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While intra-EU methane emissions account for a small share of global emissions, the EU has significant leverage to impact global gas markets as the largest importer of internationally traded natural gas. In fact, fugitive methane emissions across the entire value chain are estimated to be between three and eight times higher than those from the intra-EU gas supply chain. In order to meet the 55% reduction target in overall emissions by 2030, the legislative instruments presented under the European Commission’s Methane Strategy and the introduction of a carbon border tax could require top exporting countries to adopt anti-flaring measures, significantly affecting transboundary gas value chains.

Reducing the EU’s Methane Footprint

On Oct. 14, 2020, the European Commission (EC) adopted the Methane Strategy with the objective of improving measurement and reporting of methane emissions by the private sector, which may eventually be subject to upcoming binding mitigation obligations. In fact, the legislative action anticipated in the Strategy mainly affects the energy sector, covering the oil, gas, and coal supply chains.

Perhaps the most notable action which is set to become a legislative proposal in the coming months is the adoption of a compulsory measurement, reporting and verification (MRV) mechanism of energy-related methane emissions based on the methodology of the Oil and Gas Methane Partnership (OGMP 2.0). In addition to this, the EC plans to introduce an obligation to improve leak detection and repair (LDAR) of leaks on all fossil gas infrastructure, with a focus on flaring efficiency. Ultimately, these obligations would lead to specific legislation eliminating flaring and venting throughout the entire supply chain up to the point of production.

Beyond EU borders, the Strategy impacts international value chains through the proposal to introduce a Methane Supply Index (MSI), which would track methane emissions of gas supply sources. Key to natural gas import-export markets, the MSI would be capable of comparing the methane footprint of different gas corridors from the point of production until the EU border so as to offer transparency to final consumers.

Such an index would complement the MRV mechanism, which could be further strengthened by the introduction of a performance standard requiring natural gas suppliers to meet a set benchmark upstream emission intensity value, as proposed by industry leaders. Although the Strategy does not explicitly refer to emissions-based standards throughout its text, eventually, the performance standard could be introduced under the Commission’s legislative proposal for the MRV mechanism.

Gas Imports to Remain Relatively Stable through 2030

Gas imports constituted about 85% of total EU gas demand in 2020, of which 20% were estimated to be imported in liquefied form. As domestic production and storage capacity declines, Stratas Advisors expects natural gas demand to remain relatively stable though on a gradually declining curve through 2030, especially in specific sectors where electrification becomes more common. This will be reflected in imports, which will recover from supply and demand imbalances caused by the COVID-19 pandemic in early 2022, to later decline over time.

The figure below provides projected market shares of gas imports by source country.

EU’s Gas Imports by Source Country, 2020-2030

Source: Stratas Advisors, 2021

As output experiences a steep decline in main domestic production hubs such as Groningen and capacity in storage sites reaches record lows, the EU will continue to rely on natural gas imports via pipeline, where Russian gas is forecasted to remain dominant despite growing geopolitical tensions. Norwegian pipeline gas imports, which today constitute over 15% of EU gas imports, are set to fall slightly in the following decades as a result of declining output, attributable mainly to the absence of new fields or large-scale investments in existing fields. However, Russian and Norwegian gas will still constitute about 60% of all gas imports into the EU.

Other Eurasian countries such as Azerbaijan will also increase supply towards Europe through the Southern Gas Corridor (SGC), which is set to diversify sources of supply and reduce EU dependency on Russian gas. In the case of Algeria, tensions with Morocco have led to the non-renewal of the long-term contract with Spain, thus resulting in the closure of the Maghreb-Europe Gas Pipeline (MGE). Algeria has guaranteed that large volumes of gas will still be supplied to the Iberian Peninsula through the Medgaz pipeline and through LNG bunkers to make up for the shortfall caused by the closure of MGE, but Stratas Advisors expects Algerian gas imports to experience an average annual decrease of 3.4% through 2030.

Although pipeline gas is the preferred transportation pathway for Europe, LNG imports had been increasing in years before the COVID-19 pandemic. During 2020-2021, widening differences between Asian and European LNG spot prices led to a shift in LNG exports by main producers, although demand recovery will boost LNG imports in the EU close to 2019-levels by 2022. Besides Russia, the U.S. and Qatar are expected to lead LNG supply in the EU, with combined volumes constituting almost half of LNG imports. In particular, Qatari LNG imports will likely grow in the coming years with the North Field Expansion project, which is set to increase Qatar’s LNG output by over 60% by 2027. Nigeria will continue to provide close to 10% of LNG to the EU, although its role is not expected to grow significantly in the coming decade.

EU Policy Developments to Shape Market Dynamics

In addition to the EU’s Methane Strategy and its underlying emissions mitigation obligations, Stratas Advisors has identified a series of market-based factors which could have a significant impact on natural gas markets. In particular, longer-term reforms to the EU Emissions Trading System (EU ETS), as anticipated by the Commission’s Fit for 55 Package in July 2021, are set to exert further pressure on carbon prices while supply declines, which could eventually affect fuel switching prices.

Yet the measure that could affect gas imports the most would be the introduction of a border carbon tax, either through the extension of the EU’s proposed Carbon Border Adjustment Mechanism (CBAM) to energy products or through the adoption of a new mechanism specifically targeted to methane. In fact, the economic impact of CBAM on natural gas imports would be somewhat limited, as in principle it would only cover CO2, N2O, and PFC emissions from flaring – and not those associated with methane. If methane emissions from flaring, venting, and leaking were eventually included, the introduction of a border carbon tax as well as MRV mechanisms for methane emissions mitigation could become a significant economic burden for countries with higher-than-average flaring intensities.

Stratas Advisors expects EU legislative action to focus on either methane performance standards or border levies on energy products, both of which would need a robust monitoring and verification mechanism that could be introduced through the MRV instrument. In any of the cases, careful design would be necessary to ensure that international trade law is not violated and that market displacements are not encouraged. Besides risk of non-compliance with WTO law, including methane emissions under the CBAM could be complex as they would need to be incorporated into the EU ETS first, requiring serious political will.

In addition, since CBAM is being designed to avoid carbon leakage, a border carbon levy on natural gas imports should rather serve as a means to incentivize non-EU trade partners to adopt methane mitigation measures. As alternatives to CBAM, the introduction of a levy on the basis of a methane performance standard would apply to gas extracted inside and outside the EU, minimizing the risk of conflict with WTO law.

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