Russia used energy as weapon, now Europe can turn tables Analysis by Barron's

Barron's has published an article arguing that Russia failed to use its gas weapon to compel Europe and now the latter has an excellent opportunity to retaliate. Caliber.Az reprints the article.

Russia’s use of its gas supply as a political tool against its neighboring countries and the European Union has destroyed its reputation as a reliable supplier. Its strategy to persuade Europe to accept its annexation of Ukraine involved underdelivering gas in 2021, and then progressively squeezing Europe’s supply by making it dependent on payment in rubles, cutting several countries off, and closing the Yamal and Nord Stream pipelines unilaterally.

Russia’s squeeze had a major and immediate adverse impact. Gas prices surged to over 10 times the normal rate, causing inflation, reduced incomes and profits, as well as slowing down economic growth. At the same time, Russia still enjoyed record gas revenues, which increased by 55.7 per cent in 2022, even as natural gas exports to Europe fell by 56.1 per cent. 

However, the Kremlin’s attempt to weaponize gas led to an extraordinary adjustment. Pipeline supply fell by 85 per cent from preinvasion levels, while the supply of ship-borne liquefied natural gas increased. Europe’s gas-storage level ultimately hit a record high. This success resulted in gas prices falling to less than twice preinvasion average levels. The International Energy Agency suggests that Europe’s efforts to reduce gas demand should be sufficient to cover a complete cutoff of Russian gas next winter, even in a stress scenario.

Russia tried and failed to use its gas weapon to compel Europe. Now that Russia has lost its leverage, Europe has an excellent opportunity to retaliate. By doing so, it can support Ukraine and minimize the threat to Europe’s energy security. Specifically, we propose four steps.  

First, to strengthen Europe’s gas resilience and independence from Russia, the EU should raise its gas storage target. The current plan is to fill storage facilities to 90 per cent by Nov. 1. The EU should aim for 100 per cent, and count EU-owned gas stored in Ukraine toward the target. Given that Ukraine should exit winter with around 8 billion cubic meters in storage out of 33 bcm total capacity, and domestic production will allow injection at a pace of around 1 bcm per month through the summer, Ukraine can offer at least 15 bcm of capacity to store additional volumes of European gas. Because no more than 250 million cubic meters can be injected daily, action should be taken to support injections starting early in the filling season. A joint purchasing mechanism should be used to finance this additional storage.

Second, the EU should end all purchases of Russian pipeline gas except via Ukraine. Doing so would end current flows of around 10 bcm a year through Turkey. To achieve this, stricter enforcement of European rules on “unbundling” ownership and distribution could be implemented. Currently, the Ukrainian gas transmission system can accommodate more than three times the volume of Russia’s gas supply to Europe. We propose to cap the allowable volume of Russian gas that can flow through Ukraine at 40 bcm a year, a level that was set in the current Russia-Ukraine gas agreement for 2021-24. Making the Ukrainian gas transmission system Russia’s sole channel of gas supply to Europe would facilitate a levy on all Russian gas sales to Europe to finance Ukraine’s reconstruction and compensation.

Third, we propose the wider EU should follow the U.K. and Germany and end the purchase of Russian LNG. In its recent report, the IEA does not project LNG imbalances in 2023, with LNG trade volume projected to increase by 4.3 per cent, led by European imports to an all-time high of 180 bcm. The demand recovery in Asia is projected to be modest, while LNG exports are expected to grow by 4.3 per cent now that the damaged Freeport LNG terminal on the U.S. Gulf Coast has reopened. Europe’s LNG purchases increased by 63 per cent in 2022, while India and Bangladesh decreased imports by 17 per cent and Pakistan by 18 per cent—implying that in a stress scenario, Europe would be able to outbid others for gas.

Fourth, with Europe no longer dependent on Russian gas, it’s time to impose sanctions on key Russian gas companies involved in last year’s conspiracy to squeeze Europe, including Gazprom and Gazprombank, as well as personal sanctions on their boards and management. Russia lost its status as a leading gas supplier to Europe. Its share of total EU imports declined to just 8 per cent in the early months of 2023. At the same time, European gas storage is at a record high, and prices have fallen sharply since their peak in the third quarter of last year. However, 2022’s high energy prices caused welfare losses for consumers. Therefore, sanctions are necessary to prevent similar behavior from anybody else in the future.

Over the next year, these measures would reduce Russia’s export earnings by $8 billion, helping constrain Russia’s invasion of Ukraine. This plan turns the tables on Russia: from Europe being dependent on Russian gas to Russia being dependent on Ukraine for access to the European market. It paves the way to impose a levy on Russian gas flows to finance Ukraine’s reconstruction as the price of future Russian access to the European market.