April 3, 2014

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TSG IntelBrief: The Gas Bloc: Russia’s Sphere of Energy Influence

 
Amid the concerns over increased Russian troop movements and heavy weaponry near the border of eastern Ukraine is an underlying and deep concern about its most powerful geopolitical weapon: natural gas. Warning Russia not to use energy as “an instrument of aggression,” US Secretary of State Kerry announced on Wednesday that the US and the European Union (EU) would work with Ukraine to reduce the country’s dependence on Russian natural gas. However, such an effort will take years, with considerable logistical and geopolitical challenges. In the meantime, the question remains as to Russian intentions and capabilities, with natural gas as leverage.

Yet the issue of Russia’s using natural gas as a tool of intimidation and aggression is quite apt. Russia is the main supplier to Europe as a whole, including the EU and former Soviet republics like Ukraine. Placed in context, the difference is between Russian gas-related delivery capabilities to Western Europe relative to former Soviet republics and Warsaw Pact countries.

Russian deliveries account for 34% of the natural gas supplies to the EU (a close second to Norway’s 35%), but a closer look at the numbers helps better define the question of intentions and capabilities as it relates to reinstalling a Russian sphere of influence.

The breakdown of selected countries’ percentage of Russian natural gas compared to their total imports:

Germany: 40% (and likely to increase with completion of the Nord Stream pipeline. Like other Western European countries, Germany pays “full price” to Gazprom, Russia’s gas monopoly)

Hungary: 50%

Ukraine: 51%

Austria: 52%

Greece: 55%

Poland: 54%

Czech Republic: 80%

Latvia: 100%

Lithuania: 100%

Estonia: 100%

Sweden: 100%

An even closer look reveals that Russia’s 3-tiered pricing system (created after the breakup of the Soviet Union) is specifically designed to create and maintain a sphere of influence using energy. Former Soviet republics (except for the Baltic states) pay 30% less than EU countries such as Germany and Greece, and depend on low-interest loans from Russia to pay even that. This discounted price is a considerable source of leverage for Moscow. Wayward former republics might find their discounts disappear without recourse—as Ukraine experienced this week when Gazprom increased the cost of gas by 40%, claiming unpaid gas bills and following the Russian annexation of Crimea. The just-announced International Monetary Fund (IMF) aid package to Ukraine will be used, in part, to pay Russia for natural gas deliveries—an irony not lost on President Putin. Through price and supply dominance, Russia is not reconstituting the old Eastern Bloc from the days of the USSR, but rather a new Gas Bloc, protected by pipelines instead of troops.

This new Gas Bloc allows Russia to shape and maintain its traditional sphere of influence. It is hard to overstate Russian concerns of regional encirclement and geopolitical weakness, and equally hard to overstate the challenges to be overcome, if the EU and US truly endeavor to wean countries such as Ukraine from Russian gas. Pipelines are expensive to construct and the areas through which they must travel are a geopolitical minefield. Western Europe has sufficient liquid natural gas (LNG) terminals to accommodate increased shipments from other sources but Eastern Europe and the vulnerable former republics will need years to build up the necessary infrastructure. There is no short-term solution to this long-term issue.

Ukraine will face hiked prices for Russian gas but likely not the halting of deliveries to the extent it saw in 2006 and 2009, when Russia decreased gas imports to Western Europe in response to Russian-Ukrainian tensions. Russia has not hesitated to manipulate gas supplies to former Soviet republics but won’t so easily again disrupt gas supplies to its customers in the West who pay full price. Indeed, Russian dominance in natural gas cuts both ways, with over 50% of all Gazprom exports going to the EU. By contrast, the former Soviet republics account for 28% of Gazprom’s exports, and much of that is either deeply discounted with payments still lagging or even free in the shape of payment for transit fees for pipeline use.

A petro-dependent country such as Russia—with oil/gas exports providing over 50% of its GDP—will be less aggressive towards clients who seek alternatives to Russian gas supplies if those supplies become too fickle, politicized, or weaponized. Russia can’t afford to spurn its highest-paying customers, and attempts to diversify away from Europe and towards Asia will take years as well. Provided they develop the necessary infrastructure, countries in Western Europe will have plenty of other options from which they can import LNG in the near future, including the US, Qatar, and Norway. Even Germany, Russia’s largest client in Western Europe, is increasingly transitioning to more renewable sources of energy, such as wind and solar power. For Eastern Europe, however, alternative options are limited.

The near-term geopolitical gains that Russia can achieve through aggressive maneuvers in the Gas Bloc won’t be enough to warrant the long-term costs of Europe making coordinated and prolonged steps towards non-Russian energy alternatives, leaving Russia to focus more on the Gas Bloc as its regional leverage.
 
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FORECAST 

• Russia will increase pressure on Ukraine through progressively unsubtle tactics, to include manipulations of gas prices and contracts
 
• The EU will work to increase non-Russian gas supplies but find all options nearly prohibitive in terms of geological machinations and financial costs
 
• Russia intends to keep Ukraine within its sphere of influence, energy and otherwise. But it doesn't intend a military conflict with the West and will approach, but not cross, the line between intimidation and confrontation.

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