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European gas liberalization cut import costs by $70 bil in last decade: IEA

Highlights

Spot pricing left Europe exposed to supply shortage: Zeniewski

EU to pay $30 billion more this year than oil-indexed prices

Liberalization 'essential' to transition, market fundamentals

Liberalization of the European wholesale market for natural gas has yielded a $70 billion saving in importation costs over the last decade, a report published by the International Energy Agency has said.

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Authored by World Energy Outlook, or WEO, Energy Analyst Peter Zeniewski, the report aggregated the total cost of import as the Continent shifted away from 30% gas-on-gas competition in 2010 to 80% in 2020, and also from oil-indexation within long-term supply contracts.

"The gradual transition to gas-on-gas competition... has saved an estimated $70 billion in lower gas import bills cumulatively over the past decade," Zeniewski said, while conceding that "spot pricing may have left the EU exposed to recent supply issues."

The current supply shortage, and the record-high wholesale prices this has given rise to, has meant the total cost of gas imports in 2021 are estimated to be $30 billion higher than if Europe has persisted with oil-indexation in gas supply to the previous extent, the report showed.

"Today's record-high natural gas prices have raised questions about the liberalization of the European Union's natural gas market and its gradual move toward allowing real-time market trading to set prices rather than long-term contracts," Zeniewski said.

"While liberalization has meant greater European exposure to the recent spikes in the price of imported gas, it has also cut the EU's gas bills over the past decade," he added, "and the increased flexibility it provides will be essential as the continent transitions to greater reliance on renewable energy sources, which are cleaner but whose output is more variable."

Oil linkage

The report explained how most of Europe's gas supply before the 2000s was determined by long-term contracts linked to oil prices, and how gas prices used to follow market trends in oil.

"This provided a relatively stable reference price that underpinned large-scale investments in upstream projects, transport pipelines and liquefied natural gas (LNG) terminals," Zeniewski said. "However, gas prices did not reflect supply-demand fundamentals of the gas market itself, and buyers in the EU were unable to take advantage of periods of lower-cost supply, particularly following the US shale gas revolution."

Zeniewski went on to describe how the EU had built up significant now capacity for natural gas imports through pipelines or via LNG over the last decade, adding that the shift towards spot pricing allowed the EU to benefit from low LNG prices during periods of ample supply.

"However... gas supplies are now tight and spot prices in Europe are at record highs," Zeniewski said, adding that this reflected "gas's value as a flexible energy source able to meet both short-term and seasonal peaks in demand."

The report went on to say how falling domestic production from the UK and in particular the Dutch Groningen gas field had limited the Continent's ability to meet peak demand.

"The last large-scale use of domestic capabilities to meet sharp swings in demand was in 2015-16," Zeniewski said. "Since then, imports – in combination with storage injection and withdrawal – have largely filled the gap."

Policy implications

In the WEO's 201 Stated Policies Scenario, EU gas demand is forecast to decline by 10 billion cu m between 2020 and 2030, while domestic gas production is estimated to fall by 15 Bcm, or by 30% compared to 2020 levels, the report highlighted.

The report also said that LNG and pipeline imports would grow to meet this supply gap, although demand in developing Asian economies is set to rise by 250 Bcm over the same period, "setting the stage for greater competition for marginal volumes should periods of tight supply arise again."

Energy efficiency improvements due to heat-pump installation, batteries and other measures, were quantified at almost 90 Bcm by 2030, meaning that EU gas imports would peak in the mid-2020s.

"The dilemma for policy makers is that, despite declining overall demand, flexible gas supply remains essential over the next decade, particularly in the power sector," Zeniewski said, predicting that while annual gas-to-power demand was set to be 10% lower by 2030, peak weekly demand would be 15% higher as gas provides a balancing role for intermittent renewables.

"Even as heat pumps replace direct natural gas use in buildings, the seasonality would be transferred to the electricity sector, where gas-fired power would again be the fall-back option," Zeniewski said, adding that gas import prices with still hold "considerable influence" on peak energy affordability under a marginal-cost pricing system.

This would sustain the strong link between electricity and gas markets for some time to come, Zeniewski said, and that gas would remain an important component of electricity security.

"A parallel ramp up in low-carbon gases such as hydrogen and biomethane, and a reconfiguration and repurposing of gas infrastructure, can ensure that gases continue to play an essential role in managing large seasonal variations in electricity demand," he concluded.