The European gas crisis stopped being news long ago: the price per 1,000 cubic meters of natural gas has held above the unprecedented $1,000 mark since September. The scale and duration of the unfolding crisis raise questions about the premises of Europe’s natural gas policies in the last decade. Officials in the United States described domestically produced LNG as “freedom gas,” but why hasn’t it played a stabilizing role in the current crisis? How will this experience affect the energy relationship between Europe and Russia?
Initially, the LNG spot market did not grow quickly, and by the mid-2000s, less than 10 percent of the LNG produced worldwide was sold on the spot market. It began to expand more rapidly when oil prices rose at the end of the 2000s and European countries started to look to reduce their dependence on inflexible, long-term natural gas contracts, as well as to detach gas prices from the price of oil. As a result, the share of short-term trading on the world LNG market rose from 16 percent in 2009 to 40 percent in 2020. At the same time, the average duration of LNG contracts fell to all-time lows.
There was an abundance of LNG in 2019, and much ended up finding a home in Europe, which had plenty of natural gas storage and was in the process of switching from coal to natural gas for power generation. LNG prices collapsed in 2020 because of the pandemic, and LNG increasingly began to replace “Gazprom gas” in Europe.
The events of 2021 demonstrated just how volatile the LNG spot market could be. The current crunch began when prices rose sharply in Asia because of cold weather and the rapid post-coronavirus recovery of the Chinese economy. After several months, higher prices arrived in Europe: prices at European hubs reached $250 per 1,000 cubic meters in January; by July they were $500; and in September they hit $1,000.
With such prices, one might imagine that LNG would have begun flooding into Europe. But that didn’t happen. Between January and the start of November, LNG deliveries to the European market actually fell by nearly a quarter compared to the two previous years. Instead, all the LNG on the spot market was being sent to Asia, where prices were even higher (they reached $2,000 per 1,000 cubic meters in October). Prices were so much higher in Asia that Atlantic basin suppliers were more than compensated for the extra transport costs.
The main reason for the LNG deficit on the European market was the price. U.S. politicians have said repeatedly that supplies of American LNG are capable of reducing Europe’s dependence on Russia. But when push came to shove, it turned out that U.S. commercial companies would send LNG wherever their profit margins were greater. This year, that was to Asian markets.
Whatever the rhetoric, the United States has signed relatively few long-term agreements with Europe for LNG. As a result, 51 percent of U.S. LNG exports went to the Asian market in the first eight months of this year, while 29 percent went to Europe, and 20 percent to Latin America. The three biggest importers of U.S. LNG right now are South Korea, China, and Japan.
There is nothing run-of-the mill about the current natural gas crisis, and it could lead to fundamental changes for both European economies and major suppliers like Russia. The Europeans will likely create mechanisms to protect themselves from the unchecked growth of price bubbles. It’s possible that their response will include the creation of strategic natural gas reserves, or new discussions about a “single window” system for EU natural gas purchases (although that would be difficult to implement). More likely than not, there will also be a new round of criticism of Gazprom by Eastern European countries.
Most significantly, however, we’re likely to see new strategic decisions concerning the development of the European energy market in favor of renewable energy sources. This is a direct threat to the future of Russia’s natural gas exports.
The paradox of the situation lies in the fact that Europe’s natural gas crisis is, to a large extent, the result of attempts in recent decades to deregulate the markets and increase the role of spot trading. In the end, all it took to drive prices sky-high was economies recovering faster than expected from the pandemic against a background of falling natural gas extraction in Europe, Gazprom’s reluctance to increase pipeline gas supplies, and flexible LNG contracts that allowed flows to be rerouted to Asia.
It turned out that the link to oil prices—so criticized by Europe when oil prices were high—had its pluses. At moments of high spot price volatility, the link mitigated price fluctuations, ensured a degree of predictability, and meant some significant financial savings.
The current crisis has also revealed much about the LNG market. In recent years, LNG investment decisions have been made in the absence of long-term contracts that would guarantee utilization. Risks that may be acceptable for some commercial companies, however, are not always acceptable for governments that have social obligations, such as supplying heat and electricity. If a company gets its calculations wrong about an LNG project (and there are companies losing money even now), then it’s only shareholders that suffer. But if there are problems for a state’s energy imports, then the consequences can be far more serious.
The natural gas crisis has shown how risky it is for governments to rely exclusively on unseen market mechanisms to implement energy strategies. Europe’s long-term contracts to import 100 billion cubic meters of natural gas per year will expire by 2025. If a few years ago it seemed there was no way these contracts would be extended on the same terms (i.e., for a long period), today that is no longer a given.
Another consequence is likely to be that the Europeans will become far more serious about securing the hydrocarbon supplies necessary to make the transition to renewables. Competition among suppliers for the still-attractive European market will intensify accordingly. And Europe itself will be unable to ignore the need for predictable, long-term relationships—even if it continues to choose suppliers according to not only business criteria, but political factors too.
All of this gives Russia a unique chance to extend existing long-term contracts with Europe for both pipeline natural gas and LNG, and to agree new ones. Moscow’s export strategy, however, must be more flexible, more open, and accompanied by more friendly rhetoric if it is to seize the opportunity. Even if the crisis has exposed Europe’s natural gas trading blunders, this is not the moment for Russia to throw stones, or abuse its capacity to apply pressure.
This material is part of the Russia-EU: Promoting Informed Dialogue project, supported by the EU Delegation to Russia.
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