The Ukraine conflict An energy reset

Beyond the clear humanitarian crisis, Russia's invasion of Ukraine has led to significant economic volatility, with the energy sector in particular experiencing a period of uncertainty. The immediate impact of high oil and gas prices is set to be heightened as a number of countries look to phase out oil and gas imports from Russia. Indeed, the decision to halt oil and gas imports may be taken out of Europe's hands, if Russia realises its threats to cut supplies. As European governments start to reappraise their energy supplies and reformulate their energy policies, one question is gaining momentum: Will this set us back on our path to Net Zero, or will it accelerate it?

Until last month the plan for the UK and Europe, in particular, has been clear: a decarbonisation strategy with increasing investment in renewables but with gas playing a key role as a transition fuel. The Ukrainian crisis has cast a dark shadow over that strategy literally overnight, as governments have been forced to divert their attention from the longer-term Net Zero imperative to more immediate concerns about energy security and addressing the deficit left if Russia's oil and gas supplies are taken out of the energy equation. It is clear that renewables will play a leading role in this, with some governments formulating ambitious plans to bring forward large-scale deployment of tried and tested technologies such as solar and wind. What has changed, however, is that the new focus on domestic energy supplies requires, by implication, a shift in policy direction.

What does this shift in direction mean in practice? In the short-term it means that some European countries are looking at previously unacceptable options such as coal to address the immediate imperative of keeping the lights on and providing heating. While deals are also being made to secure gas supplies from elsewhere, the UK and Europe are facing up to the reality of the risks posed by international gas markets and looking at alternatives for the medium and longer term. While it is early days, it seems likely that in terms of Net Zero goals, this is not so much a step backward but a step towards a slightly different path. In this article we consider what that path may entail for a number of different countries, as well as some of the general themes we are seeing.

General themes

LNG

Importing more LNG to Europe where there is existing terminal capacity available, such as in France, Spain and the UK, is seen by many as a viable and immediate solution. However, it is unclear at this stage whether LNG could completely replace gas from Russia, particularly on a more ongoing basis rather than just a stop-gap measure. Moreover, LNG carries with it a cost premium, particularly in the current squeezed LNG market. Although LNG is acknowledged to be an expedient option when transitioning from fossil fuel-based energy supply to low-carbon energy, it may divert the funds otherwise spent on renewable projects towards prolonging the transitional period, especially in countries where new regasification terminals would have to be built, such as Germany and Italy.

Energy pricing concerns

Oil and gas prices have seen record highs, and in many instances spot prices remain significantly above the fixed prices provided for in long term supply agreements. This presents problems for both sellers and buyers. Sellers tied to long term fixed prices (which remain prevalent for LNG sales in Asia-Pac) are looking for ways out of their contractual commitments, thus freeing up volumes for sale at higher market prices. Consideration is being given to legal concepts such as force majeure, and frustration and civil law concepts such as hardship. Spot market purchasers, on the other hand, are seeking to reduce their exposure to current price hikes. A period of contractual review and adjustment has likely already begun. Could it be that we will see a de-prioritisation of pricing competition and a transition back to historic natural gas pricing models such as that under Groningen model contracts, with longer term commitments and periodic price review? Could we see a return of the 1970's North Sea practice of contractual hardship clauses in common law governed gas supply agreements?

Renewables

Renewable projects have a starring role, supporting the energy transition, but equally supporting countries' energy security concerns. The UK, France and Germany have explicitly stated they will accelerate renewable project deployments to be able to rely on domestically produced energy, in addition to the obvious sustainability benefits of deploying more clean energy projects. There is a clearly positive trend towards renewable projects across the continent with all governments looking to remove red tape and administrative bottlenecks attached to greenfield renewable energy project development. It may well be that subsidies are offered to attract further investment in the renewables sector (or that existing incentive mechanisms are revamped). However, governments face a fine balance between offering effective subsidies but not introducing a system that is too "successful" – history has shown that subsidy regimes which become oversubscribed and in turn are scaled back or removed altogether can and will lead to domestic litigation as well as investment treaty disputes.

The scaling up of renewables deployment may also face some supply chain pressures. In particular, there are continued constraints on the supply of solar panels – most recently stemming from further Covid lockdowns in China, as well as direct impacts from the Ukraine conflict, with constraints on the availability of steel from Ukrainian factories as well as aluminium from Russia, all necessary for construction of renewable projects. Scaling up existing technologies will also bring with it disputes risk, in that technologies may not end up performing as well in new and more challenging environments.

Heating

In the heating sector, existing strategies to replace gas boilers with alternatives, such as electric heat pumps, are now even more relevant. However the demand for such pumps has increased to a point that bottlenecks are arising due to lack of supply. Potential regulatory challenges around F-gas, insulation and upskilling of the workers, mean it will take some time before Europe can wean itself off gas boilers. The UK is currently leading the charge with France and Germany equally ramping up the replacement efforts.

Country analysis

Outlined below is a snapshot of how some Western European countries are responding to the conflict from an energy perspective.

France

Current dependence on Russian oil and gas: 9% of oil and 24% of gas is imported from Russia

Plans to end imports of Russian oil and gas: 2027

Degree of impact:

France is severely affected by the high prices of oil and gas due to shortages, especially from a consumer perspective and in the transport sector. The oil and gas storage capacity in France is extensive, and as such there are no immediate concerns around oil and gas shortages before the end of this winter even if Russian supply should cease. Longer term concerns surround energy security and the import of critical resources from outside the country in general.

Immediate response to high energy prices:

1. Tariff protection, limiting the increase of the final electricity and gas price for the customer. The Government will compensate the supplier if they limit the prices to consumer – estimated cost is EUR 20bn.

2. State aid to be granted to undertakings in specific sectors particularly sensitive to energy consumption. A new framework has been adopted and France is currently working on the regimes they will adopt on that basis.

3. An exceptional increase of ARENH (regulated access to historic nuclear energy) of 20% for year 2022, allowing other energy suppliers aside from EDF access to generated nuclear power on a supplier only basis. There is currently a debate around a possible permanent increase of the capacity for the future.

Changes in strategy:

Nuclear: At the moment, 70% of France's energy comes from nuclear plants in the country. Emmanuel Macron announced the construction of 14 new reactors by 2025 just before the war started, pledging to extend the life of all reactors if safe to do so. In 2015, Francoise Holland's Government aimed to reduce this share to 50% by 2025, with this goal being postponed to 2035 in 2019. With the presidential election upcoming, these targets may change depending on the result, although given the further intensification of energy security concerns, this policy is likely to stand. There are also talks around full state ownership of EDF % again.

Renewables: In addition to further nuclear power capacity, greater focus on renewable energy has been announced, specifically in the biogas and offshore wind sectors. As a reaction to the war, France is aiming to accelerate new offshore wind tenders and simplify the launch of new projects by increasing the level of subsidies in biogas and offshore wind.

Hydrogen: Nuclear energy is to be used to increase production of hydrogen and there is anticipated increase in hydrogen projects in the gas sector as well.
LNG: Although it has LNG terminals, France was known to view LNG as "too dirty". Even so, France will likely look into increasing LNG imports, however, it is unlikely any further LNG terminals will be built as part of the measures resulting from the conflict.

Storage: The Government is currently looking at different possibilities to adapt oil and gas storage units to be able to store more and be in a more secure position next winter, in line with EU measures.

Conclusion: Energy transition in France is likely to accelerate as a result of the war with further nuclear reactors built, red tape for renewable projects simplified, new tenders for offshore wind and biogas projects launched with increase in the supporting subsidy regime to match the goals.

Germany

Current dependence on Russian oil and gas: 30 – 35% of oil and 49% of gas is imported from Russia

Plans to end imports of Russian oil and gas: Mid-2024 for gas; end of the year (2022) for oil

Degree of impact:

Aside from gas pricing affecting the whole continent, trading companies, utilities and suppliers are running into problems for gas deliveries as they can't cover its supply at the current price. Energy security is critical as Germany is one of the most energy-dependent countries on Russia.

Immediate response to high energy prices:

1. The ministry will legally oblige power suppliers to reduce bills for consumers after the levy for renewables on the power price is scrapped in July 2022.

2. Obstacles to massive onshore wind expansion to be removed with law this summer (conflicts between wind and nature conservation and the species protection law, planning law or insufficient land use designations).

Changes in strategy:

LNG: Germany's attitude towards LNG has changed significantly as a result of the conflict. The construction of two terminals have been announced (with one further being under consideration), citing the need to reduce reliance on Russian imports. At least one of the terminals should be completed by 2026 and will have the capacity to take in 10% of Germany's gas requirements. As Germany does not have sufficient LNG import and regasification capability and needs to turn to construction of terminals, this will be a costly endeavour and is likely to set energy transition back in the country, or, at minimum, prolong the transition period. The chancellor is aiming to secure LNG supplies from Qatar. The Government stipulated the terminals will be built to be able to handle green hydrogen imports with a climate-friendly twist on LNG.

Renewables: As in other European countries, pace of wind and solar projects is set to triple as Germany brings forward its goals, supported at an EU level. Equally, there is focus on electric heat pumps replacing gas boilers.

Coal: Germany announced the resurgence of coal production, specifically, higher outputs of lignite – the worst-polluting form of coal – to compensate for an expected shortage of Russian gas in the coming months. This is likely to set Germany back in its race to Net Zero.

Nuclear: Although there is nothing yet official, there is understood to be talks around prolonging the operation of existing nuclear power plants, which goes strongly against the historical Government policy. Whether this will be feasible remains a question though, as it is uncertain whether it will be possible to secure sufficient plutonium. The phase out of nuclear is due to happen at the end of this year.

Conclusion: In Germany, a complete change of attitude can be observed. Germany, as one of the countries most dependent on Russian gas, is facing coal production extension and construction of new LNG terminals. With its current position on nuclear, it is likely to struggle to reach its original Net Zero goals. With more LNG terminals being built, it is also questionable whether, given the significant investment, there will be enough funds left for renewable projects. With Germany's renewable energy mix being at more than 50% and legislative reforms in place to enable more projects faster, the strategy may offset the measures they are currently having to put in place, which could also be an expensive endeavour.

Italy

Current dependence on Russian oil and gas: 46% of gas is imported from Russia

Plans to end imports of Russian oil and gas: 2024 (gas), N/A for oil

Degree of impact: In the short term, gas prices are likely to be of most significant concern, consistent with elsewhere in Europe. Although Italy is significantly dependent on Russian gas supplies, this is not an imminent threat thanks to its good storage capacity.

Immediate response to high energy prices:

1. Reduction in the price of fuel duty by 25 cents per litre for everyone until the end of April.

2. 500 million euros of state funding will be allocated to tackle the critical situation of road transport.

Changes in strategy:

LNG: At the moment, Italy does not have sufficient LNG import terminals to replace Russian gas supply, however its gas pipelines from the south are underutilised. Potential issues may arise as the supplies are restricted due to instability in Libya and limited production in Algeria. In most recent developments, Snam and CdP were mandated to procure a floating LNG regasification vessel to quickly increase LNG import capacity. The long-term plan is to stabilise and expand existing alternatives to Russian gas, such as that sourced through Azerbaijan’s Trans Adriatic Pipeline and Libya’s GreenStream Pipeline. The Transmediterranean Pipeline, which transports gas from Algeria via Tunisia to Sicily, will also play a key role in this. Equally, there is talk of expansion of the TPA gas pipeline coming from Turkey. There are currently three LNG terminals in Italy (in addition to the LNG regasification vessel in the pipeline) and to bring in more LNG, significant investment in infrastructure will have to be considered.

Renewables: Renewable energy is due to pick up in line with the EUR 59.47bn that Italy was assigned from the NextGenerationEU funds for green initiatives. The Government acknowledged there are permitting issues for renewable projects at the moment but is considering how to remedy the situation.
Interconnectors: In the longer term, Italy may have to look into building new interconnector pipelines across the continent in order to boost internal flexibility to redistribute new LNG supplies as well as piped gas.

Oil: The government is considering to use more of its (limited and underutilised) oil & gas extraction capacity.

Conclusion: Currently, there are no major shifts in Italy's policies regarding the supply of oil & gas, and the streamlining of permitting processes for renewable projects suggest Italy will remain on the right trajectory for its energy transition. If gas pipelines are fully utilised, there will likely not be a need for further infrastructure, such as LNG terminals, to be built and as such, Italy's energy security needs should be covered without going backwards on its Net Zero pledges.

Spain

Current dependence on Russian oil and gas: Less than 10% of gas is imported from Russia

Plans to end imports of Russian oil and gas: N/A as Russia is not a main provider

Degree of impact:

The most significant impacts in Spain at the moment, similarly to other European countries, are around gas and electricity prices. Major gas companies are moving away from contracts based on Brent pricing, preferring to pay penalties for breach of contract, as the pricing is now much lower than the spot price in Europe (linked to TPF and Medgaz pipelines). This is changing the dynamics for industrials as they have to pay much more for oil, with many ceasing production as they cannot manage the price risk, without knowing if they will be able to pass it through. Truck drivers are also on strike due to high fuel prices which is causing a shortage of goods in parts of the country.

Immediate response to high energy prices:

1. EUR 16bn in direct aid and soft loans to help companies and households with the pricing crisis, including subsidised loans, limits on house rent increases and caps on energy prices as well as fuel subsidies. The plan is due to come to effect on 1 April and is a result of an exception being granted to the Iberian peninsula from European Union.

Changes in strategy:

LNG: As gas will play an increasingly important role in the whole of Europe, everyone will turn to countries like Spain with several LNG terminals and the highest regasification capacity in Europe. It is not expected that additional infrastructure will be needed at this stage as there is sufficient terminal capacity to bring in more gas from Libya and Algeria, subject to any concerns with these countries' ability to increase production.

Interconnectors: The historical issue with gas in Spain has been the limited interconnectedness of gas pipelines with France. It can be expected that this issue will become a priority at the European level with investments likely to flow from infrastructure funds to fix this issue.

Renewables: There are likely to be measures removing administrative bottlenecks from renewable projects development, in line with the EU priorities and policies, however, nothing specific has been announced as of yet.

Nuclear: Last year, the plan in Spain was not to extend the lifespan of nuclear plants. Today, the attitudes are shifting and extending the lifespan of nuclear plants is currently under consideration.

Oil: All E&P activities were suspended some time ago and fracking was forbidden too. It is unlikely any of this will change due to the current war.
Conclusion: Spain, as one of the most important LNG importers in Europe, will play a significant role in energy supply for Europe, if its interconnectedness with France can be improved. This can slightly assist prolonging the use of gas as a transition fuel across Europe, however, it should not change Spain's favourable trajectory towards its Net Zero goals.

UK

Current dependence on Russian oil and gas: 4% of gas, 8% of oil is imported from Russia

Plans to end imports of Russian oil and gas: The UK Government has pledged to phase out imports of Russian oil by the end of 2022, and further reduce the already minimal gas imports.

Degree of impact:

The UK is less exposed to any direct energy impact from the Ukraine crisis as it only imports a small proportion of its oil and gas from Russia, in contrast to a number of its European neighbours. However, the UK is not immune to the impact of high oil and gas prices and possible constraints on supply in global markets, such as may arise if there is greater competition for LNG. The longer term strategy to tackle this issue is to become less dependent on imports and produce more power in the UK.

Immediate response to high energy prices:

1. A "default tariff cap", introduced in 2019 to protect domestic customers on a variable rate tariff, has acted as a buffer to protect domestic customers from recent gas and electricity prices spikes. However, the cap is periodically reviewed and takes into account wholesale prices and therefore does not fully insulate domestic customers from energy prices rises. The price cap has risen to historically high levels and is due to rise further later this year in response to the escalating gas prices.

2. In response to high transport fuel prices, the Government has cut fuel duty for petrol and diesel by 5 pence per litre, which is the biggest cut overall (in cash terms) that has ever been applied across all fuel duty rates at once.

Changes in strategy:

The UK Government has announced a new Energy Security Strategy directly in response to the energy security challenges brought to the fore by the Ukraine conflict.

Nuclear: The Government has committed to a significant acceleration of nuclear, with an ambition of up to 24GW by 2050. This would represent up to around 25% of the UK's projected electricity demand. Small Modular Reactors are expected to form a key part of the nuclear project pipeline. A new government body, Great British Nuclear, will be set up to bring forward new projects, backed by substantial funding, and the Government will launch the £120 million Future Nuclear Enabling Fund this month.

Renewables: The Government previously confirmed its commitment to renewables in the Energy White Paper of 2020 but has now set a new, even more ambition target to deliver up to 50GW of offshore wind by 2030, including up to 5GW of floating offshore wind. The Government has also committed to reforms to reduce the time taken to complete the consenting process for offshore wind. No new targets have been set for solar PV and onshore wind, although the Government has said it will consult on planning reforms for ground-mounted solar PV projects. A budget of £285 million has previously been confirmed for the fourth allocation round of the Contracts for Difference (CfD) scheme currently underway to support renewables and the Government has previously committed to further annual rounds.

New build gas-fired generation: As gas prices reach record highs, the Government is not looking to subsidise gas use but is looking at gas-fired generation (including CCUS-enabled gas fired generation, see discussion on CCUS below below) as a whole and considering what price it needs to be to make it economic.

Hydrogen and CCUS: The Government is pushing ahead with the design and implementation of the Low Carbon Hydrogen Business Model, Net Zero Hydrogen Fund and other hydrogen-related consultations to subsidise the construction of new 'blue' (CCUS-enabled methane reformation) and 'green' (electrolytic) hydrogen production facilities, including to offset further effects of the Ukrainian war on the energy transition and overall gas import dependency (even though not Russia-related). The aim outlined in the Energy Security Strategy is to double up the ambition to up to 10GW of low carbon hydrogen production capacity by 2030. Viability of blue hydrogen may be a concern due to the high price of gas. The Government's ongoing CCUS programme currently has two CCUS clusters on the path towards FID.

Oil and gas: The Government has once again emphasised the important role of North Sea oil and gas exploration and production in conjunction with decarbonisation. The North Sea Transition Authority is scheduled to launch a new licensing round in the autumn. Although onshore shale gas "fracking" had been previously ruled out by the UK Government, the Government has now commissioned a technical review on shale gas by the British Geological Society to consider any further scientific updates on seismicity (as concerns about seismic activity where one of the major reasons for the halting of shale gas exploration). This clearly opens the door to possible future shale gas development in the UK.

Conclusion: As the UK is one of the least affected countries in Europe when it comes to supply of Russian gas, its support for nuclear, renewable energy as well as hydrogen and CCUS is likely to allow the UK to remain on track for its Net Zero goals.

Although the assessment above can only give us a glimpse of what is a constantly evolving situation, it is clear the overarching impact on each country's Net Zero goals will be determined by a fine balance between imminent gas supply and energy security needs, which is best addressed by increased imports of LNG, and simplification of the administrative processes to make construction of greenfield renewable projects truly helpful in the crisis in mid-term rather than long term.