<- Back
Summary
The Homing Bird

A newsletter to help you understand the key challenges of climate finance.

Sign up to our newsletter

The Great Gas Game

Return to Blog
Sommaire
Book a call

In the dead of winter 2022, as temperatures plummeted, gas reserves started to dwindle. Prices skyrocketed. Talks of shortages and blackouts dominated headlines. Europe sneezed, and the global energy market shook, sending shockwaves through the European Union Emissions Trading System (EU ETS). Welcome to the Great Gas Game: a tale of energy, politics, and financial markets.  

In this edition of the Homing Bird, we are breaking down everything you need to know about the gas market, from a European perspective. For investors in the European Union Allowance (EUA) market, the stakes are high, with gas prices shaping short term EUA price movements and impacting your portfolio. And for everyone else, it impacts everything from consumer prices, to industrial production employment, to political stability and national sovereignty. It’s time to lift the hood and dive deep into the murky waters : 

  1. Why Europe is so dependent on natural gas 
  2. What are the geopolitics of gas playing out behind the scenes
  3. How gas prices drive EUA prices, and why it will not always be the case
  4. What the future holds for European gas. 

You will discover that in the Great Gas Game, entire countries can be priced out of the gas market and literally “turned off”. That gas prices can grow tenfold over a short time span and crash back down just as quickly, putting enormous stress on economies and societies. And that the friends of yesterday can become tomorrow’s foes, testing the most resolute of alliances.  

Why does Europe rely on Gas 

Europe isn’t capable of producing all the energy that it needs: it simply doesn’t have the natural resources. It only produces only 44% of its energy, relying on imports for the remaining 56%. And its total energy mix depends heavily (23%) on natural gas, which fuels homes, industries, and power grids. 

1.1 Electricity generation 

Around 20% of Europe’s electricity needs are covered by gas-powered production. Maybe a bit counterintuitively, gas is particularly important in countries that rely heavily on renewables. That is because renewables are intermittent, and gas is very practical to fill the gap when output is low and the electricity grid needs to be balanced. As gas-fired power plants can ramp up or down quickly, they are ideal during demand peaks. 

1.2 Industrial Use

Industries also use gas either as a source of heat or as a raw material. For example, the production of ammonia, fertilizers, or hydrogen use gas as a raw material. On the other hand, Steelmaking, glass, ceramics, or cement production require gas to create heat at very high temperatures (above 1.000°C). These industrial processes can’t simply be replaced with electricity or hydrogen without major investments : for them, gas remains the cheapest and most efficient option. 

Gas represented 20%-25% of industrial energy consumption in Europe. 

1.3 Residential heating 

Finally, around 40% of residential heating and water heating in homes around Europe depends on Gas. 

All in all, Europe consumes an astonishing 320 billion cubic meters (bcm) of gas annually—equivalent to 3,370 TWh of energy. Considering that its local production is only a declining fraction, it creates tremendous dependencies on foreign supply. 

1.4 Switching away from gas 

We use gas for a lot of different purposes, and we use a lot of it. But could we simply…use something else ? 

Well, we can use coal for electricity production, but greenhouse gas emissions from coal are twice those of gas for an equivalent output, so it goes against decarbonation objectives. Nuclear is still contested in many states, and takes decades to build up. And, as we have seen, renewables are intermittent, and, like nuclear, it requires significant time and resources to scale. So while the switching opportunity for power production is high, it won’t happen overnight. 

For heating, fuel and electricity can both be used (assuming the electricity is from a low carbon source), as well as heat pumps or centralized systems using biomass or waste heat. However, fuel emits more greenhouse gases, and changing energy source requires retrofitting homes, which is expensive and slow. The switching opportunity exists, but it is not obvious that it will happen. 

And for industrial processes, the potential is limited. The investment needs are massive, and the infrastructure isn’t mature enough - especially in the case of hydrogen as an alternative source. 

In short, we are going to continue to need a lot of gas. 

So the question is, where do we get it from? 

In come the players 

2.1 The Value Chain

Gas is always delivered to the end customer (power plant, industrial plant, home) in a gaseous form. And it is always extracted from onshore or offshore fields in a gaseous form as well. However, in the middle, there are two different paths it can take. 

Pipeline gas travels through…pipelines ! The value chain is fairly simple. Gas is extracted, purified, and transported through pipelines in a high pressure gaseous form through land and sea. It then enters regional distribution networks, connected to end users. 

Liquified Natural Gas on the other hand travels by boat, on specialized LNG tankers with cryogenic tanks. Here, gas is extracted, then liquified, transported, delivered in ports, and “regasified” in regasification plants. It then enters the regional distribution networks. 

While pipeline gas is constrained by fixed routes,  LNG is practical over oceans. However, it requires a shipping fleet (650 ships globally), ports that can accommodate these ships that are sometimes congested, and regasification plants that need to be built. These are all bottlenecks that can create tension on the market, and contribute to price spikes. 

Europe was historically more of a pipeline gas fan, with abundant, cheap, reliable supply. This was the EU Gas supply sources in 2021: 

“East” here refers to Russia. 

However, in 2022, it was forced to transition away from Russia, and into LNG. 

2.2 Inherited dependence on Russia

To understand why Europe suddenly shifted from pipeline gas to LNG, we need to understand the history behind Europe’s gas infrastructure. 

In the 1950s and 60s, the Soviet Union discovered rich natural gas reserves, and started large scale extraction. In the 60s especially, it built an extensive pipeline network throughout eastern European satellite states. The Brotherhood pipeline was one of them, and extended all the way to Austria, then in the Western bloc. 

During the cold war, western European states like Germany and Austria saw Soviet gas as reliable and affordable, and supplied the then Soviet Union with technology and pipelines in exchange for gas, in spite of the political rivalries. This expanded the pipeline network, with Ukraine being a key transit state between Russia and the west. 

When the Soviet Union collapsed, Russian gas exports were a critical revenue source, and gas exports to Europe were expanded. As Russian gas was cheaper and more abundant than other energy sources, Europe continued to diversify away from coal and nuclear, increasing its reliance on natural gas for power generation, heating, and industry production. New pipelines were built, such as the Yamal, Blue Stream, and Nord Stream 1 lines. 

By the 2000s, Russian gas represented 40% of Europe’s gas imports, with a discrepancy amongst countries: Germany, Italy, and Austria were heavily dependent. Russia strengthened its grip on these markets by offering long term, fixed price contracts. In spite of warnings on this over-reliance by ex USSR states such as Poland, countries like Germany pursued ever deeper ties, building Nord Stream 2 for example. And as Europe’s climate ambitions started to take shape in the early 2000s, gas was an obvious and readily available alternative to coal. 

This is the (simplified) natural gas infrastructure linking Europe to Russian gas. 

2.3 The turning point in 2022

Everything halted with the invasion of Ukraine in 2022. Europe imposed sanctions on Russian gas and sought to reduce its dependence. In response, Russia cut its supplies through key pipelines, flexing its muscles. Europe is threatened with skyrocketing energy prices, gas shortages, and potential blackouts. The price increased tenfold, fueling massive inflation, an increase in cost of living for consumers creating political instability and unrest while penalizing industrial output. 

Prices went from around 20€ / MWh pre 2022 up to 350€ / MWh at their peak mid 2022. 

Europe desperately looked for alternatives, and in doing so shook global markets. 

Europe sneezes, the world shakes 

When Europe turned away from Russian gas, it set off a global scramble for alternatives, reshaping energy markets and creating new winners and losers.

3.1 Maxing out pipeline capacity 

All of a sudden, Europe is looking to replace massive amounts of Russian gas from other sources. 

First, it turns to its other partners : Norway, Algeria, and Azerbaijan, also supplying pipeline gas. While they were already operating at close capacity, agreements were reached to boost exports and max out every existing capacity.  This wasn’t sufficient however. The real change could only come from a shift to LNG. 

3.2 Going full LNG 

However, the limiting factor here was the infrastructure: the liquefaction facilities, the number of LNG carriers, the port capacity, and regasification plants, and regional networks: 

  • Liquefaction facilities in the exporting countries take years to build, as do tankers and ports. 
  • Considering the EU’s decarbonation trajectories, no one had the incentive to invest in regasification plants in Europe given the 25 years needed to recoup the capital expenditure versus the absence of a stable, long term perspective for natural gas. Existing LNG terminals existed in Spain, France, and Italy but not in Germany for example. 
  • And regional markets were built to distribute gas coming from the east through Russian pipelines. Not gas coming from the west from the Atlantic seafront. Building the connections to the end users, and reorienting gas flows, are challenges in themselves. 

Finally, there is also the issue that the global market was already tight, with little supply surplus. Asia was a key buyer, especially China, driving LNG prices higher.

So, what gives ? 

3.3 Supply and demand pincer movement 

Tragically for the European economy, part of the solution came in the form of demand reduction. In practice, that means that energy intensive industries like steel, chemicals, and fertilizers reduced or halted production due to exorbitant gas prices. 

Tragically for the environment, countries switched back to coal-fired power plants and even and peaker plants. 

On the supply side, emergency infrastructure expansion was organized with the deployment of floating storage and regasification units, which have easier investment payback profiles as they can move around, following demand. And investments were made in cross-border interconnections to improve regional distribution. 

3.4 America to the rescue

In parallel, the US ramped up its LNG exports to Europe and the UK. In shale gas boom in the 2000s and 2010s had created a surplus of natural gas, and heavy investments in LNG export terminals to monetize this surplus. These terminals were fully modular and scalableThe infrastructure was readily available. 

The US also relies on spot contracts rather than long term engagements, and were able to reallocate exports from Asia to Europe without breaching contractual obligations. As European gas prices were so high, and Europe being geographically closer (thus reducing shipping times and increasing turnaround efficiency) it was in the US best interest to support its allies. The US government supported the move, expediting infrastructure expansion approvals and coordinating with the EU to secure LNG deliveries. 

3.5 Repercussions in Asia…and the world

Inevitably, prices rose across the world, and Europe’s willingness to pay record-high prices, subsidized by governments to ease the burden on households and industries. Less wealthy nations in south and southeast Asia had to turn back to coal and oil. 

Rerouting US LNG to Europe hit Asian economies hard, especially major importers like China, Japan, South Korea, and India. 

China turned to Russia and pipeline gas, basically doing the reverse action of Europe. Japan and South Korea implemented energy-saving policies to reduce consumption, while also facing higher prices. India shifted back to coal and oil for power generation, increasing its greenhouse gas emissions. Brazil ramped up hydroelectric generation. 

Europe was able to buy its way out of the energy crisis. Pakistan was less fortunate. Mills in Punjab were forced to shut down due to gas shortages, impacting the country’s vital textile industry. Widespread power outages crippled the country. Bangladesh saw millions without electricity, and India grappled with power shortages amidst heatways. 

Gas prices and EUA prices 

In Europe, gas prices started being the main driver behind EUA prices, with the correlation being close to 1 in the first half of 2024. 

Notice how EUA prices (blue) follow gas prices (red) throughout the first half of 2024 before decoupling during summer months. During winter, the correlation strengthens again. 

This is because power producers can switch from burning coal to burning gas to generate electricity, depending on the relative price of each energy source. 

4.1 Coal to gas switch 

To decide whether coal or gas is the more economically viable option, they consider : 

  1. The price of coal
  2. The price of gas
  3. Coal emits twice as much CO2 as gas for an equivalent quantity of electricity produced. 
  4. Therefore, the price of EUAs, which must be bought in a quantity equivalent to emissions. 

This means that for one unit of energy produced with coal, twice as much EUAs must be bought than for the same unit of energy produced with gas. And this relationship has created a strong correlation between gas prices and EUA prices. 

4.2 Decarbonation of power production

However, power plants are not the only buyers of EUAs. Industries also purchase EUAs, as do shipping companies, and aviation companies. As the share of power generation from fossil fuel decreases, the weight of the power sector in the EU Emissions Trading Scheme will decrease. And therefore, the share of EUA demand coming from the gas to coal switch will also decrease, decoupling EUA prices from Gas prices. 

Where things stand today

While the European Commission imposed mandatory storage levels across the EU to avoid shortages or blackouts, gas storage levels are unseasonably low in spite of weaker consumption. And prices started picking up again, with global demand straining supply and Russian gas continuing to be phased out. 

5.1 Europe’s eastern front 

On January 1st 2025, Ukraine refused to renew a 5 year transit agreement for Russian gas supplies to Europe, dating back to 2019 and representing 5% of total gas imports. It was the last pipeline carrying Siberian gas to Europe. In the middle of winter, with a cold spell ongoing, and reduced wind output (so no wind power production), this sent gas prices in a frenzy. In an attempt to destabilize Europe, Gazprom (which is set to lose US$ 6 billion a year from the Ukrainian move) retaliated by cutting off gas to the Russian-controlled region of Transnistria in Moldova. This in turn engineered an artificial energy crisis and cut off 450 000 people from gas, hot water, and heating and forced all industries to close (this is happening now, in early January). 

5.2 Europe’s western front

In the meantime, Trump is threatening Europe with tariffs unless Europe purchases even more LNG from the US. This creates a new circle of dependency, with a more aggressive US trading partner that needs to secure buyers for its ramped up gas industry, with economic (for now) coercion if need be. 

As shown in the map below, pipeline gas to Europe has virtually ended, with 0 mcm per day this week, whereas LNG flows represent 44% of all gas imports, the rest being split between the North Sea and North African pipeline routes. 

Notice how LNG flows represent 44% of all gas imports, whereas eastern pipelines are shut down. LNG Terminals are concentrated on the Atlantic coast, creating strong geographic imbalances. 

5.3 Winners and Losers in the Great Gas Game

While Norway and Algeria benefited from increased pipeline gas exports to Europe, the real winner is the US. While Asian and South American countries were priced out of the market, with drastic impacts on their economies and populations. 

As for Europe, it traded one energy bully with another, and will need to continue to reduce its gas demands in a structural manner. Europe’s climate policy, with its focus on energy efficiency, expansion of renewables, and deployment of heat pumps, can be the powerhouse of this shift. At Homaio, we’re here to help you decode these dynamics and make informed decisions

Sources : 

European Commission Joint Research Center - Security of EU Gas Supply (link)
Eurostat - Energy in the EU, 2023 Edition (link)
Institute for Energy Research - Europe’s Latest Natural Gas Supply Crunch (link)
Bruegel - European Natural Gas Demand Tracker (link)
Center on Global Energy Policy - Anatomy of the European Industrial Gas Demand Drop (link)
Rystad Energy - Rebalancing Europe’s Natural Gas Supply (link)
International Energy Agency - Natural gas supply-demand balance of the European Union 2023 (link)

Do you like this article?

Share it with your network and introduce Homaio to those interested in impact investing!

Understanding in depth

No items found.

You might also like

You might also like

No items found.