Invasion of Ukraine Forces Reckoning over Europe’s Deep Energy Links to Russia
by J. Kasper Oestergaard, European Correspondent, Forecast International.
The Russian invasion of Ukraine has forced a reckoning in Europe over its deep energy links to Russia. In the first half of 2021, the European Union depended on Russia for as much as 48 percent of its natural gas imports. EU member states themselves only produce approximately 12 percent of total consumption, meaning that more than 88 percent is imported. A new EU energy strategy is expected to be unveiled on March 2. The strategy calls for a 40 percent reduction in fossil fuel use by 2030 and requires European energy companies to fill their storage facilities with natural gas this summer so that the continent is less dependent on Russian natural gas next winter. The EU’s goal is to gradually wean itself off Russian gas in the coming years so that by the end of this decade, only an insignificant share of natural gas consumption originates in Russia. The decision by Germany to halt the certification of the $11 billion Nord Stream 2 pipeline could be regarded as the first major step in the process – assuming it stays out of service.
Critics might argue that a departure from Russian energy dependence would have been the prudent response eight years ago in the immediate aftermath of the 2014 annexation of Crimea, the beginning of the war in the Donbas, and the tragic events surrounding the crash of Malaysia Airlines Flight 17, which was shot down by pro-Russian rebels on the border between the Donetsk and Luhansk provinces in eastern Ukraine. In fact, Russia’s share of EU-27 natural gas imports has increased significantly since 2014. Now nearly a decade later, Russia has invaded Ukraine, a move that has been widely condemned around the world. Demonstrations against Russian aggression are taking place all over Europe as well as in the United States and elsewhere, and world landmarks are lit blue and yellow in solidarity with Ukraine.
The seriousness of the situation Europe is now facing cannot be overstated. A major nuclear power has invaded and violated the territory of a sovereign state on the false pretense of protecting pro-Russian forces in the easternmost parts of Ukraine, in the provinces of Donetsk and Luhansk. Meanwhile, Vladimir Putin’s rhetoric alone should be a cause of great concern. In a bizarre and emotional speech that announced the invasion, the Russian president even referred to Ukrainian President Volodymyr Zelenskyy and his government as neo-Nazi thugs and drug addicts. On Sunday, February 27, Putin announced his decision to put his nuclear forces on alert, thereby escalating tensions. Russia is effectively a totalitarian state, and the Russian people are being subjected to propaganda and outright lies by state-owned media. Meanwhile, alternative sources of news such as social media are being severely restricted. These are indeed dark days not just for the people of Ukraine but for all of Europe. Putin has shown his true colors and from here, it is hard to envision any going back to a normalized situation between the West and Russia. With the events now unfolding in Ukraine, the EU and the rest of Europe cannot sit by and in good faith keep buying Russian natural gas, oil, and other energy products without having a clear and determined strategy in place to eliminate the dependency as fast as possible.
In a globalized world of interdependent trade and money flows, sanctioning a major economic power is rarely easy. Since the invasion of Ukraine commenced Thursday last week, Ukrainian leaders have called for instant sanctions on European imports of natural gas and oil from Russia, something that would inflict significant damage on the Russian economy. However, Russia has prepared itself and built up an all-time high foreign exchange reserve of $630 billion, partly thanks to high commodity prices over the past year. This means that an embargo would have no immediate impact on events unfolding in Ukraine. For Europe, the price increases triggered by an embargo would be prohibitive and by next winter, there would likely not be enough gas in storage, resulting in shortages and rationing. European gas stocks are currently only 31 percent full, which is significantly below the normal level at this time of the year. In case of an embargo or other disruption, liquefied natural gas (LNG) can be transported into Europe by sea from major producers such as the United States and Qatar. This could make up for some of the lost supply, but it would still be years before an LNG infrastructure large enough to replace much of the Russian supply could be in place. LNG will most likely be only part of the solution to Europe’s problem. It normally takes upwards of two years to deliver an LNG vessel, and sufficient port capacity and other ground infrastructure are also required. On the positive side, existing LNG terminals in Europe have never been fully utilized and as much as half of capacity was idle in 2020. Higher pipeline volumes from the U.K. and Norway are other potential sources of supply. Europe has for long been too focused on securing cheap gas from Russia instead of diversifying its supply, something that has now proved to be an unfortunate decision. It can also be questioned whether it was ever prudent risk management by member states and the EU leadership to depend on a single nation for nearly 40 percent of the EU’s total natural gas consumption. The United States and the EU have announced that they are working together to ensure sufficient and timely supply of natural gas to the EU from sources around the world to mitigate any supply shocks caused by the crisis. A full-scale halt of Russian gas supplies is still regarded as an unlikely outcome, however.
For European leaders, companies, and private individuals, it is certainly an inconvenient truth to be indirectly financing Putin’s aggressive ventures in Ukraine, knowing that even an instant embargo would not be enough to stop the bloodshed. Poland’s Prime Minister Mateusz Morawiecki bluntly stated after the EU summit on February 24 that “We are buying as European Union lots of Russian gas, lots of Russian oil. And President Putin is taking the money from us, from the Europeans. And he is turning this into aggression, invasion.” In 2020, the total value of Russian exports of mineral fuels and products to the EU, including oil and gas ($64.1 billion), exceeded Russian defense spending in 2020 ($61.7 billion).
Depending on how the crisis develops, Europe will likely continue to be highly dependent on Russia for its energy needs in the coming years. Russia, on the other hand, depends heavily on the revenue from natural gas sales to Europe. In 2020, 72 percent of Russia’s natural gas exports and 48 percent of oil exports went to OECD (Organization for Economic Cooperation and Development) nations in Europe. Revenues from energy sales are estimated to account for more than 19 percent of Russia’s consolidated budget in 2021, and energy exports to the EU contribute about 45 percent percent of that, or 9 percent of the consolidated budget. With the EU looking determined to cut its energy ties with Russia, Putin will have to find alternate buyers and will undoubtedly look east toward China. The geopolitical stage is clearly set for even stronger economic ties between Russia and China, and we can expect to see major changes in international energy trade flows in the coming years.
The European Natural Gas Market
Total EU natural gas consumption has been flat over the past decade. In 2020, the EU consumed a total of 399 billion cubic meters (bcm) of natural gas, of which 56 bcm, or nearly 14 percent, were produced by EU member states. In the first half of 2021, EU natural gas consumption amounted to 226 bcm, up 23 bcm, or 11 percent, from the same period in 2020. In the first half of 2021, indigenous production was 26.5 bcm, equal to nearly 12 percent of total consumption. The Netherlands is currently the largest natural gas producer in the EU.
Apart from Russia (48.4 percent of total imports – net mass share), the main sources of EU natural gas imports in the first half of 2021 were Norway (18.0 percent), Algeria (13.2 percent), the United States (5.8 percent), Qatar (4.4 percent), Nigeria (3.4 percent), and the United Kingdom (3.2 percent). Natural gas prices in Europe are up six-fold over the past year and surged 51 percent on the day of the invasion before falling back. The EU’s indigenous natural gas production has been on a declining trajectory over the past decade and is down 60 percent since 2011. This is mainly due to North Sea gas field depletion and the decision by the Dutch government to shut down the Groningen gas fields by 2022 because decades of draining its gas are triggering earthquakes. However, in the midst of supply shortages and surging natural gas prices in Europe, the Dutch decided in early 2022 to nearly double production from Groningen. The decision to close the gas fields later this year has not been changed.
Germany was the largest buyer of natural gas in the EU with 91.2 bcm consumed in 2020, ahead of Italy (71.3 bcm), the Netherlands (44.1 bcm), France (39.5 bcm), and Spain (32.1 bcm). Of the 27 member states, only Cyprus did not consume any natural gas. The dependence on Russian natural gas imports varies by member state. A few nations depend on Russia for nearly all of their gas consumption. Germany and Italy were Russia’s biggest natural gas customers of all in 2020.
As illustrated by the chart below, the pipelines that transport natural gas into the EU originate in Russia, Norway, North Africa, the United Kingdom, and Azerbaijan. Also, a number of LNG import terminals are scattered across the continent. LNG terminals will most likely play a more significant role in the coming years as the EU seeks to become less dependent on Russian gas. Moreover, record high natural gas prices in Europe are making it attractive to transport LNG by sea. Currently about half of the EU’s LNG passes through terminals in Spain and France. EU LNG imports in Q3 2021 were 17.1 bcm, down from 18.8 bcm in Q3 2020. In the third quarter of 2021, Qatar was the EU’s largest LNG supplier, accounting for 4.6 bcm – equal to 26.9 percent of total imports, followed by the United States (4.3 bcm / 25.1 percent), Nigeria (2.8 bcm / 16.4 percent), Russia (2.5 bcm / 14.6 percent), and Algeria (1.8 bcm / 10.5 percent).
Following the invasion of Ukraine, German announced it will construct two LNG terminals at existing ports in Brunsbüttel and Wilhelmshaven.
European leaders will have to make tough decisions in the coming days, weeks and months. Europe simply cannot be in a position where much of its energy supply comes from what is effectively a totalitarian regime waging aggressive war. There can be no doubt that it will take years for Europe to eliminate its dependence on Russian energy supplies and natural gas, in particular. The best path for Europe is a gradual, determined and ambitious effort to replace Russian imports with supplies from other nations while, at the same time, increasing the share of renewables in its energy mix.
Based in Denmark, Joakim Kasper Oestergaard is Forecast International’s AeroWeb Webmaster and European Editor. In 2008, he came up with the idea for what would eventually evolve into AeroWeb. Mr. Oestergaard is an expert in aerospace & defense market intelligence, fuel efficiency in civil aviation, defense spending and defense programs. He has an affiliation with Terma Aerostructures A/S in Denmark – a leading manufacturer of composite and metal aerostructures for the F-35 Lightning II. Mr. Oestergaard has a Master’s Degree in Finance and International Business from the Aarhus School of Business – Aarhus University in Denmark.