After a very hot summer, winter is coming. As Gazprom announced a new round of ‘maintenance’ due to start later this week, uncertainty about the reliability of Russian gas flows to Europe during winter months increases. At the same time, high expectations are being placed on the meeting of EU Energy Ministers scheduled for September 9th – on the back of Ursula von der Leyen’s comments on the need to decouple the skyrocketing price of electricity from that of gas.
One key topic however seems to attract remarkably little attention: the role of energy savings. Energy savings have a major role to play in the sustainability equation of the EU’s energy balances. This can be seen very clearly by comparing the development of gas stocks in Germany and Italy under three different scenarios for the coming months. Having little option to diversify away from Russia in the short term, Germany has been saving energy at a significantly higher rate than Italy so far in 2022 and as a result its outlook is now less bleak than many had expected. Having more options for diversification available, Italy has been reducing consumption marginally – but the sustainability of this strategy in the coming months hinges on its other import partners (Algeria in particular) delivering on their promises.
Methodology and Assumptions
Gas stock at the end of period T is calculated as follows:
Gas Stockt = Storage(t-1) + Net Inflowst + Domestic Productiont + Consumptiont
To give a concrete example, this means that gas stock at the end of September 2022 will be calculated as storage at the end of august 2022, plus net inflows in September 2022, plus any domestic production in September 2022, minus consumption in the same period. Real time data on EU countries’ gas storage levels are available on GIE AGSI website. In the rest of the analysis, the initial level of storage is taken to be at the level recorded on August 31st, 2022.
To estimate gas inflows, I use data on daily inflows and outflows of gas at each gas entry point into a given country, which is available from the European Network of Transmission System Operators for Gas (ENTSOG). Net inflows are calculated as the difference between imports and exports at each entry point. From this, I then calculate the average monthly net inflows observed so far in 2022 (January-August), which serves as the baseline for the scenario analysis. For each entry point, researchers at Bruegel have estimated the implied Russian share of gas flows. This can be used to estimate by how much each individual flow would be reduced in the event of Russian reducing and or cutting completely its exports.
Lastly, data on monthly domestic consumption is obtained from Eurostat. The baseline consumption is calculated as the average of consumption observed in 2019, 2020, and 2021 for each month. Observed energy savings are calculated as the reduction in the consumption observed in 2022 with respect to the same months of 2021, based on the latest available data (which cover the first six months of the year).
Weather is held constant in all scenarios. A warmer winter would result in lower baseline consumption, whereas the opposite is true for a cold winter. While it is remarkably difficult to predict the weather, data suggest that the winter of 2021/2022 was a warm one in both Germany and Italy. Therefore, energy savings estimated with reference to 2021 may be inflated compared to the average of 2019-2021.
- Scenario 1: complete cut of Russian flows and no change in winter consumption compared to 2021. This a very adverse scenario, that serves to understand just how sizeable the shock from a complete cut-off of Russian gas would be, absent any energy savings.
- Scenario 2: complete cut of Russian flows but consumption in winter months keeps decreasing by the amount it has been decreasing on average over the first six months of 2022, based on observed consumption data.
- Scenario 3: Russian flows are reduced by 90% for the rest of 2022, but consumption in winter months keeps decreasing by the amount it has been decreasing on average over the first six months of 2022, based on observed consumption data. This is a more favorable scenario in which energy savings combine with some Russian flows coming in.
All scenarios with persisting larger Russian flows would be more optimistic than Scenario 3. Colder winter would lead instead to more pessimistic results in all three scenarios.
Geographical Substitution Scenario
The scenarios use average 2022 net inflows from individual entry points as the baseline for future flows. To the extent that it has happened already, geographical diversification is therefore accounted for for in the form of higher baseline flows through the entry points where it occurred (which are also not affected by the simulated Russian shock).
The scenarios above however make no assumption regarding the size and timing of additional future diversification. In the case of Germany, options for geographical substitutionare limited so we do not consider this factor. Germany might benefit from redirection of Nordic flows, but it would be difficult to make assumptions on how much and when. Germany could also benefit from delayed phaseout of nuclear energy, but this is still very aleatory.
In the case of Italy, future geographical substitution has more potential as the Italian government has been pursuing agreements for additional gas imports from North Africa. Based on public information, however, it is still unclear how much will flow and with what timing. The contracts signed as the end of August contain the following information:
- ENI – Congo (agreement signed in April 2022): the agreement foresees acceleration and increase of gas production in Congo, primarily through the development of a LNG project with start-up expected in 2023 and a capacity of over 4.5 BCM/year once fully operational. No date is given for when this project should be fully operational, or for how much it would produce in the start-up phase.
- ENI – Egypt (agreement signed April 2022): This is a top-up to an agreement already signed in 2021. Altogether, the two agreements will provide LNG cargoes for overall volumes of up to 3 BCM in 2022. The press release states that these will be “for Eni LNG portfolio bound to Europe and Italy”. No details are given as to how much of the total 3 BCM are already accounted for in 2022 flows to Italy, nor how much would go to Italy in 2022 out of the total.
- ENI – Algeria (agreement signed in April 2022): agreement to increase gas supplies through Transmed. The press release states that the agreement should “gradually provide increasing volumes of gas from 2022” but does not state how much is expected from it in 2022. For 2023/24, ENI expects up to 9 BCM per year in 2023-24.
- ENI – Algeria (agreement signed in May 2022): SONATRACH and Eni to evaluate the gas potential and opportunities for accelerated development at specific fields already discovered in Algeria. The gas production volumes expected from the areas covered by the agreement is equal to ~ 3 BCM per year and will contribute to increasing the export capacity of Algeria to Italy through Transmed. No expected date given.
On top of these bilateral deals, Italy is also envisioning to put in service two regassification units (FSRUs) bought by SNAM. Both SNAM FSRU Golar Tundra (Piombino) and SNAM FSRU I Limited (Ravenna) have a continuous regasification capacity of 5 BCM per year. Golar Tundra is expected to start operations as an FSRU during the spring of 2023, while the second FSRU is currently bound by a charter agreement with a third party until November 2023 and operations are scheduled to commence in the third quarter of 2024. To be put at work, both FSRUs are subject to completion of authorization, regulatory processes and the construction of the necessary infrastructure connecting the terminal to the existing gas transport network. The location of the FSRUs is proving to be politically very controversial, so there could be unanticipated delays.
Overall, the potential for additional geographical substitution not yet accounted for in observed 2022 data would depend entirely on Algeria. In July, Sonatrach stated the intention to provide an extra 4 BCM in 2022 on top of the 21 BCM that Italy received from Algeria in 2021, with delivery to start in August. So far, however, Algerian flows in August 2022 have average ~61,5 million cubic meters a day. This is less than the average daily flows between March and July (~62.7).
For Germany, heavily dependent on Russian gas, a complete cut from Russian gas flows with no change in consumption would be disastrous (Scenario 1). But German gas consumption has already decreased by 15% on average during the first 6 months of the year compared to 2021, and by 9% compared to the average consumption in the same months of 2019, 2020 and 2021. A stable gas demand destruction in the order of 15% is harsh but is it continues saving energy at this rate, Germany would end up having enough gas to withstand a scenario with complete cut of Russian gas flows (Scenario 2), although by fully wiping out storage. Assuming Russia keeps sending ~10% of gas flows, an energy saving rate of 15% would leave Germany with ~7% of its storage left by the end of winter (Scenario 3). This would by no means leave Germany in a comfortable position, and it would require continued sizeable demand destruction and likely pre-emptive rationing to avoid depleting storage in case of adverse unforeseen shocks – but it is a somewhat less bearish outlook than many had anticipated. Any scenario with larger Russian inflows would be more positive.
Italy starts off from a better position than Germany in terms of dependence on Russia for gas. But gas consumption has declined by significantly less: just 2% on average over the first 6 months of 2022 compared to the same period of 2021. Compared to the average for the same period of 2019-21, gas consumption has increased by 0.7%.
Why do we see these differences in energy savings? One obvious explanation resides in the fact that the share of gas that is used for electricity production out of total gas consumption is higher in Italy (~35%) than in Germany (~15%) and this is an area where substitution may be especially difficult in the short term. Yet, gas consumption for electricity production has decreased by 3% in Germany over the first 6 months of the year compared to the average for the same period in 2019-21. In Italy, the same measure has increased by 9%. Excluding the electricity generation component, the difference is still sizeable: gas consumption has decreased by 10% in Germany over the first 6 months of the year compared to the average for the same period in 2019-21, while in Italy the same measure has decreased by just 3%.
While this in part certainly reflects stronger economic growth in Italy compared to Germany over the same period, policy matters too. So far, the Italian government has been focusing more on sheltering consumers from the impact of higher energy prices than on spurring system-wide energy savings. Italy has spent 2.8% of GDP in less than one year (one of the top three largest intervention in the EU) on measures aimed at reducing the impact of prices on consumers. While some subsidization is necessary to protect those most in need, untargeted interventions have the downside to also reduce the incentive to save energy or substitute for gas.
In Germany on the other hand, substitution and savings have been gradually taking place even where it was initially thought to be impossible. Car manufacturer Audi, for example, said it can substitute 20% of its gas consumption in the near term, and that only 10% of the gas it uses is irreplaceable. Chemical giant BASF stated that it can substitute 15% of gas used for heat & steam with oil and substitute the gas needed to produce ammonia by importing. Steel manufacturer Arcelor Mittal on the other hand said it can cut its gas consumption by switching to importing metal inputs.
At this rate of energy saving, based on data as at August 31st 2022, Italy would deplete its gas stock by the spring of 2023, even if Russia were to keep sending 10% of the flows (Scenario 3). Italy would need to increase its energy savings to weather a scenario of full cut in Russian gas flows (Scenario 2), where demand would be exceeding supply by end of February. The required demand adjustment is much smaller in absolute term than the one needed in Germany, but would still need to be at least double what has been observed so far.
Future geographical substitution
What is the role of geographical substitution? As discussed, the substitution that has been taking place so far is already reflected by using as a baseline for net inflows the average of net inflows observed at each gas entry point over the first half of 2022. This seems to suggest that the geographical substitution that has already taken place is not enough for Italy to avoid running into negative storage, absent further demand reduction. If we focus on Algerian gas – where there is a clearer timeline – and assume that the expected future additional substitution takes place, the picture changes significantly and it would leave Italy in a comfortable position, with storage only marginally below its 2021 levels by May 2023, even without an increase in energy savings compared to the one observed so far in 2021. At that point, assuming the FSRU units are operational, storage could be rebuilt to high level via increased LNG imports.
However, for Algeria to deliver all the extra gas promised in the contracts, it would take the North-African country to increase its flows to Italy by almost 50% every month for the remaining months of 2022 and to more than double them monthly in 2023/24. Assuming in a bear scenario that only 50% of what is promised is delivered, storage by spring 2023 would still be in positive territory but much below its 2021 levels – creating more uncertainty for 2023. Increased energy savings would still be warranted for Italy to mitigate the risk of depending mostly on one supplier for future expected extra flows, as well as the uncertainty surrounding the weather and potential negative impact of a colder winter.
The current energy debate in Europe revolves around prices and storage, omitting to discuss the role of quantities and flows. This leads to confusion. The fact that prices are skyrocketing appears difficult to reconcile with the (good) news that storage is approaching very high levels ahead of schedule. But storage accounts typically for ~25% of annual gas consumption, so if flows were to be significantly reduced, storage would deplete fast at unchanged levels of gas consumption. Europe has a shortage of gas, of which high prices are a derivative. Under this quantity constraint, capping prices at unchanged consumption would still implicitly require some rationing. Energy savings can play a key role in mitigating this trade-off, and it should therefore feature high on the agenda of the EU Energy Ministers’ meeting in next week.
Silvia Merler – Head of ESG and Policy Research
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