RUSSIA'S STRATEGIC GAMBIT RESHAPES ENERGY DYNAMICS

Rafiq Latta, Nicosia; David Pike, Vancouver - Feb 18, 2022

Russia has been implicitly exploiting Europe’s energy dependence to advance its strategic and energy objectives amid parallel crises over gas supplies and Ukraine. Although Moscow refutes that it is using gas as a weapon, the relationship with its No. 1 strategic customer has become increasingly adversarial. Moves by Europe to turn its back on gas could be adding to Russian grievances — concerns also shared by other producer nations as big consumers look to abandon fossil fuels. The standoff is already reshaping Eurasian security and energy architecture, with Russia eyeing new market opportunities and a strategic partnership with China. Energy transition impacts are murky, although any hope that high prices might remind consumers of the importance of supply security could backfire. But there is no doubt that the coming energy decade looks more politicized, expensive and volatile than it did six months ago.

“Better not sit on a hedgehog if you're naked,” warns Russian author Mikhail Bulgakov in his classic novel The White Guard, set in Kyiv during Ukraine’s 1917-21 War of Independence. It is advice the EU would do well to heed. Increasingly, its failure to make any preparations to withstand the energy impacts of a conflict with its dominant energy supplier looks like hubris.

Europe is now realizing the price after Russia curbed gas supplies to contractual limits. It also faces the implicit threat of further disruption if the Ukraine crisis escalates. Europe’s sensitivity to such disruption has been boosted by a perfect storm of the energy transition, thinning OECD stocks, Covid-19 demand rebound, and outages from and sanctions on other key suppliers.

Not only is Moscow winning financially from steamy oil and gas prices, but its coal exports have been the prime beneficiary of EU fuel-switching. “There is Russian leverage, and it is leverage we have allowed to happen,” says Jonathan Stern of the Oxford Institute for Energy Studies. 

What’s clear is that Russian gas supply policy toward Europe, its No. 1 strategic customer, is being driven partly by a sense of an adversarial relationship with it (on gas, sanctions, Nato encroachment and human rights), combined with gas revenue ambitions, and, early on, legitimate inventory targets.

Energy's Hidden Hand

Russia flatly denies it has used gas as a weapon. Certainly, there is no question that Moscow has met all its minimum contractual commitments. By the same token, it has chosen to channel incremental volumes into filling its stocks, rather than offer spot volumes — arguably for commercial reasons.

But the tactic also exerts leverage. It sends a message to EU customers of the benefits of long-term contracts and the need to be more pragmatic about gas' role in Europe’s energy mix. It also shows Russia’s importance as a major gas exporter, at a time when anti-fossil fuel sentiment was gaining momentum and consumers were trying to seize control from producers of the energy agenda.

The larger message, as Russia also addresses its grievances with the post-Cold War security architecture, is essentially that Moscow still matters — in gas markets, security and geopolitics — and cannot be ignored.

It is also plausible that erosion of the producer-consumer dialogue in critical climate talks in Glasgow may have played a role in Russia’s apparent callousness to consumer price pain. Certainly, the message producers heard in Glasgow — essentially, "we are moving away from oil and gas at speed, and there is nothing you can do about it" — was a wake-up call to many. Since Glasgow, there has been less open Russian concern that high oil prices could trigger US shale growth.

While there is no suggestion of collusion, it is noteworthy that Opec-plus has also ignored consumer calls to accelerate its oil supply increases, arguing first that the market was not short of supply and then that any increase would only exacerbate spare capacity concerns.

Deliberate or not, there’s no doubt that producer actions and high prices have impacted the policy debate. Brussels is signaling that it is staying on a low-carbon path, but mounting price pushback within the OECD could yet impact transition policy trajectory, with some concessions for gas’ role. But high prices also carry risk for producers, as they could accelerate the pace of change.

Tectonic Shifts

Much bigger stories are also at play in the current crisis, as Russia, China, the US and Europe continue to jostle in a post-Cold War realignment of Great Powers, while positioning themselves for fundamental geopolitical changes as the energy mix reshapes.

Longer term, it seems certain Europe will continue to try to minimize its dependency on Russian gas, as signaled by a recent visit by EU Energy Commissioner Kadri Simson to Washington to discuss increasing imports of US LNG, among other things. But these alternatives will for now be more expensive than Russian gas.

Washington faces waning leverage in traditional energy markets, even as it champions consumer-led low-carbon policies and tries to square these with sensitivity to oil prices and its own status as a major oil and gas producer. Energy sanctions, Washington’s weapon of choice, look increasingly unfit for purpose. Canceling the 55 billion cubic meter per year Nord Stream 2 project would no doubt hurt Russia but could also leave the EU facing increased costs and supply shortfalls. Denying Russian use of the dollar risks incentivizing alternative payment arrangements, thereby undermining the petrodollar regime that has underwritten US economic hegemony since the 1970s. And Washington no longer exerts the same pull over Opec kingpin Saudi Arabia.

The conflict is also strengthening Sino-Russian political and economic cooperation and their shared interest in challenging the US-led world order. Recent agreements between Beijing and Moscow stopped short of creating a formal military alliance but laid the groundwork for one. Beijing’s deals to buy additional Russian piped gas and crude were relatively minor volumetrically but signal new momentum for a strategic energy relationship. China’s energy transition path is less opposed to gas than Europe’s, so deeper energy ties here could buy Russia time.

Power Play

Meanwhile, Russia’s troop mobilization is advancing Moscow’s claims to great power status. But it is also absorbing extra revenues from higher prices, and any actual war in Ukraine would be exponentially more costly.

For Washington, the great fear is that compromise over Ukraine and Nato's reach more broadly could trigger both further assertiveness from Russia and intensified challenges from Beijing over Taiwan, trade and South China Sea maritime sovereignty. In this great power struggle, so far it is China, not a party to the Ukraine confrontation, that looks best placed to emerge as the clearest winner. But Russia’s brinkmanship has scored some wins: Gas' role is subject to more debate in a transitioning Europe; the US and Nato have been engaged in intensive security talks with Moscow; and Russia's alliance with China has deepened, providing a counterbalance to the West.

Europe, meanwhile, is finding out the hard way that the low-carbon transition — for which it has long been a world champion — will not be a smooth process. Policymakers, investors and others will make mistakes. Producers will push back. And the path to more energy security in the long term could involve more insecurity and disruption in the near term.

Rafiq Latta is a Nicosia-based senior correspondent covering the Middle East and Opec for Energy Intelligence and David Pike is editor-in-chief at Energy Intelligence. A version of this article originally appeared in Energy Compass.

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