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14 December 2022

IEA warns against gas complacency, but how credible is the threat?

The International Energy Agency’s Executive Director Fatih Birol said on Monday during a joint conference with president of the European Commission Ursula Von der Leyen that the EU may need to spend €100 billion to avoid gas shortages from further cuts to Russian supply, but that it would pay for itself within 2 years through lower energy bills.

Birol went on to say that since the onset of Russia’s war in Ukraine, Russia’s output of natural gas to Europe fell from 140bcm down to 60bcm, and that there is the potential for Russia to cut gas supply altogether, Europe will then have to make up that difference through LNG imports and demand reductions before the next heating cycle next winter.

Chinese demand is also a factor, with the country set to abandon its zero-covid policies because of the evidently rather successful protests a couple of weeks ago. Should Chinese gas demand rebound on the lifting of this policy that would increase competition for the increasingly finite commodity, threatening European supply in 2023.

New LNG coming to market has also been limited, with only 20bcm of new capacity being added to market at a time when demand is increasing.

The mention of mild temperatures is a little odd, so far this year Europe has experienced a rather mild winter all things considered. Birol’s implication is that should this change for 2023, gas demand is going to increase, putting further strain on limited natural gas and LNG supplies. While weather patterns are cyclic, Europe has experienced a number of mild winters in the last few years as a result of climate change, and this is unlikely to change tack.

The IEA has predicted that a shortfall of 27bcm of natural gas is possible in the worst-case scenario and that action should be taken immediately to address it, but there’s a few issues with this assessment.

Firstly it’s important to understand a few things about the IEA and its incentives for doom and gloom.

The main reason for this is that the IEA and Europe truly don’t have a reason to be complacent, things are bad and could very well get worse. If the IEA was to say anything other than suggesting that the sky is going to fall, people wouldn’t take the threat seriously. Public-facing agencies don’t have the luxury to be optimistic because people take their words seriously, so giving the worst-case scenario is standard from anyone in this position.

Most western nations did similar things during the height of the Covid-19 pandemic as it encouraged prudence and discouraged contentment in what was a dangerous situation, mostly leading to improved outcomes.

Bold statements around bad things happening while providing solutions also make the agency look good, regardless of whether or not the threat was credible in the first place. Saying this sort of thing publicly makes the IEA look good and draws eyes to the agency.

It’s also important to consider the IEA’s abilities when it comes to forecasting. The IEA’s yearly flagship publication, the World Energy Outlook (WEO), is a great exercise in data collection, but it’s an indictment to forecasting techniques. This year’s WEO predicted across multiple scenarios with different levels of renewable investment that the levelized cost of energy (LCOE) of renewable technologies like solar would be consistent despite different investment levels. Implying that the agency doesn’t have a solid grasp of wright’s law or access to any historical context within technological research which would prove its claims wrong. We have more grievances with its forecasting techniques, but we’ve covered this in the past, and it isn’t entirely fair to dismiss this prediction in its entirety on the basis that it will be as incorrect as the agency’s prior works. So let’s assess some factors independently.

First Russia’s natural gas output is the most important and is contingent upon the outcome of its war in Ukraine, due to this being the trigger of its deteriorated relationship with the rest of Europe. Russia is burning through ammunition and might as well be burning rubles to power its war machine, completely shutting off natural gas supply to Europe would be mutually detrimental as Russia still seems set on continuing its invasion for which it needs to be able to afford ammunition to bomb more civilian infrastructure.

So far Russia has limited gas supplies in order to increase the relative value of what it does export, abusing the relative inelasticity of supply of natural gas to inflict pain upon Europe while continuing to make money from its exports. If it isn’t exporting any gas at all to Europe it doesn’t get to benefit from high prices, cutting off its nose to spite its face.

Secondly, China’s gas demand isn’t bound to an upwards trajectory just because of lifting its zero-covid policy. While this is likely to lead to some level of increased demand, its level of success in lifting these restrictions is immensely important and isn’t something anyone will know for a good while yet. For all anyone knows China could reimpose restrictions at the faintest hint of increased hospitalization rates, back to levels seen this year.

Finally, LNG facilities can be built with some speed, and while new capacity has only increased by 20bcm as Birol mentions, capacity can increase rapidly from nations such as Qatar where discussions are ongoing, even if these discussions draw some controversy.

Another factor is the potential for a recession lowering industrial demand through 2023 which will help to maintain those supplies which can be acquired.

What should be taken from this prediction is that more needs to be done in renewables deployment and with regards to energy efficiency measures as Europe was doing before. This prediction is somewhat preaching to the choir of companies who’re already moving as fast as they can to abuse astronomical energy prices. The plans that Europe has put in place should be accelerated to its utmost, interconnection and collective purchasing would help countries that otherwise struggle to negotiate for themselves.