The price of energy in Europe has surged immensely due to the war in Ukraine and the political theater that is playing around it.

Here is a chart showing the yearly percentage increase of energy costs:

Out of the different energy sources, oil and gas have gotten the most attention since those are the two energy sources where Europe has put itself into a position in which it is very dependent on Russia.

Current European import amounts from Russia:

• about 25% of its oil supplies
• about 40% of its natural gas supplies

And here is a pipeline map that clearly illustrates the importance of Russian energy supply for Europe:

These pipelines are running like blood vessels and veins through the whole European continent, supplying people and companies with the necessary energy supplies to survive, operate and thrive.

Now, out of the two energy sources, the price of natural gas has surged even more drastically and also gotten the most attention.

The main reason for this is that oil can be more easily shipped around via oil tankers, while the process of getting natural gas onto ships involves a more complicated process. As I wrote last month (emphasis added):

While it is possible to shift oil suppliers, it is far more difficult to change sources for natural gas. Oil can be globally transported on tankers while gas is mostly transported to Europe through pipelines. In order to ship gas from other sources, it first needs to be cooled down into liquefied natural gas (LNG). This process is complicated, more expensive and requires an infrastructure which first needs to be set up, requiring time and capital expenditures. Currently, a bit more than 50% of the natural gas is supplied via pipelines with a distinct geographical destination, which is the reason why the gas prices have way higher variations across different geographical areas than oil has.

Furthermore, unlike the oil tankers, that are unspecialized and can easily be rebuilt to serve other functions, the LNG carriers are very specialized in their design. It follows, that the whole production and operation purpose of them, requires a particularized commitment for their intended use. Their appearance is also quite unique:

Finally, once the LNG carrier arrives at the desired port, there is a regasification required, before the gas can be pumped back into the pipeline and sent to its final destination, either directly for burning, or to plants to produce electricity. This regasification process requires special terminals and the necessary pipeline infrastructure to connect it appropriately.

As pointed out in a Reuters article, Europe simply does not have sufficient infrastructure, to handle much larger LNG imports at the moment:

As can be seen, Spain does have the highest capacity at the moment with 6 LNG terminals, but the problem is that these terminals have only a limited connection to the European pipeline system and therefore the utilization of the excess capacity, shown in the bar chart, is quite limited.

Since most of the other countries with LNG terminals already run near their capacity limits, Britain and France are the main possible countries that can import additional LNG supplies and make it accessible for other European countries.

This available capacity accounts for a bit more than 40 billion cubic meters (bcm). The annual amount of Russian gas imports into Europe is estimated to be around 155 bmc, which means that roughly 25-30% of the Russian natural gas imports can currently be replaced by LNG.

This number can be increased in the future by a) building out the pipeline network especially with regards to Spain, which would allow another 40 bcm, and b) by constructing new LNG terminals.

Germany, which is the biggest importer of Russian natural gas, currently has no LNG terminal in operation. However, it is the main European country that is currently working towards the capability of getting more supplies through LNG into Europe. There are already 3 projects of constructing LNG terminals in progress, with the following capacities:

1. Brunsbeutel, with a capacity of 8 bmc and likely to start operations in 2026.
2. Stade, with a capacity of 12 bmc and forecasted to start operations in 2026.
3. Wilhelmshaven, with 10 bmc LNG capacity, and forecasted to operate in 2027.

In total, this could bring in an additional 30 bcm LNG import capacity to Europe, which would bring the total capacity to about 110 bcm of additional LNG and could therefore satisfy about 70% of the current demand from Russia (155 bmc). However, it still wouldn’t be sufficient to cover all of the current inflows from Russia and more importantly, it won’t be fully available for at least another 3-5 years. Thus, currently it seems an impossible dream to completely avoid Russian imports.

Other solutions would be to rely to a greater amount on renewable energy for electricity production, which also takes time, is costly and has decreased reliability, or nuclear energy, which unfortunately is still a taboo topic in some European countries (most notably Germany).

So far, we have only analyzed the demand side for Europe of the LNG story. The supply side is another issue. The LNG that is currently produced also has its recipients. If Europe goes on the market to buy more LNG, this has the consequence that they need to bid against other already existing buyers. This consequently results not only in higher prices, but also means that current importers, who are bid out of the market, must find new energy supplies. This will be especially challenging for countries like Japan and South Korea, who currently import large amounts of LNG and do not even have the option of receiving natural gas through pipelines.

Current gas production in other countries can of course increase over time, but it is not like a switch that can just be turned “on” and “off”. The Plug tweeted another revealing chart showing the LNG exports of the U.S., which is the largest LNG producer:

To summarize it, Europe is in a precarious situation, which is why Russia is energy-wise in a position where they have some room to set the terms. It was a quite obvious move to demand payment in rubles and while European politicians might cry about “contract breaches”, they have to face the reality that it is them, who want to block Russian imports, but still need their energy for now. Moreover, alongside the U.S., they have sanctioned some major Russian banks and are freezing Russian reserves held in USD or Euro. So what are the Russians supposed to do about that? It should be clear that they won’t supply countries who are clearly acting as an enemy now towards them with ‘free energy’.

The dominant position of Russia when it comes to energy is shown in:

• The fact that they are able to just stop supplying gas to countries which are not willing to pay in ruble, such as Poland and Bulgaria.
• The exchange rate of the ruble has already recovered from its initial decline and is now higher than before the war started.
• Hence, while Europe has seen the energy prices surge astronomically, Russia so far hasn’t had any significant decline in export revenues, even though the export volumes have declined.

To be honest, the way European politicians are acting seems quite clumsy, uninformed and short-sighted. Moreover, they don’t appear to spend much time thinking through the possible implications of their actions.

Some possible long-term global ramifications of Europe’s energy policy might be as follows:

• Europe finds other suppliers to import natural gas via LNG, by paying higher prices and therefore bidding out their current customers.
• These current LNG customers (mainly in the Asian hemisphere) will instead be able to get cheaper prices offered by Russia who is now sitting on idle resources and therefore increasingly shift their business to Russian suppliers.
• This would be in some sense a political win-win scenario, since Europe can achieve its goal of avoiding imports from Russia, while Russia can now sell those unused resources, due to elevated LNG market prices, to other bidders who need to find new suppliers since their former suppliers now ship their energy to higher paying European customers.
• The main winners would be the LNG exporting producers (mainly in the U.S.A, Qatar and Australia), who can sell at higher prices to European customers.
• The main losers of this scenario would be:
  • European companies who are now facing increasing costs of production.
  • European citizens, especially those who are politically agnostic and do not care so much about where their energy comes from, but are now faced with permanently elevated prices.
  • Other countries that rely on LNG imports due to the lack of other energy sources.

Since this is a constantly developing and changing story, It remains interesting how it all ends up playing out.

Also see the related article about how to look at natural gas as an economic indicator:
Natural Gas as an Indicator