This article is part of ECFR's Wider Europe Forum
Russia’s pipeline strategy and the threat to gas supplies pose real challenges, but instead of focusing on real diversification, the Commission has to mediate the negotiations and be the ‘financial broker’.
There is an immediate threat to gas supplies that the European Commission needs to deal with. The recent break-down in negotiations over gas supplies to Ukraine should be taken very seriously: Europe cannot bet on warm weather to deliver security of gas supplies. Ukraine (and by implication Europe) was lucky to live through the last winter safely with minimal gas purchases from Russia. There are no guarantees that every subsequent winter will be warm. And there are few options (and little time) for Europe to secure gas flows to its citizens this coming winter other than doing its homework – preparing for the worst this coming winter – and to continue supporting Ukraine in securing finances for filling up its storage capacity.
Strained relationships between the EU and Russia due to the Ukrainian crisis have forced Gazprom – Russia’s state gas monopolist – to abandon the idea of controlling pipelines from ‘wellhead to burner tip’. Gazprom’s new grand vision in Europe is to build pipelines to the EU border and from there its clients are expected to take gas to their home markets. As part of this vision, it also commits not to use Ukrainian pipelines after 2019. So if Europeans need Russian gas they should build the missing links connecting to Gazprom’s proposed pipelines – the Turkish Stream and the recently-announced expansion of the Nord Stream link – themselves, or so goes the current thinking in Gazprom and the Kremlin. However, neither Turkish nor Western companies are rushing to build these pipelines.
What is left for European energy security is the possibility that Western energy companies may take risks in dealing with Ukraine’s transit issues post-2019. Indeed, this may seem unpalatable for risk-averse Western companies; however, recent policy and market developments in Ukraine – aimed at energy reforms following Europe’s guidelines – give us some optimism that there might be some degree of ‘normalisation’ of energy trade on the continent in the next few years. To ensure this normalisation, however, Europe should keep engaging with Ukraine and Turkey – the two most important transit countries for European gas markets – to make sure that energy market liberalisation processes there do not stall due to domestic political dynamics and short-term energy populism.
Europe without Russian gas through Ukraine (ca. 70 billion cubic metres per year) is tantamount to Northeast Asia without Japan’s entire nuclear power fleet
So, what will happen to European gas markets, should Moscow stop using Ukrainian pipelines after 2019? First, Europe might be left without Russian gas going through Ukraine by the early 2020s. The implications of this scenario may be rather dramatic for Europe, had we not lived through a period of rising energy demand, and by implication prices, post-Fukushima. Europe without Russian gas through Ukraine (ca. 70 billion cubic metres per year) is tantamount to Northeast Asia without Japan’s entire nuclear power fleet.
However, such a shock might not impact European prices in the same way as it did in Northeast Asia because we are entering a ‘buyers’ market’. Indeed, the demand in Asia is lower than anticipated and developments in liquefied natural gas (LNG) capacities globally favour gas consumers. But, the recent slump in oil prices means that some of the LNG production capacities may never materialise, while the low price environment would also encourage more gas demand. Thus, markets are self-correcting the imbalances and eliminating the potential surplus.
What could really constrain the long-term upward pressure on prices, should such a supply shock materialise and persist, is Europe’s willingness to pay for gas, which is relatively low. This is perhaps thanks to German, Spanish and Italian taxpayers who contributed to financing renewables, making electricity markets in Europe not only ‘greener’ but also to strategically counterbalance the market power of gas suppliers such as Russia or Qatar. Still, a price increase in relative terms could be rather sharp in the short-term, should we witness the removal of Russian gas volumes through Ukraine.
Even if the commercial side of the transit question is resolved, a ‘transit–avoidance’ policy is deeply rooted in the minds of Gazprom’s masters in Kremlin
Thus, the desired positive development is some sort of reconciliation between Russia and Ukraine, possibly through the containment of the conflict in the Donbas. In principle, Gazprom might continue using Ukrainian pipelines if ‘commercial’ conditions – such as the transit fee – are attractive. But recent announcements suggest that Ukraine is asking too much and Gazprom is unhappy with the proposed transit price. Furthermore, even if the commercial side of the transit question is resolved, a ‘transit–avoidance’ policy is deeply rooted in the minds of Gazprom’s masters in Kremlin. This policy dates back to the early 1990s and since then Russia’s gas policy has been to bypass Ukraine’s pipelines at any cost.
It remains to be seen whether structural changes in the markets and geopolitics force Gazprom’s political masters to ‘rationalise’ its European strategy, and in particular its strategy vis-à-vis Ukraine. Should this rationalisation happen, then the Russians could ‘flood’ European markets with cheap gas, fuelling the much sought re-industrialisation of European economies. But this would require more than just a rational business plan – investing political capital to rebuild trust at the highest level between Russia and Europe, and most importantly, between Russia and Ukraine. Russia’s pipeline strategy and the threat to gas supplies pose real challenges, but instead of focusing on real diversification, the Commission has to mediate the negotiations and be the ‘financial broker’.
Chi-Kong Chyong is Director of Energy Policy Forum, EPRG, University of Cambridge and the author of the ECFR publication Why Europe should support reform of the Ukrainian gas market – or risk a cut-off (October 2014).
The European Council on Foreign Relations does not take collective positions. This commentary, like all publications of the European Council on Foreign Relations, represents only the views of its authors.