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2 March 2023 Macro Research

Natural Gas Update

Why natural gas prices in Europe are likely to go up again

We are launching the Natural Gas Update, a new thematic publication about the European gas market.

■ Thanks to a combination of energy-saving measures and mild weather, the consumption of natural gas has so far been
exceptionally contained across Europe, creating an unprecedented storage buffer that has contributed to bringing the TTF
price down by around 85% from its summer peak.

■ For next winter, the market seems to be pricing in a scenario where Europe manages to keep its gas consumption at the low
levels recorded in 2022. In such a scenario, current domestic production and imports will likely be enough to balance the
market and so TTF prices might stabilize at around EUR 50/MWh.

■ With lower consumption cuts, instead, Europe will need to secure more imports of LNG, which is in short supply. And the
situation could become more complex if there were a complete halt of imports of Russian gas.

■ Overall, it is more likely than not that gas prices will rise from current levels. We expect TTF prices to average EUR 80-90MWh in 2H23.

The TTF price, the European natural gas benchmark, is down more than 85% to less than EUR 50/MWh after peaking at around EUR
340/MWh last August. Futures contracts point to prices stabilizing at around current levels throughout 2023 and 2024. An exceptionally
mild winter, combined with a well-designed strategy of supply diversification and measures to reduce consumption, has led to untapped
storage capacity of around 64%, which is more than 10pp higher than the historical average for this time of the year.

While Europe can reasonably breathe a sigh of relief, gas prices are likely to rise again in the coming months, possibly significantly.
Russian gas still matters in the effort to balance the European market no matter how low inflows are compared to the past (around
20% of pre-conflict levels) – and last year they declined gradually, still providing an important buffer in 1H22. If Russian gas continues
to flow in at current levels, Europe might need to secure more LNG supply in what is likely to become an increasingly tight market
as Asian demand recovers. Were imports of Russian gas to stop completely, the amount of LNG needed would be even higher and
probably beyond Europe’s regassification capacity. Moreover, there is a risk that the positive experience of the current winter,
combined with today’s lower prices, might reduce efforts by European households and firms to cut consumption (the first
consumption cuts are the easiest while additional cuts become progressively harder to make as energy consumption falls).

For this reason, relief should not lead to complacency. The risk is that the tightness of the market will become apparent towards
the summer, pushing prices up. In the following, we run a simple scenario analysis to highlight potential vulnerabilities. We show
that, despite the positive buffer from today’s high storage levels, Europe will need Russian gas, more LNG supply and
consumption cuts to meet its demand needs next winter, assuming a normalization in temperatures. Still, the TTF price might
move towards EUR 100/MWh during the summer when storages are refilled. With no Russian gas, the price will likely go beyond
that level, albeit probably remaining significantly below EUR 200/MWh.

Current situation

In very broad terms, four variables are needed to track the evolution of the European gas market: consumption, storage, domestic
production, and imports. Before focusing on the scenario analysis, we will briefly discuss recent trends associated with each of
these variables.

Europe’s consumption of natural gas in 2022 was around 13% lower than in the previous year (but below the 15% target that EU
members committed to on a voluntary basis back in the summer), down to 430bcm from around 495bcm. Consumption cuts were
partly mandated, partly voluntary, and partly a result of favorable weather conditions. Some sectors that use natural gas intensively
for their production, such as chemicals, metals, and glass, were among the largest contributors to these consumption savings. In
the most extreme cases, some firms in those industries halted activity completely and might not reopen in the future, despite lower
prices. However, as shown in Chart 1, there is substantial cross-country variation. Spain, for example, benefited from its lack of
exposure to Russian gas and only moderately cut consumption. Both France and Italy cut by less than the European average,
whereas Germany and the Netherlands cut significantly more, with reductions of around 20% compared to 2021.

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2 March 2023 Macro Research
Natural Gas Update

CHART 1: CONSUMPTION CUTS IN 2022 WERE SIZABLE

Reduction in natural gas consumption in 2022 vs. 2021 (%)

0.0

-5.0

-10.0

-15.0

-20.0

-25.0

Source: International Energy Agency (IEA), UniCredit Research

While European production of gas is relatively stable at around 195bcm annually, imports declined moderately last year to around
260bcm from 272bcm in 2021. Chart 2 shows the changing map of Europe’s natural-gas imports. Russia is no longer the main
supplier to the continent. Imports of Russian natural gas dropped from around 140bcm in 2021 to 62bcm in 2022 and are expected
to amount to 26bcm in 2023 if current inflows remain constant throughout the rest of the year. Azerbaijan and North Africa are
playing an increasingly important role as suppliers to Europe, but LNG has been the key game changer in recent years. It accounts
for almost 70% of Europe’s imports compared to around 25% in 2019. Around 45% comes from North America, about 25% from
Africa and the remainder almost evenly split between North Africa and Russia.

CHART 2: LNG IS BECOMING INCREASINGLY IMPORTANT

Europe's gas imports (%)

LNG (including from Russia) North Africa Russia Azerbaijan

100

75

50

25

0
2015 2019 2023

Source: Energy Aspects, UniCredit Research

As a result of the drop in consumption and supply diversification, along with EU-mandated storage targets, gas storage is at
historically high levels for this time of the year (Chart 3). About 60% of storage capacity is still untapped across the EU, levels
usually recorded in December. Such high storage levels will help to lower the risk of shortages during the next cold season.

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2 March 2023 Macro Research
Natural Gas Update

CHART 3. HIGH STORAGE LEVELS

EU gas storage (% of total capacity)

100

75

50

25

2011-19 average 2021-2022 2022-2023

0
May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr

Source: Gas Infrastructure Europe, UniCredit Research

Possible scenarios

We put together this information to run three simple scenarios. The first assumes that overall consumption in 2023 will remain at
the 2022 levels. Even if next winter turned out to be more in line with historical temperatures, boosting demand of gas for heating,
European countries might still find additional ways to save energy on other fronts. In this case, domestic production and current
imports would be enough to cover consumption needs for next winter, without securing additional LNG globally. This is a benign
scenario that seems to be priced in by the market now and is consistent with TTF prices stabilizing at around EUR 50MWh.

The other two scenarios, instead, relax the assumption of unchanged consumption to see how much additional LNG Europe
would need to import from the rest of the world. In both cases, we assume European gas consumption will be 10% (and not 12%)
below 2021 levels, at around 450bcm overall, as existing energy-saving measures would probably not be enough to offset the
assumption of colder winter temperatures. The second scenario involves a situation where Russian gas continues to flow into
Europe at current levels (natural gas at 26bcm and LNG at 18bcm), while the third involves a situation where imports of Russian
gas are completely halted in all forms. In both cases, we assume that domestic production will stay at around 195bcm and that
storage levels will be at 50% in April and provide a buffer of around 17bcm for next year (only a portion of the left storage can be
used for technical reason).

Chart 4 shows the outcome of the two simulations. With Russian gas still flowing at the current pace, Europe would be short by
around 12bcm – the equivalent of about 3% of the expected consumption in 2023. Europe could fill this gap by importing more
LNG. According to Energy Aspects, global LNG production in 2023 is expected to increase by 25bcm. This means that Europe
would need to seize half of this increase. Nevertheless, Europe would find itself in fierce competition with recovering Asian
demand, particularly from a reopened Chinese economy. As a result, increasing LNG market tightness will likely lift the TTF price
above current levels and towards EUR 80/MWh.

With no contribution from Russian imports, the gas shortage would amount to around 57bcm – 12% of expected consumption
and more than twice as much as the expected growth in global LNG production in 2023. If the 18bcm of Russian LNG were
redirected to Asia, freeing up some supply, Europe would still be short by almost 40bcm (around 10% of consumption). This
means that the global LNG market would be highly undersupplied and the TTF price would likely move well beyond
EUR 100/MWh. Even if there were enough LNG supply, Europe might lack regassification capacity, which now amounts to
157bcm (although more is under construction), with Italy already using more than 80% of its regassification capacity, France
more than 60% and Germany around 50%. In the third scenario, around 190bcm are needed to meet consumption needs.

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2 March 2023 Macro Research
Natural Gas Update

Of course, if we relaxed our assumption about the consumption cuts, the gas shortages in both scenarios would be significantly
higher, creating even more-intense upward price pressure. Conversely, if mild weather conditions or more drastic changes in
energy consumption were to lead to greater drop in demand, there would not be gas shortage at all (even with a further reduction
in Russian gas).

However, even in the most negative scenario, there are at least three reasons why we think that natural gas prices in Europe will
remain well below EUR 200MWh and so well below the peaks hit in 2022. First, high prices last year were partly due to the
uncertainty and unpreparedness for an unprecedented shock like the Russia-Ukraine conflict. Compared to one year ago, Europe
is in a much stronger position to deal with gas shortages. Second, the joint purchases of natural gas at the EU level will contribute
to capping prices thanks to the strong negotiating power of the bloc. Third, in March, the EU will introduce its own price benchmark
for LNG contracts. Currently, LNG prices in Europe are pegged to the TTF price, which is directly influenced by disruptions to the
inflows of natural gas to Europe. A new benchmark, instead, would make LNG prices in Europe more responsive to dynamics in
the global LNG market than to natural gas deliveries through pipelines. But it is likely that the TTF price and this new benchmark
would be highly correlated.

CHART 4. THE ROLE OF RUSSIA NEXT WINTER WITH HIGHER CONSUMPTION

Additional non-Russian LNG Russian LNG

Russian natural gas Non-Russian LNG at 2022 level
Non-Russian imports of natural gas Natural gas production in Europe
Buffer with EU storage at 50% in April 2023 European consumption with 10% cuts
500
Half of expected global Twice as much as
LNG growth in 2023 expected global
LNG growth in 2023

Russian
contribution
250

0
bmc Scenario with stable Russian gas and LNG Scenario with halted Russian gas and LNG

Source: IEA, Energy Aspects, UniCredit Research

Conclusions

Despite Moscow’s role as gas supplier for Europe being far less prominent than it was in the past, it will remain essential to
balancing the European market until new regassification capacity is built and alternative energy sources are explored. Moreover,
while LNG is more important in Europe’s energy mix than it was a few years ago, there are limits to the relief it can generate due
to constraints not just in terms of European regasification capacity but also global liquefaction capacity. Russia, for example, can
only produce around 40bcm of LNG annually, but it used to export around 210bcm of natural gas through pipelines before the
war. Furthermore, its LNG production capacity is supposed to increase to around 100bcm only by 2035. So, just a small proportion
of the foregone exports of natural gas to Europe can be injected into the global LNG market. Therefore, in Europe, consumption
cuts remain key ahead of next winter. Overall, our simulations suggest that current gas prices reflect fairly optimistic assumptions
in regard to the evolution of the demand-supply balance over the coming quarters. Therefore, it is more likely than not that gas
prices will rise from current levels. We expect TTF prices to average EUR 80-90MWh in 2H23.

Edoardo Campanella, Economist (UniCredit Bank, Milan)

+39 02 8862-0522
edoardo.campanella@unicredit.eu

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2 March 2023 Macro Research
Natural Gas Update

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2 March 2023 Macro Research
Natural Gas Update

UniCredit Research* Macro Research

Marco Valli Dr. Ingo Heimig

Global Head of Research, Head of Research Operations
Chief European Economist & Regulatory Controls
+39 02 8862-0537 +49 89 378-13952
marco.valli@unicredit.eu ingo.heimig@unicredit.de

Head of Macro Research

Marco Valli
Global Head of Research,
Chief European Economist
+39 02 8862-0537
marco.valli@unicredit.eu

European Economics Research

Dr. Andreas Rees Dr. Loredana Federico Stefan Bruckbauer

Chief German Economist Chief Italian Economist Chief Austrian Economist
+49 69 2717-2074 +39 02 8862-0534 +43 50505-41951
andreas.rees@unicredit.de loredanamaria.federico@unicredit.eu stefan.bruckbauer@unicreditgroup.at

Tullia Bucco Edoardo Campanella Walter Pudschedl

Economist Economist Economist
+39 02 8862-0532 +39 02 8862-0522 +43 50505-41957
tullia.bucco@unicredit.eu edoardo.campanella@unicredit.eu walter.pudschedl@unicreditgroup.at

Chiara Silvestre
Economist
chiara.silvestre@unicredit.eu

International Economics Research

Daniel Vernazza, Ph.D.

Chief International Economist
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EEMEA Economics Research

Dan Bucşa Gökçe Çelik Mauro Giorgio Marrano

Chief CEE Economist Senior CEE Economist Senior CEE Economist
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Artem Arkhipov
Head, Macroeconomic Analysis Hrvoje Dolenec Pavel Sobíšek
and Research, Russia Chief Economist, Croatia Chief Economist, Czech Republic
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Chief Economist, Slovakia Senior Economist, Romania Chief Economist, Bulgaria
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