Natural gas markets experienced a wild ride in 2021 due to a combination of volatile geopolitics, extreme weather, and poorly conceived green energy transition plans. Much of the same looms in 2022. Although the United States is a major producer and exporter of natural gas, higher prices for the commodity are showing up in heating bills, which are feeding inflation—which hit 7.5 percent in January, the highest level in forty years. The risk of war between Russia and Ukraine, potential conflict between Algeria (a major natural gas supplier to Europe) and Morocco, and reduced investment in new exploration and upgrading of key infrastructure all leave the door open to another volatile year defined by tight natural gas supply and high prices. While 2021 left economic policymakers and businesses scrambling, 2022 will be a year where seat belts are mandatory.
Natural gas has carved out a central place on the global energy map. It is a key transitional fuel source for many countries; it is cleaner than coal and oil and will help the shift to green energy. As it is, natural gas is a core part of the U.S. energy picture, supplying a little over 40 percent of fuel to generate the U.S. electricity supply, well ahead of coal, oil, nuclear power, and alternatives. According to the International Energy Agency (IEA), natural gas accounts for around one-quarter of global electricity generation, which goes into power production for home heating, manufacturing, and municipal lighting. The IEA notes, “Its storability, its ability to be delivered through pipelines, or liquefied and sent by ships, as well as the ability of gas-fired power plants to turn on and off quickly, allows natural gas to respond to both seasonal and short-term demand fluctuations and to provide back-up to the growing use of variable renewables such as wind and solar power.”
One of the major transformations is how natural gas markets, which in the past were dominated by long-term contractual relationships, became a globalized market. This was driven by the availability of shale gas and rising supplies of tradeable liquefied natural gas (LNG). As the IEA noted: “The growth of the gas trade, as well as a shift away from long-term contracts toward spot pricing in many markets, has created greater interconnectivity between markets with demand or supply shocks in one region now having global implications, on both gas and electricity prices.” Consequently, major developments in one market are quickly felt in other markets.
The global natural gas market is constructed around a core group of producers and LNG exporters and hungry energy users, namely Europe and Asia. With China and India being net importers of natural gas, Asia looms large as a user, accounting for 345.4 billion cubic meters in 2020, with Europe in second place at 114.8 billion cubic meters. The world’s top three importers are Germany, Japan, and China.
The last two years have been challenging for the natural gas market. Gas prices plunged in 2020 (to historic lows) due to a combination of forces, including Covid-19 and supply chain disruptions, greater interconnectivity of natural gas markets, and signs of energy price volatility during the energy transition away from fossil fuels. That changed in 2021 due to a strong recovery in demand. But as economic recovery came in a rush in the United States and China, renewed demand strained fossil fuel markets for oil and gas, and even coal. As one Brookings Institute study noted of 2021, “Prices are skyrocketing as demand chases fuel supply that has not yet recovered from the pandemic drop.”
In 2022, geopolitical tensions are adding stress to natural gas markets. The main pressure point is the substantial Russian troop buildup on the border with Ukraine. The concern is that if Moscow launches a military intervention into Ukraine, such an action would disrupt the flow of natural gas from Russia to Europe. Considering that Russian natural gas constitutes close to 40 percent of Europe’s energy needs, any major military confrontation would not be conducive to supply and price stability. It would also put Europe into an energy crisis, especially in Germany which is highly dependent on Russian natural gas (think Nord Stream I pipeline and the waiting-for-regulatory approval Nord Stream II).
There is considerable debate over whether Russia would turn off the natural gas pipelines to Europe in the case of a war with Ukraine. While Europe is dependent on Russia for its natural gas (and oil), Organization for Economic Cooperation and Development Europe received 72 percent of Russian natural gas exports in 2020 (according to the EIA). Asia accounted for only 11 percent of Russian natural gas exports of which China stood at 5 percent (though that number is expected to head up). Germany is the main destination.
The question is: ultimately how much economic pain can Russia take? Losing the German market over the long term would be a major blow to the Russian economy. In some ways, the resolution of Eastern Europe’s sticky geopolitics and natural gas prices run through Berlin. A war in the east is Germany’s worst nightmare, which partially explains Berlin’s reluctance to extend military assistance to Ukraine and caution on what measures could be taken against Russia. Moscow’s hope is that Germany will play a passive, reactive role, which seeks to protect its own national interests (such as trade and Russian natural gas which accounts for 55 percent of its imported gas).
Russia’s objectives are to reestablish a strategic depth vis-à-vis the West with a zone of subservient Eastern European buffer states. This would mean a rolling back of the NATO military presence, an acknowledgment from the United States and Europe that certain Eastern European states were now in a Russian orbit and that Moscow has the right to dictate the foreign and military policies of those states under its influence. Considering that the use of military force has been successful in pursuing Russian national interests (Georgia in 2008 and Crimea in 2014), the threat of such action against Ukraine to prevent it from joining the West (either as part of NATO or the EU) has raised geopolitical tensions to old Cold War levels and held out the very real prospect of armed warfare in the East.
Europe’s three major sources of natural gas are Russia, Norway, and Algeria. While both Norway and Algeria have extra capacity, they cannot make up the entire difference for a loss of Russian supply. Moreover, there is a degree of political uncertainty hanging over Algeria. Algeria and Morocco (through which one natural gas pipeline transits) are very much at odds due to Rabat’s growing closeness to Israel, which is helping upgrade its armed forces. This has alarmed Algeria. At the same time, Algeria supports the Polisario Front, which is fighting a war of liberation from Morocco in the Western Sahara. The picture is even more complicated as Algeria has allegedly allowed Iran to work with Hezbollah to help train Polisario forces.
In November 2021, Algeria shut down a major natural gas pipeline that runs out of its gas fields through Morocco and to Spain and Portugal. Algeria still maintains a flow of natural gas through another pipeline connecting it to Italy and has two LNG plants that ship energy to Europe as well. Algeria’s domestic political situation is currently stable, but tensions lie not too far below the surface. Moreover, there is rising domestic demand for Algeria’s natural gas.
In 2022, Europe could find itself facing an energy crisis, which could hurt the global economic recovery. Part of the problem is that other sources of natural gas are not readily available. According to Standard & Poor’s (January 2022), a quick read of other major natural gas producers does not paint a rosy future if Russia turns off the gas spigot to Europe:
Libya, already struggling to supply its term customers and wracked by political instability and security problems, “has no additional capacity for gas exports.”
Egypt, which has over the past several years made some major offshore gas discoveries, “has maxed out its LNG export volumes.”
Qatar, in the Persian Gulf, has largely contracted all of its volumes already, “though sources suggest some cargoes could be diverted to Europe if Asian customers are amenable, which would require some deft negotiations.”
Likewise with LNG customers of the United States, which is already shipping record cargoes to Europe.
Australia, the world’s leading LNG exporter, which hit a record high in 2021 with LNG exports, is thought to be close to peak production, while its sales are largely locked into countries in Asia, namely Japan, India, China, South Korea, Vietnam, Pakistan, Thailand, and Bangladesh.
It can be argued that natural gas has become a victim of its own success. As the key transition fuel, it is in heavy demand. The problem is that supply is now lagging demand; if the geopolitical aspirations of certain countries are brought to bear it could worsen. While Americans have come to take natural gas supply as a given, they should not. Cheap and readily available natural gas is increasingly hard to find on the menu. In an age of rising geopolitical tensions problems in global markets could have an impact at home, while cyberattacks and extreme weather (like Storm Uri that hit Texas in February 2021) could lead to energy supply disruptions. U.S. and European policymakers would be wise to remember Benjamin Franklin’s words, “By failing to prepare, you are preparing to fail.”