The current crisis in Ukraine reminds the European energy industry of January 2009, when a dispute between Ukraine and Russia resulted in the blockage of pipelines that carry natural gas across Ukraine to Europe. The blockage led to a two-week crisis that severely affected 18 countries. Across Europe, the spot market price of natural gas increased by 40 percent to €32 per megawatt hour.
Although the larger geopolitical consequences of the current upheaval in Ukraine could be far greater than in 2009, the short-term economic impact on the rest of Europe will likely be more limited. Compared with five years ago, the EU is far less reliant on pipelines passing through Ukraine, has larger natural-gas reserves, and has more options for substituting Russian gas with liquefied natural gas (LNG), which is available on the world market. The fact that the Russia-Ukraine standoff is occurring at the approach of spring, when gas consumption falls off dramatically, also lightens the potential impact.
Should the Ukraine crisis stretch into the summer, the implications for the rest of Europe will be far more severe. Gas pipelines crossing Ukraine remain critical. The biggest of them, the so-called Brotherhood pipeline that branches into Slovakia, Austria, Italy, the Czech Republic, and Germany, transports 15 percent of the natural gas consumed in Europe and accounts for one-third of its gas imports. A cutoff would cause European energy costs to spike, hurting everyone from consumers to industrial users.
We consider the prospects of a long-term stoppage unlikely. And in the event of a prolonged crisis, Europe’s options for coping are better than they were five years ago. A crisis could also prompt the EU to take further measures to ease its dependence on Russian gas, such as making greater use of LNG and perhaps even accelerating plans to develop reserves of shale gas.
Companies operating in Europe must nevertheless take into account both the short- and long-term risks related to the events unfolding in Ukraine. The short-term fallout of a Ukrainian pipeline blockage would be mitigated by the following factors:
- Alternative Pipelines. The Nord Stream pipeline, which opened in 2011, runs beneath the Baltic Sea and links Russia directly to Germany, the EU’s largest market. Moreover, newly implemented interconnector pipelines connect the gas markets of central European countries. Although it can transport around half as much gas as the Brotherhood pipeline, the Nord Stream is operating at only around 45 percent of its 55 billion cubic-meter (bcm) capacity. Therefore, shipments can be substantially increased. What’s more, several pipelines are now capable of reversing the east-to-west flow of gas. Such a reverse would mean that many eastern European countries—including Ukraine—would be able to import gas from their neighbors.
- New LNG Sourcing Options. Since 2009, several new LNG terminals have opened, boosting the EU’s regasification capacity by about 30 percent to 200 bcm as of 2013. New terminals in Poland and Lithuania—both of which currently depend heavily on Russian gas—that are scheduled to open in 2014 will add another 9 bcm of capacity. LNG available on the world market comes primarily from the Middle East, Southeast Asia, Australia, and Africa. Most of that is sold in Asia and is now substantially more expensive in the spot market than Russian natural gas.
- Ample Storage Capacity. Partly in response to the last crisis, the EU has added 14 bcm in storage capacity over the past five years. The total storage capacity now equals around one-quarter of annual EU gas consumption and more than 40 days of peak winter consumption. The most vulnerable central eastern European countries—for example, Austria, Hungary, and Slovakia—have enough capacity to ride out a supply interruption lasting more than 100 days. Ukraine itself has the largest storage facility in Europe. At the beginning of the winter, it was nearly filled to its capacity of more than 30 bcm.
- Softer Demand. One positive aspect of the European economic crisis is that it relieved the demand side pressure on the gas market. Longer-term trends, such as improved energy efficiency and plunging production at gas-fired power plants, contributed to an overall stagnation of gas consumption. In key markets for Russian gas, demand has dropped significantly since 2009: consumption declined by 7 percent in Germany, for example, and by 20 percent in some eastern European countries.
These four structural changes, plus a relatively warm winter, mean that in the short term, Europe will likely be comfortably supplied with natural gas even if supplies through Ukraine are completely cut off. If the crisis drags on and escalates, however, the Ukrainian pipelines will be sorely missed later in the year. The first signs of trouble could appear in April and May, when European nations begin to refill their depleted storage capacity of gas so that they will be well supplied in October, when the heat is turned on again. Under this scenario, we see the following mid- and long-term consequences:
- Higher Energy Prices. A prolonged drop in the gas supply from Ukraine would end the recent period of oversupply and increase gas prices. The higher prices would hit European energy-intensive industries, such as chemical producers—already at a cost disadvantage relative to the U.S.—particularly hard. By winter, higher prices would also exacerbate so-called fuel poverty by increasing the number of European households that cannot afford to keep adequately warm.
- Further Pain for Gas-Fired Power Plants. The high price of natural gas in Europe relative to coal prices already puts gas-fired plants at a serious competitive disadvantage. A prolonged hike in gas prices in parallel with a supply disruption could force the closure of some of these plants and push others into bankruptcy.
- Regulatory Actions. To cushion consumers and industrial users from the impact of higher energy costs, governments and regulators could intervene in the gas market by freezing prices for end users. That would result in heavy losses to wholesalers, who would not be able to pass the higher costs of imported gas on to their customers.
- New Infrastructure and LNG Investment. As it did in 2009, a natural-gas supply crisis would likely prompt European nations to boost their capital investment in additional pipelines and storage projects. New LNG terminal projects that are stalled will gain renewed interest. Russia, meanwhile, could push faster to build its South Stream gas pipeline, which will reach Europe through the Black Sea, bypassing Ukraine.
- A More Favorable View of Unconventional Gas. Ukraine has one of Europe’s largest deposits of shale gas, estimated at 3,000 bcm, about one-fifth the size of proven U.S. reserves but five times UK reserves. Large oil and gas companies, such as Shell, Chevron, and ENI, are exploring these fields and are expected to begin commercial production in 2018. Other European nations, such as the UK, Poland, and France, also have shale deposits. But they have been slow to develop these resources or have even banned them because of concerns related to the environmental impact of hydraulic fracturing or to economic viability. A cutoff of Russian supplies could improve the business case and political support for unconventional gas projects.
Given the highly unpredictable nature of events in Ukraine, companies should prepare for the worst: a long-term blockage of gas supplies from Russia. They should prepare strategies—such as hedging against rising gas prices and lining up alternative sources—for coping with higher energy costs. Fortunately, because the European gas market is today better equipped to deal with such an event than in 2009, it can limit the negative impact. By taking action now to guarantee energy security over the longer term, European governments and the energy industry can greatly reduce the odds that another political crisis involving Russia will again put the region’s economy at risk.