Solving Europe’s Energy Dependence Problem

Europe’s politicians are scrambling to redefine the continent’s short- and long-term relationship with Russia.  

What that means exactly is not yet clear, Citi analysts say. But when geopolitical tides turn so suddenly and fundamentally, they tend not to turn back quickly. An extended period of policy shift looks all but certain. 

One tenet is likely to be an attempt to reset Europe’s reliance on Russian energy. What can politicians realistically do? A push on the “green”-accelerator would be part of the response, expanding on existing initiatives in energy-efficiency, renewables development and Europe’s longer-term goals around hydrogen. But politicians also understand that these shifts will be generationally-slow: the data shows that Europe’s green push of the last decade has had no impact on the region’s energy-import dependence. 

Either through policy or directly supporting investment, it would be logical for Europe to look to ways it can plug the gap with non-Russian oil and gas. To the question of where capital can flex quickly enough to help Europe out, Citi analysts reckon the answer lies in North America, with US shale in particular seemingly still having plenty more to give. With this backdrop, Citi says three shifts look likely: 

1.   US shale gas could flex through LNG. European buyers can look to underwrite the projects that are now queued to take investment decisions; policy-makers might help by approvals on LNG-import facilities. This could, over time, provide significant incremental capacity: just the six projects in the queue for 2022 could, by 2026, replace 40% of Europe’s imports of Russian gas. 

2.   Policy-makers – in Europe and the US – could look to encourage US E&P managements back to growth. For instance, Permian players – with cash returns in the mid-high teens and 50+ years of resource life – are being told not to grow. A return to growth could be shouldered within this industry, helping to reduce the global risk premium. 

3.   The economics are more marginal, but the price environment is starting to look more favourably on some of the Canadian heavy oil brownfield expansion projects. European policy-makers may struggle to support Canada fully – the environmental footprint is high – but like US shale, this is a source of growth that could play an important part in replacing Russia supply.  

Europe’s Energy Dependence Problem  

Europe imports a lot of energy, much of it from a handful of key suppliers. While there might be an instinctive belief that Europe’s world-leading plans around renewables has lessened this dependence, declining domestic output of fossil fuels has in fact made the energy-balance worse over the last decade. 

Russia supplies 30% of Europe’s energy imports, slightly higher in gas (35%) and slightly lower in oil, though that dependence is down from 36% in 2010. Of the two fuels, gas is more problematic for policy-makers because it is infrastructure-dependent.  

Two other observations by Citi analysts about the chart above. One is the low dependence of China on Russian energy, a picture that is likely to change; if Europe looks to take less Russian oil and gas over the medium-term, then China may see the attraction of stepping in. The other observation is the US which, driven by the bounty of shale, has moved its economy to one of net energy export. 

Over the coming weeks and months, an obvious political response will be a push towards building more renewables. This has been Europe’s direction of travel for some time now, the population seems to support it and technology and capital remain aligned to drive down the cost of supply. Europe’s nirvana remains one where deep electrification through renewables, coupled with some green hydrogen, offers unlimited cheap, zero carbon energy. 

But that is not the reality today. Fossil-fuel dominated European energy mix comes at a high cost, particularly for gas. At current forward prices, Europe faces an energy bill of $1.2 T in 2022, higher than the previous peak of 2008 and 2.5x the average bill in 2015-19. This is going to be a trying time for consumers and industry as the energy-price burden filters through. 

A key question is whether the European population will continue to support current energy policy, or see it as a failure (i.e. too-rapid a push into green vs the reality of today). And navigating that balance, according to the Citi report, means that policy-makers are likely to pursue a dual agenda – the green accelerator, plus at the same time looking at ways to pivot the supply of oil and gas away from the high single-country exposure to Russia. 

The Future Is Shale  

US shale gas sits as a dominant source of low-cost gas supply, both as non-associated and associated (with oil). The sheer quantities involved overwhelm the domestic market; export – as LNG – is the logical route to market. This year the US is expected to become the world’s largest LNG exporter (overtaking Qatar and Australia), just six years after the first LNG cargoes flowed from the US Gulf Coast. 

Europe currently takes a little over 20% of US LNG. Feedstock prices into an LNG plant on the US Gulf Coast at around $2.50/MMBtu are not as low as alternatives in Qatar, Russia Yamal, or Mozambique, but still competitive enough to land gas into Europe at around $6-7/MMBtu to make a 10% return on investment. That is not as competitive as where Russian pipeline gas has been into Europe over say the 2016-20 period, but is considerably below current spot prices of closer to $30/MMbtu. 

Europe’s relatively low share of US LNG likely has something to do with a lack of risk-appetite; Asian buyers were much more willing to underwrite that risk. But with the size of the industry today, more certainty over feedstock availability (and therefore costs) and a growing need, US LNG could be a big part of the flex that Europe needs.  

Geologically Citi’s sees the growth-story in US shale as still offering much potential to global oil markets. NPV-optimal output levels could be around 12-13 mbpd from US shale oil, an expansion of around 4-5 mbpd from today. In addition, there will be around half this number again in natural gas liquids and lease condensates.  

The question, posed by the Citi report, is whether the current environment can be used to encourage the industry to change course; to do its part to keep the world oil markets well supplied? For more information on this subject, please see Global Energy - Europe/Russia: Where Can Energy Capital Flex?, published on March 1st. 

Citi Global Insights (CGI) is Citi’s premier non-independent thought leadership curation. It is not investment research; however, it may contain thematic content previously expressed in an Independent Research report. For the full CGI disclosure, click here.