INTERNATIONAL
Russia’s energy weapon is a fiction
Spring 2008
Anxieties that Vladimir Putin’s resurgent Russia could cut supplies of gas to Europe have provoked talk of another cold war. But Andreas Goldthau explains why energy is useless to Moscow as a foreign policy instrument
Commentary:
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Fears of Russia’s predatory power politics have done much to fuel concern in Europe about energy security. The recent Ukraine case is just one in what to European eyes is a long list of worrying events, that includes gas disputes with Georgia and Belarus, Russia’s attempts to by-pass Poland through the Nordstream pipeline, and the squeezing-out of Western companies from upstream projects like Sakhalin-II and Kovykta. President Vladimir Putin’s public sympathy for the idea of a cartel of gas producing states, together with Russian attempts to curb alternative supply routes to the European market, support conjecture that Russia is increasingly using its energy supplies as a foreign policy instrument.
In spite of this widespread public perception, however, the real threat to European energy supplies lies elsewhere, in the fundamental lack of investment in the Russian upstream sector. The prevalent and geo-politically charged European discourse on energy security is therefore misleading.
Rising energy prices have done much to speed Russia’s recovery from the post-Soviet period in which its political and economic muscle had withered away. Now, though, as it seeks to play power politics with energy, it is in its partners’ eyes becoming increasingly unreliable. The result of all the gas disputes is that energy-poor Europeans have finally become aware of their dependence on imported hydrocarbons. And they have become increasingly uncomfortable with an energy game in which the producers set the rules. The consequence has been calls for collective action on the consumers’ side to make up for this strategic disadvantage. Proposed measures range from rather vague recommendations that Europe should "speak with one voice" to hard-nosed calls for an "Energy-NATO" uniting the alliance members to counterbalance the risk of blackmail by such producing countries as Russia.
All of these suggestions have one thing in common: a geo-political tunnel vision that regards energy in terms of traditional “hard security”, or in other words as part of a power game played by states as they seek to dominate the international scene. In fact this is a misleading and short sighted view, while the much-feared Russian “energy weapon” is itself rather blunt.
First, oil must be taken out of any power politics equation. Most crude oil is traded on the global market and, unlike gas, is brought to the consumer via a variety of routes. This means that whenever a producer country may decide to cut its oil supply to a consuming country, it can do so, but in the knowledge that this is unlikely to have any major effect as the targeted country can make up for the shortfall by buying the shortfall on the spot market. The only way oil can be used as a weapon is if all producer countries – or those grouped in OPEC – decide collectively to block oil supplies to their customers. This rather unlikely possibility is made even more remote by the fact that Russia is not an OPEC member.
That leaves natural gas. It is true that Russia has the world’s largest gas reserves and has emerged as the most important supplier country to western and central Europe, where it covers up to 100% of gas imports. It is also true that this dependence may in the near future become even more pronounced, when Europe’s fast depleting own resources will need to be made up for by still higher imports. But although all this would suggest considerable Russian leverage, there is no case for believing in an energy weapon in gas either. This is mainly for two reasons.
Gas is a two-party play. The exploration and production of new gas fields, construction of pipelines and the maintenance of infrastructure are all extremely expensive and time-consuming endeavours, so producers and consumers generally negotiate long-term contracts that can run for up to 25 years and exclude secondary trading. These contracts provide each side with the planning security they both need; the producer can safely invest in a multi-billion dollar project secure in the knowledge of a constant and reliable return on investment, while the consumer has the certainty of guaranteed supply for several decades that removes any need to build-up expensive stocks to buffer supply shocks.
Gas is also a regional play: it is transported almost exclusively via pipelines, which, once built, make it very costly for either party to abandon the game. If, for instance, a producer wanted to deliver gas to a different customer, he would have to invest a lot of money in new pipeline infrastructure. The same logic applies for the consumer, only the other way round. A glance at the dense pipeline grid connecting Europe and Russia shows that neither side has an interest in dumping the money they have already invested, nor do they have much of a choice. Russia has no alternative customer base in, say, China, because the infrastructure simply isn’t there, and wouldn’t be for some time. The Europeans, for their part, can’t go shopping around elsewhere for precisely the same reason. Hence, both Russia and Europe are bound together in a mutual dependence that started decades ago.
What could alter this dynamic, though, is a structural change in the gas market. If there was, for instance, a global spot market for natural gas, the existing bi-lateral relations between producers and consumers could give way to the sort of trade relations that exist in oil. Much hope is presently being placed by some in Liquefied Natural Gas (LNG) as this relatively new technology allows gas to be shipped in large quantities by tankers. If so, this could break up the regional characteristics of the gas market. Once LNG starts to account for a growing share of overall gas consumption, a truly global gas market could emerge. That sort of change in the market would offer new options for both producer and the consumer, and would foster new pricing mechanisms based on global supply and demand.
But LNG is unlikely to provide a panacea for Europe’s fears about energy security, or at least not in the short or medium term. Because gasification of natural gas is very costly, LNG is quite expensive compared to traditional piped gas. It is therefore only an option when extremely long distances have to be covered. Also, the initial up-front costs of building Gas-to-Liquid (GTL) plants and LNG ports are much higher than for pipelines, which is why LNG producers are also seeking long-term contracts so as to have the planning security that guaranteed sales volumes give. In other words, even if expectations are high, LNG may not provide an alternative any time soon. But it may emerge as a second market that will probably be characterised by some of the same dynamics as piped gas.
All in all, there is little substance to the fear that Russia could use its natural gas as an “energy weapon” against Europe. If it were to do so, it would simply loose its main customer without any possibility of signing a contract with an alternative customer. And that’s certainly not an attractive move for a country whose federal budget depends on energy sales for the largest share of its revenues.
So if not the energy weapon, what should Europeans worry about? If Europe finds itself left out in the cold one winter soon, it will not be because the Russians have intentionally cut off the gas supply, but because their future production may turn out to be insufficient. This probably sounds paradoxical, as Russia owns the largest gas reserves in the world. In fact, however, the major Russian gas fields have already started depleting. At the same time, and as a by-product of resource nationalism, western companies have been largely squeezed out of the major current exploitation and production projects. As a result of the monopolised structure and strict state regulation of the domestic Russian gas market, private Russian gas producers have no incentive to produce or invest. The monopolist Gazprom now bears the main burden of getting the Yamal and Shtokman fields on-stream before the matured giant fields in western Siberia quit producing. Gazprom has also neglected the maintenance of existing fields and facilities in favour of activities outside its core business. The International Energy Agency estimates that Gazprom will have to spend an average of $17bn a year up to 2030 on exploitation and production projects, as well as on the maintenance of current fields, if it is to satisfy growing domestic demand and its export commitments. There now seem serious doubts as to whether Gazprom will be able to manage this.
At the end of the day, the crucial issue in Europe’s energy supply picture is not Russian power politics but dry economics. There is a perceptible investment gap in the Russian gas sector that is likely to cause a supply gap for European households. The policy recommendation for Europe is therefore simple and straight forward: put a stop to all the philosophical debates about Russia’s gas weapon and instead initiate serious talks with Moscow on measures to stabilise production and prevent further irritations among the transit routes. To this end, the Energy Charter Treaty (ECT) should once again be the core of Russian-European gas relations. At present, a number of reservations have prevented Russia from ratifying the treaty, notably the exclusion of EU-Russian trade in nuclear materials, the “regional integration clause” and third party access to its transit infrastructure. Whatever the substance of these fears, there is much to be gained by Europe in making substantial concessions on these points if that will secure Russia’s commitment to a reliable multilateral framework in the energy sector. As became very obvious during the crises with Ukraine and Belarus, it is essential that the ECT’s dispute settlement mechanism should start to work properly if future disagreements are to be prevented from turning into conflicts.
Europe meanwhile should establish its own mechanisms to buffer short-term interruptions in gas supplies, in case further disputes were exert to unwanted side effects on European markets. This will call for more infrastructure investment, the building of interconnections between national markets and of storage facilities in all of them. If European Union member states could achieve these two goals in the fairly near future, they will have done much to secure their gas supplies. Much more than through cold war-style rhetoric.