Just over a year ago Europe was on the verge of a looming energy crisis. Natural gas prices had spiked at more than 15 times the levels seen before the invasion of Ukraine. The risk of power cuts and recession were all too real.

In the event Europe avoided major gas shortages and the damage caused by the decoupling from Russian gas was less than feared. This was a remarkable feat, achieved through reduced gas demand and sourcing alternative energy supplies, particularly liquified natural gas (LNG). 

Although Europe is in a stronger position than a year ago, major gas shortages remain a possibility over the winter. The three biggest risks are from severe weather, shifts in global LNG supply and demand, and Russia closing off remaining supplies of gas to Europe. 

Temperatures are a significant driver of natural gas demand with, for instance, a 1°C fall in daily temperature estimated to result in a 3-4 per cent increase in UK gas demand. Last year’s unseasonably warm autumn and winter helped to reduce energy consumption. Futures markets are pricing a roughly 50 per cent increase in gas prices by December as demand rises during the colder months, though this would still be roughly half the level seen last winter. Severe weather, or disruption to LNG supply, could push prices much higher.

In the last 18 months Europe has largely replaced Russian pipeline gas with more expensive LNG. Unlike pipeline gas, LNG is traded globally and its price is subject to shifts in world supply and demand. European gas prices have jumped in recent weeks on concerns that a pay dispute in an Australian LNG plant may disrupt supply. Australia typically serves the Asian market, but traders are concerned that disruption to Australian supply would increase Asian demand for gas that would otherwise go to Europe.

China is the obvious source of marginal demand for gas, accounting for more than one-fifth of global LNG imports in 2021. The lingering effects of China’s COVID lockdown dampened Chinese energy demand last year and helped European countries to build up winter gas stocks. This year China’s lacklustre recovery and muted demand in other Asian markets have continued to suppress global demand for LNG.

On the supply side Russia could yet turn off its remaining supply of gas to Europe. Russian supply has fallen from about 40 per cent of all European gas imports to 10 per cent since the invasion of Ukraine. Cutting off these supplies would reduce Russian state revenues but would also be disruptive for Europe.

The message is, whatever the source, even moderate disruption to supply or demand could cause large swings in the LNG price.

Europe is in a stronger position than it was a year ago, having switched away from Russian gas, added wind and solar capacity, increased energy efficiency, reduced energy consumption and rebuilt gas storage levels. The EU has also extended last year’s target of a 15 per cent reduction in natural gas usage for 12 months. It is a measure of its success that European gas storage capacity is currently about 94 per cent full, far above the 80 per cent seen this time last year. 

On balance Europe seems likely to get through winter without major disruption to energy supply.

Leaving aside such risks, there is still the problem of elevated energy prices. Gas prices have fallen but are still way above what were regarded as normal levels before the pandemic. The Brent crude oil price has risen by more than 25 per cent over the summer on resilient demand and the announcement of prolonged production cuts by Saudi Arabia and Russia. Higher gasoline prices have led to an unexpectedly strong pickup in America’s inflation rate in August. 

Elevated energy prices seem likely to be here to stay. That will dampen growth in consuming nations – and will help drive the shift to renewables. Last week, Fatih Birol, the head of the International Energy Agency (IEA), heralded “the beginning of the end” of the fossil fuel era with a forecast that demand for oil, natural gas and coal will peak before 2030. The IEA says that Europe’s energy crisis, along with new technologies and China’s shift away from energy-intensive industries, are behind the new forecast. This is the silver lining in Europe’s energy crisis.

A personal view from Ian Stewart, Deloitte’s Chief Economist in the UK. To subscribe and/or view previous editions just google ‘Deloitte Monday Briefing’.

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