How to Contain Putin’s Russia
A Strategy for Countering a Rising Revisionist Power
Earlier this month, as Europeans watched Russian soldiers move into Crimea, they shuddered at the thought of the cold months remaining before spring, fearful that the crisis would cause pipeline gas deliveries from Russia -- on which many European countries depend and which mostly transit through Ukraine -- to stop. Foremost in their minds was the 2009 Ukraine gas crisis, when a disagreement between Russia and Ukraine over payments disrupted gas supplies in many European countries and left scores without heat in the middle of winter.
Since then, European countries have made progress securing their gas supplies, including by improving pipeline infrastructure within Europe so that gas can flow more easily among European states. But Europe remains vulnerable. Supply has something to do with that, but even more challenging in the long run are Europe’s unhelpful energy policies, defaulting utilities, and rising coal consumption. They explain why Europe does not consume the additional gas supplies that are already available.
These problems are also why recent proposals from the United States, including the ones put forward by U.S. House Speaker John Boehner (R–O.) and the former energy adviser Jason Bordoff, to speed up U.S. natural gas exports to Europe to shield the continent from the Ukraine crisis are off base. Before the United States pulls out its gas nozzle, it should consider a few points about Europe’s energy supplies. If it does, it will realize that Europe can do the most to improve its energy security with a few fixes at home.
PUT THAT IN YOUR PIPE
Observers may speak of a European energy market, but that is an illusion. States on Europe’s periphery, such as Bulgaria, Greece, and Hungary, have much higher energy prices and bigger security challenges than those in the center of Europe, such as Germany. That is because natural gas is not a global commodity with one price but is sold at varying prices in different markets, depending on local supply and demand dynamics. Countries in western Europe have access to more sources of pipeline gas than do most of those in Europe’s periphery and therefore enjoy securer supplies and cheaper prices. Eastern European countries are especially vulnerable because most are landlocked and thus cannot access liquefied natural gas (LNG) imports, which can be delivered only to sea ports (the United States’ exports to Europe would come as LNG). That would not matter if Europe had a robust and interconnected gas pipeline system, but it does not. Moreover, even if U.S. LNG could reach eastern Europe, most countries there would not be able to afford it. North American LNG, after liquefaction, transit, and regasification, would cost at least double the price of Russian gas in eastern Europe’s pipelines. And that gas is already prohibitively expensive: In recent years, the high price tag has driven down gas consumption and led to a boost in coal use. In other words, LNG from the United States is no real competition for pipeline gas out of Russia.
Perhaps realizing all that, Europeans have focused on bringing more eastern pipeline gas into the continent. At the end of last year, the European Union took an important step in this direction with the establishment of the Southern Gas Corridor. This pipeline will begin in Azerbaijan’s massive Shah Deniz gas field and end in Italy, connecting seven different countries. The project will reach some of Europe’s most vulnerable nations and most likely help lower gas prices there. In doing so, it will edge out coal once more and help lower pollution and carbon emissions.
It should not be surprising that the Southern Gas Corridor has caught Moscow’s ire. Russian-run Gazprom is attempting to buy up gas transit and transmission infrastructure along the pipeline route to try to undermine the project. Even more insidious, it has paid environmental movements to try to stymie construction with environmental claims. This is not the first time that Gazprom has used bogus environmental movements to promote its interests. It has also funded anti-fracking campaigns in Europe, including in Ukraine and Bulgaria, to slow Europe’s development of local gas supplies. If public watchdogs in Europe do not monitor and publicize Russia’s manipulation of environmental causes, distinguishing its claims from those of legitimate environmental organizations, it will find itself increasingly dependent on Russian gas imports.
Europe’s efforts to increase eastern pipeline gas are a good start toward addressing the continent’s energy woes. In the future, it should also encourage the development of spurs from the southern corridor into other vulnerable markets, such as the Balkans. That would both increase the volume of southern corridor gas that would reach the European Union and help wean countries just beyond Europe’s borders off Russia.
Europe’s problems would be challenging enough if they related only to energy supply. But they go deeper than that. Europe’s energy policies are based around an extreme free-market ideology that is not well suited to the region’s patchwork of energy markets. Since the early part of the last decade, Brussels has worked to reduce the role of the state and EU institutions in the energy sphere. It has supported the privatization of energy companies, the unbundling of the gas and electricity supply chains, and the adoption of hub pricing instead of long-term supply contracts. Its (unproved) assumption is that freer energy markets will enhance supply security.
Brussels seems to be taking its cue from the relatively successful U.S. natural gas model, which is based mainly on spot pricing and involves very little government interference. However, the U.S. gas market is fundamentally different from that in Europe: Deregulated gas trade works stateside because most gas there is domestic and no producer supplies more than three percent. In Europe, most gas is foreign and three producers, all from outside the European Union, each supply close to a third of it. In Europe’s case, the adoption of hub pricing may actually allow outside players to increase their hold on Europe. Gazprom, the biggest, could manipulate hub prices by flooding or withholding gas from particular hubs to its own advantage.
Moreover, there is no evidence that market forces will lead to the development of the kind of infrastructure Europe actually needs. With the exception of support for the Southern Gas Corridor, it has been unable to address the unevenness of the European gas market. And there is not much profit to be gained from building strategic gas-storage units, gas pipeline interconnectors, and reverse-flow mechanisms on pipelines, all of which could cushion against disruptions to gas supply. European states and EU institutions thus need to take the lead -- or at least give companies a regulatory push -- in order to establish bulwarks against supply disruptions.
Europe’s energy policies are deficient in one last area. Its efforts to address climate change have led to a perverse combination -- rising consumption of renewables and coal. Moreover, to prevent the lights from going out, European countries are on the verge of having to bail out a large number of aging utilities firms, which are unprofitable due to impractical regulation. Until Europe gets its regulatory house in order, more gas deliveries won’t do much good. If there is a lesson for the EU from the U.S. shale gas revolution, it is that energy policies succeed best when public interest and commercial logic line up.
For all the talk of Gazprom’s nefarious intentions in Europe and Ukraine, Europe must also remember that this is not a clear case of good guys versus bad guys. Over half of the gas that Russia supplies to Europe transits through Ukraine, and some of Gazprom’s largest gas storage facilities are located there. But the country has not been a responsible partner for Russia. Successive Ukrainian leaders, motivated by personal gain, have conspired with local oligarchs to siphon off gas and have refused to pay Kiev’s gas bills to Russia. The new Ukrainian leadership needs to take steps to reduce the corruption related to the gas industry and should be prepared to raise energy prices at home to reduce consumption.
Similarly, the United States and Europe should not balk at Russia’s decision to raise the gas prices for Ukraine. If higher prices push Ukraine to improve energy efficiency at home, develop some of its potential domestic gas resources, and wean itself off Russia, all the better. Moreover, just as Moscow should not be obligated to subsidize lush gas consumption in Ukraine, neither should the U.S. taxpayer subsidize it through loans. In 2014, Europe will elect a new parliament and new EU Commission leadership. On its agenda will be resetting Europe’s energy policy. Hopefully, it will realize that energy is a utility and not a commodity, and that the European Union must take a leading role in ensuring that the lights do not go out. And hopefully the United States will hold off on fast-tracking exports until the benefit of those extra supplies for Europe becomes clearer.