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Putin’s Gamble & Europe’s Looming Energy Crisis

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Alan Riley, The American Interest

Russia has laid the groundwork to pressure the European Union with surging gas prices and supply shortages next year, but the longer a new gas crisis goes on, the greater the chance it will cost Russia dearly. Will Moscow or Brussels blink first?

As Europe is sweating out yet another hot summer, energy executives and policymakers are working out how their fellow citizens will survive the next winter. The urgency of their task is underscored by the current Ukrainian gas transit contract, which will expire on January 1, 2020. Unless this state of affairs is remedied, the gas flowing through the Ukrainian Brotherhood pipeline, the single largest stream of Russian gas entering the European Union, amounting to nearly all the gas consumed by Germany annually, will stop.

Since July 2018, the European Union has mediated negotiations between Russia and Ukraine  without success. Thus Europe faces the prospect of its third gas crisis (following the previous two in 2006 and 2009) in the past two decades. The second crisis, in 2009, which lasted a mere two weeks, saddled Europe not only with surging prices continent-wide but also physical supply shortages in some states. This time around there is a very real risk that the supply interruption will last considerably longer.

From a commercial perspective, the impasse makes no sense. The Russian energy company, Gazprom, ought to being doing everything in its power to ensure that the gas supply to Europe is not interrupted, since its commercial reputation is on the line. But for the Russian state, and thus for the state-controlled Gazprom as well, commercial interests are not necessarily decisive. For the new European Commission, which comes into office on November 1, it will be a real test of its mettle. Does the Commission, alongside the EU member states, panic and buckle as supply shortages appear and prices surge? Or do they hold the line, find temporary solutions from fuel switching to deploying reverse flows, and refuse to bow down to Russian energy blackmail?

Often neglected in much of the commercial and technical energy analysis as to whether another supply crisis may occur is the current relationship between Russia and Ukraine. The Russian Federation has annexed Crimea and is currently running part of eastern Ukraine with the assistance of military forces it funds and controls. So far 14,000 Ukrainians have been killed in the conflict and more than a million Ukrainians have been displaced by the conflict. Over the course of the conflict, Ukraine has expanded its army to more than 300,000 troops, most of whom are stationed near the occupied areas of the country. These forces continually exchange fire across the line of contact with the Russian-controlled forces, which include regular Russian army units.

By providing more Russian natural gas to Europe than any other route network, the Brotherhood pipeline creates two major problems for the Kremlin. First, it makes it more difficult to enlarge military operations in Ukraine without potentially threatening the movement of profitable Russian gas into Europe. Second, the gas transited across Ukraine generated, in 2018, transit payments to Ukraine of $3 billion. Three billion dollars is approximately the size of Ukraine’s defense budget.

Russia is also growing extremely frustrated with the European Union over the construction of the Nord Stream 2 pipeline, which would allow Moscow to substantially bypass the Brotherhood pipeline. An EU law that came into force in May extended the application of the bloc’s energy law to import pipelines, including the Gazprom-owned Nord Stream 2. EU energy law imposes a series of conditions, including the need for a non-EU pipeline owner to obtain security of supply certification, from EU and member-state authorities. Given its previous record of cutting off gas supplies to Central and East European EU states, Gazprom will likely have trouble obtaining this certification. Furthermore, the necessary permits are not yet in place to begin laying all of Nord Stream 2’s pipes (about 60 percent have been laid so far). So far Denmark has not granted any route permits for the pipeline, and currently the Danish Energy Agency and Gazprom are locked in litigation over the best route for the line. The Danish component of the pipeline, however, amounts to only 140 kilometers of Nord Stream 2’s 1,440 kilometer route. That final bit of pipeline could be laid in approximately one month.

The outlines of a Russian strategy are clear here: 1) Build all the pipeline, save the final bit in Danish waters; 2) Let the Ukrainian contract expire on January 1; 3) Sit back and wait. Moscow can then indicate that it is perfectly happy to provide more natural gas to Europe—but only via Nord Stream 2. To be sure, the Danish government will have to speedily permit the remainder of the pipeline, which will still not be in compliance with EU energy law. But what, in a chilly late January or early February, will the European Union do?

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