Gas war won - what next for European energy market

Article written by Andris Piebalgs, Professor Florence School of Regulation , former European Commission Energy Commissioner

As the spring of 2024 approaches, Europe's energy resilience is increasingly evident. Despite cold spells, gas storage levels remain robust, exceeding 70% on average. Forecasts predict that Europe will enter spring with 50-55% gas storage capacity, significantly surpassing the 10-year average of 35%. Following 2023's trends, natural gas imports, particularly LNG from the US, remain strong. In 2023, the EU imported nearly 100 million tonnes of LNG, marking a 5% increase from the already record-high levels of 2022. Notably, EU natural gas demand has dropped by 19% compared to the average of the years 2019 to 2021, with reductions evenly distributed across industry, power generation, and households. Impressively, Europe has exceeded its target to reduce gas demand by 15%.?

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Europe’s natural gas futures are currently near a six-month low at EUR28 per megawatt-hour, a rate last seen in June 2021 before the onset of Russia's 'gas war'. Some traders are already shifting focus to the next winter. The EU finds itself in a comfortable position for future winters, though European gas prices are likely to react more swiftly and intensely to supply and demand fluctuations due to the need to attract LNG cargoes to Europe.?

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Amid the ongoing war in Ukraine, it's crucial to analyze the factors that led to Russia's 'gas war' and where European systems have shown the greatest resilience. In 2021, Russia emerged as the dominant gas supplier to the EU, accounting for 40% of imports. That year, its gas exports via pipelines to EU customers peaked at 146 billion cubic meters. With EU’s own gas production declining, Russia covered one-third of the EU's natural gas demand. Furthermore, Gazprom's control over some European gas storages and its strategic NS1 and NS2 pipelines, bypassing Ukrainian routes, nearly solidified its dominance in the European gas market. However, European gas market regulations thwarted full dominance, though it appeared sufficient for Russia to leverage energy supplies as a deterrent against support for Ukraine.?

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The EU typically enters winter with about 100 billion cubic meters in gas storage, but reserves were significantly lower at the end of 2021 due to reduced gas flows from Russia. With strategic storages under Russian control, alternatives were limited. This scarcity led to soaring prices, yet Gazprom did not alter its strategy. Displeased with Europe's response to its aggression in Ukraine, Russia further decreased exports, hoping to cause skyrocketing prices and physical shortages. However, Europe proved more resilient than expected. The market responded with high prices, curbing demand, encouraging fuel substitution, and attracting LNG cargoes to Europe. The growth of US LNG exports, offering destination flexibility, contributed significantly to a more adaptable global gas market.?

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However, the surge in wholesale energy prices compelled governments to implement measures to protect consumers from rising costs. The EU Member States allocated €540 billion for this purpose, covering both gas and electricity due to their interconnected pricing. Although these measures aimed to support households and industries, they were often untargeted and price-distorting, such as tax cuts, rather than income-support measures. Some European-level interventions, like capping electricity producers' revenues and introducing a wholesale gas price cap or more correctly market correction mechanism, demonstrate a lingering mistrust in EU energy markets, leading to suboptimal crisis responses with higher societal costs.?

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The EU Agency for the Cooperation of Energy Regulators (ACER) in its 2023 Market Monitoring Report reaffirms confidence in European energy markets. The disruption of Russian gas supply was a primary driver of price spikes, while measures like increased storage injections also contributed. The EU’s integrated gas system displayed remarkable resilience. ACER views the 'gas crisis' as a significant rebalancing of the EU energy market with lasting impacts. While EU's increased reliance on LNG could heighten price volatility, greater transparency and competition at new LNG terminals could mitigate this trend.?

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The war continues to devastate Ukraine, but in the 'gas war', Russia has faced defeat. Its strategy of using gas supplies as a weapon has backfired, destroying its role as the EU's primary gas supplier. The EU's gas market design has proven resilient.?The reform of electricity market design has been focusing on consumer protection and market stability. The energy crisis has reinforced European cooperation in the energy sector, highlighting the robustness of the European energy market.?

Looking ahead, two interrelated challenges confront energy markets: decarbonizing Europe's economy and reinforcing energy market resilience. By 2050, Europe aims for net-zero emissions, with significant targets set for 2030 and soon for 2040. The legislative process for achieving these climate goals is nearly complete, with a major task being the transposition of European legislation in national law and its implementation. The EU has a well advanced carbon market, but for many transformative investments the carbon price level and potential volatility do not yet provide enough incentives to invest. Carbon Border Adjustment Mechanism (CBAM) in support of just transition is still to be implemented. The 'Fit for 55' legislative package introduces additional regulations and targets, necessitating consistent and transparent planning. National Energy and Climate Plans (NECPs) are crucial for EU Member States to align with European objectives. However, the current drafts of these plans reveal significant gaps in policy detail, transparency, and consistency. Decisions on infrastructure, such as new electricity transmission lines, hydrogen transport and storage, biomethane injection in grids, and CO? transport and storage, will profoundly impact energy markets.??

The transition's success will significantly depend on the state aid provided. While the foundational rules for applying such aid remain consistent across all Member States, differences in priorities and the scale of support will notably influence the energy market's operation. In the period of 2020-2021, Member States nearly doubled their expenditure on state aid compared to the 2015-2019 average, signalling a robust commitment to energy transition. However, this increase in spending introduces the risk of fragmenting the internal energy market, necessitating vigilant and coordinated actions at the community level to maintain market integrity. The disparities in financial commitment are already striking: in 2020, an average of 0.57% of the EU's GDP was allocated to supporting renewable energy sources, with one country investing nearly twice the average and ten others spending less than half. Although subsidies are essential for facilitating the transition, it is crucial to avoid a subsidy race that could undermine collective efforts. The proposed Net-Zero Industry Act seeks to enhance the regulatory landscape, offering predictable and long-term incentives for investments in zero-emission technologies. However, the final agreement by legislators on this act remains uncertain, underscoring the ongoing need for strategic dialogue and policy alignment.?

The physical protection of energy infrastructure is also an issue. Incidents like the Estonian-Finnish EstLink 2 cable failure and the Balticconnector pipeline damage highlight the importance of robust and secure energy infrastructure. Markets react to infrastructure failure, but they can neither protect nor repair it.??

Robust European energy markets are crucial for the transition towards carbon neutrality and for bolstering resilience against external shocks. Enhancing these markets through effective regulation and improved infrastructure is essential. Their performance during the 'gas crisis' exemplifies their value, and it is crucial to bolster Europe's confidence in these systems. The history of the EU's energy market is characterized by a gradual shift from national monopolies and a dependency on fossil fuels towards a more unified, competitive, and eco-friendly energy framework. This transformation mirrors wider changes in EU policy goals, moving from post-war reconstruction and economic amalgamation to tackling contemporary issues such as energy security, market efficiency, and the mitigation of climate change. As the EU navigates new energy challenges, including the shift to a low-carbon economy and the imperative to strengthen energy independence, its energy market is poised to evolve further in response to these dynamic global and regional pressures.?