In last week’s BWR, I discussed Russia’s political and economic relationship with Latin America. How is Russia exploiting its Latin American relationships, and are they strengthening?

In this week’s BWR, I will discuss Europe and Russia’s changing natural gas market. European consumption is down, and inventory is high. Europe substitutes Russian gas with other sources and alternatives. Climate change contributes to excess gas inventories in Europe, and Russia is pivoting toward Asian markets. Has Russian gas been permanently displaced from the European market?

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Takeaways:

EUROPEAN ADAPTATION: Europe has adapted relatively well without Russian pipeline gas through energy and source substitution. The EU increased supplies from existing non-Russian sources: Norway, for example, rather than Russia, is now Europe’s biggest source of gas, while it has found alternative energy sources – LNG from the US and Qatar, and, to a lesser extent, renewables.

RUSSIAN ADAPTATION: Russia is struggling to replace European markets with new markets in Asia. Gazprom exported 22 bcm to China in 2023 — a record, but only a fraction of the 140 bcm it exported to Europe before the 2022 invasion of Ukraine. The challenge is an absence of reliable infrastructure to deliver natural gas to China and other Asian consumers. This infrastructure needs to be built out and financed. Power of Siberia 1 cost $70B to build before it became operational, and it is still operating at roughly 60% capacity. PS2 is estimated to cost $17B.

PERMANENT MARKET DISPLACEMENT: The longer the war continues, the longer sanctions and the ban on Russian gas will last. During this time, the European market will continue to replace Russian gas with more reliable sources of gas and alternative energies. Russia risks permanent market displacement as time passes, and this transition continues. 

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Background

The decades-long symbiotic relationship between Russia’s cheap natural gas and Europe’s thirst for it — particularly in Germany — was mutually beneficial. Russia generated billions in hard currency revenues, and Europe received cheap energy.

Russia delivered natural gas through a cost-effective network of mostly Soviet-era pipelines that transit Ukraine and Belarus. German industry, from automobile to fertilizer manufacturers, leveraged the cheap Russian natural gas to make German industry globally price competitive. It also served as low-cost heating for European homes.  

Putin’s second invasion of Ukraine in February 2022 disrupted this relationship. It resulted in a dramatic reduction of pipeline gas deliveries to Europe due to Western economic sanctions against Russia and three mysterious underwater explosions in February 2022 leading to the subsequent disablement of the Nord Stream pipelines. Nord Stream 1 and 2 have a combined annual capacity of 110 billion cubic meters (bcm) and cost €7.4B and €9.5B, respectively, to build. The pipeline network now lies in need of repair, estimated at €500M, and is corroding with salt water. The longer the pipeline network remains unrepaired and dormant, the greater the probability it becomes economically unfeasible to revive. 

These changes have resulted in Russia’s total natural gas exports declining an estimated 42% to date from 2021 levels. In 2021, Russia exported around 244 bcm to Europe, China, Turkey, and the Commonwealth of Independent States (CIS). Of this, approximately 140 bcm went to Europe; these volumes dropped to around 27 bcm in 2023. Most of this drop derives from the near-disappearance of pipeline gas deliveries to Europe – approximately 120 bcm. 

Energy Substitutes, Sources, and Climate Change Displace Russian Gas

The “cold turkey” withdrawal from Russian gas was difficult for Germany in particular. Still, it did not result in the catastrophic collapse of German industry, as some Western economists had predicted. It did result in the closure of a few fertilizer plants, higher automotive production costs, and higher heating costs for EU citizens. For example,  BASF laid off thousands of workers and shut down sections of its plant in Ludwigshafen, Germany due to the higher cost of non-Russian gas.

Nevertheless, Germany (and the EU in general) have successfully adapted to the new energy market by substituting Norwegian gas for Russian, importing LNG from the US and Qatar, and, to a lesser extent, boosting renewables (solar and wind). Norway is now Europe’s largest volume supplier of gas to Europe.

Norway delivered 109.1 bcm of gas through its 8,800KM pipeline network in 2023. The US was the largest supplier of LNG to Europe in 2023, accounting for nearly 48% of LNG imports – 7.1 billion cubic feet per day (Bcf/d). 2023 marks the third consecutive year in which the US supplied more LNG to Europe than any other country. 

 

Qatar and Russia remained Europe’s second and third-largest LNG suppliers last year, representing 14% and 13%, respectively.

At the same time, Europe experienced another relatively warm winter in 2023, leaving the continent with relatively high gas inventories. As per Reuters, storage facilities were still 67% full compared with a ten-year seasonal average of 49%, and we are now 2/3 through the winter season.

Meanwhile, European gas traders are in talks with Ukraine to store excess gas. Ukrainian Prime Minister Denys Shmyhal said during a cabinet meeting:

“We preserved and continue to store 2.5 bcm of gas from foreign companies. Our ambitious plan is to become Europe’s ‘gas safe,’ and we offer European companies to store up to 10 bcm in our storage facilities.”

While this certainly increases storage capacity for Europe and improves Ukrainian government revenue streams, these storage facilities also become de-facto Russian military targets by virtue of its presence in Ukraine. The Kremlin has demonstrated time and time again no qualms about targeting civilian infrastructure or civilians.

Russia Struggles with New Markets   

Russia’s Gazprom has been the most affected by changing Western demand and sanctions on Russian gas. Last year, Gazprom reported record sales to China, 22 bcm via the Power of Siberia 1 pipeline (PS1); it is a fraction of the annual average 140 bcm it exported to Europe in 2021, before the second invasion of Ukraine. PS1 has yet to reach its total yearly capacity of 38 bcm. PS1 competes with Chinese domestic energy sources and the growing use of renewables in the region. Still, Gazprom continues discussions with China regarding the construction and offtake terms of Power of Siberia 2 (PS2). which would connect the gas fields that once supplied Europe to China. PS2 will have an annual capacity of 50 bcm.

PS1, which began operations in 2019, is estimated to have cost $70B. PS2 is expected to cost $17B to build as it connects existing infrastructure and transits Mongolia.

As discussed in BWR’s “No Limits” Limits of the Putin Xi Relationship”, time is on Beijing’s side. Russia is struggling to deliver its gas while it needs revenues. Therefore, Beijing is in no hurry to negotiate the financing of the project or negotiate offtake prices in the absence of a reliable delivery infrastructure.