Paris, 1 October 2024
Author: Gergely Molnar, Energy Analyst – Natural Gas
The architecture of global gas supply security needs to be carefully reassessed
Russia’s full-scale invasion of Ukraine in 2022 triggered the first truly global gas crisis, with natural gas and LNG markets contending with supply disruptions and unprecedented price volatility.
The gas crisis had broader implications on other energy commodities, including electricity with gas being the marginal price setter in many markets including heat, which remains heavily reliant on gas, and coal via gas-to-coal switching. Beyond the energy complex, the fertiliser sector was among the most impacted, due to its high exposure to natural gas prices, which in turn led to dramatic increases in the price of food.
The International Energy Agency (IEA) responded swiftly to the unfolding global energy crisis, by providing advice to policymakers through a 10-Point Plan on Reducing the European Union’s Reliance on Russian Gas just one week after Russia’s invasion of Ukraine. An IEA Ministerial meeting on Gas Markets and Supply Security was held in February 2023 and a Task Force on Gas and Clean Fuels Market Monitoring and Supply and Security was set up.
While the immediate effects of the 2022/23 gas supply shock have eased and gas markets returned to growth in 2024, the structural changes which emerged in 2022 will persist for years. In this context, the architecture of global gas supply security needs to be carefully reassessed through a closer dialogue between responsible producers and consumers.
The 2022/23 gas supply shock transformed gas markets in a structural manner
Russia’s piped gas deliveries to Europe fell suddenly by almost 120 bcm through 2022-23, equating to around one-fifth of the global LNG market. This unprecedented gas supply shock not only drove up natural gas prices to all-time highs and necessitated a readjustment in natural gas demand, but fundamentally transformed the global gas market.
LNG effectively became a new baseload source of gas supply for Europe.
Benefitting from the growing flexibility and liquidity of the global LNG market, Europe sharply increased its LNG imports, including from the United States amid the rapidly declining Russian piped gas flows: the share of LNG in the European Union’s gas demand rose from an average of 12% over the 2010s to above 35% since 2022 – a share similar to Russia’s piped gas before the invasion of Ukraine. As LNG flows were increasingly directed to Europe, price-sensitive buyers with high exposure to the spot market faced a deterioration in their gas and electricity supply security, with rotating power cuts introduced in Bangladesh and Pakistan amid the inadequacy of gas supplies.
The phase-out of Russian piped gas to Europe reduced supply flexibility.
Besides the volumetric loss and difference in costs, Russian piped gas contracts included significant intra-annual and inter-annual flexibility, with the nomination rights ultimately lying with the buyers. This flexibility – underpinned by the country’s huge swing fields – played a key role in meeting short-term and seasonal variability in demand in Europe. This contributed to the balancing of European and global gas markets. It is estimated that the inter-annual flexibility provided by Russian piped gas averaged close to 10 bcm on an annual basis through the 2010s.
Europe’s role as a balancing market is set to decline, while China’s influence on global LNG flows is set to rise.
Steep cuts in Russian gas supply reduced Europe’s ability to optimise between flexible piped gas flows and LNG imports and hence largely eroded Europe’s role as a balancing market. China’s role as a balancing market is expected to increase over the medium term, especially when considering the country’s active role in securing LNG contracts. Nevertheless, China is unlikely to have the same balancing role as Europe had in the past due to its limited underground storage capacity, less flexibility in piped import contracts and low liquidity of domestic gas hubs.
This structurally lower gas market flexibility means that other options, such as storage, LNG peak-shaving1 and demand response, will have to play a greater role in balancing the market in the coming years. In addition, a closer dialogue between producers and consumers should explore the development of innovative commercial offerings, new procurement mechanisms and co-operation frameworks favouring a more flexible supply of LNG. And while natural gas is expected to face different demand trajectories across regions, there is a continued need to assess how to ensure investment in gas infrastructure and the evolving nature and role of long-term contracts.
Structural changes in the global gas market following the 2022/23 gas supply shock – Open
Moreover, the weather sensitivity of natural gas demand is expected to increase. Climate change is driving more extreme weather patterns. Cold spells and sizzling summer heat waves can increase gas and electricity demand in a sudden and unpredictable manner. In markets with a growing share of variable renewables, gas-based generation plays an increasingly important back-up role in ensuring electricity supply security. These changes might increase the variability of natural gas demand and hence necessitate greater gas supply flexibility.
Assessing flexibility options along gas and LNG value chains
The flexibility options available along gas and LNG value chains play a key role in ensuring the uninterrupted availability of natural gas at an affordable price. Flexibility mechanisms can be essentially divided into three distinct categories:
- Primary supply flexibility determines the overall volumes of natural gas which can be made available to a market. Upstream deliverability together with the availability of spare LNG liquefaction capacity and spare capacity on export pipelines determines whether the primary supply of natural gas can be increased. Typically, natural gas fields have limited variability in their production rates, except for a handful “swing fields”, which can ramp up and ramp down output to meet seasonal demand fluctuations. In certain markets, reducing gas flaring/venting could improve natural gas supply availability. Similarly, long-distance export pipelines and LNG liquefaction typically run close to their nameplate capacity. In 2023, the average utilisation rate of LNG export facilities was very high, near 90%.
- Midstream flexibility mechanisms ensure the timely and efficient allocation of natural gas and LNG among market participants. LNG shipments -when underpinned by destination-free contracts- are a key contributor to midstream flexibility and the growing liquidity of the global LNG market. Underground storage facilities play a key role in meeting seasonal demand swings. Short-term demand variability is typically met by fast-cycling salt caverns, floating LNG storage, peak-shaving LNG plants and linepack in transmission systems, in addition to the flexibility included in the contracts.
- Demand-side flexibility options can temporarily reduce natural gas demand via market-based mechanisms and/or administrated measures. This includes fuel-switching capabilities in the power and industrial sectors, demand auction systems, awareness-raising campaigns incentivising behavioural changes and administrative gas demand restrictions. In markets phasing out coal-based generation, fuel-switching might become more limited over time. Administrative measures are typically introduced in a manner that first non-protected consumers (e.g. industries) reduce their consumption in order to secure gas deliveries to protected consumers (e.g. households, hospitals).
All these flexibility mechanisms played a crucial role in mitigating the impact of the 2022/23 gas supply shock. However, the crisis has also demonstrated the need to further enhance flexibility options along the gas and LNG value chains in order to improve the resilience of the global gas market.
Flexibility options along gas and LNG value chains – Open
More stringent storage regulations have been adopted across key markets since 2022
The 2022/23 gas supply shock put natural gas storage regulation in the spotlight as import markets aim to reinforce the resilience and deliverability of their respective gas systems. Those regulations relate both to physical and virtual storage options.2
Singapore introduced a standby LNG facility at the end of 2021 and in June 2022 the Energy Market Authority extended it until 31 March 2023 to address the risk of gas supply disruptions.
The European Union adopted a new Gas Storage Regulation at the end of June 2022 with a target storage fill level of 80% of capacity before the winter of 2022/23, and 90% ahead of all following winter periods. Under the current regulation, storage capacity filling obligations will come to an end on 31 December 2025.
Australia implemented the East Coast Gas System Framework in May 2023 in response to the significant challenges experienced across east coast gas markets. The new framework provides the regulator with additional powers, including to purchase services provided by a storage provider.
Japan’s Ministry of Economy, Trade and Industry (METI) has launched the Strategic Buffer LNG (SBL) since 2023/24 focusing on winter season. Under this system, METI designates private operators with additional LNG procurement capacity as companies authorised to handle SBL operations. In the event of a contingency that could hinder LNG supply, the government instructs the designated companies to sell their LNG cargoes to utilities in Japan facing the risk of supply disruption. The government will compensate the designated operator for any losses and operational costs caused by the instructed trade. JERA was designated as the first supplier under Japan’s SBL in November 2023.
Simplified scheme of the functioning of Japan’s Strategic Buffer LNG – Open
International co-operation can enhance flexibility mechanisms along gas and LNG value chains
The measures undertaken by governments and regulatory agencies since the beginning of the 2022/23 gas supply shock were key to mitigate the impact of the crisis and to strengthen the resilience of their respective markets. These policies and regulatory measures followed a national or regional approach due to the nature of natural gas markets.
In an increasingly globalised gas market, however, storage regulations can have extra-regional implications. This calls for closer international dialogue and improved transparency on measures related to gas reserve mechanisms. The International Energy Agency will provide a regular update on natural gas storage and its evolving regulatory frameworks across key markets. A first overview of storage regulations was provided in the IEA’s Global Gas Security Review 2023 edition. Measures improving the transparency of natural gas and LNG inventory levels should be also considered.
Regional import markets have become increasingly interconnected due to the growing share of destination-flexible LNG. While this adds a layer of security during supply-demand shocks for the worst-affected countries, it also means that shocks originating in one market can have implications for other regions. This is clearly demonstrated by the relatively high correlation between regional spot prices through the last decade, for instance between northwest Europe and northeast Asia.
In this context, there is a need to complement national and regional initiatives with a closer international co-operation on global gas supply security. Reinforcing flexibility mechanisms and options along gas and LNG value chains will require co-operation between responsible producers and consumers on several issues, including:
- Improving the liquidity of the global LNG market: the growing flexibility and liquidity of the global LNG market was crucial in the response to the gas supply shock of 2022. According to the IEA’s internal LNG contract database, the share of destination-free LNG contracts rose from 30% in 2016 to 47% in 2023 and is expected to increase to 52% by 2027 as existing destination-fixed contracts expire, while new destination-flexible contracts enter into force. Intergovernmental agreements can accelerate this process by eliminating/relaxing existing destination inflexibility and/or ease regulations related to reloading. The LNG reserve co-operation agreement between Japan and Thailand is a recent example of international efforts to improve regional gas supply security taking advantage of improved destination flexibility. Wider use of flexible commercial solutions, such as LNG contracts with cancellation clauses and/or with seasonal flexibility options can further enhance the liquidity of the global LNG market. More flexible primary LNG contracts could also improve the depth and the liquidity of the spot LNG market.
- Enhance the availability and deliverability of underground gas storage by integrating the Ukrainian gas storage system in the European and global gas market: Ukraine’s vast natural gas storage capacity (~30 bcm) can significantly contribute to European and global gas supply security, especially in the context of Europe’s greater reliance on the global LNG market. In 2023, Ukrtransgaz, the storage system operator, underwent successful certification in line with the European Union’s Storage Regulation. Ukraine is offering up to 10 bcm of storage capacity to European market players. Besides European traders, this storage capacity could be marketed to global LNG players, including to those with a growing exposure in Central and Eastern Europe.
- Voluntary gas reserves mechanisms: carefully crafted gas reserves mechanisms (either physical or virtual) can contribute to greater gas supply security and price stability. The IEA will host a series of workshops to assess the modalities of gas reserve mechanisms. Building on an extensive consultation process, the IEA will provide an analysis on potential frameworks for voluntary gas reserve mechanisms presented in a special Report.
The International Energy Agency stands ready to support its governments and partners in strengthening flexibility mechanisms along gas and LNG value chains. Recognising the crucial role of gas storage for gas supply security and market stability, the IEA developed a Gas Reserve Programme with the support of the Government of Japan.
The 13th LNG Producer-Consumer Conference – co-hosted by the International Energy Agency and Japan’s Ministry of Economy, Trade and Industry and on 6 October 2024 in Hiroshima- will provide a platform for the public and private sectors to discuss gas supply security.
References
- Small-scale LNG peak shaving facility provides liquefaction, storage and regasification services. Natural gas is liquefied and stored during off-peak periods and is regasified and send-out to the gas system during peak demand periods.
- Virtual storage essentially refers to options embedded in contractual agreements which provide the buyer with upside supply flexibility in exchange of a fee paid upfront.
Source – IEA