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An Energy Weapon vs. Russia?

by Michael Levi
March 5, 2014

REUTERS/David Mdzinarishvili REUTERS/David Mdzinarishvili

As the standoff between Russia and Ukraine drags on, there are increasing calls to use U.S. oil and gas exports to weaken Vladimir Putin’s hand. There’s something to this, but it’s likely to be a lot less powerful than most pundits seem to think.

Europe imports about thirty percent of its natural gas from Russia. Russia could, in principle, cut off some or all of that supply. That prospect presumably makes European leaders less willing to take strong positions against Russia in its confrontation with Ukraine. People have argued that boosting U.S. natural gas export capacity (or, more precisely, changing policy to make that more likely in the future) could do two things. First, in the current crisis, it could deter Putin from using the gas weapon, lest he encourage Europeans to make concerted efforts to shift their long-term gas procurement to the United States when that becomes possible in a few years. Second, in future crises, it could blunt the Russian gas weapon, since U.S. exports would be available to fill in for Russian supplies.

(You might have noticed that I haven’t said anything about oil. That’s because the idea that U.S. oil exports would give Europe some sort of special buffer is silly. The world oil market is pretty flexible, and U.S. exports would be a drop in an already large sea. To the extent that Europe is constrained in its ability to switch oil sources quickly, that’s because of infrastructure, something U.S. exports wouldn’t change.)

There are two essential things to keep in mind when thinking through the claims about natural gas exports.

First, decisions about whom to export to and import from are made by commercial entities, not by governments. When a U.S. analyst says, “we should tell Europe we’ll sell them our gas”, the first response should be, “who’s ‘we’”? (The second response should be, “who’s Europe?”) The U.S. government doesn’t get to sell gas to anyone; it can create a framework in which commercial entities can sell gas, but after that, it’s up to those businesses to decide where the gas goes. Similarly, “Europe” doesn’t buy gas – all sorts of European companies do, within European and national regulatory frameworks.

Second, surging natural gas into Europe to respond to a crisis requires that there be infrastructure in place that can accommodate that surge. In the case we’re talking about here, that means having a bunch of unused (or partly used) European natural gas import terminals that can suddenly absorb newly arrived U.S. supplies. And remember – back to the first point – these terminals will be built by private players.

So what does this all mean for the big strategic claims?

It is difficult to see how U.S. exports will substantially erode the long-run share of Russian gas in Europe. It is far more profitable for buyers of U.S. natural gas to ship it to Asia – where prices are far higher – than to Europe. (The exception is if European companies are willing to pay a hefty premium to get their gas from the United States – but remember, these are commercial entities, which makes it very difficult for them to do that.) There is, of course, a knock on effect from that, since if U.S. gas frees up other supplies that were destined for Asia, those supplies can potentially move into Europe instead. But Russia remains a relatively low-cost supplier into Europe, and can trim its prices to keep its market share. Moreover, unlike European gas companies, the big Russian players have much tighter ties with the state. If Moscow wants them to keep their share in the European market for strategic reasons, it may be able to make them do that. Russia would lose money – an important piece of geopolitical harm – but its leverage wouldn’t be slashed.

What about supplying gas to Europe in a crisis? Here the basic constraint is infrastructure. Gas demand is seasonal, so during some parts of the year, there may be underutilized LNG import terminals. [UPDATE 3/6: Moreover, with a weak European economy, there is currently a lot of unutilized European LNG import capacity year-round; whether that persists indefinitely remains to be seen. Even in the current case, though, Russian imports into Europe greatly exceed spare LNG import capacity.] Were Russia to cut gas supplies to Europe during a crisis, if prices rose high enough, those terminals could be used to surge in some supplies. During other times (notably winter, when gas demand is most acute) the terminals will be fully utilized, making them unavailable to bring in new LNG supplies. The only way around that is to overbuild. This might happen by mistake, but unless European policymakers offer financial incentives, profit-seeking firms won’t do it on purpose.

There is one other wrinkle worth thinking about here. The United States is currently able to take a harder line against Russia than Europeans are in part because the U.S. economy is insulated from energy-related turmoil. Were the prospect of surging gas into Europe a real one, we’d be having all sorts of debates here about the economic fallout for the United States from escalation with Russia. [UPDATE 3/6: It's worth distinguishing here between swinging U.S. gas from Asian to European customers, which wouldn't affect the U.S. market, and boosting total U.S. exports, which would.] Ironically, while being more connected to European gas markets might give the United States more tools in a future crisis, it could also deter Washington from aggressively confronting Russia.

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Post a Comment 12 Comments

  • Posted by Geoffrey Styles

    The distinction you’re drawing between commercial players and government entities in the gas market is important, though it can cut both ways. It’s also the case that because of the economics of LNG projects and the associated supply chains, most LNG has been sold on long-term contracts, so the quantity available for a “surge” at any time is relatively small–often the result of spare capacity that emerges as plants are debottlenecked, or buyers that find themselves with a surplus under contract.

    However, the big uncertainty behind any scenarios such as you describe is how the gas market will react to a wave of new US LNG, much of it from smaller projects. Could a liquid, all-year global spot market for LNG emerge? That might change the calculations you describe, just as the perception of a large number of new LNG projects could alter the thinking of commercial customers considering signing long-term contracts or renewals for Russian gas today–long before the US facilities start up.

  • Posted by dennis mcconaghy

    Reconsideration by Europe of its gas shale gas potential will surely be one of the effects of the current Ukrainian crisis.
    Having more indigenous gas supply can only improve leverage on the Russian regime.
    Moreover, there was never a fundamentally sound reason for Europe to eschew its shale gas option in the first place.

  • Posted by PW

    Following the weapons analogy further (but of course we don’t want a war) for Russia to stop gas exports to Europe for any length of time is the commercial equivalent of mutually assured destruction (MAD).

  • Posted by Nick Grealy

    The problem is of course that Europeans have, until very recently, refused to get serious about their own shale resources, the same “gas weapon” the US has. In this respect, the US can advise and promote shale, as Energy and State have been doing for several years in Europe and beyond. But ultimately, it’s up to us, and Putin’s foray is the greatest gift the shale industry in Europe could ask for.

  • Posted by D

    The one thing Levi leaves out that I think could be the more significant positive impact of US LNG exports is their ability to then advance the decline of oil-indexed natural gas sales to Europe (and elsewhere) by Russia. The growing global LNG spot market has begun enabling EU firms to renegotiate their contracts with Russia away from oil-indexed prices (that are much higher than they would be otherwise (more than double US prices)).

    Undercutting not just the volumes of gas Russia sells, but just as importantly the price it gets for the gas it’s already selling, should be the dual-track goal. In this regard, the article also underemphasizes the positive impact of US LNG exports to Asia. Anything we can do to help Japan lessen its imports of Russian gas, and the price it pays for Russian gas, serve to weaken Russia economically just the same as if the sales were undercutting Russia’s exports to a European customer. Basically, it doesn’t matter what part of Russia’s revenues we diminish, as long as we can diminish them… their economy doesn’t have much else keeping it going.

  • Posted by Tomasz Jędryszek POLAND

    All can by negotiatet, I think.

  • Posted by Don Stowers

    The US exports natural gas to Mexico via pipelines, but we can only transport it to Europe in the former of LNG. At this time, US midstream companies are in the process of obtaining permits for and constructing LNG processing plants and export terminals. To date, only five permits have been approved and none has begun exporting LNG yet. Any significant exports are still several years away at the earliest. If Russia halts gas supplies to Europe, which would be cutting its own throat due to lost revenues (Gazprom gets 80% of its revenues from natural gas that flows through Ukraine), the US would be unable to ramp up exports quickly enough to make any difference. US companies planning to export LNG have signed long-term agreements with utilities in Japan and other Asian countries to furnish gas for 20 to 30 years. Would the US government force companies to break these contracts in order to send gas to Europe? Let’s face it, Europe has gotten itself into a bind over its failure to develop its own energy supplies — namely shale gas.

  • Posted by Gregory

    US government is certainly capable of creating an entity that would buy natural gas from US producers and sell it to similar European entities, which will then disburse gas to the consumers. While there is no mechanism to _force_ the gas purchases and sales, the reality is that governments have very strong ability to _persuade_ market players to cooperate with them, especially in industries which are already strongly regulated.

  • Posted by Ryan M. Ferris

    I may be wrong here, but the document(1) pointed by today’s guardian article(2) would appear to show 35 “FTA” approved terminals with 2 pending. The DOE appears to have approved 6 of those. I suspect Russian pipelines can export gas cheaper now than European LNG terminals can import American shale gas. However, I seriously doubt that any geo-political events that would change the current calculus would not be capitalized upon by the American energy very quickly. Try lightning speed….

    (1)http://energy.gov/sites/prod/files/2014/03/f8/Summary%20of%20LNG%20Export%20Applications.pdf
    (2)http://www.theguardian.com/business/2014/mar/07/eu-leaders-gas-russia-ukraine

  • Posted by Peter

    Also worth pointing out which countries in Europe currently import LNG : Mainly Spain and the UK, which do not import gas from Russia (or very little), France (imports a modest amount from Russia and modest amount in the form of LNG), Belgium (no gas from Russia). Italy is, currently anyway, the only major LNG importer that is also a substantial importer of Russian gas as well.

    There may be flow on impacts of greater LNG, say from US in 3-5 years time, but we are talking about an indirect impact. LNG capacity is being built in Poland, for example, but it would have to be price competitive with Russian gas (reports are that it will be pricey for Poland to import LNG).

    Basically when we talk about Europe’s dependence on Russian gas, it varies greatly from country to country. Also, in the two largest markets for Russian gas, Germany and Italy, the share of Russian gas in those markets is smaller than in central and eastern Europe, but in these latter countries the size of their overall gas consumption is smaller. And of course these countries do not have LNG capacity.

  • Posted by Newton

    Fracking gas in USA is unprofitable at current prices ,companies are losing money {no wonder they are pushing LNG exports .In the name of helping our brothers in EU against the big Bad Bear} , hmm Fracking is actually scraping the bottem {what you call tight oil} EU does seem to hear ya on fracking as a 10b deal was just signed guess where … pushing GMO on EU in TTP deal would include Monsanto hmm can you say Breadbasket of europe but it gets worse the govt of usa after admitting 5b of taxpayers has gone to help Ukraine Oppisition groups now suggest same taxpayers should subsidize nat gas to EU in LNG sales hmm {but cant save Detroit}

  • Posted by Kirill Eltsov

    This is an excellent and thoughtful article, just one point to add – more because it appears slightly outside the article’s scope that because the author overlooked it.
    I believe – partly because I am Russian – that Europe’s fears of The Big Bad Bear turning off the gas tap are much over the top, driven more by some people’s business interests than real energy security. And that is because technologically, once you have laid a pipeline to your customers and started to produce gas, you depend on them just as they depend on you.
    A gas well – unlike oil – is nearly impossible to close down at will, so once you’ve started drilling for gas, you’d better be sure of your demand. Hence long-term contracts in Europe and current woes of some U.S. shale gas producers who cannot “save” their product until the price rises; sell-or-flare instead of take-or-pay.
    Pipeline delivery makes life even worse for the supplier. Suppose the relationship with the customer on the receiving end is terminated for some reason (war). If you deliver by pipe, there is no way for you to use the idle pipeline, so you just sit there losing money. If, on the other hand, you deliver by tanker, you only have to find someone else with regasification infrastructure (or even without, as floating regasifies are already on offer) to buy it. This is the real Big Bad Bear situation: the next tanker just turns to Japan instead of, say, Poland, the consumer freezes, BBB is happy.
    So my less subtle point is, is Europe going to be more secure depending on pipe gas (Russian) than on LNG (U.S., Qatar, take your pick)? What will they invent then – Big Bad Camel, Big Bad Grizzly?

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