China Is Not Ten Feet Tall
How Alarmism Undermines American Strategy
In 2005, the state-owned Russian energy company Gazprom and several European firms agreed to create Nord Stream AG, a consortium that would oversee the construction of the world’s longest undersea natural gas pipeline. German and Russian leaders noted that the pipeline, connecting the Russian city of Vyborg to Greifswald, would let Gazprom serve gas markets in northwestern Europe directly through Germany. With Germany as a major energy transit hub, the EU could then protect its gas supplies if conflicts between Russia and Ukraine were to disrupt the flows from the pipelines to the south.
Polish officials felt differently. Radek Sikorski, then foreign minister, compared the arrangement to the Molotov-Ribbentrop Pact of 1939, the non-aggression deal between Hitler’s Germany and Stalin’s Soviet Union that led eventually to the joint invasion of Poland. Warsaw regarded Nord Stream, as the pipeline is known, as a geopolitical risk that would increase the influence of Moscow and Berlin over its own domestic gas supply.
At the time, EU officials dismissed Sikorski’s comparison as an exaggeration. Over the three years since Russia annexed Crimea and began its war in eastern Ukraine, however, his warnings have seemed increasingly prescient. To be sure, Nord Stream will not lead to a Russian-German invasion of Poland—but the pipeline, which was first used in 2011, has brought Berlin and Moscow closer together in a way that has left some Central and Eastern European states, including Poland and Slovakia, more vulnerable to Russian arm-twisting.
An expansion of the project, called Nord Stream 2, is on track to be completed by 2019, renewing the urgency of these concerns. At an estimated cost of $11.8 billion, Nord Stream 2 would add two more gas pipelines to the two already in place, doubling the project’s capacity and deepening the reliance of central, southern, and eastern European states on Russian gas. Although the project would alleviate gas shortages in some of those countries, the added capacity would weaken the position of Ukraine—through which a number of large pipelines now pass—in the European gas market. It is also further dividing the EU between members that favor the project and those that oppose it.
What’s more, Nord Stream 2 could generate hundreds of millions of dollars in revenue for Gazprom. That should trouble Western officials, because the company’s revenues support Moscow’s foreign policies. Gazprom effectively subsidizes Russia’s wars in eastern Ukraine and Syria, finances Kremlin propaganda aimed at undermining European unity, and lubricates the machinery of anti-European parties across the continent.
The good news is that there are a few ways that the EU can reduce its reliance on gas from Russia while meeting its own energy-efficiency targets. It can take steps to increase its use of renewable and unconventional energy, for example. It can expand its program to build liquefied natural gas (LNG) import terminals, accommodating the delivery of more natural gas from the United States and the Middle East. And it can construct more pipelines between EU member states.
A FOREIGN CURRENCY PIPELINE
As one of the world’s largest oil and natural gas exporters, the Russian state derives more than half of its revenue from energy production. As oil and gas prices have fallen in recent years, the country has had to accommodate deep budgetary shortfalls. Moscow based its revenue and spending forecast for 2016, for example, on a projected oil price of $50 per barrel—and when oil prices fell well below that threshold, the government had to come up with $130 billion in reserves to compensate for the shortfall. Russia’s wars in Syria and eastern Ukraine have increased the financial burden. The country seems set to face revenue problems as long as energy prices stay low.
Foreign currency loans would help Russia bridge those gaps, but Western sanctions have choked off Moscow’s access to them. That leaves energy exports as one of the few remaining ways for Russia to raise foreign currency. To get much-needed dollars and euros, Russia must extract and export oil and gas, regardless of low prices.
So far, Nord Stream 1 has not contributed much to Gazprom’s bottom line, even if it has added to Russia’s foreign reserves. The project looks to be disastrous for Gazprom’s shareholders—especially the Russian government, which owns 51 percent of the company. That is partly because Gazprom is obligated to pay about $319 million to send gas through the pipeline every quarter, regardless of the amount of gas it ships. (Gazprom can recover some of that money as one of Nord Stream’s shareholders.) There is little reason to believe Nord Stream 2 would be more profitable.
Making matters worse for Russia, the EU already restricts the amount of natural gas that it can import from Russia through Nord Stream. In 2016, the EU imported less than half of the Russian natural gas that pipelines could accommodate. (Even though Gazprom’s exports through Nord Stream 1 remain below the current pipeline’s capacity, the company and the Russian government hope that building Nord Stream 2 would lead Germany to push harder to raise Russian gas sales to other European countries.) And Gazprom is far weaker than it was when Nordstream’s first phase became operational. Global gas prices have fallen recently, the company is set to build another costly pipeline in the Russian Far East, and sanctions have blocked its access to credit from global financial institutions.
For all these reasons, Nordstream 2 looks set to be a disaster for Gazprom and for the Russian government. So why then is Moscow moving forward with the project?
Although the economics of Nord Stream 2 make little sense, Russia has far better geopolitical reasons to build the pipeline.
For starters, Nord Stream 2 could give Moscow more leverage over Ukraine and a number of other neighboring states. With the ability to meet almost all of Western Europe’s natural gas needs through the Baltic Sea, Moscow could cut off some of Kiev’s energy supplies without jeopardizing its gas exports to the West. (Such a move might challenge its legal and contractual obligations within the EU, but Russia has shown no enthusiasm for meeting the letter of its obligations under similar circumstances, much to the concern of EU authorities.) Moscow could take similar measures against other countries transited by pipelines from Russia, such as Belarus, Poland, and Slovakia.
Russia may or may not take such a step. More certain, however, is that Nord Stream 2 would weaken Ukraine’s position as a major shipper of gas to Europe, stripping Kiev of at least $2.2 billion in revenue and undermining the West’s investments in the country’s reform, which depend partly on economic stability.
The expanded pipeline would threaten the economic health of other countries, as well. If Europe’s consumption of natural gas falls as it turns to renewable and unconventional energy sources, the continent could eventually procure all the gas it needs through the expanded Nord Stream pipeline, taking advantage of economies of scale by using the pipeline to its full capacity. That, in turn, would make the facilities linking Russia to Europe through Belarus, Poland, and Slovakia redundant, depriving those countries of an important source of income and leaving them more vulnerable to Russian pressure. More generally, Nord Stream 2 could weaken Europe’s interest in finding alternative sources of gas in the decades ahead—especially if Gazprom modifies its prices to beat out the competition.
In the meantime, the debate over Nord Stream 2’s construction has already helped pit the Baltic states, Poland, and the United States against Germany, undermining Western solidarity to Russia’s benefit. In June, for example, the U.S. Senate voted to tighten sanctions against Russia in a measure that included German and Austrian companies involved in Nord Stream 2 (it was followed by the House of Representatives in July). Austria and Germany condemned the vote, raising the level of antagonism between Berlin and Washington to its highest point since the presidential inauguration of Donald Trump. “Europe’s energy supply is a matter for Europe, not the United States,” declared German Foreign Minister Sigmar Gabriel and Austrian Chancellor Christian Kern in a joint statement. Behind the strong words lay German businesses’ deep commitment to Nord Stream: the project could make the country a major energy-transit hub. (Former German Chancellor Gerhard Schröder is the chairman of the board of Nord Stream AG.)
If Nord Stream 2 is completed, it almost certainly would affect the United States’ LNG exports to Europe. Just days before Germany and Austria challenged the U.S. sanctions, the first ever shipment of U.S. LNG into central Europe landed by tanker at Swinoujscie, a Polish port on the Baltic Sea. Polish officials participated in lavish celebrations to welcome the tanker to an $845 million terminal built to diversify Poland’s gas supplies and reduce the country’s dependence on Russia.
Other countries in the region, such as Lithuania and Estonia, are also planning to accommodate LNG shipments—not only from the United States, but also from Australia, Africa, and the Middle East. Lithuania has already built an LNG terminal and imports gas from the United States, some of which it sends to Latvia and Estonia. Such facilities threaten Russia’s market share and Moscow’s influence over countries that depend on Russian gas.
GAS IN RUSSIA’S TANK
Western defenders of Nord Stream 2 argue that the expanded pipeline will satisfy the EU’s need for imported natural gas as domestic production declines. Some refer to Nord Stream AG’s claims that the existing pipeline was used in 2016 to as much as 80 percent of its capacity and that usage is increasing. But other estimates suggest that Russia uses less of Nord Stream 1’s capacity to deliver gas to Europe, and the EU’s consumption of natural gas looks set to decline in the future. From this perspective, it seems harder to justify a second pipeline.
Some German businesses may profit from Nord Stream 2 in the short term, but the real winner from the expanded pipeline would be Russia. Last year, Gazprom provided 33 percent of the natural gas consumed in the EU. By giving the green light to Nord Stream 2, the EU would empower the very country that is working hardest to undermine it. The EU’s reliance on the pipeline’s supply of gas would boost Russia’s foreign reserves and deepen its dominance over European energy markets. Meanwhile, Western investments in new pipelines connecting European nations to the German end of the Nord Stream pipeline would commit Europe to Russian natural gas supplies, discouraging the region’s progress on energy efficiency.
Although German gas consumption is declining, Europe’s shift away from nuclear and coal power could lead to a limited comeback for gas as a so-called transitional fuel. At the same time, the decline in the EU’s domestic gas production, especially in the Netherlands, could lead to increased demand for gas imports in Germany. For those reasons, Nord Stream 2 could give Russia an increased share of the German energy market.
As an alternative, the EU should continue its drive to meet tough targets for energy efficiency. It should also continue to diversify its sources of gas, reducing its reliance on Russian supplies. Led by the European Commission, it should strive to harmonize its member-states’ energy policies. The goal should be a unified approach to Russia that does not favor the narrow goals of individual states and companies, but protects the interests of the entire EU.