How will Europe fare if Russia cuts its gas?

EVERY FOUR years, the European Network of Gas Transmission System Operators has had to carry out a simulation of disaster scenarios. In the most recent such exercise, last year, ENTSOG boffins examined 20 shades of disaster and concluded that “European gas infrastructure provides sufficient flexibility for the EU Member States to… ensure security of gas supply. Encouraging words. But the gas companies have not considered the specter that now haunts Europe. What if Vladimir Putin invades Ukraine again, the West hits Russia with sanctions, and Mr. Putin retaliates by shutting down all pipelines carrying Russian gas to the West?

Conventional wisdom was that a complete shutdown of piped gas from Russia, which accounts for about a third of flared gas in Europe, was unthinkable. Thane Gustafson, author of “Klimat,” a thoughtful book on Russian energy, observes that even at the height of the Cold War, the Soviet Union did not halt gas exports. And during the fiercest gas dispute between Russia and Ukraine in 2009, only gas passing through that country was interrupted, and only temporarily.

But a stoppage is no longer unthinkable. Mr Gustafson now says: ‘I don’t think Putin is unlikely to hit the gas tap over Ukraine at all.’ Unlike his Soviet predecessors, the Russian president can afford the cost of a brief energy shock. Jaime Concha of Energy Intelligence, an industry editor, calculated the numbers. Excluding penalties and assuming the average daily price observed in the fourth quarter of 2021, he estimates that a complete cut off of piped gas to Europe would cost Gazprom between $203 million and $228 million per day in lost income. So if such an embargo lasted three months (Mr Putin’s leverage wears off in the spring, when gas demand drops to just 60% of January’s), the lost sales would amount to about 20 billions of dollars.

A loss of this magnitude would have been devastating for the shaky Soviet economy, which relied heavily on hard currency earned by selling gas to the West. But Russia now has some $600 billion in central bank reserves and could easily take such a hit. And he might even get by financially, at least in the short term. Simple swipes at Ukraine have already driven up gas and oil prices (the latter accounts for the bulk of Russia’s energy revenue, not gas). Without war, JPMorgan Chase, a bank, predicts that higher prices will allow Gazprom to make more than $90 billion in gross operating profit this year, up from $20 billion in 2019.

If Russia wielded the gas gun, how much harm would it hurt the West? If the disruption was limited to gas transiting through Ukraine, as in 2009, the rest of Europe would be fine. On the one hand, Gazprom has already reduced the flow of gas through Ukraine. Citigroup, a bank, estimates it is half the level seen last year and a quarter of that of 2019.

What if Mr Putin cut off all gas to Europe? Immediate disruption would be inevitable. This would be felt most in Slovakia, Austria and parts of Italy (see graph), estimates David Victor of the University of California, San Diego. Among the major European countries, Germany is the most vulnerable. Due to its climate-motivated push to phase out coal-fired power plants and its ill-considered decision in the wake of Japan’s Fukushima disaster to shut down its nuclear power plants, it remains more dependent on natural gas than necessary. It is Europe’s largest consumer of gas, accounting for around a quarter of its total energy consumption, with Russia supplying more than half of its imports.

The good news is that Europe’s energy system is more resilient than it was during the 2009 crisis. Andreas Goldthau of the University of Erfurt in Potsdam points to some helpful changes. Pro-competitive measures (such as the banning of “destination clauses” which prohibit the resale of gas) have weakened Gazprom’s grip. A dense network of gas interconnections now connects formerly isolated countries (see map).

Another source of joy is liquefied natural gas (LNG). Heavy investment in regasification plants means that Europe has a lot of spare capacity. Citigroup estimates that with historic utilization rates for these plants operating at 50% capacity or less, the region can theoretically manage enough to replace nearly two-thirds of Russia’s pipeline gas imports. The limiting factor is therefore not regasification capacity, but the available supply of LNG. Given that it takes a long time to develop new production and export capacities, Europe’s best hope would be to seize the LNG shipments originally destined for overseas.

One investor notes that when European prices tripled between October and December last year, “an armada of LNGsailed to Europe as cargo was diverted from Asia. This influx compensated for a drop in Russian gas imports (see graph 2). Market rumors suggest a new armada is on the way. Chinese state-owned energy companies, which plan to make quick profits from high gas prices in Europe, hope to sell dozens of LNG shipments. Massimo Di Odoardo of Wood Mackenzie, a consultancy, adds that because the trip from America to Europe is shorter than to Asia, LNG tankers can make more trips, which reduces export capacity to Europe by about 10%. All in all, he thinks extra LNG could make up 15% of the shortfall that would result from a full Russian shutdown.

Another source of resilience is the amount of gas stored. Last year’s harsh winter, along with Gazprom’s reluctance to fill storage units it controls in Europe, left gas storage at levels below the five-year standard. Even so, Rystad, an energy research company, calculates that a continuation of normal weather this winter would leave enough gas in storage in the spring to make up for two months of lost Russian gas exports. Some analysts believe that the surplus could even cover four months of cutoff, although a cold snap would quickly reduce this buffer.

Europe also has a secret weapon. Mr Di Odoardo points to his massive but little-discussed reserves of “cushion gas”. For technical and safety reasons, regulators insist that storage units such as salt caverns and aquifers hold a huge amount of gas that is not normally available for sale. Wood Mackenzie analysts estimate that up to a tenth of this cushion can be used without causing problems. If regulators gave permission, as they would in a war-induced crisis, that would be well over a month of Russian imports.

In sum, Europe will suffer if Russia cuts the gas; but this price will be paid on the wallet rather than by physical suffering. This cost will be exacerbated, predicts Jonathan Elkind of Columbia University, because “Europe is not starting from a calm, but from a market to end”. Mainland energy markets have just suffered a price shock at the start of winter, and the price outlook for all energy commodities is poor. JPMorgan Chase predicts that, even without a Russian gas cut, Europe will spend about $1 billion on energy this year, up from $500 billion in 2019. If the region were forced to consume its gas stocks to survive a cut Russian, it would then have to spend even more during the summer to frantically replenish its reserves in order to avoid an energy crisis next winter.

It’s an unpleasant prospect. But a higher price would be paid by Russia in the longer term. A source notes that Gazprom would face “massive” trade fallout, ranging from penalties payable to customers to stopping the flow of dollars to Russia for contract payments. Gazprom would struggle to secure long-term contracts in Europe after such a show of aggressive unreliability. And Mr. Putin’s beloved Nord Stream 2 gas pipeline would surely bite the dust. A shutdown could even persuade China, which is now cautiously importing more Russian gas, that its longstanding concerns about Russia’s reliability are well-founded.

Mr Victor argues that such brazen use of the energy weapon would likely lead Europe to do much more to reduce its dependence on Russian gas exports “less because they are not safe and more because revenue…is what funds Russian bad behavior.” As Mr. Gustafson forcefully puts it: “If Putin wanted to destroy Gazprom’s business in Europe, he couldn’t do it any better.

Correction (January 25, 2022): The original version of this story stated that Jaime Concha’s estimate of how much a cut in piped gas to Europe would cost Gazprom was based on the average daily price seen in 2021. In fact , it was based on the fourth quarter price alone.

This article appeared in the Europe section of the print edition under the headline “Putin’s Energy Weapon”

Comments are closed.