Can Europe cope if Russia shuts off Ukraine gas transit?

The gas transit and supply contracts between Russia and Ukraine expire at 10 am on 1 January 2020 (Moscow time) – the future of Ukraine transit remains the largest uncertainty for global gas markets in 2020.

Murray Douglas, director, European gas at global natural resources consultancy Wood Mackenzie, said: “Ukraine remains the major transit route for Russian gas into Europe – over 76 billion cubic metres (cm) will be transported via Ukraine this year.

“Our base case assumes some form of agreement will be reached and there will be no disruption to the transit flows via Ukraine. But the uncertainty is high, and the implications of a disruption significant.”

Douglas said a long-term disruption to gas flows through Ukraine in average weather conditions will increase prices at TTF throughout 2020 by an average US$2 per million British thermal unit (/mmbtu) versus Wood Mackenzie’s base case. He added price spikes would be most severe in early 2020 as uncertainty and sentiment would drive the market.

Disruption

By the second quarter of 2021, TTF would return to the levels similar to Wood Mackenzie’s base case, as flows through Nord Stream 2, TurkStream, and TAP ramp up, and the market remains awash with liquefied natural gas (LNG). Importantly, the onward connections for Nord Stream 2 and TurkStream will be largely complete by 2021, helping alleviate pressure across the continent of any ongoing disruption.

Douglas added: “A combination of a disruption with a prolonged cold snap would drastically worsen the situation. Even a shorter disruption of just one month, coupled with two months of colder than average weather, would lead TTF above US$7.5/mmbtu through January-February 2020.

“A longer disruption beyond such a cold snap would lead to significant supply shortfalls across a number of markets in Central and Eastern Europe. However, assuming only the short disruption, prices stabilise at about US$1/mmbtu above our base case outlook by the second quarter of  2020, remaining higher to replenish storage.”

Although the impact of any disruption on north-west European hub prices beyond 2020 appears muted, more volatility would be expected. A long-term cessation of Ukraine transit makes prices in north-west Europe more susceptible to spikes during maintenance of Nord Stream or Yamal-Europe pipelines, as well as to the risks of weather-related demand increases, or LNG demand spikes in Asia.

Avoiding spikes

Furthermore, north-west European markets remain well connected, with multiple means of balancing the market through supply and demand mechanisms. The most susceptible markets are in Central and Eastern Europe where we would expect significant price spikes should there be a  disruption.

Douglas said: “In 2020, Europe will have a variety of market mechanisms available to compensate for a lack of Ukrainian transit. There are alternative Russian pipeline routes - Nord Stream, Yamal-Europe, Blue Stream and TurkStream. 

“The potential for higher-than-forecast utilisation of Nord Stream 2 will be limited in 2020. Nord Stream 2 will start in July 2020 but the 55 billion cm per annum twin pipeline will take time to ramp up and the full onward capacity through EUGAL is not fully available until 2021.

“Alternative sources of pipeline gas and LNG will step up. The market is oversupplied, and the abundance of LNG will help fill the gap in the event of Ukraine transit disruption. There is also additional supply response available from Norway and Algeria.”

Storage will play a significant role in balancing the market. Europe entered winter with a record 101 billion cm in storage. Any lack of Ukrainian transit in the first quarter will be largely compensated by increased storage withdrawals.

Demand response

“Demand response remains the largest lever Europe has at its disposal – high prices will incentivise power generators to lift coal output once again, reversing some of the recent gains in coal-to-gas switching across the continent. But in some cases, markets will be unable to meet projected levels of demand with a prolonged transit disruption,” he said.

“North-west European prices will be the first reference point for many in any disruption scenario. However, these markets can adapt to a disruption with minimal fuss and no real risk.  

“The Central and Eastern European markets are the most exposed. Under a long-term disruption, some may be unable to fully meet expected demand levels in 2020. The impact varies, but Hungary, Croatia, Serbia, and Bosnia would certainly be affected. These markets have limited fuel switching capability in the power sector, so any gas supply shortfalls may require government intervention to prioritise consumers to provide balance.”

Ukraine itself would be severely affected by any transit disruption. Although Russia has not made direct gas sales to Ukraine since late 2015, Ukraine continues to rely on gas which enters the market on a reverse-flow basis from the transit lines to Slovakia, Poland and Hungary. Ukraine pushed its gas in storage to over 20 billion cm before this winter – this will provide adequate cover for the first quarter of 2020. But reinjection requirements through summer will be challenging without transit and the market would face enormous challenges to lower demand levels adequately.

Impact

Douglas said: “Ukraine transit disruption – if it happens – will not go unnoticed.

“It will have a significant impact on prices, particularly if the winter is colder than average. Europe will attempt to limit the effect of the transit disruption by relying on stored gas, alternative Russian routes and other piped supplies, as well as LNG imports and demand response in the power sector.

But this will be not enough – some markets will be more exposed than others – facing shortages of gas in the case of prolonged disruption.

“The situation will improve somewhat post-2021 when Nord Stream 2, TurkStream and onward pipelines within Europe ramp up. But we still believe that Ukraine will remain a key component of security and stability of Russian supplies to Europe.”

Ukraine will provide necessary flexibility during periods of maintenance at other routes as well as in case of demand spikes. In the long-term, as European import dependency grows, it will give Gazprom an option to maintain or even increase its market share without the challenges of constructing new pipelines.

“The talks are still ongoing – the next round is scheduled for 19 December 2019. But while the outcome of negotiations remains uncertain, we believe transit will continue – an outcome that Europe is banking on,” Douglas said.