Europe eyes costly options to live without Russian natural gas

Philip Aldrick and Rachel Morison 3/3/2022

(Bloomberg) — Western European nations are scrambling for ways to live without Russian natural gas, bracing for the possibility that either the Kremlin switches off the taps or political pressure for tighter sanctions erupts into a full energy embargo.

With Russian troops advancing into Ukraine, European Union governments are concerned that the source of 40% of the region’s gas could either be interrupted in the fighting or by economic measures to contain Russian President Vladimir Putin. 

“We need to wean ourselves of the dependency on Russian gas and oil and we need to do that much quicker than we had anticipated,” EU climate chief Frans Timmermans said on BBC Radio 4 on Thursday. “The European Commission will make proposals next week to make that happen as soon as possible.”

Gas is crucial because it fuels power plants, heavy industry and home heating across the region. It’s what utilities turn to when production slips from weather-dependent renewables like wind turbines and solar panels. And it’s replacing coal plants that historically were the backbone of European electricity supply.

The short-term options are limited. Coal prices have surged this week, making that fuel a costly and more polluting alternative. Taking liquefied natural gas requires facilities that take years to build, and European buyers still must compete for limited supplies. Expanding pipelines also can take decades and cost billions. 

A complete blockade on Russian gas would require Europe to revive coal plants that have been closed on environmental grounds and buy LNG, according to the Bruegel research group in Brussels. Germany is preparing to extend both coal and nuclear plants that were due to shut at the end of this year. 

Drawing more LNG would leave EU nations with a 70 billion-euro ($78 billion) bill to refill gas storage facilities this summer. That’s almost six times the 10 billion euros spent in previous years -- a price too high for many industrial companies that were complaining about rising energy costs long before the Ukraine crisis. 

Nevertheless, momentum is building for European nations to act. U.K. Prime Minister Boris Johnson this week urged leaders to “do something that is long overdue, and finally wean ourselves off of Russian oil and gas.”

Poland has called for a ban on Russian fuel, and the White House has said “energy sanctions are certainly on the table.” Britain has said it’s considering all options to hit Russia’s energy sector. But for the most part, European Union officials aren’t yet considering sanctions on energy because of the damage it would do the region’s economy. 

Instead, they are accelerating plans to reduce dependency over the longer term. Germany and Italy are planning to stoke up coal plants, and Germany is looking to build capacity to import more LNG. 

“Diversification of our energy supplies is something to aim for regardless of what happens with Russian gas supplies in the immediate future,” Italian Prime Minister Mario Draghi said on March 1. “We cannot be so dependent on the decisions of just one country, as this jeopardizes our freedom.”

Germany is particularly exposed, since half of its gas and coal comes from Russia. An array of financial sanctions have been imposed on Russia but they have carved out exemptions for energy so far. 

“We should see that we become as independent as possible,” German Economy Minister Robert Habeck said in a radio interview Wednesday. “That won’t happen overnight because we’ve become more dependent on imports from Russia over the past 10 years. We’ve gotten ourselves into quite a corner there, but now we want to get out of it.”

Some analysts don’t think energy will escape the growing list of sanctions levied against Russia and are starting to look at the potential impact. Halting or limiting Russian energy will boost prices that have already surged more than six times above levels a year ago, driving up inflation across the region. 

“Diplomatic pressure will soon become too great to avoid an energy embargo,” said Shamik Dhar, chief economist at BNY Mellon and former chief economist at the U.K. Foreign Office. “This will weigh heavily on growth and the cost of living.” 

What Bloomberg Economics Says ...

“Europe’s leaders have to balance the costs of a 40% hit to European gas supply against the pressure that would apply to Putin. Now that the Central Bank of Russia has itself been sanctioned, the calculus may be shifting. Access to reserves is limited and Putin is more reliant on energy revenue for FX. Pulling that could deepen a nascent financial crisis and amplify the hit to the Russian economy.”

--Jamie Rush, Bloomberg Economics

Shortages would limit industrial production and higher energy prices would deepen the cost of living crisis across the continent. Full sanctions could also push economies in the region into recession, according to Bloomberg Economics.

Avoiding the worst economic outcome would take both decisive action, warmer weather and luck. With spring approaching, the end of the heating season is near. That’s when more gas typically flows into storage tanks instead of being burned for heat and power. The risk is that utilities are forced to restock at inflated costs or that supplies would have to be rationed, weakening the buffer that needs to be in place before next winter.

Italy, which depends on Russia for 45% of its gas, has expressed confidence it can survive a cutoff. Options include expanding the Trans Adriatic Pipeline that brings gas from the Caspian Sea region into the southeastern corner of Italy, drawing more from links to Algeria and Libya or taking in additional cargoes of LNG. Many of those projects would take years to complete.

“Italy has no supply issues in the short term,” Ecological Transition Minister Roberto Cingolani said after a meeting of European Union energy chiefs in Brussels, according to news agency Ansa. “We have to think about refilling storages from next year. But we have a short, medium and long term strategy to end the dependency on Russian gas.”

Coal would be the biggest winner if Russian supplies were cut, with targets to rein in greenhouse gases and global warming likely to slip away. 

Germany has been trying to close coal plants to meet its climate targets, and it vowed to halt all nuclear power plants in response to the earthquake that hit the Fukushima power station in Japan in 2011.

A few recently retired coal plants could be brought back on stream, said Hann Koenig, head of commissioned projects for central Europe at Aurora Energy Research Ltd. Rysted Energy expects coal generation to jump 11% this year, returning to 2018 levels.

“Prolonging nuclear lifetimes is another option, as is running gas fired power plants on oil, which many can do, especially older ones,” Koenig said. “The environment has to take a step back.”

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