Europe Needs a Strategic Gas Reserve

Due to the tensions between Russia and Ukraine, as well as to the instability of Libya, the EU is facing once again a high level of energy vulnerability that proves how poor and inconsistent its energy policies have been. For almost 15 years now, Brussels has been devoting its efforts to liberalizing the downstream energy market, aiming in particular at fostering competition in gas distribution and power generation. It also set rigid standards in order to cut greenhouse gas emissions by 2020, strongly supporting the development of renewables. Coupled with the economic crisis, these actions have created excess capacity in gas distribution and power generation, which in turn has brought investors in these sectors to their knees, without offering a solution to the underlying security problem: Absent abundant and competitive supply, the European gas market remains at the mercy of those that control the raw material.

The EU imports 66% of its natural gas, and still depends on a limited number of gas suppliers dominated by Russia. The EU has been riding for years on the trite slogan of "supply diversification," leaving its implementation to market forces -- that is, to companies operating on a competitive basis and facing difficulties in finding economically sustainable supply options. Thus, for almost 20 years now there has been much talk about plenty of new pipelines from new suppliers, and yet most of them have just remained paper-projects due to their high costs. The only exception could now be a gas pipeline supplying Europe from Azerbaijan and the Caspian region, but that cannot in itself solve the European problem.

Major European Natural Gas Pipelines

Given the failure of past policy to improve energy security, Brussels and several European governments are now updating their "diversification" mantra by putting their hopes in US natural gas -- or, better, in the large amounts of the resource produced by hydraulic fracturing for shale gas. However, the US will hardly become a big exporter of natural gas in the course of this decade. There are many reasons why. Chief among them is simply that the more gas the US exports, the higher the domestic price of the resource will be. And this is something most Americans don't want. One should never forget, in fact, that the low cost of US energy is now possibly the most powerful factor behind the nation's industrial renaissance and job creation. For this reason, the US government is very cautious in authorizing new projects for natural gas exports. What's more, it's likely that most of the future US gas exports will head toward Asia, where prices are far more rewarding.

So, in the short term, Brussels has no immediate option to deal with a gas crisis other than to repeat that such a crisis is improbable. A recent stress test on the effects of a Russian gas disruption delivered by the European Commission on Oct. 16 has led the outgoing EU Commissioner Gunther Oettinger to say: "If we work together, show solidarity and implement the recommendations of this report, no household in the EU has to be left out in the cold this winter" (IOD Oct.17'14). Yet, by reading the report, one cannot feel very safe.

The best scenario implies a cooperative effort by the 28 EU members plus 10 of their neighboring countries to "share the burden" of a disruption and cooperate to allocate the available supplies. Yet this kind of cooperative effort is a chimera. Even without considering the difficulty in coordinating such an effort among the 10 non-EU members, the EU members themselves have historically demonstrated very poor performance in terms of energy cooperation. The most striking example of this is their failure to interconnect gas and power networks on the continent, mainly due to national self-interest. The lack of such interconnections is now a major factor of vulnerability for the cooperative effort requested by the commission's report in case of crisis -- as it admits.

The report also suggests that a positive factor for the current European gas market situation is the high level of gas storage, which is almost 94% full -- equal to around 77 billion cubic meters. This figure is much higher than in the past few years, but the problem is that most European gas storage is made up of commercial inventories that companies may draw upon at any moment. In other words, companies may theoretically empty those stocks for commercial reasons before a crisis occurs. True, that extreme scenario is improbable: But one cannot rule out the possibility of large drawdowns that could make gas inventories insufficient in the face of a crisis.

Finally, the report doesn't consider the possibility that a Russian gas disruption might take place in combination with potential disruptions from Libya, which is highly unstable politically, or other supplier countries. The commission also puts its faith in the possibility for Europe to offset any crisis by increasing gas imports from Algeria and through LNG, but those options would imply much higher costs for European consumers. Furthermore, such supplies may not materialize easily in an actual crisis.

Amid all these uncertainties, the EU is not doing what actually is within its reach. First, as we have seen, Brussels is doing nothing to impose the interconnection of all European gas pipelines and power grids. More importantly, it has never contemplated the most effective, although radical, option for natural gas security -- the autonomous buildup of a strategic gas reserve (SGR) directly managed by the EU authorities. Here too, the construction and management of so-called "strategic" stocks, to be employed in emergency situations only, has been left to private initiative on a national basis, thereby turning out to be absolutely inadequate for overall European needs.

Learning From History

After the 1973 oil shock, the OECD countries took the decision to develop their own strategic petroleum reserves under the direct control of the nation-states and the supervision of the International Energy Agency. This decision was aimed at preventing a scramble for supply in a shortage and preventing deadly competition among industrialized countries for oil supplies, which would only increase the market power of oil producers. In the 1990s, this duty was extensively delegated to oil companies, because the oil market was by then well-supplied. However, even now -- to give but one example -- the US government directly maintains a Strategic Petroleum Reserve of about 700 million barrels to be tapped in an emergency, which adds to stocks held by companies. China does the same, even if the exact size of its strategic reserves is unknown.

Such a European SGR should integrate existing national strategic stocks, and it would likely need to have an order of magnitude of around 15 Bcm-20 Bcm. Brussels could make use of depleted gas fields, perhaps in the North Sea, or other options available in Europe, to build it up. A revision of the EU budget would allow for the creation of such an SGR. Natural gas for the reserve should be bought when prices are lower, far from winter and summer peaks. In case of emergency, companies distributing gas in Europe should be obliged to buy it depending on their market quota and contractual obligations.

An SGR controlled by the EU would be the only structural solution to the recurring nightmare of European gas vulnerability, particularly in a historical period of great instability all around Europe.