Europe’s Energy Crisis is at a Tipping Point
Russia’s shutdown of the Nord Stream 1 gas pipeline threatens to further squeeze the disposable income of Europeans. A typical family in the EU could face energy bills of €500 per month by early next year without the introduction of price caps, according to Goldman Sachs Research – up 200% from 2021.
Samantha Dart, a senior energy strategist at Goldman Sachs, expects the real effects of the shutdown to still be ahead, especially for ordinary citizens. “This is a very painful process and it’s impacting the European population in many different ways,” she says. “Ordinary people haven’t even felt the full brunt of this situation.”
Despite this, Dart is optimistic there are some clear solutions to navigate this crisis. She answers some of the key questions surrounding Europe’s unprecedented energy crisis below:
What does the latest news about the shutdown of Nord Stream 1 mean for European gas markets?
Northwest Europe was already facing a very big deficit in gas supply because Russian supplies had been reduced over the course of the past several months. This latest decision by Gazprom effectively brings the remaining supplies to zero in the region. This means that the deficit is getting bigger and that needs to be compensated so that the region can get through winter. The use of natural gas is heavily associated to what season it is; we store it up over the course of the summer, so we can use it when we need it in the winter. Now, we’re facing a situation where a massive component of that supply is no longer there. The challenge just got a lot more complicated.
This is what has been causing natural gas prices to rise to such unprecedented levels. To give some perspective, the 10-year-average of natural gas prices in Europe before this crisis was just over €20 per megawatt hour. The size of the problem now — or rather the size of the deficit in supply now — has forced prices above €200 per megawatt hour, meaning they are more than 10 times the 10-year-average in this market. This makes the situation look like a price problem, but this crisis all stems from a problem over quantity. Prices are the symptom; the real problem is lack of natural gas and that’s why demand needs to drop.
How deep could this crisis be for Europe, especially over the winter months?
The depth or severity of this crisis could be defined by the weather over the coming months. If in the middle of winter, you get a particularly cold spike, this is a situation which creates more panic in the market as you don’t have a lot of time to react to it. The risks of rationing gas supply are not part of our expected base case scenario. But if things get particularly cold, that’s when rationing becomes a bigger risk.
The clearest way ordinary European citizens will be impacted is through energy bills becoming much higher, especially in the next six months or so, because there is a bit of a delayed passthrough of cost to the consumer. This isn’t the only way this crisis might affect people. One response to this crisis might be to lower industrial consumption of natural gas. This could mean lower economic activity, higher levels of unemployment and even greater potential for recession. A recession already is the base case assumed by our economists for Europe. It’s not an easy process to go through winter without the main fuel that keeps the lights on.
Does Europe have any clear solutions to try and reduce the impact of this crisis?
Due to the seasonality of natural gas usage, storage levels will be key for how Europe navigates the coming months. Many European countries have storage levels ahead of the targets. For example, Germany had a target of being at 75% full at the beginning of September and it started this month being more than 85% full in storage already. The hope is that this process continues so Europe can face winter with decent levels of storage in place.
There are other drivers that can help Europe in this period. For example, back in June, Germany announced it would support the restart of previously retired coal fired power plants – plants that have been paused for emergency situations. Well, this qualifies as an emergency. If more of these plants come back into action, it means natural gas can be prioritized for the winter.
Alternatively, some countries in the region have discussed the introduction of reverse auctions, a form of government intervention where natural gas is bought back from industrial users and put in storage instead. This could be immensely effective for the market as it would effectively destroy demand and consumption levels. So far, a lot of the discussion around government intervention and policy measures have focused on capping prices and trying to limit the passthrough of high energy costs to consumers. This addresses the affordability issue, but it does not address the quantity issue. The main problem is that we are in a deficit. So instead of subsidizing the use of energy, we think it would be most effective for governments to curtail demand in a controlled way.
Crucially, demand destruction is what is needed so that Europe has enough gas for heating purposes in the winter. That’s the main priority. If prices go higher, that will disincentivize consumption of natural gas. The region has done a lot of work already on compensating for its natural gas deficit. If you look at how much demand has dropped versus average, it’s impressive. Now that Russian supply is gone, European countries are trying to save up gas and that is done by destroying more demand and trying to attract additional imports. If Europe continues to curtail its demand and to attract Liquefied Natural Gas (LNG), it can get through winter more easily.
What can Europe do longer term to reduce its reliance on Russian gas?
From a logistical perspective, there is a lot being done right now. The building of new infrastructure to import more LNG is a good example of that. Currently, Europe can import LNG, but a lot of the infrastructure is not in the right place. For example, the U.K. has a lot of import capacity but doesn’t have the storage capacity. We also need more of this infrastructure in countries like Germany and the Netherlands. So, over the next several years, we expect Europe’s capacity to import and store LNG to improve significantly. That’s part of the answer.
The second part of the answer is you need the actual LNG to fill in that capacity. You need more supply globally and that also comes from investment. That investment usually depends on those proposed supply facilities contracting their supply. We need to see more contracts being signed with those proposed supply facilities so that they can build and bring more LNG to market. Already there are several facilities under construction; the only problem is that they are not scheduled to come online until at least late 2024. This is also not going to be an overnight solution: investment takes time to result in higher supplies. It’s going to take a little bit longer for Europe to come out of this crisis.