The Ukraine Challenge and Europe's Energy Needs Collide

September 10, 2014 Topic: SanctionsEnergySecurityForeign Policy Region: Ukraine

The Ukraine Challenge and Europe's Energy Needs Collide

"Although politically tempting, making energy resources part of Western crisis management was a rash decision."

The crisis in Ukraine is the most severe security challenge in Europe after the Cold War. Energy has featured prominently in public debates surrounding the conflict. Yet, energy-market realities hinder some of the political preferences that currently feature prominently in the hallways of European capital cities. European policy makers should therefore push for separating energy from hard security issues in this conflict.

After a hesitant first few months, in May, European and U.S. policy makers decided to make energy resources part of the sanctions on the Russian regime. Russia is one of the world's prime energy producers. Its state budget is fuelled by energy (predominantly oil) revenues and Europe relies on Russia for 30 percent and 35 percent respectively of its gas and oil consumption. Yet, although politically tempting, making energy resources part of Western crisis management was a rash decision, as we have cautioned before. This is because several of the underlying rationales are questionable.

The first underlying rationale is that Europe can deal with a major gas-supply disruption. It cannot. Granted, due to a very mild winter, gas-storage facilities throughout the EU are filled, increasing resilience to short-term supply shortages. But having sufficient natural gas in the EU-wide system does not mean all member states can access it. First, results of an EU stress tests reveal that although Europe has made progress since the last supply disruption took place in 2009, several states in Central, Eastern and Southern Europe remain vulnerable. EU Commission data clearly confirms that resilience against supply disruptions is far from optimal. While Western Europe may survive longer, current storage in some East European countries would last as little as two or three months; yet winter may last significantly longer. Still, Washington and Brussels suggest that Europe could deal with a supply disruption if demand were roughly 75 percent of last year’s. This, however, means betting on a very mild winter—not a good basis for sound policy formulation.

The second rationale has been, as some have postulated, that Russia would leave the taps open while energy-sanctions efforts were stepped up. Charming as that may have sounded, it was never realistic. Last May, Gazprom decided to cut gas supplies to Ukraine, against the backdrop of an open bill amounting to over $5 billion, which poses a threat to EU energy security. Moreover, the Ukrainian Parliament recently started exploring the possibility of stopping the transit of gas to Europe. Indeed, Ukraine in the past has used its geographical monopoly on Russian gas transit to Europe, to get its way on energy pricing and non-energy related policy issues. The infamous gas crises of 2006 and 2009 left consumers in Bulgaria, Slovakia and elsewhere out in the cold while they cost Gazprom some $1.5 billion and severely damaged Russia's reputation among European customers. The crisis was primarily caused by disputes over prices and transit terms, with Ukrainian vested interests playing a central role in escalating events. Whilst the share of Russia's Europe-bound gas exports transiting Ukraine has fallen to around 50 percent, thanks to new pipelines including Nord Stream, Kyiv still has the grip on 40 billion cubic meters (bcm) that are needed to meet European winter demand and in turn generate an estimated $73 billion in annual revenues for Moscow's coffers. With Kyiv getting desperate, it is not inconceivable that Ukraine will consider playing the transit card to force Europe's and Russia's hands in the conflict.

The third underlying rationale is that energy sanctions are a means to coerce Russia into altering its behavior. They were never tough, to start with, although Washington did its best to frame its efforts as being forceful in comparison to the tepid European approach. One of the reasons for sanctions thus far lacking ambition is economic interests among core constituents on both sides of the Atlantic, including top Fortune 500 companies such as ExxonMobil and BP. With both U.S. and EU policy makers carefully catering to their domestic interests, sanctions in the energy sphere had little chance of becoming much more than nuisance. More fundamentally, however, it is highly questionable whether American and European policy makers want the Russian economy to be brought to its knees. They can obviously have no interest in a tumbling nuclear state on Europe’s doorstep. For Russia, energy is what the finance industry and the IT sector are for America: the backbone of the economy. Imagine Washington's reaction in case either Wall Street or Silicon Valley were crippled as a result of actions taken by an outside force. As Paul Saunders warned in a recent Op-Ed, the last time the United States targeted the energy sector of a major power—Japan—this ended with a world war. So if the sanctions “worked,” they might in fact trigger outcomes that are neither desirable nor even close to their initial goal— establishing peace in the Ukraine.