If your read most of the non-specialised media and listen to the most vociferous (and silly) European politicians, the reason for the gas crisis is simple: the usual culprit, Putin, is using the gas crisis to blackmail the EU countries. So he is holding back the Russian gas to show the EU how dependent they are on Russia, and also to get them to approve the North Stream 2 pipeline so they can become even more dependent on the Russian. There are of course also more serious politicians as Angela Merkel who has stated clearly that Russia has delivered all the gas they have signed contracts for.
Before the advent of LNG, the markets for natural gas were regional, covering regions interconnected by pipelines. So the European gas market connected the main suppliers Norway, Netherlands, Russia, Algeria and recently Azerbaijan to the European consumers. LNG in contrast can be transported by ship all over the globe and is hence a commodity similar to oil. The advent of LNG has thus connected the regional gas markets with each other, creating a world market, and new suppliers have been added to the EU gas market, principally Qatar and, more recently, the US. However, the LNG has an additional cost as the natural gas has to be compressed (liquified), transported by ship and decompressed at the destination, so it has some disadvantages compared to piped gas (also environmentally). This additional cost is around 3-4 USD per million BTU (mmBTU), so when the European spot price for natural gas was low (before the Covid crisis it was in the range of 5-8 dollar per mmBTU) it was difficult for LNG to compete. However, with the present spot price in Europe and Asia of more than 30 USD per mmBTU, the cost disadvantage of LNG is only 10-15% compared to piped gas.
EU has succeeded in integrating the different national energy markets by expanding the natural gas network and interconnecting the national electricity transmission systems. This gives much more flexibility, which is useful, particularly with the increasing share of intermittent renewable energy. By adding LNG terminals, it has also diversified the suppliers of natural gas. Presently it seems that there is more than enough pipeline capacity connecting it to its suppliers, including Russia, even without the 'North Stream 2' pipeline. There are presently two main pipelines from Russia, through Ukraine and through Belarus and Poland. To this comes from the start of 2021 the 'Turk Stream' pipeline which connects Russia to the Balkans through Turkey (it was originally called 'South Stream' and should have been routed directly to Bulgaria, but this was vetoed by the EU). It is on this basis difficult to understand the anxiety related to the North Stream 2 pipeline. For the energy security of EU (and particularly Germany) it must be preferable to have several alternative routes for getting the gas from Russia, so not to depend on possible blackmail or overpricing by the transit countries. It can still gradually phase out the dependence on Russian gas, particularly if it is willing to pay a premium for LNG from the US and Qatar.
Qatar is the largest exporter of LNG in the world. Photo courtesy of Qatargas Operating Company Limited.
Now, what is then the reason for the soaring gas prices in Europe? The main explanation is that the demand for gas has increased as the world economy is recovering from the Covid crisis and many countries are in a process of phasing out coal-fired power plants. To this comes some specific European supply problems (declining gas production in the Netherlands, maintenance works in Norway, fire at a gas production complex in Russia, less wind during the summer and so on). So natural gas prices are increasing all over the world. The US LNG, the “Freedom Gas”, is presently mainly going to Asia and not Europe. “They have more purchasing power now,” said one LNG broker, referring to Asian buyers. “Europe has pipeline supplies and China and Japan don’t have alternatives.”
But it is not all a question of price. The world market for LNG is still dominated by long-term contracts, while Europe is pushing for a spot-market with day-to-day pricing. When supply is tight, it means that the price of the limited amount of gas that is not sold already through long-term contracts and thus finds its way to the spot market is soaring. It is estimated that while a decade ago around 70% of the EU gas imports were through long-term contracts, the share is now less than 20%. According to calculations made by the International Energy Agency (IEA), this has saved the EU countries around 70 billion dollars during the last decade as spot prices were low. However, now comes the pain as the same source estimates that the extra cost for the EU in 2021 alone will be around 30 billion dollars. However, the IEA advises EU to stick to its guns and continue with spot-market prices, as the pain will be transitory (as IEA shares EU's preference for spot markets).
The EU has the same policy for the common electricity market which is also based on spot prices, and here it is even more complicated. The idea is that the price is continuously (hour-by-hour) determined by demand and supply. Electricity will then be delivered from the power plants that have the lowest operational costs, and when the price goes up, the power plants with higher costs will start producing until supply meets demand. The power plant with the highest operational cost that is producing at that moment will determine the price. As both renewable and nuclear energy have high capital cost but very low operating costs, it means that when there is idle capacity from these, the price of electricity will be close to zero. When there is not enough, it will be determined by the most costly power source still in production, which by now, as coal is being phased out, is natural gas. With soaring natural gas prices that means soaring electricity prices, which is causing turmoil in many EU countries, and of course windfall gains for nuclear and renewable energy providers.
For the EU, being basically a neoliberal project, this is the best of all worlds. There are moments of pain and moments of gain. And the market is always the best mechanism to solve these issues.
I beg to differ. The argument for these liberalised energy markets underestimates the cost of particularly two issues. Firstly, the cost to society when the markets are wrong, particularly when not enough is invested in electricity generation capacity, can be enormous. This is thus about energy security. Secondly, despite what economic models based on simplistic assumptions may predict, spot-markets are in practice inherently volatile, and volatility has a cost for society, as it is difficult for private companies and consumers to plan under these conditions.
Germany is one of the countries promoting the hydrogen economy. The German company Siemens is developing electrolysing units which they claim have 75.5% efficiency converting electricity into hydrogen. The company is also working with the conversion of natural gas infrastructure to hydrogen. Photo: https://www.siemens-energy.com/global/en/offerings/renewable-energy/hydrogen-solutions.html
Planning has to my opinion an advantage over spot-markets. The EU (and hopefully the world) is in a costly and complicated transition to renewable energy (and nuclear in some countries), which means big investments in new non-contaminating generation capacity. Because of the intermittent character of sol and wind energy, reserve capacity is needed and here natural gas is expected to play a fundamental role closing the gap. In e.g. Germany it is hoped that natural gas in the longer term can be substituted by “green” hydrogen produced by renewable energy, and that it will be possible to adapt and reuse part of the natural gas infrastructure to this end. Countries and companies that are expected to make hugh investments in this energy transition will of course require some guarantees that they will be profitable, and if they can’t get these guarantees in the form of longer-term contracts, they are likely to underinvest, including in the natural gas production which will be needed in the transition period. It is therefore no wonder that exporting countries, including Russia, prefer selling to costumers who are willing to enter into long-term agreements. EU with its spot-market enthusiasm will win, if there is over-investment worldwide, but it will suffer if there is under-investment. It may even freeze from time to time.
1) As it is so often the case, there are internationally different measures which make comparisons difficult. The EU prefers the metric system and hence typically refers to the price per million cubic meter gas. However, the Anglo-Saxon countries use British Termal Units (BTU). It is the quantity of heat required to raise the temperature of one pound of liquid water by 1 degree Fahrenheit. It is the same with crude oil, which is measured in barrels in the USA and cubic meter or tons in the EU. 1 ton crude oil is 7.46 barrels.
2) Presently, Russia has two separate gas pipeline systems. The Western one which supplies the European part of Russia, Western Siberia and Europe, and the Eastern one which supplies Eastern Siberia and China through the Power of Siberia pipeline. So there is presently no way gas from the Western gas fields can be supplied to China or from the Eastern gas fields to Europe. Russia is now planning to interconnect the two systems with the 'Power of Siberia 2' pipeline which will connect the Yamal peninsula to Mongolia and on to China with a capacity of 50 billion m3 per year (which is almost the same as the North Stream 2 pipeline). The estimated cost is 20 billion USD. The feasibility study for the project has been accepted by Gazprom, and the route through Mongolia has been agreed upon with the Mongolian Government. Presently, it is planned to be ready for transporting gas around 2030, but as always with these big infrastructure projects this timeline may easily slip (or the project may never be finished). However, the strategic justification for the project is clear: to give Russia the option to sell its gas to Asia in stead of Europe in case the relations with the European countries continue to deteriorate.