Western nations have expressed their opposition to Russia’s invasion of Ukraine in united fashion. An incrementally tightening regime of financial and trade sanctions have been imposed on the country with an end goal to restrict trade and deprive Russia of the capital needed to finance its war effort. During March, the US advanced one step further than its European counterparts and imposed an immediate ban on imports of Russian sourced oil and gas. The UK announced a tandem plan to phase out the import of Russian oil by year end 2022. The lack of follow through by European Union (EU) members to ban Russian energy imports marks a splintering of the West’s united response to Russia’s invasion. Also, it exposes a heretofore underappreciated conundrum as Europe relies heavily on imported natural gas from Russia.

Let’s look at the numbers. Europe consumes around 550 billion cubic metres (bcm) per annum of natural gas. This makes it the region’s second largest source of fuel at approximately 25% of total energy consumed. Of this amount, roughly 204 bcm or 37% is supplied by Russia. Europe receives around 177 bcm of Russian gas via pipeline and an additional 27 bcm via liquefied natural gas (LNG) terminals. Increasing LNG consumption across the globe has resulted in LNG transport facility utilization rates at around 90%, leaving limited spare capacity. Within Europe, LNG facilities have an estimated 65 – 70 bcm of spare capacity. This means that Europe does not currently possess sufficient infrastructure to fully offset Russian pipeline flows with LNG. With new LNG facilities requiring a 3-to-5-year lead time to complete, the bottom line is that European aspirations to achieve independence from Russian energy will take a few years to come to fruition.

The US and the EU unveiled a plan that will boost US LNG supplies to European countries by the end of 2022. Under the agreement, Europe will receive at least 15 bcm of additional LNG by the end of 2022. The source of the additional LNG supplies was not clearly stated. The next US LNG project is not scheduled to come online until 2025. The incremental supply will likely come from a reallocation of US spot capacity or from the redirection of cargoes from other regions.

The European Commission has released a strategy for European countries to reduce imports of Russian gas by one third by the end of 2022. Diversifying gas supplies and reducing dependence on fossil fuels are key pillars of the plan. The numbers appear reasonable in theory. However, affordably switching to alternative suppliers may prove difficult in practice within the existing framework of global LNG markets. The global LNG market is roughly 500 bcm per annum. The Asia Pacific region is the largest buyer of LNG, consuming 350 bcm per annum. European Union efforts to reduce imports of Russian pipeline flows by increasing LNG flows will increasingly see European countries competing with Asian buyers for the limited supply of LNG cargoes. During the second half of 2021, we saw this play out through a tandem spike in TTF (European LNG marker) and JKM (Asian LNG marker) prices as colder winter weather, lower renewable generation and reduced pipeline flows from Russia led to increased regional competition for LNG spot cargoes. The history implies that if Europe ramps up spot LNG purchases to replace Russian volumes, it may lead to a surge in LNG prices leaving demand destruction as the ultimate mechanism to balance natural gas markets.

Sources: Bloomberg, BofA and Goldman Sachs. Infrastructure and consumption/supply data - as of Dec 2021. Price related data is as of March 26, 2022.