Russia’s gas pipeline strategy and Europe’s alternatives

DISCLAIMER: All opinions in this column reflect the views of the author(s), not of EURACTIV.COM Ltd.

Gazprom will stop using Ukrainian gas pipelines in 2019. [sunshinecity/Flickr]

Europe depends heavily on Russian gas, but Gazprom’s plan to stop using Ukrainian pipelines will require a new EU strategy, writes Chi-Kong Chyong.

Chi-Kong Chyon is, Director of Energy Policy Forum & Researchers at EPRG, University of Cambridge.

Strained relationships between EU and Russia due to the Ukrainian conflict forced Gazprom, Russia’s state gas monopolist, to abandon the idea of controlling pipelines “from wellhead to burner tip”. Gazprom’s new grand vision in Europe is to build pipelines to the EU border and from there its clients are expected to take gas to their home markets. As part of this vision, it also commits not to use the Ukrainian pipelines after 2019. So if Europeans need Russian gas they should build the missing links connecting to Gazprom’s proposed pipelines – the so-called Turkish Stream and the recently announced expansion of the Nord Stream link – so goes the current thinking in Gazprom. However, neither Turkish nor western companies are rushing to give firm commitments to build the missing pipelines. In this case, what may happen to European gas markets, should Moscow commit not to use the Ukrainian pipelines after 2019?

First, Europe might be left without Russian gas going through Ukraine by the early 2020s. The implications of this scenario could be dramatic for Europe, after a period of rising energy demand and prices. Europe without Russian gas through Ukraine (ca. 70 billion cubic metres per year) is tantamount to Northeast Asia – following the Fukushima accident – without Japan’s entire nuclear power fleet.

However, one could well be correct to point out that such a shock would not impact European prices in the same way as it did in Northeast Asia because we are entering the “buyers’ market”. Indeed, the demand in Asia is lower than anticipated and developments of liquefied natural gas (LNG) capacities globally are favouring consumers. But, the recent slump in oil prices means that some of the LNG production capacities may never materialise, while the low price environment would also encourage more gas demand. Thus, markets are self-correcting the imbalances eliminate the potential surplus.

What could really constrain the long-term upward pressure on prices, should such a supply shock materialise and persist, is Europe’s willingness to pay for gas, which is relatively low. This is perhaps thanks to German, Spanish and Italian taxpayers who contributed to financing renewables, making electricity markets in Europe not only greener, but also a strategic counterbalance the market power of gas suppliers, such as Russia or Qatar. Still, price increases in relative terms could be rather sharp in the short-term, should we witness the removal of Russian gas volumes through Ukraine.

Thus, a possible positive development that is perhaps most sought after by many across the Eurasian continent is some sort of reconciliation between Russia and Ukraine, possibly through containment of the conflict in the eastern part of Ukraine. In principle, Gazprom might continue using Ukrainian pipelines if “commercial” conditions, such as the transit fee, are attractive. But recent announcements suggest that Ukraine is asking too much and Gazprom is unhappy with the asked transit price. Furthermore, even if the commercial side of the transit question is resolved, the “transit–avoidance” policy is still deeply rooted in the minds of Russian leaders: the policy dates back to early 1990s and ever since then Russia’s gas policy has been to bypass Ukraine’s pipelines at any cost.

It remains to be seen whether structural changes in the markets and geopolitics force Gazprom’s political masters to rationalise its European strategy, and in particular its strategy vis-à-vis Ukraine. Should this rationalisation occur, then the Russians could flood the European markets with cheap gas, fuelling the much sought re-industrialisation of European economies. But this would require more than just a rational business plan. Investments in political capital are needed to rebuild trust at the highest level between Russia and Europe, and most importantly, between Russia and Ukraine.

Thus, for now, what remains for European energy security is the possibility that western energy companies may take risks in dealing with Ukraine’s transit issues post 2019. Indeed, this may seem unpalatable for risk-averse western companies; however, recent policy and market developments in Ukraine – aimed at energy reforms following Europe’s guidelines – give us some optimism that there might be some degree of “normalisation” of energy trade on the continent in years to come. To ensure this normalisation, however, Europe should, of course, keep engaging with Ukraine and Turkey, two most important transit countries for European gas markets, to make sure that their energy market liberalisation processes do not suffer due to internal political dynamics and short-term energy populism.

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