EU Winter 2023 - Disguised as a Great Pyrrhic Victory

?·?????? Global LNG market as a common ‘Pool Math Problem’

• TTF<>JKM Spread tilting the LNG pool

·?????? The desired contract structure which will work out for EU

• When one door closes for Russian exports, another one opens

·?????? The ‘Five Pillars’ of the European energy security

• EU might need to ‘fight the battle’ more than once

·? Custom LNG Benchmark price –?countermeasure against overpriced natural gas

The current energy crunch proved how in the middle of difficulty lies opportunity. It is clear enough that LNG has marked a tremendous year especially in Europe – nearly 75% of the US LNG was destined to the Old continent, where more than 25 new FSRUs are expected to be built across the EU in the coming years(e.g.., Le Havre Total, Greece plans to have 5 FSRUs, Italy another 2 FSRU, Poland FSRU one in Gdansk and expanding the Swinoujscie).

It's highly plausible that EU might need to ‘fight the battle’ more than once, where the million-dollar question would be whether EU could attract at least the same amount of LNG in the future, where seven cargoes out of each ten vessels were destined to EU

The rapid growth in LNG shipments to EU, together with plethora of new LNG export facilities(US, Canada, and Qatar) and increasing EU demand for LNG(reaching nearly 70% YOY) is turning the LNG from an ancillary alternative fuel of EU into a basic source of energy. In the end of 2022 for the first time, the LNG imported in EU would exceed 128BCM and in anticipation to break the 150bcm by the year’s end(just for comparison, Russia exported 158 bcm in 2021). In light of at least 20 proposed LNG Import terminals in EU the share of LNG into the EU market could get even greater.

Europe needs to go above and beyond the current winter

? The EU security of supply for the current winter could be deemed a winning hand for EU, but one would need to keep in sight winter 2023-2024, when supposedly no Russian Pipeline gas will be used for UGS replenishing. For instance, in 2022, no more than 15-20% of the EU Gas demand was met by Russian PNG or below 80BCM, but a great share of this was delivered in the Summer storage filling season and Europe made the most out of the Q1 and Q2 Russian supplies, whereas the remaining gap was easier to be reconciled with LNG.

Although the average amount of LNG imports in EU for the next couple of years is expected to average 140bcm per annum, how about the non-delivered Russian PNG which is estimated at 35bcm?

From the perspective of winter 2023-2024, this scenario does not seem to repeat itself and it is highly plausible that EU might need to ‘fight the battle’ more than once. From the position of next winter 2023, European Buyers might need to sign Long-term SPAs and stay clear of Spot market for next year, unless they intend to retain the high premium and attract the expensive NG in Europe, moreover any chilly winter (in Europe or Asia) could still make an extremely tight demand/supply balance.

As a matter of interest, the European energy system actors rushed to procure their LNG cargoes beforehand: e.g., exploring partnerships with Qatar, UAE(Adnoc) and Australia(Woodside), EnBW was the first German counterparty for VG, another long-term SPA was signed between Engie and NextDecade, PGNiG and VG, Centrica and Delfin LNG, Repsol, Edison, EDF, Shell, BP and VG etc.

In total, only in 2022 the signed new supply will be for more than 20BCM with another 10 BCM coming in 2023 and 64BCM in the next few years.

In spite of the good progress on the SPAs, the situation is still nowhere near(only 4% of the annual EU consumption) to be enough for locking the essential amount of LNG. With the expiration of the old SPAs, it would be advisable to revive the oil-indexation component and other traditional features in the pricing formulae as a viable option for the LSPA. Through signing new LSPAs, EU will not only secure a steady flow of LNG but also is given an opportunity to hedge against the TTF, in case different oil indexation etc.

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?Recipe for the full gas storages in 2022 are as follows

?·???????Greater flows from Norway and Algeria

·???????TTF - JKM convergence in February that brought an influx of US LNG cargoes

·???????The record high August TTF intraday prices, accounted for a price spread HH<>TTF above $90/MMBtu, resulting in lifting more US cargoes towards Europe

·???????Milder summer temperatures in Asia

·???????A good bit of Russian pipeline gas during the most intense injection period

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Draining from the same LNG pool

Just as in the event of a very common ‘pool math problem’, EU needs to visualize the problem and work out the right approach. In fact, the interdependence in the LNG supply and demand is very clearly distinguishable, all market players are draining from the same LNG pool and the location arbitrage tilts the pool in order to drain more LNG from one supply point or another and any established relationship is prone to change. Qatar for example, proved to be a traditional supplier, but this had not stopped them from diverting their cargoes to more profitable and higher-priced APAC and seek more profitable margins. Same as Europe replaced Asia as the top destination for US LNG exports in 2022, this could take the opposite effect once the TTF<>JKM differential rebounds at a premium to the TTF. The advantage of luring US cargoes to EU in first place is the proximity and secondly that they rely more on prompt and short-term deliveries without restricted destination clauses such as for Qatar and Australia which tend to rely more on LMSPAs. Under the assumption that 'tug-of-war' strategic thinking is intrinsic to the global LNG procurement, as long as it persists, the teamwork will happen to be of crucial importance in the end(EU joint purchases could be the interim solution).

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Custom LNG Benchmark price –?countermeasure against overpriced natural gas

? Lately it has been widely discussed that along with the new SPA agreements for securing the supply and revamping the existing PNG/LNG infrastructure with new additions, it is about the right time to establish another price benchmark tailored for the EU LNG needs.

Currently, there is one dominant gas hub used for price assessment – TTF. The Gasunie TTF serves as a price location, used as proxy in overall for all import regions within EU. As being the most liquid one, a great number of other regional prices are dependent on it, e.g., (PEG, THE etc.). Hypothetically speaking, if EU already secured enough LNG regas projects and intra-EU gas pipelines, a pre-condition for affordable LNG pricing would be a custom-built benchmark price precisely reflecting the LNG market trends and moods in Europe.

Whereas the JKM represents fully LNG market conditions, the TTF is still fusing the LNG and PNG, thus the LNG Shippers are exposed to any volatility or contingency linked to the pipeline gas(notably the geopolitical tensions), which makes it fundamentally different from JKM. Alternatively, the new LNG benchmark price could be directly linked to the JKM reference price adjusted with some mark-up so as to reflect more accurately the cargoes delivered into EU, rather than continue using the TTF.

The end goal is price decoupling of the LNG from pipeline gas, in this way the price will be less vulnerable to the geopolitical factor, which remains to be associated to a great extent with the Russian gas pipelines. The second objective will be achieving more homogeneous pricing and increasing the market interactions between regions, rather than subordinating all gas prices to the NWE.

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?Stumbling issues necessitates drastic measures in a timely manner

?In the wake of extortionate NG prices, introducing a solution package where a ‘Burden sharing Mechanism’ based on the recently adopted ‘Regulation on Gas Storage’ was in place for all EU members, aimed at flattening out the unequal UGS capacity distribution. As a matter of fact, only 18 Countries do have their own gas storage facilities(e.g. Greece relies only on LNG Storage), whereas more than 75% of the EU Total UGS storage is composed of 5 countries – Germany, Italy, France, Netherlands, Austria. Any member without such an access, ideally, would be able to hold reserves in other countries UGS accounting for at least 15% of their domestic NG consumption. Interestingly, countries with full UGS capacity are struggling to cover 15% of their annual consumption. (Despite the massive regas capacity, UK’s storage potential turns out to be the EU-28 Achilles' heel, with only 1.5bcm or about 2% of its annual consumption.)

The UGS facility is a highest-priority infrastructure for Winter 2023 as it could provide about 30% of the winter supplies under normal circumstances, at a rough guess the winter demand in EU will be about 40bcm. As being the cornerstone in the current action plan, it should not surprise us that EU is trying to facilitate and stimulate the storage injections by all possible means including providing a discount on the tariffs of the UGS the entry/exit points.

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Russian pipeline gas registered a steep fall compared to 2021 (YoY) with only the routes Ukrainian and Turkstream being used, while the others remain idle.

Deliveries from Russia to the EU dropped by almost 80% accounting for less than 10% of the consumed gas with no more gas shipments through Yamal and Nordstream and some negligible deliveries through the Sudzha entry point on the border with Ukraine and the TurkStream pipeline.

When one door closes for Russian exports, another one opens

With roughly 18 BCM of Russian LNG fresh from the oven, yet another trump card to be played

Being the 4th largest LNG producer, despite the harmful effect of the sanctions and holding up the progress on completing its new LNG export facilities, this year the exports of Russian LNG almost doubled from 10MT for the same period last year, hitting approx. 18 BCM for Q1, Q2, Q3 and accounting for more than 15% of the overall EU LNG portfolio, definitely not bad especially when compared to the PNG performance with less than 10%.

In light of the flourishing LNG deliveries in Europe, Russia is not to take the blame for it, interestingly this is a matter of ethics and responsibility for each market player. Instead, one should give credit to countries notably Belgium, Netherlands, France and Spain, where the last two took the lion share of the Russian LNG. This is not necessarily bad, although in a more ethical view, it shows a sign of a two-faced approach and inconsistency with the initially set intentions by the European Commission.

?The dormant competitors

?EU companies would need to think fast and act first by signing a series of large-scale long-term SPAs based on the ‘Chinese model’, so as to hedge themselves against any ups and downs of the turbulent global LNG market and securing supplies in the midst of the Atlantic-Pacific basins competition.

?If we take for example Japan, which possesses almost the same number of import terminals as Europe 36,Japan does not store any natural gas in gaseous state, all storage is for LNG(96% is in LNG Tanks – 18bcm(excluding the negligible and tiny 2bcm from UGS). Which means that Japan’s gas Demand is highly susceptible to any meteorological events and most of the Japanese legacy SPAs still have the oil-linkage. All this make Japan appear as a serious competitor for the global LNG supply. Nevertheless, the new Asia Contingency plan seems to bring comfort, since this plan envisages policies to reduce reliance on the imported LNG for power generation, in addition to the restart of some of the nuclear plants so as to reduce the dependence on fossil fuel. Not less important remains the depreciation of the Japanese Yen versus the USD dollar, which would not be advantageous since most of the LNG cargoes are traded in USD/MMBtu.

?If we consider the largest LNG importing country China, then we should keep in mind it has already halted LNG from being sold to external Buyers(even though just until recently they have been reselling about 10BCM of LNG to EU), this could possibly push up the EU NG prices and brings us back to the last winter in Asia when as a consequence of the ‘cold snap’, price spikes and severe bidding for Spot cargoes was triggered. All this could drag potentially EU again into a tight market condition with ?low liquidity and high transaction costs, fighting over crumbs, stemming from the event that unlike Europe, China is responsible for nearly 60% of all new LSPAs achieving a long-term certainty.

The ‘Five Pillars’ of the European energy security

1. Norway - providing the gas lifeline to EU with greater exports to Europe this year of approx. 6Bcm, and made a determination for ramping up production and sending more gas(This year expected to provide more than 120Bcm by the end of the year). In addition, the Baltic Pipeline – Norway to Denmark started flowing on October 1st. with 10bcm capacity
2. Algeria - as being the third largest gas supplier to EU(10% of EU NG portfolio) and sending out almost 85% of its gas exports to the Old continent, on top of this the Algeria-Sardinia GALSI Pipeline project has been put again on the table.
3. ?Although rather implausible, Netherlands Groeningen gas field is with original recoverable remaining reserves more than 800 BCM and could also fortify the EU energy security if the cap on production is lifted. Having said that, currently it contributes with no more than 4bcm reduced to 2.8bcm this year.
4. Azerbaijan is set to increase the transmission capacity to 20 bcm in the next years in order to double the capacity of the pipeline annually by 2027. In 2022 the export to EU through the Southern Gas Corridor is expected to reach 12 bcm, compared to only 8bcm for 2021.
5. LNG import - The eye-watering year-on-year EU LNG demand surged by more than 60%, which acted together with the European Commission energy-saving initiatives RepowerEU and took some of the load off, though we should not overlook the many complex factors on which this success was hinged.