Can LNG ensure European security of supply?
In May 2014, in the aftermath of Russia-Ukrainian crisis, the European Commission adopted European Energy Security Strategy, establishing two pillars of European security of supply: prevention and mitigation. The main goal was to prevent gas supply disruptions by implementing “gas stress tests” (modelled by ENTSOG) and to foster solidarity (Regulation 994/2010) between European member states regarding redistribution of storage capacity under Emergency plan. According to CEER, LNG could become a key source of European flexibility and diversification. Thus, this article will summarise and explain the role plaid by the LNG in the establishment of the European security of supply.
In 2014 EU had already 8 LNG suppliers, however, at that time and given the rigidity of upstream logistics, LNG share in European energy mix constituted only 12%. Nevertheless, growing supply is expected to make LNG trade more flexible and short term-oriented. While the EU will remain a major ‘swing consumer’ who imports access capacity not purchased by other markets, the overall contribution of LNG to European SoS will heavily depend on price. Further on, given uneven distribution of gas supply among the EU, European security will become an internal matter depending on the ability of states to cooperate in solidarity.
There are 23 import terminals who possess 201 bcm of annual capacity (with 5 more terminals of 28 bcma under construction), however, their utilization rate went down from 53% in 2013 to only 19% in 2014, accounting for 163bcm of unused capacity in 2014. Looking at the numbers, it becomes clear that had the terminals been utilized at full capacity, LNG could have constituted 41% rather than 8% of EU gas market share. Thus, it is imperative to encourage investment in LNG infrastructures in order to provide Europe with more flexibility regarding its gas supply.
In order to attract investment, most existing terminals are considered to be exempt from TPA regulations, whereas the new ones can be also granted exemption according to Directive 2009/73/EC. It is also possible to extend exemption, however, the procedure is subject to the regulator, while the outcome of his decision should not distort competition. Overall, the status of the terminal depends on whether it’s considered as ‘essential infrastructure’ (like pipeline) or ‘competitive facility’, however, all LSOs are to publish a standard level of information on their websites, according to Regulation 715/2009. Transparency Template (in voluntary operation by GLE at initiative of CEER) helps potential and existing shippers find relevant information on services and respective costs what in turn is essential for the overall market development.
Despite its key advantage of being the primary and depoliticized alternative to the Russian gas, LNG industry in Europe remains very conservative since it uses only proven unchanged technology. However, there are various LNG infrastructures in use and there is currently enough flexibility of services offered by terminals. For instance, Italy and Lithuania have floating storage and gasification units (FSRU) whose construction time is twice as short (i.e. about 2 years) and who are more socially acceptable (for environmental reasons) than traditional LNG terminals given less land use. They can be both ‘purpose-built’ and converted from an old LNG carrier what makes their CAPEX less capital-intensive. At the same time, despite smaller storage volume of the facility, FSRU’s OPEX are much higher. What the UE currently lacks is small scale LNG services and infrastructures (that would contribute to the implementation of the Clean Power for Transport Package by producing less emissions), however, the EU is ready to propose new services such as reloading, virtual gas pipelines, trans-shipment, bunker ship loading and LNG refueling.
While LNG infrastructures continue to develop, its underutilized capacity raises the question whether the EU have enough interconnections for energy security. Due to being a part of the global gas market (and, thus, being dependent on global demand and supply), the logistic of infrastructure interconnectedness is fairly important for the EU. Thus, these infrastructures have to be economic and have to directly answer market needs. Today, however, there is a striking and persistent imbalance between European additions to liquefaction capacity and additions to regasification capacity (what can be partially explained given capital cost differences) that accounts for low utilization levels8 averaging about 22% in Europe.
There has been a 60% year-on-year increase in reloads implemented by regasification facilities that stems from a week European demand and price attractiveness in other regions. However, despite its degreasing gas demand, the EU is expected to import more LNG what is in a way predetermined by its declining domestic production. The mid-term supply will likely come from the Middle East (that used to be a secondary supplier after Asia Pacific) and Australia and is expected to increase, while post-2020 situation of capacity expansion remains unclear and will depend on investor’s response to price dynamics. Overall, European demand will be driven by its economic activity, impact of energy efficiency measures, demand for gas-fired power generation and relative price of alternative sources of gas supply.
Until recently the prices in North East Asia, North West Europe and North America were divergent, however in 2015 NBP and Asian LNG spot prices reflect similar patterns. Only Henry Hub price (determined by shale revolution, reduced Import, low coal price in the EU and low industrial demand for gas as well as post-Fukushima nuclear dismantlement) remains cheaper, giving the USA additional incentives for export. Today, 53% of the EU (80% in North West EU) gas supplies are traded in gas-for-gas markets that gives reliable price signals thus determining most economic and efficient supply mix. LNG flows (given availability of cargoes not under contract) also respond to these price signal thus becoming more flexible for short-term trading and arbitrage between markets. In other words, surge for LNG will raise its price to attract the cargoes given that LNG tends to flow to higher-paying and liquid markets.
In order to make LNG a part of the European Energy Security Strategy, helping it prevent rather than mitigate supply disruptions, it is necessary to adopt market-based measures requiring participation of all parties from the EU Commission to LNG operators and network users, using an existing GLE Transparency Template as a tool to provide information to the market. Non-market measures (such as adherence to the principles of transparency, nondiscrimination, standardization and harmonization) should be utilized in case of so-called ‘exceptional events’, while there is also an overall need to improve resilience to sudden disruptions. Thus, it is advised to (1) make contracts (master agreements) that would provide LNG to potential users at times of supply disruption, (2) procure additional LNG on spot markets, (3) use storage at LNG terminals to allow for flexibility, (4) develop flexible delivery facilities (eg. FSRUs) and their respective connection infrastructures. Given that markets that are prone to disruptions are not liquid and poorly diversified, they are unattractive to cargoes in times of crisis. FSRU and virtual pipelines could become a possible solution, however, utilization of the former is still technically constrained as it takes about 5 months to re-locate it. Additionally, LNG shippers could enter into arrangements between themselves (eg. swaps), while LSOs (LNG System Operator) and TSOs (Transmission system operator) could increase transparency and accessibility by preparing bundled services in advance in order to cross several countries with a single capacity request if deemed appropriate in case of emergency. Competent authorities should coordinate the effort at national and regional level, ensuring that regulatory and administrative barriers (such as shipper authorization recognition) are removed to allow LNG trades, terminal send-outs and natural gas flows to respond to an emergency situation and cross several countries to supply gas when needed.