On the Brink: EU Energy Security and the Russia-Ukraine crisis
Is Europe prepared for Russian blowback from potential sanctions?
With warnings of imminent invasion being issued by the US this past week, the crisis in Ukraine appears to be reaching a tipping point. Putin’s motivations and ultimate goals remain subject to much speculation ranging from a full-scale invasion and regime change to an elaborate bluff to extract cost-free concessions from NATO. Regardless, much of the direct risk to Europe stems from Russia shutting down gas exports in response to any financial sanctions planned by the US and its allies upon an invasion.
The prospect of Russia curtailing natural gas shipments across its network of pipelines remains a seemingly frightening prospect across European capitals given the continent’s heavy reliance on Russian gas.
Source: JPMorgan, The Economist
In fact the once unthinkable prospect, the complete shut-down of gas exports by Gazprom for months, would be feasible given that Russia’s foreign reserves ($643Bn) far outweighs the estimated revenue losses (~$7Bn per month based on Energy Intelligence) it would incur. Shut-down factories and rolling brown-outs in central and eastern Europe are distinct possibilities.
So what actions are being taken by the US and its NATO allies to mitigate this risk and what would be the impact on global energy markets? Furthermore, could Europe actually go on the offensive and proactively shutdown Russian gas exports as recently proposed by Anne Applebaum in The Atlantic?
First let’s put some numbers to the issue. The EU currently imports ~225 million cubic meters of gas per day (MCM/d) from Russia. This volume already represents a steep decline from 2021, when it averaged ~400 MCM/d. This ~40% decrease was driven by Russian export restrictions, particularly through Ukraine. Critically these actions by Russia have been tailored to keep Gazprom fully compliant with all contractual obligations, while still delivering a clear political message.
Source: IHS Markit, The Economist
Fortunately LNG imports, particularly from the US, have been able to fill this shortfall. Infrastructure investments over the last decade by the EU and exporting countries have greatly expanded LNG terminal capacity on the continent. In fact even with imports now at all-time highs, the EU still has an additional ~200 MCM/d in spare regasification capacity available.
So while the EU could theoretically import its way out of a crisis, excess global supply remains very limited. Hence the diplomatic push by the EU Commission and Biden administration to help secure additional shipments from Asian allies like Japan and South Korea if a crisis occurs.
And while this diplomatic push has helped at the margins, it’s market forces that have done the heavy lifting in delivering additional supplies. European spot prices in the past month have averaged between 5% and 570%(!) higher than the Asian and North American natural gas markets, respectively. This price difference has redirected flexible LNG shipments, that is those gas volumes not locked in long-term contracts, away from Asia, where a milder winter has alleviated some demand, and allowed European customers to make these additional purchases.
Source: EIA, FRED, S&P Platts
Another area the EU can tap additional capacity is through lower cushion gas volumes at the 140+ underground gas storage (UGS) units operating in the region. Cushion gas is the minimal volume required to maintain pressure and deliverability in a storage reservoir, but WoodMacKenzie estimates that an additional 10% could be produced from these UGSs in a crisis, which would account for up to a month’s worth of Russian imports.
So in a short-term crisis the EU is actually in surprisingly good shape, particularly if gas flows from Ukraine are the only pipelines impacted. The additional cost of a more limited crisis, perhaps $50-100Bn for the remaining winter months, is manageable particularly if the EU can effectively direct gas volumes and financial resources to its more vulnerable members.
Energy Sanctions on Russia: Hitting them where it hurts?
But what about Applebaum’s idea of proactively restricting Russian energy imports to punish Putin’s aggression, particularly if a more protracted struggle emerges?
Here things get more difficult. Like much of the world, the EU is already struggling with inflationary pressures. The resulting higher gas prices through sustained LNG imports and the need to refill UGSs for the coming winter will be particularly trying for eastern and central European states.
Furthermore, even with the ability to maintain LNG import levels, it’s not clear how Asia would cope with the loss of gas imports without exacerbating global supply chain issues. New LNG sources expected to come online this year, like Venture Global’s new export terminal in Louisiana, adding 25 MCM/d in export capacity, simply can’t bridge the expected gap of 100-200 MCM/d next winter on the continent.
Meanwhile on the political front, while opinion polls show high levels of support for Ukraine and NATO efforts, this is not uniformly embraced across all member states. It’s easy to imagine that sustained economic pain from higher energy prices, combined with compromised elites in Germany and Italy, a surprise victory by Le Pen or Zemmour in the French presidential elections in April, and continued subversion by fifth columnists like Orban’s Hungary, could wear down European resolve on proposed sanctions and ultimately reward Kremlin aggression.
So while Applebaum’s sentiment of inflicting severe economic pain via restricted gas imports from Russia might deliver a forceful message in theory, the knock-on effects to European economies emerging from Covid may very well serve the Kremlin’s goal of dividing the coalition. Unlike Putin, Western leaders will answer ultimately to an electorate that seems ill-equipped to handle further disruptions to their daily lives as evident by the growing unrest around pandemic related restrictions. Moreover Russia receives most of its energy revenue from oil exports and with the Brent benchmark now surging to $95/bbl any losses from European gas sales may not matter much to the Kremlin’s bottom line.
A better reaction to a Russian invasion would be to maintain currently reduced gas imports and expedite ongoing energy diversification efforts on the continent, including signing more long-term LNG contracts with US suppliers. Aggressively targeting Russian elites as Applebaum proposes makes a lot of sense: seizing their London assets, confiscating any remaining yachts in Mediterranean ports, and otherwise making them persona non grata in all allied countries around the world. Only by turning Putin’s inner circle against him and fueling public discontent by the inevitable stream of body bags from a well-funded Ukrainian insurgency, can the West deliver a message that the former KGB agent cannot ignore.
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