The crisis has demonstrated the urgent need to boost supplies from every source
Ed Crooks, Vice-Chair, Americas, Wood Mackenzie
Right up until the first shots of World War 1 were fired, many Europeans did not believe that a conflict between the Great Powers was possible. The ties of trade, investment and culture, and even the close family connections between the monarchies of Germany, Russia and the UK, seemed strong enough to prevent hostilities. Herbert Henry Asquith, the UK’s prime minister, told a cabinet meeting in late July 1914 that although tensions were building between the Austro-Hungarian Empire and Serbia, “happily there seems to be no reason why we should be anything more than spectators”. Less than two weeks later, Europe was at war.
Europeans’ attitudes to their dependence on natural gas supplies from Russia often had a similar character: they could not believe that such a rational, mutually beneficial trading relationship could be broken. When US president Donald Trump warned at the UN in 2018 that Germany would “become totally dependent on Russian energy if it does not immediately change course”, German diplomats chuckled and shook their heads. Europe had been buying Russian gas for decades, and its supply had been dependable through the Cold War, the break-up of the Soviet Union, and the rise of Vladimir Putin. Until it wasn’t.
The news that Russia was suspending gas flows through the Nord Stream 1 pipeline crystallised fears that have been building since the invasion of Ukraine on February 24. When supplies through Nord Stream began to be disrupted in June, Gazprom maintained a fig leaf of excuses about technical difficulties forcing the flows to be restricted. It has continued to blame equipment malfunctions, but has made it clear that flows through the pipeline will be halted indefinitely. No-one is laughing now.
As Massimo Di Odoardo, Wood Mackenzie’s vice-president for gas and LNG research, explained earlier this month, Europe is now essentially at the mercy of the weather. If the continent has a mild winter, then European gas supplies should be adequate. In an extremely cold winter, demand curtailments will be inevitable. Alexander De Croo, Belgium’s prime minister, warned in an interview with Bloomberg: “A few weeks like this and the European economy will just go into a full stop… The risk of that is de-industrialisation and severe risk of fundamental social unrest.”
At the Gastech 2022 conference in Milan last week, some policymakers were prepared to be very frank about the mistakes that have led to this crisis. Joao Galamba, Portugal’s secretary of state for environment and mineral resources, said in a plenary session: “There is now a common understanding that some choices in the last 20 years were disastrous for Europe.
But while the understanding of the roots of the crisis may now be widely shared, there is less agreement among governments, regulators and businesses about the appropriate solutions. In broad terms, it is clear what is needed: Europe has to curb its demand for natural gas, by investing in renewables, nuclear power and hydrogen. And it has to find new sources of supply, both by pipeline and as LNG, to replace the Russian gas flows that have been shut off indefinitely.
The details, however, are more difficult. There are still significant disagreements over the extent to which the urgent need to bring more gas into Europe should override other policy priorities, such as maintaining competitive markets or limiting emissions. And there is a fundamental tension at the heart of Europe’s strategy that is not easy to resolve: governments want the industry to increase supplies of fossil fuels in the short term, while maintaining a commitment to reduce demand for those fuels in the medium to long term to meet their climate goals.
Policies, regulations and voluntary commitments intended to address the threat of climate change are still having an inhibiting effect on investments that could increase gas supplies into Europe, some executives say. The European Central Bank, which supervises banks in the eurozone, has in recent years been putting greater emphasis on climate change, saying: “We are firmly committed to doing our part to address climate change, within our mandate”. Reporting the results of its first major climate risk stress test in July, the ECB said banks needed to do more to collect data on their customers’ emissions, and to use that information to assess the potential impact of net zero goals and other climate policies.
Government-backed lenders have been moving in the same direction. The European Investment Bank, the EU’s lending arm, ended all financing for fossil fuel projects and companies last year. The World Bank stopped investing in upstream oil and gas in 2019, and did zero new fossil fuel financing of any kind in fiscal year 2021.
It is difficult to assess exactly how significant these constraints have been in restricting investment in oil and gas. Low prices over much of the past decade have probably been much more important. But the direction of the effect is clear, and set to grow unless action is taken. Octavio Simoes, chief executive of Tellurian, argued in an interview for Gastech that energy suppliers and European regulators needed to find an agreement to ease restrictions on financing new gas infrastructure.
It is clear that the US will play a critical role in easing the crisis by replacing Russian gas imports into Europe with LNG, in both the short term and as new export capacity comes on stream in the future. There has already been 28 million tons per year of new LNG export capacity given final investment decision worldwide so far this year, almost all of it in the US. By the end of 2024, Wood Mackenzie expects at least another 100 mmtpa of new LNG supply to be given the green light around the world, with the majority of that on the US Gulf Coast.
However, there are still signs that policies and attitudes dating from before the crisis are affecting the energy industry today. Last week, the Environmental Protection Agency denied Cheniere Energy’s request for a continued exemption from the National Emission Standards for Hazardous Air Pollutants (NESHAP) for 82 turbines at its two LNG facilities. Wood Mackenzie’s Ian Heming said the decision created an uncertain situation that could result in Cheniere having to replace or retrofit all 82 turbines.
In its recent second quarter earnings call, Cheniere said that “if necessary, we would be able to develop a solution that would enable compliance without material financial or production impact.” It remains uncertain, however, whether the EPA will allow enough time for that solution to be implemented with no effect on production.
Another concern in the US industry is the fate of proposed legislation to streamline permitting procedures for infrastructure projects, which should help all developers in both fossil fuels and low-carbon energy if it is passed. Senator Joe Manchin of West Virginia, a Democrat who is often the decisive swing vote in the Senate, linked permitting reform to his support for the Inflation Reduction Act, including support worth about $370 billion for low-carbon energy, which was passed last month.
Under Senator Manchin’s plan for reform, the president would designate at least 25 “high-priority energy infrastructure projects”, and prioritise permitting for these projects. There would be maximum timelines for permitting reviews, and constraints to prevent excessive delays caused by litigation over development. President Joe Biden supports the plan, but some on the left, including Senator Bernie Sanders and at least 72 Democratic members of the House of Representatives, oppose it. It seems that the fate of the reforms is hanging in the balance in Congress.
Companies working to develop oil and gas infrastructure should be among the beneficiaries if the legislation passes. But relations between the industry and the Biden administration remain chilly. Ryan Lance, chief executive of ConocoPhillips, suggested at Gastech that while the industry did have a dialogue with the administration about permitting reform, “it's not constructive and it's not substantive.”
One important factor in policymakers’ and regulators’ attitudes, however, is that the worst of the crisis is still ahead of us. If Russian supplies remain disrupted, and the weather is cold, Europeans could face a very difficult winter, with the prospect of more to come until flows are resumed or alternative sources are on stream. By March, the political calculus for European countries and their allies, including the US, could look very different. Any actions that might obstruct the flow of gas into Europe will be much harder to support.
Britain lifts ban on shale production as it aims to become an energy exporter
One of Queen Elizabeth II’s last duties before her death last week was officially asking Liz Truss, the new leader of the Conservative party, to form a government. One of Truss’s first acts after taking over as prime minister was launching a plan intended to alleviate the impact of the energy crisis in the UK, both in the short and the long term.
For the short term, there are price controls that mean an average household gas and electricity bill will not rise above £2,500 a year from October. Under the previous price cap framework, it was scheduled to rise to £3,549 a year. Businesses will also get support under a separate system. The cost, which has been estimated at a total of about £150 billion, will be paid for by government borrowing.
For the longer term, the prime minister said she wanted to accelerate “all sources of domestic energy, including North Sea oil and gas production”, as well as “hydrogen, solar, carbon capture and storage, and wind.” Her goal, she said, was that “far from being dependent on the global energy market and the actions of malign actors, we will make sure the UK a net energy exporter by 2040.”
That is an ambitious objective. A new note by Fraser McKay and colleagues in Wood Mackenzie’s Upstream team suggests that for oil, it is possible for the UK to become a net exporter, if not easy. Consumption would have to be driven down rapidly, in line with a scenario for limiting global warming to 1.5 °C, while production rises in line with the potential high case in our projections. For gas, though, becoming an exporter looks challenging in the extreme. Even in a possible low scenario for gas consumption and a high case for production, the UK remains a substantial net importer.
Risking political controversy, Truss’s plan includes an end to the UK’s ban on hydraulic fracturing, introduced in 2019 on the grounds that it was “not currently possible to accurately predict the probability or magnitude of earthquakes linked to fracking operations.” The government said at the time that although hydraulic fracturing was widely used in countries including the US, Canada and Argentina, shale exploration would be paused “unless and until further evidence is provided that it can be carried out safely here.” Truss said last week that the UK had huge reserves of shale gas, and production could begin in as soon as six months “where there is local support”.
However, Wood Mackenzie’s analysts are cautious about the production outlook for UK shale gas. They write: “Removing the ban on hydraulic fracturing is a big step forward for shale proponents. But for new supply to materialise, E&Ps would need to commit to exploration and appraisal work. The above and below ground risks are substantial.” Even if drilling were to start straight away, 2023 volumes would likely still be “negligible”, they add. “The exploration and appraisal process could easily take until the latter half of the decade if a shale oilfield service sector is not quickly scaled-up.”
EU energy ministers have failed to agree on whether to attempt to put a price cap on Europe’s imports of Russian gas.
Sales of electric fan heaters have surged in Germany as people prepare for winter, raising the prospect that the power grid could be overloaded, the country’s utilities have warned.
Germany plans to extend the lives of two of its three remaining nuclear plants by a few months to help shore up power supplies over the winter. The government has decided that the two plants should be put on standby, to be available if needed, until mid-April of next year. They had been scheduled to shut down by the end of 2022.