The Importance of TAP for Italy: Some Scenarios
Italy, like most European countries, is heavily dependent on gas imports from outside the EU. Yet, as Italy’s gas consumption grows, mainly due to the completion of the methane pipeline system in the country and the increased use of gas for power generation, there is a corresponding decline in domestic production.1 Inevitably, the historical condition of dependence will worsen. These circumstances affect the market structure, as almost 93% of Italian imports flow through pipelines.
Among the possible interventions considered over the last decade, it was suggested that Italy, with its geographical position at the junction of North-African, North-European and Russian streams, could be turned into the “Southern-Europe gas hub”. This was clearly articulated in Italy’s most recent National Energy Strategy (NES). In this context, Snam, the Italian transmission system operator (TSO) provided for by the law-decree (D.L.) of January 24th 2012, n.1, modified in Law (L.) 24th March 2012, n.27, and by the decree of the Prime Minister (DPCM) 25th May 2012, should play a major role in contributing to supply security and, in general, national energy security (Sileo; 2012).2 However, energy security is not exclusively guaranteed by a long-term strategy; a comprehensive approach also demands the ability to manage possible short-term supply shocks. The Italian gas system has recently faced critical situations, in particular in 2005 and 2006. Based on its practical experience, Italy has learned how to cope with emergencies, and always managed to ensure the supplies for its final domestic consumers. Moreover, since 2008, gas consumption has dropped, thanks to the financial crisis. Having stopped growing, by the end of 2011, gas consumption reached its 2003 level.
On this basis, the Trans Adriatic Pipeline (TAP), at present the most ambitious project concerning the Italian gas infrastructure system, can be considered consistent with a security- led strategy. TAP’s rationale is mainly one of diversification: carrying 10 bcm of Azerbaijani natural gas from the Shah Deniz II field each year, TAP would provide a new and significant energy source. Moreover, a second phase is already planned, in order to increase the nominal capacity of the pipeline up to 20 bcm/year, through a new compression station. This additional capacity may play a pivotal role in the Italian supply strategy, which depends heavily on imports (particularly from Russia, Algeria and Libya), both in terms of security and industry. In the recent past, Italy has experienced gas shortages, due to the particularly rigid climatic conditions and lack of flexibilityin the volumes imported from abroad. On those occasions, the storage infrastructures played a much larger role than usual, raising questions about their economic and strategic sustainability. Moreover, alternative uses of gas, such as unconventional industrial uses in steel production and a substantial shift in fuel transportation, are likely to emerge.
A new southern route may also have strategic implications for Italy, strengthening its role as an entry point for non-Russian, non-LNG gas to travel to Northern Europe. In this sense, the efforts of the European Commission through the Southern Gas Corridor initiative - despite the obstacles posed by divergent national interests – has a strong basis. In this sense, TAP may play an important role in fulfilling the demand of other European countries, whose consumption patterns also seem to be shrinking.
Trends in the Italian gas market: an overview
Supply and sources
Italy is heavily dependent on gas imports. In 2013, the national production share was limited to 11% of total consumption (7.7 bcm),3 while net imports (imports minus exports) amounted to almost 88% of the total (61.7 bcm). Most of this imported gas comes from Algeria and Russia. In 2011, Italy imported 22.9 bcm from Algeria and 19.7 bcm from Russia. Among others, Qatar (6.2 bcm) is the main LNG importer, through two regasification terminals (Panigaglia and Portoviro).
Domestic demand
Italian natural gas demand has continued to shrink over the last decade, aside from a minor and temporary recovery in 2010. This decline was anticipated, and indeed industry-led since 2004: total industrial consumption has dropped by more than 35% over 10 years (from 21 to 13 bcm). This reduction is due to: 1) a reduction in gas use as a result of the economic crisis, particularly harsh for the industries involved, and 2) more efficient use of gas, considered a key factor in competitiveness.
Meanwhile, the household gas consumption, which amounts to roughly half of the total, has experienced a slight increase, also due to the cold temperatures this winter. Unfortunately, the use of gas for heating is unpredictable, and the patterns observable in the past years can be considered exceptional; therefore few can be used to predict future trends. In addition, natural gas is facing new competition, such as heating pumps, induction stoves and heaters, which will probably limit growth in consumption.
Power generation of electricity significantly affects Italian natural gas consumption: in fact, it has historically amounted to one-third of the total. Despite the installation of further capacity in terms of combined cycle plants over the last decade, consumption of thermoelectric generation has dropped significantly since 2009. A structural fall is evident following the peaks in 2007 and 2009 (33 – 34 bcm), when thermoelectric plants helped to fill the power deficit of the electric system. The contraction of consumption in recent years can be explained based on two main factors: 1) the overall decline in electricity consumption and 2) the upsurge in renewable energy sources.
All in all, consumption patterns in Italy show both a temporary low and a structural contraction: the actual bottom is surely related to the economic crisis. While that will eventually end, the decline is also the consequence of a permanent shift in the consumption paradigm. In particular, we attend to the rise of the relative (and possibly absolute) importance of residential use. This has two major implications. First, whether or not total gas volumes bounce back to 2005 levels, the overall volatility of the market will change. In fact, domestic use is strictly related to climatic and seasonal conditions (i.e. winter consumption is much higher than summer consumption) and from year to year (for example, in the event of a particular cold winter).
The second consequence raises security issues: given the EU regulation on security of supply4 and its implementation within national law, domestic consumers are protected in case of supply shortages.5 This protection guarantees supplies to consumers in case of: 1) extreme temperatures during a 7-day peak period occurring with a statistical probability of once in 20 years; 2) any period of at least 30 days of exceptionally high gas demand, occurring with a statistical probability of once in 20 years; and 3) for a period of at least 30 days in case of the disruption of the single largest gas infrastructure under average winter conditions. An increasing impact of domestic consumption also increases the share of protected consumers, and therefore of the supply that must be secured to the expenses of other uses, such as power generation. Given the impact of thermoelectric power generation on total power generation in Italy, the European provisions on supply security raise serious concerns in case of a winter disruption, when electricity demand is high, photovoltaic production is negligible and priority is given to domestic consumers.
Security issues: lessons from the recent past
The Italian gas system has significant experience of critical and unexpected situations. Two exceptional events have taken place in recent years: the interruption of the Greenstream flow due to the outbreak of the conflict in Libya at the end of February 2011, and the 6-month shutdown of the Transitgas pipeline (which connects Italy to Northern Europe), from July to December 2010, because of a landslide in Switzerland.
In the attempt of realizing a crisis infrastructural equipment, which can face the interruption of a pipeline or the consequences of an exceptional cold snap, storage infrastructures stand as key-asset for the system.In the current system, those facilities play a crucial role in satisfying consumption modulation, because they ensure the flexibility required for the execution of administration contracts to the selling companies. Good storage capacity has also been proven to be a basic precondition for the creation of a liquid market, both in the gas and electricity sector, increasing arbitrage opportunities among markets in different countries. Such liquidity is currently not a feature of the Italian system, that cannot rely on satisfying networks neither at the internal nor at the European. To further illustrate this point, it is useful to consider a specific case: the emergency situation that arose in February 2012.
On February 1st 2012, Gazprom did not appear to be able to meet the increased supply demand its European clients. In the Italian context, this imbalance was reflected in a discrepancy between requirements and transits of 12.3% at the entry point of Tarvisio. The gap increased up to 24.2% the following day, and up to 30% by February 3rd. Despite the geopolitical tensions arising from polarised views of Ukraine’s alleged violation of the gas agreements - having withdrawn more gas than its contract allowed for - the main factor in the 2012 crisis was simply the cold snap which struck Europe, Turkey and indeed Russia itself.
The withdrawing of stored volumes has thus covered, once again,6 the Russian shortage. Friday 3rd February, 32 Mcm were withdrawn from storage, in order to meet an unusual high demand:414.7 Mcm daily. The following week, due to the extreme cold and intense industrial activity, the demand did not shrink, reaching record highs on February 6th and February 7th. Consumption on February 7th was 465.9 Mcm, setting an absolute record of network intakes. A comparison with the comparable Tuesday in 2011 illustrates the exceptional nature of this peak (Figure 2).
As a result, gas withdrawals in the industrial sector in 2010 were heavily limited because of the emergency procedures that were activated.7 It is therefore easy to see that the supply shortage was the result of the low temperatures, even if it is more difficult to recognise the size of the increase in consumption. The obvious practical implication of resorting to stored natural gas at the beginning of the season is the performance decline acceleration. Italy had already experienced this phenomenon during the winter of 2005.
Some arguments have been made in favour of increasing the storage capacity. In fact, the greater the storage capacity, the greater the likelihood of guaranteed supply and, consequently, Italian energy security. This capacity, however, comes at an economic cost (the remuneration of its capital and operating expenses). Moreover, while this is a feasible solution in case of harsh climatic conditions, Italy is unable to handle a structural shortage, such as a permanent reduction in Russian or Algerian imports.
Italy’s past experiences demonstrate its heavily storage-dependent security strategy, shedding light on the possible implications of a new source: the TAP. In fact, an Adriatic pipeline could be a viable alternative both in terms of capacity (especially with the extra 20 bcm/year) from phase II, and in economic terms. Provided that TAP will work at 80% of its capacity, it will be able to provide more than 40 additional smbc per day. Such volumes cannot meet peak demand; that role is carried out by storage facilities. It can, however, ensure the replenishment of the reservoirs during the year, especially if new storage infrastructures are build. TAP supplies will also cover a substantial proportion of demand in case of the main import routes (e.g. from Russia or Algeria) experiences long term disruption.
Environmental implications
The Ilva case
The Ilva plant in Taranto is the largest steelworks in Europe. Last year, it was investigated for its environmental impact. After the a government commissioner was appointed to manage the plants ransition, there has been much discussion of ways to achieve more sustainable production in the medium and long term. The production activities of Ilva have been deemed so harmful to the environment in terms of pollution that multiple measures to limit the production itself have been taken. The repeated shutdowns of some parts of the plant in recent years. This culminated with an AIA (Autorizzazione Integrata Ambientale) decision to limit production to 8 Mt of steel per year. This has had repercussions for the entire Italian steel industry, which was already in trouble.
Among the potential plans for modernising the plant to make it more competitive and sustainable, one entails a radical change in the production process of steel that involves the use of natural gas, instead of coal. This change falls within the measures laid down by the AIA designed to increase productivity and improve environmental and human protections through the use of innovative technologies. The use of these technologies is in fact one of the points contained in the "Proposta di piano delle misure e delle attività di tutela ambientale e sanitaria" which was recently prepared for the Company by an expert committee appointed by the Minister of Environment.
In the past, a number of measures have been taken to reduce the environmental impact of the plant, but the majority have been related to post-treatment technologies. The success of these measures in limiting the diffusion of fugitive dust emissions has been disputed. Since September, experts have been working on preliminary experiments, checking whether the plants are compatible with the new technology and the new production process, i.e. producing steel with natural gas. This solution would replace the classical configuration, in place since the late nineteenth century: the coke oven-blast furnace-converter. So far, tests results seem positive, and further developments will likely be announced in the coming months.
In the current plant configuration, a huge amount of coal is held in stockyards and used in order to produce coke, the chemical agent used in the blast furnace to make hot metal. In the blast furnace, iron oxides in the shape of ores, sinter and pellets are transformed into hot metal by reductant chemical reactions generated by coke and carbon oxides (developed through the combustion of coke).
In the new gas-based configuration, the reductant is natural gas. Since this hydrocarbon, in its virgin form, has a low reducing power, it has to be converted into a mixture of H2 and CO. This conversion takes place in reactors and is called the reforming process. During this process, both the calorific value and the proportion of reducing gas in relation to the oxidizing gases (like CO2) increase.
When natural gas rather than coal is used to make iron, CO2 production could be 50-65% lower, depending on how one accounts for the CO2 sources. In addition to the drastic reduction of emissions from the plant, the production could benefit from greater flexibility and increased productivity. Flexibility is guaranteed based on the fact that the plant can operate at a wide spectrum of hydrogen to carbon monoxide ratios (0.5 to 3.5). The quality of the steel produced with the gas technology is also higher in respect to the conventional steel making process, because the virgin iron contains lower levels of unwanted elements such as zinc and copper. Additional benefits can also be identified in terms of operating costs, which, defined as materials management, are much lower.
Despite these advantages, many doubts remain about the practical feasibility of the new project. So far, experts are mainly assessing the technical feasibility of the transformation of the production process, but a detailed analysis regarding the investment costs still has to be conducted. New natural gas-based plants around the world have shown investment costs greater than 500 million Euros. According to Carlo Mapelli, the Ilva consultant for the implementation of the AIA, the natural gas needs for the Taranto plants could rise up to 1.5 bcm/y (representing 10% of the Italian industrial gas demand recorded in 2012).
Fuel shift in transportation
The use of natural gas for transportation is one of the objectives of the European Commission: Member States are to adopt national policies in order to develop markets for alternative fuels and their infrastructures. In fact, the EU aims to promote the sustainable development of the transport sector, accelerating the use of fuel-efficient vehicles for transport, thereby reducing CO2 emissions. Italy is responding to this with the increasing use of natural gas-powered vehicles, in particular CNG (compressed natural gas) cars and commercial vehicles. Indeed, CNG vehicles currently represent a concrete answer to two key factors: the reduction of CO2 emissions along with costs for motorists. Although the consumption of natural gas for vehicles constitutes only 1.23% of total demand, the sector has experience rapid growth recently, and Italy is now the leading EU country in terms of CNG vehicle adoption, with 847,000 units. In the EU, three natural gas vehicles out of four are Italian.
However, despite the strong growth in recent years, the feeling is that the Italian market could do more. The scarcity of distributors is certainly the biggest deterrent to the development of natural gas in the transportation sector, considering also the limited autonomy of the CNG- powered vehicles. In recent years progress have been made in the implementation of the distribution network. The number of CNG stations has grown by 37% in the last four years (Figure 15), but the sector needs even greater momentum to overcome the obstacles to greater market penetration.
At the Italian level, on August 9th 2013, decree n. 69/2013, containing measures for economic recovery, entered into law. Specifically, Article 4, paragraph 7 promotes the implementation of the liquid fuels distribution network and the use of methane as a fuel. The fund for the implementation of the distribution network also aims to provide grants for the closing and contextual transformation of liquid fuels distribution systems into exclusive methane distribution facilities.
AIEE, based on a study of Federmetano, which indicates 2,370,000 as the hypothetical natural gas road fleet in 2020, has estimated the demand for natural gas for low duty vehicles at around 1.64 Bcm in 2020, and up to 4 Bcm in 2030, considering both the new CNG vehicles and those with retrofitted engines. Moreover, liquefied natural gas (LNG) is set to emerge as a significant new transportation fuel over the next years, both for the maritime sector and for heavy duty road vehicles. According to AIEE, the use of natural gas as a fuel for ferries, for example, assuming the use of 276 ferries powered by LNG by 2030, would lead to an increase of approximately 1 Bcm of natural gas in demand.
Final remarks
TAP will bring additional import capacity to Italy of up to 20 bcm/year once phase II is at full speed. This capacity will face shrinking consumption (especially on the industrial and power generation side) and a more volatile and unpredictable demand. However, the 2010 European Commission regulation security of supply emphasises the importance of protecting consumers again disruption. Given the increasing political tensions in Russia and Ukraine, it is important to consider whether TAP can truly play a role in assuring supply, as it stated in the national energy strategy (SEN). Looking at Italy’s past experiences, it is difficult to argue that TAP alone will be able to provide additional gas in the event of a major interruption coinciding with a demand peak. It can, however, improve supply conditions to the soon-to-be-build storage infrastructures, especially in the event of a structural reduction in imports from one of the exporting countries.
Aside from the security and the economic perspectives, environmental impacts are anticipated in two cases. First, it is at a debate (though at its initial phase) whether a possible conversion of the Ilva steel plant in Taranto from a coal-based plant to a natural gas-based one, is economically feasible. It is estimated that such an intervention will significantly reduce the plant’s harmful emissions, which currently cause production to be heavily limited (i.e. it would be allowed to return to full production capacity). Second, from the long term perspective, the additional gas can be used in transportation, with a lower environmental impact.
A final remark must be made in relation to the “Southern-European gas hub” opportunity. In principle, Italy has the geographic and infrastructural potential to become an important hub in an integrated European gas system. Importing gas from Azerbaijan (through Turkey), Algeria, Libya and from the Arabic LNG sources such as Qatar, Italy could to export gas to other European countries. But it Italy is to become the Southern-European gas hub (or Euro- Mediterranean), it must seek a new model, encouraged by community regulations and focused on flexibility and competition, as the European Union is currently developing. National and European market competition should be associated with the creation of a commercial and infrastructural hub, serving not only national but also European demand, especially from the Central Eastern market. In order to do this, investments must be made not only in the import capacity, but also in internal transportation infrastructures and at the borders with Swiss, Slovenia and Austria, expanding the network of reverse flow pipes.
Authored by Antonio Sileo, Director at SEP Consulting and Filippo D'Arcangelo, Research Fellow at IEFE at the Università Bocconi