Gas cut or glut?

The war in Ukraine continues wreaking death and destruction, with hopes of a lasting ceasefire looking unlikely. The conflict also continues to cast a shadow on Europe’s energy market as the bloc looks to wean off its dependency on Russian gas. Listen to a discussion on whether Moscow’s new game plan could be to saturate the market with a view to price out alternative supplies, particularly from the US.

Host: Richard Sverrisson, Editor-in-Chief, Montel
Guest: Henning Gloystein, Director, Energy, Climate and Resources, Eurasia Group

Transcript

Richard Sverrisson, Editor-in-Chief, Montel: 0:06

Hello listeners and welcome to the Montel Weekly podcast. Bring Energy Matters in an informal setting as the war in the Ukraine shows. No sign of ab baiting. This week's episode, we'll look at the bigger geopolitical picture. Have we shifted into a new global order, a new period where China and Russia had assert themselves on the global stage? And what does this mean for energy markets, particularly for the coming winter in Europe and beyond? Helping me, Richard Sverrisson to discuss this and much, much more, is Henning Gloystein of Eurasia Group. A warm welcome to you, Henning.

Henning Gloystein, Director, Energy, Climate and Resources, Eurasia Group: 0:39

Thank you, Richard. Thanks for having me.

Richard Sverrisson, Editor-in-Chief, Montel: 0:41

I wanted to start off by looking at the big geopolitical picture as I talked about in the intro are we now in a new phase, Henning? Is there a resurgent China and aggressive Russia?

Henning Gloystein, Director, Energy, Climate and Resources, Eurasia Group: 0:52

I mean in terms of the conflict, the war in Ukraine, we actually think we're in this sort of stuck in the mud when this, messy stalemate, which won't see a resolution anytime soon. Russia itself, of course, has has, changed its role in the geopolitical on the geopolitical stage quite dramatically this year from being a uneasy partner at the start of the year. Or late last year to being hostile to the west. Now, and that won't change anytime soon. China seems to be sitting on the fence. China certainly is very unhappy with what's going on in the on the ground, but they can come out openly in support of the United States. That's not within the Chinese doctrine at the moment. But they're certainly unhappy with how things are going because it has of course all sorts of supply chain stress, commodity import price surges, LNG coal oil have all become furiously expensive. And of course China is seen to be a little bit of a facilitator of the war. In Ukraine by supporting Russia, even tacitly. And that is not going down well in the European Union. And it's worth keeping in mind that China and the EU are each other's biggest trading partners. China is not happy with this situation, but they can't come out openly in for support of the west either. But we think they would like some form of a resolution to the conflict. Like everyone else, they don't really see where that's going to go and how that's gonna happen.

Richard Sverrisson, Editor-in-Chief, Montel: 2:08

Isn't it also tacitly in support of Russia and doesn't it stand to gain from that in some sense? Some preferential gas deals, for example, some, if the pipe gas is not gonna flow to Europe in the same way it has done, will it now not flow east instead?

Henning Gloystein, Director, Energy, Climate and Resources, Eurasia Group: 2:23

Yeah, for sure. You're absolutely right. China will try and, profit from this crisis. Maybe not the right term, but strike deals. All the assets that Western companies have left behind in Russia. There's a lot of them, oil and gas assets that stand to be snapped up by anybody else. The Chinese might try, some folks in the Middle East might do as well. But yeah, so China will try and get access to some of those assets and for sure, gas prom is almost certainly gonna lose virtually all of its European customers in the gas market, which currently make up 80% of its export revenues. They, they can't switch those to China anytime soon. But they will build new pipelines to, to China. And the Chinese will buy that Russian gas. And we think the Russians will find out the hard way that the Chinese will buy this gas on Chinese terms because they know exactly that Russia can't sell it to anybody else at this stage. So this will be a hard deal for Russia, but absolutely, and China will pay for those in for that gas probably in Yuan and not in US dollar. So they'll try and benefit from this. Yeah.

Richard Sverrisson, Editor-in-Chief, Montel: 3:21

And they weren't paying rubles, then you don't think?

Henning Gloystein, Director, Energy, Climate and Resources, Eurasia Group: 3:23

They might do some form of the adjustment, right? Like Gasper is demanding in Europe now, so make the payment in whatever Euro or dollar, but then transfer it into ruble in Russia. But I don't think that Chinese care about that very much but the initial payment will almost certainly be made in Yuan.

Richard Sverrisson, Editor-in-Chief, Montel: 3:42

What you said about the current status of the war. You see it as a very much a stalemate, tanning. Could you enunciate a little bit? What you mean here?

Henning Gloystein, Director, Energy, Climate and Resources, Eurasia Group: 3:49

Yeah, so we, our base case for the next three months is a messy stalemate, which is literally just that. It's the Russians will not be able to totally defeat the Ukrainian forces over the next couple of months. Likewise the Ukrainians will not be able to push Russian forces out of all of Ukraine. And even if suddenly as some do suspect, Russia declared some form of a ceasefire and suddenly said, oh, look we, we now have all the, we the territory we wanted. We have freed Russian speaking Ukraine from. From neo-Nazis, whatever that would not be a ceasefire that zelensky in Ukraine can tolerate, or the west. So it would be a ceasefire that would be highly a threat of being broken continuously. And hence fighting would continue in some form. So that is what we mean with a messy stalemate. We give that currently in a base case scenario of 70% for the next three months. 25% escalation, which gets scary and it doesn't sound like much 25%, but 25% escalation from an already very escalated conflict is not a nice prospect and only 5% of a full diplomatic solution. Like I say, that would not mean a ceasefire that could be broken anytime soon, but full 5% chance of some. Un totally unforeseen situation occurring in which a full semi peaceful situation could be achieved. So we don't give that a high possibility at the moment, but never say never.

Richard Sverrisson, Editor-in-Chief, Montel: 5:12

Yeah, that's sadly a very low possibility at the moment. But this messy stalemate, how long do you think it can continue? Are we in for the long haul? The situation that Dom passed and the Eastern Ukraine has lasted since 2014. Could this last eight years, could it last out the decade?

Henning Gloystein, Director, Energy, Climate and Resources, Eurasia Group: 5:28

Yeah, I guess that is the fear that it lasts till 2024 or longer. Last a decade, so that could be some of the continuing stalemate that you see. It's a frozen conflict that it gets stuck in time. This could happen fairly easily without anybody wanting it. The, the Ukrainian forces are getting stronger in terms of equipment. But they're not getting they're also getting tired. Once the summer ends and autumn the fall starts, things get wet and cold again. Then conflict literally can get frozen or stuck in the mud physically. Russia might not be able to escalate much further without a general mobilization of his forces, which president Vladimir Putin clearly wants to avoid because that would call into doubt his special military organ operation and openly have to declare war. And yeah and absent a negotiated piece, which still as I say, looks a bit unlikely. That is exactly the risk. And then suddenly you're talking the conflict going on into 2023. And then then, we're not far from that decade.

Richard Sverrisson, Editor-in-Chief, Montel: 6:27

Absolutely. I was thinking more in terms of, the war and the donbas has already lasted eight years. Could this present conflict last eight years as well? But I think, who knows? Yeah.

Henning Gloystein, Director, Energy, Climate and Resources, Eurasia Group: 6:36

Yeah. I think your guess is as good as mine and I really don't think anybody knows. I think in the Pentagon. And in Brussels, and I'm not even sure in the Kremlin, there have a clear idea of how this is gonna end. And that is the disaster here of course, because Russia clearly thought it could end this with shock and awe in three days. Great facts on the ground before the West can even react, replace the government in Kiev and be done with it. And they didn't manage that and now they're all frozen and nobody can back down and that is the problem.

Richard Sverrisson, Editor-in-Chief, Montel: 7:01

Absolutely. But what if we can bring this into energy? Henning. What does this mean for European energy markets and even global energy markets? Now we're talking China and and Asian demand, which has always been a key driver in, in gas prices.

Henning Gloystein, Director, Energy, Climate and Resources, Eurasia Group: 7:13

Yeah, so the main thing what we're seeing here is the phasing out of Russian oil, gas, and coal is gonna happen in Europe and it's gonna be complete. And it's going to, hap happen faster than anyone thought possible only a few months ago, but it'll still take a time to be fully completed. And because it's oil, gas, and coal, this means that the operational cost for the entire energy industry globally will remain pretty high for some time. Because the Europeans for the first time are raising their coal imports again. They have to buy LNG from all over the world. They have to buy oil from anywhere. That's not Russia, and that just op, the opex costs remains high because of that. Then the CapEx cost is sky high as well, because the Europeans have to invest huge sums of money into new LNG facilities, especially the Germans, but also the Netherlands, the French, the Italians, the Polish old building. Import terminals or chartering, floating import facilities like f sru. And at the same time, they're expanding their green transition. Hydrogen, offshore wind solar. This costs gazillions and a lot so that CapEx cost is going up, and a lot of that CapEx is borrowed money. And because the cost of borrowing is rising, because of increasing interest rates around the world, that cost is com added on top of that. So we are facing this swollen. Energy supply chain costs for the next few years. And this is why you look at the, let's say the TTF forward curve in the Netherlands or the oil forward curve. Brent is above a hundred dollars I think for the next two years. And gas prices are sky high for the next two years as well, so that this is what we're facing. Even if there was some form of a negotiated solution the decisions made in the European energy sector. Are so profound that they can't really be reversed anymore, and that's gonna cost a lot of money. And that's being felt around the world. There's diesel shortages in South America in, in, we've just seen in Pakistan. LNG supply that's destined for Pakistan has been rerouted to Europe, believing causing power shortages in Pakistan just because of what's going on in Europe. And so this is gonna be with us for a while.

Richard Sverrisson, Editor-in-Chief, Montel: 9:13

So it's creating sort of ripples globally. Absolutely. But I'm just in. But if we are focusing on LNG, for example, so you're saying there are a lot of several European countries, Germany, Netherlands, France, are gonna invest in LNG terminals whether they're floating or not. But surely there's a danger here. You lock in a fossil fuel infrastructure for many years to come. No one's gonna sign an energy contract, long term for three or five years. People want long term stability here. So is there a danger that. To combat this need to substitute Russian fossil fuel, we are actually locking in into a long-term high emission scenario.

Henning Gloystein, Director, Energy, Climate and Resources, Eurasia Group: 9:53

That's indeed a a risk. Absolutely. Like on the LNG LNG side you are actually seeing a lot of contract negotiations ongoing, and it's exactly like you say, the Europeans don't wanna sign new 20, 25 year long-term contracts without with destination clauses in under which they can't resell. The LNG. They want to sign eight to. Maybe 12 year LNG contracts with full supply flexibility, which the sellers say no, that's not a good idea because we need long-term investment stability. So they're gonna have to find a compromise. We reckon what will happen is that in return for either more flexibility, so that means that Europeans can resell LNG once their demand goes down amongst the accelerated green transition. IE there will be no destination clause. They in return for more flexibility, they pay a higher base price, average price, or in return for a shorter contract period, let's say 10 years rather than 20. They pay a higher price as well. Something like that will happen because for sure the sellers wanna sign the best deals possible in the buyers as well. But the reality is there's an enormous demand opportunity for the next five to. 10, 12 years in Europe and most people in the supply side industry in the LNG sector don't wanna miss it. So they will probably sign a few compromises. But it, you're right, it's gonna cause lots of all sorts of weird problems because what we will be seeing is LNG supply will increase, the Qatari will have their Northfield expansion, essentially finance by the Europeans, and probably in particular the Germans. The US LNG expansion will also be co-financed by Europe, so we'll have more capacity, but at the same time, the Europeans are investing billions, actually, hundreds of billions into demand structuring, ripping out gas boilers at home, and ev and elect and renewables and hydrogen and so forth. So actually natural gas consumption in Europe will not increase. It's just LNG. Imports will increase to replace Russian gas, but overall demand in Europe will start to decrease quite fast in the latter half of this decade. And that could actually cause a deflationary energy, price pressure in the latter half of this decade after this surge that we're seeing now. So it's really awkward.

Richard Sverrisson, Editor-in-Chief, Montel: 11:55

Yeah, but that's only at the sort of latter half of this decade then.

Henning Gloystein, Director, Energy, Climate and Resources, Eurasia Group: 11:58

Yeah. Yeah. It's not immediate or although there is a bit of a risk even this year, and we're probably gonna do something on this quite soon. Asia Group is what happens if Russian gas isn't interrupted this year. There've, Europe's is record LNG Imports maximized all other pipeline imports. If Russian gas continues to flow and inventories are full by late mid August, late August, what happens to the gas price here? And then what happens to us LNG? It gets priced out, doesn't it? Okay. But that's a what if, we'll see. We'll worry about that then,

Richard Sverrisson, Editor-in-Chief, Montel: 12:27

yeah. But what are your expectations here? You've seen the seen flows cut off to Poland, to Bulgaria, to Finland. Have you had any kind of analysis on who could be next?

Henning Gloystein, Director, Energy, Climate and Resources, Eurasia Group: 12:39

Indeed. So when this started to happen and the Russians made true on their threat that anyone who doesn't adjust their payment gets cut off. The obvious, most obvious one was Finland, for joining NATO and having just completed a nuclear power station and a new floating energy import terminal. And, but overall gas prom has now pretty much made clear that anyone who doesn't change their payment mechanism. According to their will be cut off. But those who have switched their payment system, which most major importers in Germany, ATRI, and Italy, which are the big ones have done gas prom has pretty much called up and said, we on our books, we will continue supplying you. And that is why these importers did that. They swallowed a bitter pill, a humble pill of giving into basically blackmail. The public doesn't like it, the shareholders don't like it, but they thought it was crucial to secure supply, so they did it. And then that is their hope that they will continue receiving the gas from Russia until their contracts expire. Most of 'em around 2027. But of course there's still a risk. If the situation in Ukraine deteriorates even further, as in the war escalates or then and Europe might have to think about sanctions, which they currently really don't wanna do, but they might have to do that. Or if Putin really wants to retaliate, the Europeans will cut off themselves. So there's still a risk Absolutely. Of a lot of,

Richard Sverrisson, Editor-in-Chief, Montel: 13:54

lot of the only certainty is the amount of uncertainty out there, but exactly. But he, I know you said you're gonna be working on looking at this and the possibility that Russian flows could just continue throughout the the autumn, potentially the winter. What's the probability of that sort of remaining rather unchanged?

Henning Gloystein, Director, Energy, Climate and Resources, Eurasia Group: 14:11

That's the problem with the uncertainty, isn't it? So we haven't put a probability to it, which chickened out

Richard Sverrisson, Editor-in-Chief, Montel: 14:15

yeah. Okay.

Henning Gloystein, Director, Energy, Climate and Resources, Eurasia Group: 14:16

But so the we want to raise that possibility. Because as I said, gas Pro seems to have assured its major customers who have switched their payment, that they will continue to receive gas and that there are some folks in the eu who actually think that Putin might be seeking a climb down at some point this summer. That would still fall in an uneasy stalemate. As I said earlier, even if Putin declared a unilateral cease fight, there's no guarantee that Ukraine would talk would abide by it, and it could be broken all time. But there is a chance that this happens, that Putin does that in order to stall the sanctions process because it's very possible that if he declared a ceasefire, that some folks in the EU. Would say okay to, to show our willingness to negotiate and compromise. Maybe we should halt the oil pri the oil sanctions and promise not to do anything on gas. And that would of course be very much in Russia's favor. And so there's a possibility of that. The other thing is of course, and we don't really know whether this is true, but one of the most effective ways for Russia and for gas prom to really basically hurt the US LNG industry is to collapse the European gas price to just. Fill the inventories. And then all these fancy US LNG export projects that we're hoping to make a lot of money in Europe are priced out because it's worth keeping in mind, the US gas prices are pretty high by U US standards,$9 per MBTU for Henry Hubb. So basically European gas price can be much higher than $15 per MBTU in order for US gas to be profitable in Europe and in the uk they're already at that level. And in Europe they're still high in, in the u but it's not unimaginable. And so maybe this is what gas bonds planning the problem is, we don't know.

Richard Sverrisson, Editor-in-Chief, Montel: 15:59

Exactly. And maybe they don't know yet either.

Henning Gloystein, Director, Energy, Climate and Resources, Eurasia Group: 16:01

That is also possible.

Richard Sverrisson, Editor-in-Chief, Montel: 16:03

Yeah. The expectation, we can see as well in July that Nord Stream one is due to go offline for maintenance. Yeah. Do you think there's a danger here that the powers that be could extend that just to show, put the frighteners into some of the European gas market players?

Henning Gloystein, Director, Energy, Climate and Resources, Eurasia Group: 16:19

For sure. De Spiegel in Germany reported that yesterday, and then they had a Twitter exchange with the head of the German bun net, the grid agency. Yeah, that is the fear, the concern, the suspicion that a gasper won't say, oops, something broke. And that outage will not be two weeks, but five. And then you tighten the European market. But of course, that does also attract LNG from the US back in then, and that, that goes back to what I just mentioned. Gas problem could do that and just, show just ahead winter, the market might get really tight and you really need our gas. Very unfortunate. Or they could say No look. And try and divide Europe again and say no, we're gonna fix this really fast and we're gonna continue putting gas into storage and it's, or everything is fine. So sadly, again, it's a total unknown and that, but this is the problem because what this. It creates is a really awkward situation for utilities in Europe. You are having to plan for two total extremes. One of them is a total outage of Russian gas next winter, which could even mean energy rationing and record prices. The other one could be, if not if. If there's no further disruptions is that gas prices collapse, then a lot of, especially the private utilities who had to import gas at record prices this year, have to sell it back into the market next winter at much lower prices, which means big financial losses. And so it's really it's not a nice situation for European utilities in the moment.

Richard Sverrisson, Editor-in-Chief, Montel: 17:38

Absolutely. We saw quite a lot of bankruptcies of suppliers and of some energy companies as prices moved upwards. But you, what you're saying here is that we could see quite a lot if that this situation were to arise where Russia were to flood the market with gas. That could happen on the same. On the same, yeah. It flips flip side of the coin, if you like.

Henning Gloystein, Director, Energy, Climate and Resources, Eurasia Group: 17:54

Exactly. And there's a bit of a risk here, so that if that happened, the, your, some utilities might be really reluctant to pass on price drops to consumers because they actually had to pay for the wholesale gas at really high prices. Now they're having to sell it back at low prices. Then they might be really reluctant to do that. And this is, we're political analysts. This is politically quite toxic because the public will then get really angry with their local utilities. And the governments will probably jump on that backman bandwagon again, and they might threaten taxes or cap tariffs or who knows what. Whereas the, some of the reality on the ground might be that this situation caused real financial pain because the utilities had to buy the gas at high prices and then sell it at low prices, which is commercially not a good idea for them. And so it could really fast become quite political.

Richard Sverrisson, Editor-in-Chief, Montel: 18:39

And this is of course very speculative as well because, it's a, as we said several times, it's a vast unknown. But if we meant talk about the sellers of the LNG you mentioned the us Qatar. There are others out there that you know, and there are huge gas reserves off the coast of East Africa, for example. Do you expect that to be put into production as a result of what's happening in Europe or the price situation globally?

Henning Gloystein, Director, Energy, Climate and Resources, Eurasia Group: 19:03

Yeah, this is a scramble to meet this additional European LG demand, and the best, you mentioned the two best suited supplies for that are the us It's short cycle production. There's a lot of export capacity that was already vying for financial final investment decision. FID And that we'll get it now and it's a eu US strategic LNG Alliance, NATO partners, freedom Gas. Wonderful. Qatar was recently very conveniently declared, designated officially by the US government, a major non NATO ally, which makes business a lot easier for them. German vice Chancellor Green Party member of all things turned up in Qatar to negotiate LNG deals unimaginable four months ago. So you can see Qatar with its Northfield expansion will happen. So us first then Qatar and any extra molecules in Norwegians have great east Africa is a mixed bag because. As we said earlier if the Europeans only wanna sign contracts eight to 12 years, maybe in Poland, 20 years to replace all the coal there, but not really. There's no big commitment beyond 2035 that makes Greenfield. Offshore production, really hard to sell into Europe. Let's say Tanzania, if you are another five to seven years away from first production, and then you need 30 years or 25 years to make a return on investment, then the European window doesn't really fit Mozambique, I assume they're gonna have to try and they'll try and get it up and running as fast as possible because they're well advanced, but they, of course, have domestic security issues. The one I would look out for is actually East Mediterranean. Israel has a lot of gas and is Israel doesn't need that much gas itself. And they do have the deal with Egypt now. So if they could somehow raise Egypt's export capacity even by a little bit, that would be very convenient to go to Italy, for instance, or Greece.

Richard Sverrisson, Editor-in-Chief, Montel: 20:41

Interesting. Just, I'd like to just finish off Henning by, by looking at Germany and you mentioned this green minister going Qatar to sign LNG deals or to look for LNG deals. This is quite extraordinary, isn't it? I think what's happening here? What is Germany's LNG plans going forward? In the middle of. It's quite ambitious targets to, to reduce emissions quite drastically as well as closing down its nuclear plants.

Henning Gloystein, Director, Energy, Climate and Resources, Eurasia Group: 21:05

Yeah, Germany is in a bit of a pickle, isn't it? First of all, they can't say they weren't warned first of all, north Stream one, then north Stream two but it goes much deeper than this. It goes beyond the gas sector. Germany built this extraordinary reliance on Russian pipeline gas, but it also built an extraordinary reliance on Russian Euros, crude oil, which of course, and all the diesel developments over the last 20 years. The, so many German passenger cars run on diesel. It's all Russian oil, which was seen as very convenient and cheap. So it's an oil and gas problem that Germany got itself into. And it worked really well for a long time and now it really doesn't work well at all. It doesn't work and they have to do absolutely everything. For all the problems that this has caused, they have actually remarkably cha fast managed to. Put in new supply chains on the oil side, on the gas side, they're looking quite fast and quite successful now. They're fast tracking LNG import terminals. As far as I know, four floating facilities have been ordered and at least one, but probably two. Fixed facilities will be built over the next few years. Cost a lot of money. The only upside to this is that the fixed terminals will be probably designed in a way that they can be flipped to import liquid ammonia from the mid late 2020s, which the Germans and the Australians have already signed their hydrogen ammonia deal. And similar talks are in place with Canada and Norway. These will be flipped around from LNG to ammonia at some point again, but it all costs money. And and yeah, but that's the, that's reality. This the status quo receiving cheap and reliable, which it was for a long time oil and gas from Russia, that business model is gone. And then now Germany needs to invest a lot of money in rebuilding new business models and supply chains. And there's no other way to it.

Richard Sverrisson, Editor-in-Chief, Montel: 22:43

Absolutely. But the industry in the utility sector the big energy companies are saying no. We need to take this a bit slowly. Whereas on the ground, I'm sure there's a lot of political pressure to cut off all fossil fuels from Russia tomorrow.

Henning Gloystein, Director, Energy, Climate and Resources, Eurasia Group: 22:55

Yeah. And so it's the political side will win out on this. And corporations. The we'll have to adjust. It's as simple as that. Some of them have already quietly swallowed the pill and said, all right, let's get on with it. And some of it will be forced or by, either by their shareholders or by the government itself directly. But it, this is the way it's gonna be. Germany will phase out all of Russia's oil, gas, and coal. Coal's pretty much done. Oil will be done by the end of this year, and gas will be done much earlier than most people suspect. My suspicion is it will be. Without a disruption. Next, some point later, half of next year with a disruption will be this year. But and it will happen. It doesn't matter what the companies say there. It's that, that this horse has left the stables.

Richard Sverrisson, Editor-in-Chief, Montel: 23:37

Thank you very much for joining the Monte Weekly podcast.

Henning Gloystein, Director, Energy, Climate and Resources, Eurasia Group: 23:40

My pleasure. Thanks for having me.

Richard Sverrisson, Editor-in-Chief, Montel: 23:41

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