What Europe’s Natural Gas Addiction Means For Investors In 2022
The risks of the West’s energy dependence on Russia have finally come home to roost, but where do we go from here?
Since the fall of the Soviet Union, the world has basked in a period of relative peace. A combination of nuclear weapons and economic interdependence was thought to have made conflict between major powers an impossibility.
Then, Russia invaded Ukraine and the mirage was shattered.
Historians will be searching for the source of this conflict for years to come, but there is a single clear thread that led to Russia’s confidence in the days before the invasion: Europe’s dependence on Russian fossil fuels -- in particular, the reliance of countries like Germany on Russian gas.
Why Is Europe So Reliant Upon Natural Gas?
The European Union is the largest importer of liquid natural gas (LNG) in the world, and prior to the invasion of Ukraine, 41% of it came from Russia. This demand is largely driven by the bloc’s efforts to decarbonize and meet its climate targets. It has also necessitated eliminating or reducing coal from the energy mix and increasing renewable energy sources like wind or solar.
The problem for Europe is that its energy grid is not geared up to deal with intermittent renewable energy sources, so it needs a predictable source of energy to produce its base load: natural gas.
In the 60s and 70s, the embargo against Russia would have been less problematic because Europe was able to produce its own natural gas supplies and meet internal demand. Unfortunately, North Sea reserves became economically unviable, and Russia became the supplier of choice for the European Union.
Putin’s invasion of Ukraine has created a particular problem for Europe. The continent is eager to demonstrate support for Ukraine but is unable to militarily intervene due to the risks of nuclear warfare. This means that the Bloc’s only real weapon is economic: starve Russia of the financial resources it needs to fund its war machine.
For this tactic to be effective, Europe will need to find ways to wean itself from Russian gas, but it may be easier said than done. Germany relies on Russian gas for around 50% of its imports and European LNG terminals are not set up to handle major imports from the US or Qatar.
Which raises the question: where can Europe go from here?
How Can Europe Remove LNG From Its Energy Mix?
In Germany’s case, the war has reawakened an old debate about nuclear power. In the wake of the Fukushima disaster, Germany had been trying to remove nuclear energy from its mix, with plans to turn off all plants by 2022.
Unfortunately, nuclear energy isn’t a long-term solution, it is expensive to keep plants running, and building new plants would take years, although some see significant potential for Small Modular Reactors (SMRs).
Some countries, particularly Poland, have taken extreme steps to remove Russia from their energy mix in the wake of the annexation of Crimea in 2014. However, the Polish solution still relies on coal-fired power plants which is not a viable solution for other countries that have to comply with European green targets.
The big problem for Europe is that most states are still acting independently, but a real long-term solution will require a truly complete European energy grid, which will take time to negotiate.
Does the IEA Have the Answer?
However, there is one plan that makes sense: The International Energy Agency (IEA) 10-point plan to reduce EU reliance on Russian natural gas.
This plan is broad, but starts with not renewing expired gas contracts with Russia, sourcing gas from other nations in the short-to-medium term, and introducing minimum natural gas storage requirements for nations to increase their ability to weather supply shocks.
It also calls for an acceleration in investment in renewable energy, methods to reduce energy demand such as heat pumps and better insulation, as well as continuing to operate existing low-carbon energy sources like nuclear or biofuel.
What Does This Mean For Green Energy Investors?
From an investment perspective, this crisis has created an opportunity. Europe will finally be forced to seriously consider how to implement large-scale renewable energy projects, rather than relying on consumers installing solar and wind power on their homes.
This means that projects like wind power in the North Sea may suddenly become priorities for European governments, and investments in renewable energy companies should become very attractive in short order.
However, I believe that this has been at least partially priced in by the market. The quickest way for Europe to solve its energy problems lies in dealing with demand reduction, not supply. This means that investments in companies that focus on improving insulation or providing heat pumps are likely to do well sooner than investments in big risky renewable energy projects.
On a smaller scale, this is also an investment that ordinary homeowners, landlords, and construction companies can make today.
Even something as simple as properly insulating an attic can reduce household energy bills by as much as 10% to 30%. These savings will quickly add up as energy prices continue to rise and represent the easiest way for many of us to make an immediate impact.
How Will These Investments Impact LNG Prices?
Finally, we should address the elephant in the room, natural gas prices. In the short-to-medium term, we will undoubtedly continue to see a major increase in demand for gas in the European Union.
This will have a knock-on effect globally, as China, India, and the EU will now all be competing for the same supply of gas, making the system more vulnerable to local conditions like cold snaps.
Risk-tolerant investors may have an opportunity to take advantage of this situation by investing in ETFs with global gas exposure. However, they should be aware that as Europe transitions away from gas and toward renewables, these investments will become higher risk over time.
Summary
The Ukraine crisis has completely upended the global economy. It will be hugely difficult for governments and investors to square their desire to decarbonize, with spiraling gas prices.
However, in the long-term, it may help to force the European Union to get serious about reducing their reliance on natural gas, which could prove vital in combating the climate crisis before it is too late.