What lessons does the U.S.-Iran conflict reveal about Europe's energy supply?

Fuel prices remain high while there is still no sign of a resolution to the conflict between the United States and Iran. What lessons can Europe draw from this for its energy supply? We spoke with Peter Verbaken, Head of Liquid Commodities at APG.

Four years after Russia’s invasion of Ukraine, Europe’s energy supply is facing another setback. What is different this time?
“Back then, Europe was completely dependent on cheap Russian gas, which more or less disappeared overnight. That naturally led to a diversification of suppliers. With gas, that is really only possible through LNG, or liquefied natural gas, because it is the only practical way to transport gas over long distances when pipelines are not an option.

As a result, Europe has become much more closely tied to the global LNG market. Europe itself does not import particularly large amounts of LNG from the Middle East, yet it is still facing higher prices. That is because most of the LNG from that region was destined for Asia. Now that part of that supply has been disrupted, Asian and European buyers are competing for the same alternative shipments. That pushes up prices and makes it more difficult to replenish gas reserves.”

What options does Europe have to safeguard its energy supply, at least to some extent?
“Normally, Europe builds up gas inventories during the spring and summer months, when prices are relatively low, and uses those reserves during the winter. This time, however, prices rose sharply early in the spring. As a result, inventory building has been significantly delayed.

That was essentially a calculated risk, because there was a widespread assumption that the conflict would be resolved within a relatively short period of time. Yet here we are seven months later, and there is still no sign of a solution. As a result, gas inventories are at a historically low level for this time of year, and countries have very little room left to do anything about it. At this point, the hope is for a mild winter.

Europe effectively finds itself between several power blocs. It is already buying enormous quantities of LNG from the United States, meaning that some of the dependence Europe once had on Russia is gradually shifting toward the U.S. At the same time, Asia is a major competitor for the same resources, while the Middle East remains an unpredictable factor. The events of this year have exposed just how vulnerable that situation is.

That is why you may need to think at a higher level than simply diversifying suppliers. That can mean alternative energy sources or other forms of flexibility, making sure you have options when things go wrong. It is not something that can be solved overnight, but it definitely deserves attention.”

What kinds of flexibility are we talking about?
“Electrification is an important one, but a lot is required to make that happen. Pressure on power grids is already limiting how quickly electrification can move forward. Sound policy therefore also means investing in grid capacity so it can keep pace with the expansion of wind and solar power.

Investments in renewable energy are also an important part of the solution. However, wind and solar technologies require enormous quantities of metals, and Europe remains heavily dependent on China for those materials. So it remains a challenge to make Europe as independent as possible. Reducing dependence on oil and gas supplies may end up creating greater dependence on critical metals.

That is why this issue is strategically so important. It underscores the need for a long-term European approach. In addition to diversifying suppliers, that could include strategic reserves. The oil market has had strategic stockpiles since the 1970s, but no comparable system currently exists for gas. That is partly because it is more difficult to organize, but recent events have highlighted its importance.

Another option is to diversify supply routes. Even then, you remain exposed to global pricing. In the oil market, there are already plans for pipelines that bypass vulnerable routes. For gas, that is more complicated. LNG requires massive liquefaction facilities that turn gas into a liquid for transportation. These facilities cost tens of billions of dollars and are currently concentrated in places such as Qatar. You can build a gas pipeline, but then you also need to recreate the entire supporting infrastructure at the other end. That makes alternative routes for gas much more challenging than for oil.

As a result, some countries will remain dependent on existing shipping routes. If Iran continues to exert influence over the Strait of Hormuz, there may ultimately be a direct or indirect toll associated with using that route. For some countries, that could still be more attractive than making enormous investments in alternative infrastructure or rerouting supplies through alternatives that come with their own vulnerabilities. You repeatedly see that every solution creates new risks.”

What should we be watching in the months ahead?
“The economic consequences of the conflict with Iran now extend beyond energy prices alone. It is already affecting long-term interest rates in a number of countries, including the United States and most European countries. If inventories continue to decline and oil prices remain high, or rise even further, the situation could also have negative consequences for equity markets and the broader economy.

At the same time, the market remains difficult to predict because so much depends on political developments. In the United States, diesel and gasoline prices are already extremely high by American standards. That has political implications for president Donald Trump and the Republicans. You can imagine that further price increases could increase the pressure to reach some kind of agreement. Even a less-than-ideal deal may become attractive if it helps restore oil flows and bring prices down.

In theory, the parties involved could reach a solution tomorrow. Right now, however, both sides remain in a position where they believe the other side will be the first to give in and bear the greatest pain.”