How Europe Can Protect Itself From Russian Blackmail

The Kremlin’s Gas Wars

By Niclas Poitiers, Simone Tagliapietra, Guntram B. Wolff, and Georg Zachmann

In the days before Russian President Vladimir Putin invaded Ukraine, the United States and its European allies announced stringent economic sanctions on Russia, including its energy sector. Germany, for its part, formally suspended approval of the new Nord Stream 2 pipeline, owned by Russia’s state-owned gas company, designed to deliver Russian gas to Germany. The question now is whether and how Moscow will retaliate. There is a growing fear across the continent that Russia could hit back at Europe where it hurts most: cutting off countries that depend most on Russian natural gas.

For many European states, the threat of losing access to Russia’s energy isn’t an idle concern. Europe imports 40 percent of its natural gas from Russia, and many states have significant trade and investment exposure to Russian markets. Just as important, these energy and economic ties do not affect all European countries equally. The Kremlin will undoubtedly try to exploit these differences to sow disunity in the EU’s response to the invasion. If Russia can use its energy leverage to persuade, say, Germany or Italy to withhold support for the toughest sanctions, it could give Moscow a way to withstand the economic consequences of its invasion.

But the success of this divide-and-rule strategy is not predetermined. Intent on holding Moscow accountable for its illegal aggression, European states can effectively counter Putin. To do so, the EU will have to bolster those members most vulnerable to Russian blackmail and potentially rethink the structure of European energy markets

DIVIDE AND RULE

In theory, the European Union has a significant advantage in its economic relationship with Russia. Russia relies on European markets for more than half of its exports, whereas the European Union sends only five percent of its exports to Russia. This disparity reflects a difference in size—the EU’s economy is ten times larger than Russia’s—and differing exposure to international trade. Russia is poorly integrated into the global economy and, despite the buzz around a growing rapprochement between Beijing and Moscow, it would have difficulty replacing lost EU export revenue with revenue from Chinese markets.

Conversely, no EU country sends more than 20 percent of its exports to Russia. Although Bulgaria, Estonia, and Lithuania are most exposed to trade shocks, their exports to Russia account for only three, three, and six percent of their GDP, respectively. Russia is even less important for large economies such as those of France, Germany, and Italy, accounting for between one and two percent of their total exports. Any potential Russian countersanctions targeting EU imports would therefore have only marginal effects.

Energy is a different story, however. Natural gas has long been recognized as Russia’s most potent economic leverage in Europe, and it remains so despite the EU’s efforts to reduce its reliance on Russian supplies. Moscow’s ability to exploit that reliance could be exacerbated by wide disparities among member states’ needs. Belgium, France, and the Netherlands import less than ten percent of their natural gas from Russia; Spain and Portugal import none. Germany, by contrast, relies on Moscow for about half of its natural gas imports, and Italy around 40 percent. For Austria, Hungary, Slovenia, and Slovakia, the figure is roughly 60 percent, and for Poland, 80 percent. Bulgaria relies on Russia for all of its natural gas.

These disparities in energy consumption represent an asset for Moscow, as more gas-exposed EU countries may be unwilling to support stronger anti-Russian sanctions, fearing that Russia could disrupt or cut off their gas supply in retaliation. These concerns may, for instance, have explained Germany and Italy’s initial opposition to suspending Russian access to the SWIFT global interbank payment system.

The EU will have to potentially rethink the entire structure of European energy markets.

Still, even the most exposed European countries have alternatives to Russian energy supplies. Should Moscow turn off the gas, the EU could collectively cope—at least for a time. European commercial gas storage reserves are roughly 30 percent full, and some states also have strategic gas reserves (similar to the U.S. strategic petroleum reserve). Through a combination of more withdrawals from these stores, increased liquified natural gas imports, and limited demand-side measures such as industrial gas curtailments, most states would likely make it to autumn of 2022 without severe shortages. But countries such as Bulgaria and Poland that are heavily dependent on Russian gas and poorly connected to their western neighbors would need to significantly reduce their gas demand to manage the situation.

Such actions would, however, drive the price of energy in Europe through the roof, exacerbating an already ongoing crisis. On February 24 alone, as Russian troops crossed the Ukrainian border, gas prices across the continent rose by 60 percent. European countries might quickly see their post-COVID-19 economic recoveries derailed as higher gas prices translate into rising electricity costs—pushing up inflation and eroding household purchasing power and businesses’ competitiveness.

Still, getting through the current winter without further Russian imports is one thing. It will be far more difficult to run the European economy for several years without Russian gas. On the supply side, some states might be able to scrounge up spare import capacity from Qatar and the United States. Allies such as Japan and South Korea might also be able to divert some of their excess seaborne gas shipments. But completely replacing Russian gas would be very expensive and might prove physically impossible. Global gas markets and Europe’s other pipeline suppliers such as Algeria and Norway are already producing and exporting at full capacity. Long-term contracts, moreover, potentially limit the volume of gas that firms could redirect to Europe, even as continental prices rise.

Proactively dealing with these challenges must be Europe’s top priority if it wants to sustain long-term sanctions against Russia. Doing so successfully will involve a series of difficult political, environmental, and social choices. In the Netherlands, for instance, increased natural gas production would cause an uptick in seismic activity around the country’s largest gas field—a factor that once pushed Amsterdam to limit output. Will Dutch households accept that as a consequence of greater access to gas? Should Germany run its nuclear plants longer and even restart some dirty lignite coal plants? What would it take for France to accept more gas and electricity links through the Pyrenees—giving the rest of Europe access to Spain’s vast receiving capacity? And what about the skyrocketing energy bills for the Italian power sector or heating in eastern Europe?

THE LONG HAUL

If the EU hopes to sustain bold and far-reaching sanctions in the face of potential Russian economic countermeasures, Brussels needs to prepare for a long fight. To be effective, after all, Putin must worry that Europe might keep sanctions in place for several years. Time-limited measures might be painful for certain parts of Russian society but are unlikely to fundamentally change Moscow’s calculus.

Europe and the United States should not underestimate the challenge of sustaining such broad-based sanctions. Although political support will be high in the immediate aftermath of the Russian invasion, asset freezes, the long-term exclusion of Russia from the Western financial system, and any countermeasures from Moscow will all eventually hit specific interests across Europe. Beyond the immediate economic impact on everyday European citizens, companies that export to Russia will also be hit hard—as will banks with more exposure to Russian financial markets. The broader the remit of new sanctions, and the longer they last, the greater the chances that Russia’s divide-and-rule strategy will succeed.

To avoid this risk and ensure that the EU maintains its unity, Europe needs to embrace a comprehensive, continent-wide energy strategy. German Foreign Minister Annalena Baerbock’s announcement at the recent Munich Security Conference that Berlin would be ready to pay a “high economic price” for peace in Ukraine, for instance, is welcome but not enough. Instead, Brussels needs a systematic approach to ensure that all member states’ energy needs can be met—including those who have already voiced concerns over sanctions—in exchange for more robust support for a collective EU response to Russia.

Above all, the EU first needs to conduct a detailed assessment of its member states and companies’ vulnerabilities to Russian pressure. In particular, governments should catalog available options to lower their dependence on Russian gas and private sector exposure to the Russian market. By doing so, national governments and the EU alike can begin to understand potential pressure points that Moscow might use to undermine the emerging sanctions regime. Governments need a granular picture of their countries’ interests to safeguard them properly.

The European Union needs to prepare for a long fight.

Although far easier said than done, European governments also need to reduce their countries’ energy dependence on Russia. In the immediate term, that means that countries with more gas on hand, such as France or the Netherlands, must share with countries facing shortfalls, such as Austria and Germany. States should also explore new long-term contracts with gas suppliers to add additional flexibility to the European market. Governments will also need to encourage gas companies to refill their storage facilities during the spring and summer months, despite historically high prices. States could incentivize stockpiling through mandates and, eventually, financial assistance. Over the long term, the current crisis should spur European states to accelerate investment in renewables and better insulation techniques. Although these measures would not replace Russian gas in the near term, they might yield important results in five to ten years.

To accomplish any of these objectives, which will be painful, the EU will need to develop a constructive format for deciding how each state ought to contribute. European governments will face a series of politically difficult challenges over the next several months, and mutual support is the only way through the crisis. One option is a regular council meeting of ministers—akin to the U.S. National Security Council—that would decide on immediate responses to potential energy shortages.

Finally, the EU should establish a dedicated fund to compensate specific countries, regions, or sectors for sanctions-induced financial losses. Brussels could set up the fund quickly, using the EU Globalization Adjustment Fund or the EU Just Transition Fund as models—both of which were designed to deal with the region-specific impacts of globalization and climate change mitigation efforts. The fund could start with 20 billion euros per year, financed by EU borrowing. Such a mechanism would reduce national vulnerabilities and help Europe maintain its political unity and relevance.

European leaders know that Moscow will try to fragment and weaken the EU response to Russia’s invasion of Ukraine. Europe must step up to the challenge and articulate a coherent answer to Putin’s divide-and-rule strategy. With the right steps, Brussels can implement such a strategy promptly and in an economically feasible manner. But it will need to act quickly. If it fails to do so, the European Union could face a growing energy crisis, leaving Moscow further emboldened to weaponize the world’s energy supplies.

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By Niclas Poitiers is a Research Fellow at Bruegel. Simone Tagliapietra is a Senior Fellow at Bruegel and an Adjunct Professor at the Catholic University of Milan; Guntram B. Wolff is Director of Bruegel and part-time Professor at the Solvay school of the Université Libre de Bruxelles; and Georg Zachmann  is a Senior Fellow at Bruegel. Energiesnet.com does not necessarily share these views.

Editor’s Note: This article was originally published by Foreign Affairs on February 27, 2022.  All comments posted and published on EnergiesNet.com, do not reflect either for or against the opinion expressed in the comment as an endorsement of EnergiesNet.com or Petroleumworld.

Original article

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EnergiesNet.com 02 28 2022