Pipeline Politics: Europe, Russia, and Energy

Written by Lyubomir Hadjiyski

This article originally appeared in Business Today on December 10, 2018.

One doesn’t have to read the news to know that relations between Russia and the West are the frostiest they’ve been since the Cold War. Disagreements over Crimea, Ukraine, Syria, nuclear missile treaties, and a myriad of other topics have increasingly strained ties between Moscow on one side, and Washington and Brussels on the other. While it is usually easy to distinguish where Russia and the West stand on many issues, the line becomes blurred when addressing the energy market. The reason is simple: basic economics take precedence over complicated geopolitics.

Europe relies on Russia for its natural gas and oil needs. The European Union imports 67% of its natural gas from abroad, and Russia makes close to 40% of those imports. In 2016, around 30% of the EU’s total oil imports came from Russia. The share of imported Russian crude oil and gas imports are even higher in certain countries. A network of intricate gas pipelines ensure a constant flow of Russian gas from the northern and eastern parts of the country to consumers and businesses in Europe. While the EU has been importing gas from Russia for decades, it is the construction of yet another pipeline that is causing controversy.

The new pipeline is called Nord Stream 2. It will pump natural gas from the world’s largest reserves, located in Russia, to the EU through a pipe network under the Baltic Sea connecting Russia directly with Germany. Running parallel to the existing Nord Stream pipeline, which was built in 2011, Nord Stream 2 can double its existing capacity. Further, Europe’s gas production, which is currently concentrated in the Netherlands, Norway, and the United Kingdom, is expected to decrease in future as North Sea gas runs out; Nord Sea 2 aims to fill the gap between decreasing supply and steady demand by supplying Russian gas in a cost-efficient way. Indeed, the shorter route of Nord Stream 2 provides for cheaper transportation costs, and the promoters of the pipeline predict that it will lower European gas prices by some 32%.

Existing and planned pipelines. Source: The Economist

“Critics worry that expanding the combined capacity of the two Nord Stream pipelines to 110 billion cubic meters of gas per year will only increase Europe’s reliance on Russia for its energy needs.”

Most importantly, the project would bypass Ukraine as a transit country for Russian gas. The political relationship between the two countries has been difficult in recent years, to say the least, but their energy partnership has been strained for, arguably, an even longer time. A substantial portion of Russian gas flowing to Europe—around 80% in 2009—travels through Ukraine first. When Russia stopped the flow of gas over price disputes and Ukraine’s outstanding debts in the winters of 2006, 2007, and 2009, European consumers were affected, too. A pipeline like Nord Stream 2 circumvents this problem, and, in theory, ensures non-stop access to Russian gas without having to rely on cooperation and agreement between Russia and Ukraine.

But that’s not the end of the story; there are other reasons why Nord Stream 2 remains controversial. Critics worry that expanding the combined capacity of the two Nord Stream pipelines to 110 billion cubic meters of gas per year will only increase Europe’s reliance on Russia for its energy needs; this dependency, they argue, is dangerous in a time when relations between Russia and the West are especially heated. President Trump, in July 2018, criticized the paradox of Germany being “captive to Russia” by importing too much energy from Russia while also participating in the NATO alliance—the aim of which is to counter threats from that very same country.

The United States has been the most vocal critic of the project. Its logic is that by possessing such a key stake in Europe’s energy market, Russia could hold the continent hostage and cut off supplies if it wishes to do so. Further, Nord Stream 2 would circumvent Ukraine and therefore deprive it of $2 billion in valuable transit fees each year; this money is a valuable income source for the Ukrainian government—a US and EU ally. It is apparent that Nord Stream 2 is deeply divisive and is creating disagreements not only between Russia and the West, but also between the US and its partners in Europe.

So what does the United States propose? First is legislative action. A bill introduced in Congress back in July 2018 aims to impose sanctions on Russian firms and individuals involved with large-scale energy projects. The bill would also target firms partnering with Russia, such as those involved in Nord Stream 2. This course of action would affect Western companies based in key US allies like Germany, which would no doubt worsen relations between the US and the EU at a time when the Trump Administration has already put this relationship under significant stress. It would also alienate Europeans, and would increase the perception that the United States is opposing Nord Stream 2 because it wants to push its own energy agenda.

This introduces the second proposed American course of action: exporting more of its own LNG—or liquified natural gas—to the European Union. LNG is gas that has been cooled down to liquid form for easier transportation and handling before it is reheated for consumption. This process is both tedious and expensive, but countries like Poland and Lithuania have already constructed LNG terminals on their coasts to receive shipments of gas from the United States, thereby diversifying their energy supply. While critics of the US agenda argue it is only pursuing its own interests, proponents assert that the EU also stands to gain from diversifying where it gets its natural gas from.

Simple economics, rather than complicated geopolitical maneuvering, reveal that American LNG is not a viable solution to Europe’s energy needs. Pipeline gas is some 25% cheaper than LNG imports, making the latter economically inferior to the former. The US argues that a steeper price tag is justifiable given the potential for Russia to blackmail the EU by cutting off its gas supplies. However, Moscow needs Western payments as much as the West needs Russian gas, and stopping, or even reducing, the gas flow towards Europe would harm Russia financially. Further, since LNG is still a relatively new US export, America doesn’t yet have the production and export facilities required to meet Europe’s large demand of over 120 billion cubic metres a year by 2035. Even if the EU did move in the direction of American gas, it would face severe supply shortages.

The topic of the EU’s imports of Russian gas and oil will continue to remain an issue in the future. The German government has maintained that energy policy must be “entirely left to commercial actors,” thereby stripping Nord Stream 2 of any political significance and prioritizing economic considerations over political ones. The United States takes the reversed stance, urging EU countries to prioritize politics over economics (even if it means buying more expensive American gas). It is clear that energy has become a point of major contention not only between Russia and the West, but among Western nations, too. It is also evident that a new theater of disagreement and competition has opened up, alongside an already long list of points of contestation. For the time being, however, no other viable solutions are on the table; the gas must keep flowing.