Europe charts new gas future

The Russia-Ukraine dispute highlighted Europe's reliance on a single gas source

By Ian Cronshaw Analyst, International Energy Agency

The Russian gas crisis has given new impetus to current discussions in Budapest about the Nabucco pipeline - an ambitious project to deliver Central Asian gas to the European Union without transiting Russia or Ukraine.

On 20 January, shipments of Russian gas to Europe via Ukraine resumed after a three-week suspension, marking the end of the worst gas crisis that Europe has experienced.

The supply cuts could not have happened at a worse time, coinciding with the coldest weather period that much of Northern and Eastern Europe have seen for decades.

Offset to some extent by weakening industrial and commercial energy demand, the disruption highlighted the vulnerability of a large part of Europe to a single gas source, and how severe the economic and human impact of such large disruption could be.

Industrial output in many countries, especially in Eastern Europe, was hit hard at a time of already sharply deteriorating economic conditions, and many companies and individuals endured real hardship.

Rising demand

This dispute has to be seen in the context of Europe's growing demand for gas, especially in the power sector, and its declining production.

European gas use has grown more than 70% since 1990, with the power sector a key growth area.

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In the UK, gas-fired power has grown from virtually nothing in 1990 to more than 40% of total electricity output in recent years.

In Europe as a whole, more than three-quarters of power demand growth has been met by gas-fired power since 2000, and these trends look set to continue.

Gas has become the default option for power generation, because of its advantages - low capital cost and short lead times, plus a low greenhouse gas footprint - as well as the lack of construction of new nuclear and coal-fuelled power stations.

At the same time, Europe's gas production is falling.

UK gas production has declined by more than a third over the last five years, while further substantial increases seem unlikely from Norway, Europe's second largest supplier.

Hence Europe will need to import more gas, increasingly from more distant sources.

Need for investment

Europe is well placed to import gas from many diverse sources, including North Africa, the Middle East, Central Asia, Norway, Russia, as well as via liquefied natural gas (LNG) from all over the planet.

Worries about Russia mean the EU is likely to boost LNG imports

But to make this happen, there needs to be substantial investment right through the supply chain in new upstream production, new long-distance pipelines, and facilities for LNG liquefaction and regasification, or returning LNG to a gaseous state.

And Europe itself needs to invest:

• In new internal pipelines that can move gas around in response to supply and demand
• In gas storage, to meet seasonal demand increases as well as short-term surges, such as from the power sector
• In the market reforms that will stimulate that investment and the flexible market structures that will enable markets to respond if there are supply problems and demand increases.

This is why a number of new proposals for pipelines are being advanced.

Projects proposed or under way include: Nabucco, from Central Asia to southeastern Europe; Nord Stream, from Russia to Germany under the Baltic Sea; South Stream, from Russia to the Balkans under the Black Sea; and several new and expanded pipelines from North Africa to southern Europe.

Renewable energy sources can and must be part of this energy future too, but their costs must come down and issues associated with intermittency addressed EU seeks to expand energy grids

LNG, which currently supplies about 10% of Europe's gas demand, could expand to as much as 20% of Europe's gas needs in the medium term, but regasification terminals currently committed need to be completed, and hooked into European markets effectively.

Much of this capacity is in Spain, UK and France. If other countries are to benefit, infrastructure to move gas to inland or more isolated markets must be built within Europe.

For all these developments, it is clear that Russia, as holder of the world's largest gas reserves, will remain an important part of the European energy landscape for the foreseeable future. Transit of that gas through other countries, especially Ukraine, will remain pivotal into the medium term.

Energy security

So what can Europe do to improve its gas security, given that outlook?

In the short term, European countries need to improve their gas emergency preparedness.

More gas storage capacity is needed - but it is costly and complicated

Gas supply shortages could arise from many sources, including accidents, fires, storms, as well as more man-made causes.

Countries should draw on a range of mechanisms, in conjunction with industry and consumers, including fuel switching (especially useful in the power sector), interruptible contracts in large gas-using industries, and storage.

The latter was especially important in the recent crisis, but gas storage is expensive.

Many countries may lack suitable geology for large-scale storage, and stored gas must be moved around by an efficient, high-performance pipeline grid.

If strategic storage were to be built, it must not crowd out essential private sector storage investment.

In the medium term, greater interconnectedness of currently rather separate national markets must take place, along with the development of a more functional internal market, where gas can move according to demand and supply.

The single most important measure that can be taken is to improve the functioning of Europe's internal gas market

In the longer term, there are a number of steps Europe can take to reduce its dependence on gas imports.

Firstly, greater emphasis must be placed on improving energy efficiency, both in the gas and electricity sectors.

Secondly, Europe must act quickly to diversify its power sector, and develop the technologies to allow more diverse and abundant energy sources, such as nuclear and coal, to contribute to power generation.

Renewable energy sources can and must be part of this energy future too, but their costs must come down and issues associated with intermittency addressed. Otherwise, gas will still be vital for use as back-up power when, for example, the wind does not blow.

Internal market

The single most important measure that can be taken is to improve the functioning of Europe's internal gas market.

A well-functioning market will not only give price signals to market participants where gas can be used most efficiently, but also create an investor-friendly climate which provides incentives to investment throughout the gas value chain.

A number of new proposals for pipelines to Europe are being advanced

A large single market will be able to absorb large quantities of imported gas more easily and predictably, giving supplier countries more security of demand.

The current crisis demonstrates again the urgency of efforts to improve the European market.

This means: enhancing transparency on gas prices and flows (collecting data and making it widely available), improving the interconnection between markets, creating liquid trading hubs and providing clear and stable regulation for infrastructure investment, among other measures.

Many countries talk about the need for national energy champions.

Creating a single functioning market would form a single European energy champion - the European Gas Market.

The IEA and the European Commission are working to promote market improvements, greater flexibility, diversification and investment.

In October 2009, IEA ministers will meet in Paris, and we anticipate that gas security issues will be high on the agenda.

No-one wants to face another winter without gas supplies.

Ian Cronshaw is head of the International Energy Agency's Energy Diversification Division

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