Framing the Russia cutoff scenario...
Europe consumed 48 bcf/d of natural gas in 2021 For context - China consumed 36 bcf/d It relied on 13.8 bcf/d of Russia gas pipeline imports
Let's assume Russia flows no gas to Europe in 2023-25 How much natural gas does Europe need and where can it get it from? After accounting for demand / supply side offsets I calculate Europe needs to find 11.6 bcf/d of natural gas
Finding gas isn't like finding oil Fungibility in natural gas in extremely limited The only way to get gas is to source it from a pipeline or import a LNG cargo Given all pipelines in Europe are maxed out - LNG is the only way for Europe to find gas
So Europe needs to find 11.6 bcf/d of natural gas How easy / hard is that? Well the LNG market in 2022E is only 53.3 bcf/d So Europes incremental needs represent 22% of the global LNG market
22% doesn't seem very high unless you have experience with commodity price / inventory cycles In 2014-16 oil slipped from $120/bbl to $27/bbl on a 2% supply mismatch Said differently - a 2% change in supply/demand created a 78% decrease in price What will a 22% change do?
In fact the 11.6 bcf/d of gas needed is 6 years of growth in the entire LNG market Or 1/3 of Chinese gas demand It will be impossible for Europe to find this gas So what happens next?
Okay before we go there let's just assume the market was large enough for Europe to take 11.6 bcf/d on LNG imports How does it get to where it needs to go? This is Europe's pipeline map
So 11.6 bcf/d of additional LNG is technically impossible because Europe have (and will build) enough But all that spare capacity is located in Spain / France
Fragmentation of pipelines because of the distribution of facilities means effective LNG import capacity is much lower Spain can only export 10% of its import capacity France can't move gas north-to-south given bottlenecks Germany would need to reverse pipe flows
Let's go back to how Europe solves its natural gas problem There are a view paths - Substitute natural gas for other fuels (coal / oil) - Decrease consumption Let's talk about substitution
Energy markets must balance They solve for one another in extreme price scenarios Oil went negative in 2020 when storage was full That forced producers to shut off wells and bring balance back to the mkt
Substitution of gas occurs mainly in power The power business very simple Heat water to create steam Steam spins a turbine The turbine creates electricity Coal plants use coal to heat water Gas plants use gas Nuclear plants use uranium
35% of all gas consumed in Europe is used to generate electricity One way to reduce Europe's gas needs to subsitute from gas to coal/nuclear in the generation stack You often hear this as 'switching' capacity
We are already seeing coal imports run higher with an expectation of a 43% increase in 2023 vs 2022 elevated levels 70% of Europe's thermal coal imports come from Russia which they've banned I'll cover this in a separate thread
reuters.com/business/energ…
Substitution is beneficial because the price to buy coal is cheaper than gas Coal costs $14 vs gas at $70 / mmbtu Thus Europe saves money by switching its power sources from gas to coal Markets are sending this signal because there isn't gas available in the LNG market to buy
Substitution helps avoid Europe running out of gas But Europe is still footing a bill for gas and coal At 11.6 bcf/d of incremental needs and a $70/mmbtu price delta Europe will spend $300bn more on natural gas vs 2021 lvls or 1.7% of GDP What if prices double again?
The other way Europe can reduce its gas needs is by reducing demand But natural gas demand is very inelastic because so much of it is used in electricity or heating applications That means price increases don't adjust demand easily
The household demand sector which is 30% of demand is thought to have elasticity factors of -.08 to -.25 vs price But that assumes households will see much higher bills What's more likely to happen is countries defend consumers with caps and subsidies
That leaves us with industrial / commercial gas demand as a balancing factors It is becoming increasingly clear that this is where the pain in Europe will occur given the politics We've already seen signs that big industrial consumers are reducing output and shutting down
But how much can industrial gas demand compress? Remember the 11.6 bcf/d of gas needs from earlier? Well all of Europe's industrial gas demand in 2021 was 11.3 bcf/d
And there are consquences to curtailing industrial demand Mass unemployment Food / chemicals / refined products / steel will all need to be imported from somewhere else That'll worsen Europe's terms of trade something I covered in the below tweet
As an example of how gas is creating havoc across industrial applications in Europe let's review refining Refining is simple business You give me oil - I give you gasoline/diesel I make something like $5/bbl margins through-the-cycle My costs are labor / gas / maintenance
The price of gas in the US is $7/mmbtu vs Europe at $70/mmbtu A $1 mmbtu gas difference is equivalent to $0.20/bbl in operating costs US pays $7*.20 = $1.40/bbl in gas Europe pays $70*.20 = $14/bbl in gas US has a $12.60/bbl cost advantage in a $5/bbl margin business
This math is similar for steel / fertilizers / glass applications in Europe If the gas crunch persists - expect a radical hollowing of the Europe industrial base The consquence will be unemployment and worsening terms of trade / currency flows
You'll start seeing more announcements now given industrial gas demand is low in the summer and reaches peak into the winter Winter is coming?
What are the other paths to balance? Global prices increase far enough to encourage switching / destruction in other countries That means they consume less LNG That leaves more LNG for Europe to buy But again - 22% increase is too large for any energy market to balance easily
LNG markets are the second derivative It's the net of supply and demand It's hard enough to get one of these right in any one country We need to be humble about knowing what'll happen globally
The reality is big price moves and descrepancies of this magnitude haven't been seen in a long time We can't be percise about the inertia that exists in various sytems to bring balance But energy mkts are one of the most innovative in the world Prices usually do the solving
A more medium run scenario would involve Russia redirecting its gas flows from Europe to China Russia sending gas to China would cause China to back off its LNG imports where it is 30% of the mkt This would involve new pipleine routes that connect the European and Asian system
Or Japan can bring back its nuclear fleet and reduce its LNG imports where it is 27% of the mkt
bloomberg.com/news/articles/…
I expect - Large industrial failures w/ spillovers to employment - Increase in polarity / political tail risks - Further Euro devaluation as rate hikes become politicized This is offset by - Russia conflict resolution - Medium term greenshoots via China/Japan - Mkt novelty
