“Europe may look well prepared for the upcoming winter, but as the recent gas price volatility serves to highlight, safety margins are relatively thin.”
With European Union (EU) underground gas storage already at 90% capacity since August, a renewed energy crisis in Europe appears unlikely this winter. However, as the recent gas price volatility serves to highlight, safety margins are relatively thin. As a result, local energy prices will probably remain higher, and more volatile, than before Russia’s invasion of Ukraine. We also expect prices to be higher than in other industrial hubs, which could further erode the competitiveness of European industry.
Europe’s gas supply should last but prices will likely remain volatile
Last year, Russia ceased most of its gas exports to Europe at the start of the summer, in retaliation for the western economic sanctions applied after its invasion of Ukraine. The sabotage of the two main gas pipelines from Russia to Europe (Nord Stream 1 and 2), in September 2022, ended any hopes that Russian gas exports would resume any time soon.
With Russia accounting for around 45% of Europe’s imported gas, the subsequent energy crisis sparked skyrocketing gas and electricity prices across Europe, and pushed inflation to multi-decade highs. However, Europe did avoid gas shortages, thanks largely to efforts to diversify supplies, reduce demand and build up the amount of gas in storage ahead of the winter. Europe was also helped by a relatively mild winter and by a slowdown in Chinese economic activity, which reduced global demand for liquefied natural gas (LNG).
While the worst-case scenario was avoided last winter, many energy experts believe that this coming winter—and the next two to three—could remain challenging. Europe’s gas reserves haven’t benefited as much this year from Russian gas pipeline imports, unlike in 2022 when supplies of Russian gas continued through to July. At the same time, the reopening of China’s economy would be expected to lead to greater competition on international LNG markets, lifting gas prices.
So far, China’s economic rebound has been slower than expected, which this year has helped keep European gas prices well below their 2022 levels (Exhibit 1), and has also helped Europe to reach its 90% gas storage target well ahead of its 1 November deadline (Exhibit 2).
It is, however, too early to claim victory, particularly given that gas prices remain so volatile. In August alone, prices surged 23%, driven by the prospect of a possible strike at three LNG plants in Australia that account for up to 7% of the world's LNG supply.
Europe’s gas supply and demand dynamics
Europe may look well prepared for the upcoming winter, but as the recent gas price volatility serves to highlight, safety margins are relatively thin. Europe’s energy markets remain highly sensitive to supply disruptions, or to any change in global demand patterns caused by either a cold winter or a reacceleration of the Chinese economy. With this in mind, we’ve analysed the latest energy supply and demand dynamics in Europe to see how energy costs could influence the European economy in the months ahead.
According to International Energy Agency (IEA) forecasts, global gas demand is expected to remain broadly flat in 2023 as increased demand from Asia, driven by the reopening of the Chinese economy, is offset by an equivalent decline in gas demand from Europe.1
As was the case in 2022, Europe has so far this year managed to keep its gas consumption 15% below the 2019-2021 average (Exhibit 3). While some of the decline has been achieved by efficiency gains, the drop in gas consumption also reflects the tough economic conditions in Europe at the moment, which have led to a drop in industrial demand.
Compared to 2022, gas demand for electricity generation should decline further as renewable energy production is expected to pick up. Solar, wind and hydro power generation have already increased by 13%, 5% and 11% respectively in the first half of 2023 compared to the same period last year.2
In addition, French nuclear energy production should rebound by 10%-15% this year, from 279 terawatt hours (TWh) in 2022 to 300TWh-330TWh in 2023.3 While this increase could be partially offset by the closure of nuclear reactors in Germany and Belgium, EU nuclear energy production should still be higher this year overall.
On the supply side, the IEA estimates that global natural gas supply will remain tight in 2023.4 To make up for lost Russian gas supplies, Europe has so far mainly relied on additional LNG imports, which increased by 60% in 2022 (Exhibit 4), and additional regasification capacity, which is 25% higher in 2023 compared to 2021 thanks to new floating storage regasification units.
However, global LNG supply is only expected to increase modestly in 2023. At the same time, non-Russian gas pipeline imports, which have also increased meaningfully over the last year, are expected to remain flat in 2023 as most pipelines are already operating at maximum capacity.
European domestic gas production will also decrease this winter as the Netherlands has decided to close its Groningen gas field by 1 October 2023, accounting for approximatively 1% of Europe’s gas supply. On the positive side, however, Russia’s natural gas deliveries to China through the Siberia pipeline are expected to increase by 40%, which should in theory reduce the need for additional LNG imports by China.
Considering the above-mentioned supply and demand dynamics, as well as the fact that EU gas storage is almost full, a renewed energy crisis in Europe would appear unlikely.
However, Europe continues to import gas from Russia through the Ukraine and Turkstream pipelines, and even increased, though from a low base, its LNG imports from Russia by 35% in 2022. If the Ukraine conflict were to escalate further, these gas flows, while limited in absolute terms, could potentially be at risk.
Beyond the gas market, the conflict in Ukraine could potentially disrupt other energy sources. Nuclear energy, for example, has recently regained some traction as an alternative to gas, but here as well western countries remain highly dependent on Russia. Rosatom, a Russian state-owned company, accounts for 30% of European and 25% of US enriched uranium imports, respectively.
While these risks represent the worst-case scenario, even the base case could have a negative impact on the European economy. While energy prices have dropped substantially since last year, gas prices remain four times higher than in the US and other manufacturing hubs. This price differential acts to reduce the competitiveness of European industry, which has already been negatively impacted by the EU’s carbon pricing mechanism. Within Europe, the biggest impact will be in Germany, where the manufacturing sector contributed 26.6% of gross value add to the economy in 2021, compared to 16.8% in France.5
While Europe’s energy supply appears secure for this winter, relatively thin safety margins mean that local energy prices will probably remain more volatile, and higher, than before Russia’s invasion of Ukraine, and higher than in other industrial hubs. Higher and more volatile energy prices will erode the competitiveness of European industry, weigh on business sentiment and slow the normalisation of inflation.
However, Europe has so far risen to the energy challenge. Policymakers will likely continue to focus on the elements they can control to reduce energy stress on the economy, such as accelerating the energy transition, reducing energy demand and protecting the competitiveness of industries by deploying a carbon border adjustment mechanism, which should come into force on 1 January 2026.
While the current situation is admittedly very challenging for Europe’s economy and for European industry, these measures should ultimately reinforce Europe’s leadership in the race to net zero emissions. The current loss of economic competitiveness could, over time, become an advantage as European companies act now to reduce their carbon intensity and align with strict climate standards, ahead of their global competitors.