Gazprom Reduces Supplies Again

Gazprom’s 27 July decision to reduce the gas it supplies through Nord Stream 1 to 33 mcm means it is now delivering just one-fifth of the pipeline’s capacity. This reduction ensures Europe will continue paying (ever higher prices) for (just enough) Russian gas in order to service its day-to-day needs, whilst leaving insufficient extra to fill storage units before the winter (in late June, the Commission mandated that EU gas storage facilities should be 80% full by 1 November). The Gazprom reductions come against the backdrop of a historically hot summer, where consumer demand, including for air conditioning, is significantly higher than normal.[i]

Ironically, given the IPPC report and COP27 at the end of the year, the major beneficiary of the Russian gas supply crunch appears to be coal: the IEA forecasts a 7% rise in global coal consumption to reach the all-time record set in 2013, with electricity demand for coal likely to increase by as much as 16%.

The EU’s Response

The EU responded with the announcement of a plan for a 15% reduction in gas use across the bloc.  Part of the objective of the plan, which will be in force until March 2023, is to reduce gas use now in order to release gas to build up storage in preparation for the winter. Initially, this reduction is voluntary and it is up to Member States how to apply it, but they are required to report to the Commission on the progress of their energy savings plan every two months. However, should Russia order a complete shut-down of gas supplies to the EU, the target would become mandatory.

The focus of the EU’s 15% reduction plan is industry, with factories likely to have consumption reduction targets imposed on them; there are exemptions for manufacturers of critical goods and for plants that are difficult to restart after switching off energy. However, some EU Member States have already enacted domestic energy efficiency plans. Those plans include a range of measures: turning off lighting on historic monuments; switching off illuminated advertising; fixing maximum and minimum air conditioning unit levels at between 19-27C; banning mobile heating and a/c units; obliging shops with a/c to keep their doors closed; turning off city fountains; or obliging public swimming pools to offer cold showers only. Italy had been working on a plan to oblige all commercial facilities to shut at 1900; whether that plan survives Draghi’s demise, remains to be seen.

Alongside its energy efficiency drive, the EU has launched a global energy diplomacy push to find new sources of gas. Recognising that it cannot replace all the missing Russian gas from one supplier, it is pursuing a “fragmented purchasing strategy.” This approach has found it searching for gas at some new and unfamiliar doors–Nigeria, Algeria and Kazakhstan–as well as returning to old suppliers–Saudi Arabia, Qatar and Iraq. 

Splits in EU Solidarity?

The problem with the EU’s plan is the disparity in dependence on Russian gas: amongst the 27 EU Member States, 14 obtain more than 50% of their gas from Russia. With the exception of Hungary, EU Member States accepted the need for European solidarity, noting the interdependence of industrial supply chains. Recognizing the impact a supply shock would have on all EU economies, some argued that the uniform 15% target failed to take account of differing national circumstances.

Spain, Portugal, and Italy have been able to stockpile gas more rapidly than Northwest Europe, particularly Germany, since the outbreak of the war, through higher LNG capacity (Eni for example, is planning for a new FLNG vessel to be operational within four years) and increased gas imports from Algeria. Italy plans to be independent of all Russian gas supply from the second half of 2024, and to get through this winter will require only a 7% cut in current consumption. Spain has agreed to a similar reduction.

Germany is at the other end of the scale, importing 55% of its gas from Russia.  So far, domestic consumers have been insulated from gas price rises as most private households in Germany pay their gas bills in set advance payments.  However, that support is coming to an end. In June, Germany passed an emergency energy plan, which enabled utility firms to pass on higher gas prices to customers, and, on 28 July, the German government confirmed that a planned gas surcharge on customers could be much higher than previously expected.

Consumer Pain – “What is the Gain”?

With European gas prices having risen nine-fold in the past year, the howls of consumer pain are beginning to reach politicians’ ears. Consumers in the UK, which only receives 4% of its gas imports from Russia, have seen their bills balloon from £1,400 p.a in October 2021, to £3,360 by October 2022, with a further rise to £4,200 likely in January.  Announcing the country’s 7% energy efficiency plan, Spain’s Environment Minister was at pains to emphasise that the plan would not disrupt people’s daily lives. The German Foreign Minister voiced concerns over a “popular uprising” this autumn about gas prices.  

Any plans to accelerate the shift away from gas to electricity for domestic consumption may be jeopardized by a lack of spare capacity in the electricity grid. In the UK, developers have been warned it might take more than a decade to develop the necessary grid capacity. This problem is not unique to the UK and is only likely to increase in the years ahead with legislation requiring new homes to support low-carbon technologies such as heat pumps and an increase in electric vehicles, which will place additional strain on grids across Europe.

Is the Plan Enough for a Harsh Winter?

The 15% reduction target, which was predicated on a bitterly cold winter, would reduce EU consumption of Russian gas by 45 bcm.  A number of opt-outs will reduce that figure[ii], but the Commission is confident that even with the opt-outs, the reduction of demand will be sufficient to see the EU through an averagely cold winter. 

However, the real emerging concern is not winter 2022-2023, since European gas storage is at a relatively healthy level (71% full on 2 August), but rather winter 2023-2024: gas storage will be depleted by spring 2023 and replenishing it will be difficult with fewer options and greater competition for gas supply on a tighter market.  Already Asian demand for US LNG cargoes has increased; whereas Europe took 67% of them in May, Asia accounted for nearly half in July (France took 13 cargoes, NL took 11, Japan took nine, South Korea and Spain took seven each).

The Economic Impact

The impact of Gazprom’s decision and the associated gas price increases are increasingly obvious in the European economy.  As inflation in the UK reached a 40-year high of 9.4%, the Bank of England raised interest rates by the largest single increase since 1995 and issued a warning of a lengthy recession starting later this year and inflation reaching 13% early next year. Some reports forecast it would reach 15% by the beginning of 2023.

Eurozone consumer confidence fell to a new low in July, with inflation expected to be at a record high of 8.7% when figures are released on 5 August. The ECB raised its interest rates at the end of July for the first time in a decade, which is likely to accelerate the emerging trend of a reduction in the supply of loans to Eurozone households and businesses. There are some concerns that the ECB may have left this measure too late as the worsening economic outlook reduces the scope for further interest rate rises to tackle inflation. Such a prospect raises the danger of stagflation.

Conclusion

As Dmytro Kuleba, the Ukrainian Foreign Minister, commented: “In Ukraine Putin fights with missiles and tanks, in Europe he fights with gas prices.” Putin is pursuing a hybrid war and clearly believes Russian resolve will outlast that of the West. The outcome of this unequal contest, where one side has no concern for the court of public opinion, will depend on whether levels of European consumer pain rise sufficiently to undermine the, so far impressively solid, public support for sanctions against Russia, or whether the EU’s counter- measures are sufficient to blunt the Russian gas threat.


[i] Much of the electricity supply in Europe relies on gas-fired power generation.

[ii] Cyprus, Ireland and Malta, which are not connected to the EU gas network; Baltic States, whose electricity systems are linked to Russia; and Member States which are not major users of the European gas network and have the capacity to send LNG to their neighbours.

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Photo of Thomas Reilly Thomas Reilly

Ambassador Thomas Reilly, Covington’s Head of UK Public Policy and a key member of the firm’s Global Problem Solving Group and Brexit Task Force, draws on over 20 years of diplomatic and commercial roles to advise clients on their strategic business objectives.

Ambassador…

Ambassador Thomas Reilly, Covington’s Head of UK Public Policy and a key member of the firm’s Global Problem Solving Group and Brexit Task Force, draws on over 20 years of diplomatic and commercial roles to advise clients on their strategic business objectives.

Ambassador Reilly was most recently British Ambassador to Morocco between 2017 and 2020, and prior to this, the Senior Advisor on International Government Relations & Regulatory Affairs and Head of Government Relations at Royal Dutch Shell between 2012 and 2017. His former roles with the Foreign and Commonwealth Office included British Ambassador Morocco & Mauritania (2017-2018), Deputy Head of Mission at the British Embassy in Egypt (2010-2012), Deputy Head of the Climate Change & Energy Department (2007-2009), and Deputy Head of the Counter Terrorism Department (2005-2007). He has lived or worked in a number of countries including Jordan, Kuwait, Yemen, Libya, Iraq, Saudi Arabia, Bahrain, and Argentina.

At Covington, Ambassador Reilly works closely with our global team of lawyers and investigators as well as over 100 former diplomats and senior government officials, with significant depth of experience in dealing with the types of complex problems that involve both legal and governmental institutions.

Ambassador Reilly started his career as a solicitor specialising in EU and commercial law but no longer practices as a solicitor.