This report does not constitute a rating action.
PARIS (S&P Global Ratings) March 17, 2022--Elevated and extremely volatile European gas prices reflect mounting risks related to gas supply from Russia, and Europe's strong political push to diversify away from Russian gas, on top of an already tight supply-demand situation before the Russia-Ukraine conflict. S&P Global Ratings believes this situation, alongside evolving regulation on the gas and energy sector, the EU's steps to secure alternative gas supplies or fuels, and efforts to redirect liquefied natural gas (LNG) cargoes could eventually reshape Europe's energy market.
In our view, gas spot prices (TTF) in 2022 will depend largely on whether there is only a modest reduction in Russian gas flows versus last year's level, or a more pronounced longer-term decrease, which is no longer implausible based on the EU's recently published REPowerEU proposal. Gas prices will have to be sufficiently high to reduce Europe's gas demand and to redirect LNG cargoes from Asia to Europe. The extent of the supply shock will influence how quickly the market can rebalance in 2023 and beyond. In addition, we think a structural change of Europe's gas market will depend on the evolution of EU regulation on gas purchases from Russia, as well as Europe's specific steps to secure additional gas supplies and refill gas stocks, and its tolerance to gas demand cuts and a temporary surge in coal use. Also, it remains to be seen to what extent high gas prices could affect gas demand in Asia, and how successful Europe's efforts to attract more LNG cargoes will be.
This year, we expect to see power prices reaching unprecedented levels, possibly well above €200 per megawatt hour (/MWh) in some major European markets, versus about €120/MWh on average for the largest markets in 2021. This will be mainly due to high gas and commodity prices, as well as a power demand-supply imbalance triggered by recent closures of thermal generation capacity (for example coal plants) and increasing demand as economies recover from COVID-19 restrictions. Power prices will likely decrease only slightly in 2023.
For most integrated European utilities we rate, high power prices should have only a limited impact on earnings in 2022. This is because hedging policies, which for many cover close to 100% of their production this year, have made their EBITDA much less sensitive to merchant power. In addition, in recent years, most utilities have moved away from merchant power by expanding in long-term contracted renewables. As a result, we anticipate more earnings upside in 2023 for power generation companies, since they benefit from better strike prices on their futures hedging. However, we see that hedging positions are generally below 50% of volumes for 2023. Political intervention, including the introduction of special energy taxes, could eat into any windfall profits next year.
The European Commission's REPowerEU plan aims to reduce Europe's reliance on Russian gas to the extent possible, through diversifying gas supplies, switching to other fuels (notably renewables), cutting gas demand for residential and industrial users, and refilling gas reserves to 90% of storage capacity by October 2022, from about 26% as of mid-March 2022. In addition, some European companies may voluntarily reduce their exposure to Russian gas.
Although Russian gas flows to Europe are continuing and have not been placed under EU sanctions, the risk of physical damage to infrastructure, restrictions from either side, or indirect implications of other sanctions imposed on Russia cannot be ignored. Russian gas is not easy to replace because it accounts for 30% of the combined EU-27-U.K. gas market (35% of imports), and essentially all Russian gas supplies are under long-term take-or-pay contracts. Of the about 142 billion cubic meters (bcm) supplied to the EU-27 and U.K. in 2021, about 40 bcm came via pipeline through Ukraine.
Europe's energy policy calls for more LNG and alternative pipeline supply. However, the LNG pool available for spot sales is limited. European LNG terminals are already operating close to capacity, and most global LNG production is locked into long-term contracts (including many with destination clauses); no large additional global LNG production is expected before 2025. Moreover, Europe's own gas production has been in structural decline and the potential for alternative additional gas supplies from Norway, North Africa, or Azerbaijan appears low. Although we believe European gas stocks should last until the end of this heating season, we expect gas prices in Europe to remain highly weather dependent. Also, we expect market rebalancing to take longer because of the additional pressure to replenish gas stocks.
In the longer term, we expect the current situation to exacerbate pressures on gas demand in Europe and globally. Together with additional LNG supply after 2025, this should help eventually balance the market, however.
Related Research
- Europe's Exit From Russian Gas: 10 Questions On Utilities, March 16, 2022
- Qatar Could Gain As Europe Diversifies From Russian Gas, March 16, 2022
- S&P Global Ratings Raises Near-Term Oil And Gas Price Assumptions Following Russian Invasion Of Ukraine, Feb. 28, 2022
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| Primary Credit Analysts: | Massimo Schiavo, Paris + 33 14 420 6718; Massimo.Schiavo@spglobal.com |
| Simon Redmond, London + 44 20 7176 3683; simon.redmond@spglobal.com | |
| Pierre Georges, Paris + 33 14 420 6735; pierre.georges@spglobal.com |
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