Instability in Ukraine looms large over winter gas market

It is often said that Ireland lies on the end of the European gas pipeline. In fact, 95% of gas used in Ireland is imported from the UK. The UK then relies on a combination of both indigenous supply from the UK Continental Shelf (UKCS) and imported supply sources to meet its demand requirements. These imported supply sources include mainland Europe via the Netherlands and Belgium, Norway and places further afield such as Qatar in the form of Liquefied Natural Gas (LNG). The UK being interconnected to mainland Europe means that it too relies on gas from Russia which supplies into other European countries. As such, the price of natural gas is impacted by supply coming from Russia which helps the Continent balance its requirement for heating and power generation. Each year, Europe imports 160 billion cubic metres of Russian gas, or approximately 30% of its requirement, and half of this flows through Ukrainian transmission pipelines.

In the wake of the conflict in the southern and eastern regions of Ukraine, and the resulting EU-US trade sanctions on Russia, the potential for this instability to impact upon the winter price of natural gas in Europe is being felt on markets. Some analysts have warned of the potential for Russian gas flows to Europe to be reduced or completely halted in the coming months, with a resulting supply deficit in Europe. The impact of such a move could be a rise in the price of natural gas to consumers in the UK and Ireland, who would be indirectly impacted by such a development.

There is precedent for such a scenario. In January 2009, Russian gas giant Gazprom cut off supply to the Ukraine for a number of weeks. This move was prompted by a dispute over price and alleged late payments between the Ukrainian gas company Naftogaz and Gazprom, the Russian based producer. Coupled with this was also the Russian government’s dim view of Ukraine’s pivot towards the European Union. The issue was eventually resolved that month when the EU stepped in and brokered an agreement. However, the reputations of Ukraine as an energy transporter and Russia as an energy supplier suffered as a result of the crisis. Since then, imports of Russian gas via Ukraine have been reduced from 80% to 50%, with the completion of the Nord Stream pipeline which bypasses the country.

Another dispute over price and late payments resulted in Gazprom cutting off supplies to the Ukraine again in July of this year, despite attempts at intervention by the European Union. This has led to a risk premium being built into gas contracts throughout the summer months, and into the coming winter period (Oct 2014 –Mar 2015). If Russia were to stop pumping gas to Europe through the Ukrainian pipelines, additional gas supply could come from the UKCS and Norway with Liquefied Natural Gas (LNG) from Algeria and Qatar also available to meet any fall-off of Russian gas transported via Ukraine. There is also potential for much of the gas supply to be re-routed around the Ukraine through alternative pipelines, such as Nord Stream. A combination of these sources should allow Europe to meet its natural gas requirements for the coming winter period. However, European gas hubs could react negatively to a perceived limitation to supply, regardless of the available alternatives for meeting demand. For countries in Central and South East Europe, the shortage could become a much more serious issue as they are directly connected into pipelines traversing Ukraine. For these countries, there could be a material reduction of supply rather than a mere increase in gas prices, as could be expected in the Irish gas market. Another more optimistic scenario would be that a peaceful resolution to the conflict would combine with a mild winter which could send gas prices downwards.

On a European level, there is much more gas storage in the system this year compared to last year, with facilities already filled to almost 90% capacity and could potentially cope with up to 90 days of a supply-cut at current demand levels.

The weather will also be an important driving factor for gas prices, as it is every year. If a perfect storm of events such as a prolonged cold spell and a Ukraine gas-supply cut-off occurred at the same time as other events affecting supply (e.g. infrastructure unexpectedly going offline, natural disasters etc.), then there could be significant risk of a price spike at European gas hubs.

For natural gas users, the winter period accounts for the bulk of commodity cost due to traditionally higher prices and levels of demand.  Senior Analyst with Naturgy Joanne Daly said: “The risk of supply interruptions or restrictions on flows into Ireland is low. However, the price elasticity of natural gas means markets could see sharp price increases for even a modest impact on gas supplies. For those wishing to minimise exposure to the risk of price spikes over the coming winter, you should get in touch about the options available to you”.