Eliminating strategic oil reserves could make Europe a global energy storage provider
Europe’s natural gas storage industry is on the verge of a crisis. With more capacity in place than is needed to cover the level of demand, margins for individual storage providers are becoming tighter. An early casualty was Centrica’s Rough facility in the UK, which closed last year in the face of high maintenance costs.
The outlook will become even more troubling if plans to integrate Ukraine into the Energy Union are successful. Ukraine will bring an additional 324 TWh of storage to the table, pushing the European total up to 1393 TWh. That will drive down profits for storage operators elsewhere on the continent. If more closures are to be prevented, it seems that a new rationale will need to be found for natural gas storage in Europe.
Writing in the Oxford Institute for Energy Studies’ most recent quarterly review, natural gas industry analyst Thierry Bros proposes one potential solution. His idea is simple: to rescind the strategic oil storage obligation that the EU27 (along with other OECD countries) has maintained since the early 1970’s, and replace it with a flexible energy storage obligation. He is calling upon the EU Commission formed in 2019 to initiate discussions aimed at creating a new energy storage directive along these lines.
The new directive would maintain the total energy value in TWh retained under the current storage obligation, but without specifying an energy source. Gas, oil, batteries and pumped hydro would all be able to compete on an even footing, with contracts being awarded to the lowest bidder. The outcome would be an energy storage mix that more closely resembles the energy intensity of the modern European economy, which has seen oil fall from a 50% share of total energy use in 1970, to as little as 38% today.
“The gas storage industry has either zero years to live, or another twenty years,” Bros tells me. “Either [storage operators] go with a business as usual system, in which case they will all close down… or we are able collectively to come up with a plan.” A more flexible, market driven system could well be the answer.
Not least of the possible advantages is the fact that a non-fuel specific storage obligation will lower the cost to taxpayers. If it favours gas over oil, the new obligation will also reduce the carbon intensity of the European energy system, without presenting any hindrance to continued decarbonisation. Maintaining strategic oil reserves makes little sense with the transport sector trending firmly towards electrification, Bros points out. “We are looking at this through the glasses of the 1970’s,” he tells me.
Europe as a global storage provider
If handled correctly, the very fact that Europe’s storage facilities cover a much larger percentage of demand than in any other major natural gas consuming region (26% in the EU27 plus Ukraine, in comparison to 18% in the US and Russia, and 5% in China) could prove to be an opportunity. It is an opportunity made possible by Europe’s close trading relationship with Russia, a supplier uniquely capable of stepping up its production volumes if incentivised to do so.
In his paper, Bros sets out how the combination of surplus European storage capacity and surplus Russian export potential could turn Europe into a global storage provider for natural gas and LNG. There are already precedents for the EU playing a role of this kind in the LNG market. In the aftermath of the Fukushima disaster, for instance, LNG cargoes were rerouted from Europe to cover surging Japanese demand. And with the introduction of winter LNG cargoes from the Yamal peninsula, European LNG terminals have been able to re-export cargoes to meet demand spikes in the US.
The big driver, of course, will be China. The world’s most dynamic natural gas market is chronically short on storage capacity, which is in part why the country has had to rely so heavily on LNG. To remedy this, the Chinese state aims to invest $10 billion in natural gas storage over the next 5 – 8 years. But it is unlikely that this will be enough. The depth of most Chinese wells – often in excess of 3000m – makes storage facilities problematic to develop. The state-owned oil & gas firms will also need to solicit foreign expertise if they wish to convert aquifers and salt caverns for storage purposes. And even if China succeeds in doubling its total storage capacity, its rate of demand growth will keep the country well below the global storage average.
Relying on European storage in the short to medium term could be a more attractive option for China. “The Chinese authority could well think: do we need to spend millions of Euros to build out gas storage when we could put our money in new storage technologies?” Bros says. Drawing on existing storage elsewhere in the world would allow China to tackle its air quality problem, but without incurring the danger of sunk costs from fossil fuel infrastructure. That would make the transition to cleaner energy sources much less expensive.
For Europe, the rewards are also clear cut. By protecting its gas storage facilities through a non-fuel specific energy storage obligation, and drawing upon winter cargoes of Russian LNG, Europe can retain the flexibility to switch between LNG and gaseous gas to meet its domestic requirements. This would allow it to act as a price arbiter, responding to demand fluctuations elsewhere in the world.
In a system short on storage, where LNG is needed to deliver security of supply, the imperative is to focus on the quantity of LNG injected into the pipeline system - and therefore on the net load factor of LNG terminals. But with ample EU storage, a better way to appreciate the role Europe can play as a price arbiter is to focus on a terminal’s gross load factor. “If a terminal operates on 100% gross, and zero goes into Europe, the terminal operator will have still made a fortune,” Bros tells me. “They will have made the regulated price to unload the cargo, and they will have made the regulated or unregulated fee to reload the cargo.”
Potential challenges
For the EU to become a global storage provider, it will need to make some changes, Bros’s paper argues. The first of these is for the EU Commission to hash out the details of the new energy storage directive – never a rapid process. Secondly, the gas industry will need to overcome the problem of compounded entry and exit fees making storage uncompetitive, perhaps by hastening the implementation of the EU Commission’s Quo Vadis proposal. And thirdly, the Ukrainian natural gas industry will need to be liberalised to combat uncompetitive transit and storage fees.
Another possible issue for Europe is how important continued supply of gas from Russia would be for it to maintain its status as a storage provider. “If things go very, very sour with Russia and we don’t buy Russian gas then we have a problem - they’re part of the system,” Bros says. But given the mutual benefits that would accrue to both parties from a healthy trading relationship, it is not an outcome he deems likely. “We need the gas and they need the money,” Bros says. “Everybody can benefit.”
