LNG will be but one arrow in the EU’s energy security quiver.