Europe encounters boomerang effect in its commitment to energy transition

Spring has brought an end to the most dreaded energy winter in decades. As households across the Old Continent turn off their heating, Brussels and the EU-27 are looking to accelerate their two big bets for an energy transition without Russian imports: increasing their capacity to receive liquefied natural gas (LNG) and turning to renewables. The challenge for the EU partners is now to avoid returning to the same starting point, where an inflexible infrastructure, heavy dependence on an unreliable partner and multiple bottlenecks led the bloc to fear a winter in the dark. These investments already seem to face two major bottlenecks; a gas market shaken by the return of China and setbacks for the supply of key components for the deployment of renewables.

The European Commission's intention from the beginning of the Russian offensive in Ukraine was to curb the financing of the Kremlin's war machine while at the same time boosting its green turn in the medium term. This first winter, liquefied natural gas made it possible to replace the gas that previously came from Moscow, which in 2021 accounted for 40% of the gas consumed in the bloc. Thus, in 2022, LNG purchases increased by 67% year-on-year compared to the previous year. But for this to be possible, the European Union made a firm commitment to build new LNG regasification terminals, a step prior to being able to inject the gas into its pipelines so that it can reach homes and industries. Thus, for example, Germany went from not having any of these infrastructures to having three operational facilities at present, which allows it to avoid depending on the capacity of the rest of the partners, particularly Spain and Portugal. This is in addition to projects in France, the Netherlands, Greece, Finland and Estonia. In total, Brussels aims to increase its regasification capacity by 34% by 2024, compared to pre-war levels.

In the medium term, Europe could have up to 400 billion cubic meters (bcm) of LNG capacity by 2030, 48% more than today, according to data from think tank IEEFA. This contrasts with industry forecasts, which predict that demand for this hydrocarbon will be limited to between 150 and 190 bcm at the beginning of the next decade. In other words, the aggressive EU bid would leave at least half of the built infrastructure unused.

"It is the most expensive and unnecessary insurance in the world. Europe must carefully balance its natural gas and LNG systems and avoid tipping the balance from reliability to redundancy," says Ana Maria Jaller-Makarewicz, Energy Analyst at IEEFA. In addition, the specialist stresses that boosting this type of infrastructure will not necessarily increase security: "there is a tangible risk" that assets will be blocked. Even if the EU has regasification capacity, the functioning of the global LNG market, heavily dominated by China and Japan, does not ensure that the fuel will actually reach European shores.

For example, according to International Energy Agency (IEA) forecasts, China's LNG demand could increase by 10% in 2023 alone thanks to the economic reopening after the health crisis. IEA analysts even estimate that the rise could reach 35%, in the most competitive scenario. "If global LNG demand returns to pre-crisis levels, competition in global markets will intensify and prices will inevitably rise again," said Jean-Baptiste Dubreuil, an analyst with the OECD-dependent body, on Thursday.

On the supply side, the data presented by the think tank once again show that Europe's embrace of LNG only opens an additional window for Russian imports. While the arrival of Russian natural gas through pipelines fell by almost 60% in 2022 compared to the previous year, according to data from the Bruegel think tank, shipments via large vessels have not stopped increasing. Imports from Russia to France and Belgium increased by 58% last year. Slightly behind is Spain, with a growth of 50%, as the government has already acknowledged.

Forecasts for this year are not much better either. Bruegel analysts estimate that the EU-27 will have to face a bill of more than 9.3 billion euros for their imports of Russian LNG in 2023. This is equivalent to a third of the total energy imports that the bloc plans to buy from Moscow.

IEEFA's analysis highlights precisely that Spain would be the European country with the highest percentage of unused regasification capacity in 2024. This comes at a time when Enagás is finalizing the start-up of a new LNG plant in El Musel (Gijón) built between 2010 and 2013, which in February was approved by the National Markets and Competition Commission (CNMC) to establish a unique economic regime.

From green to red

The main reason for the fall in gas demand is the rapid deployment of renewable energies. EU plans call for at least 40% of total energy consumption to come from renewable sources by 2030. However, the market is already anticipating upcoming bottlenecks that could jeopardize this goal.

This is the case, for example, of wind energy. According to an analysis by the research agency BloombergNEF, installations of this type will increase by 15% from 2023 to 2030, while offshore wind will grow by 500% in the same period. The problem, according to the firm, is that turbine manufacturers are under "great financial pressure" that hinders further investment to grow their capacity. Major companies in the sector, such as Vestas, GE Renewable Energy, Nordex or Siemens Gamesa, announced heavy losses in 2022 due to rising material and transportation costs. At the same time, disruptions in supply chains exacerbate the crisis situation.

But the real problem seems to lie in one of the EU bloc's biggest bets: hydrogen. The lack of electrolyzers, which break down water to generate hydrogen, could jeopardize the future of this energy market, which is central to the European Green Pact. Major companies in the sector expect the market for these devices to fail to meet demand between 2025 and 2027, according to a Bloomberg survey, while citing some setbacks at present.

In addition, as a booming sector, energy companies acknowledge problems in securing engineering, construction and procurement services for their hydrogen projects. The explanation is that, being a nascent sector, each project is unique and requires a lot of contracted capacity. This creates a possibility for Chinese suppliers: Asian companies are expanding rapidly in the sector, and could find a niche in the European market if EU legislation allows it. This again puts Brussels in a bind: speed up the rapid rise of this technology or avoid a new dependency link with another power?

However, there is room for good news. The BloombergNEF study highlights that energy companies are still optimistic and confident. 47% of the surveyed firms are more optimistic about the future of hydrogen than in the previous semester, compared to only 18% who consider that the future looks worse.

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