Will Europe ever enjoy cheap Russian pipeline gas again? [Gas in Transition]
Before 2022, Russia was exporting around 200bn m3/year of pipeline gas to the EU, at a price of around $0.20/m3. That’s around $0.02 per “raw” kWh of energy – cheap by anyone’s standard. For comparison, cheap coal at $120/tonne provides a raw kWh for $0.015, but is much less flexible both as a fuel, and has almost no use as a chemical feedstock. Some customers (for example Estonia) and at some times the rest of Europe (during the COVID-19 market crash) saw Russian gas prices even lower than that, down to $0.10/m3.
With the benefit of cheap energy Europe (and in particular Germany) fostered an industrial and power sector whose margin structure, and therefore profitability, was entirely dependent on the low input cost of gas. German chemical and fertiliser plants prospered, as did the German economy. In 2021 those gas-intensive industries accounted for about one tenth of German GDP.
The Ukraine war ended that stable situation. At the end of February 2022 the European Commission imposed unilateral sanctions (not sanctioned by the UN Security Council) not on Russian gas itself but on transactions with Russia’s Central Bank, and with banks operating at its direction. Gas buyers naturally assumed that Gazprombank was caught by that decision.
The Commission’s Fourth sanctions package, in March 2022, provided a cutout for gas import deals with Gazprom. Moscow responded by decreeing that gas sales to “unfriendly” countries must be paid for in rubles, which would of course require a (banned) transaction with Russia’s central bank.
Moscow quickly suspended supplies to BulgarGaz and PGNiG, which refused to comply. Commission officials opined shortly afterwards that it would treat any company that paid in Roubles as in breach of the Central Bank sanction. Meanwhile there was, and remains, the risk (effectively a certainty) that payments in non-ruble currencies would be frozen by London, Brussels and Washington alongside the $300bn-odd that was frozen at the start of the war.
The gordian knot created by the interaction of Commission sanctions and Moscow’s response in practice amounted to a Commission ban on gas imports, not a Russian one, though it was easy to present it as the reverse, and that is the interpretation that now dominates the narrative.
Whichever is a more convincing interpretation, the pipeline gas market dribbled to a halt as existing contracts wound down (Russia fulfilled those to the letter, sanctions notwithstanding). The Commission then successfully persuaded Europe’s media that the gas supply had been stopped by a Russian embargo.
Faced with a frightening gas supply squeeze Europe turned to the LNG market to fill the gap. Here US LNG, with capacity up-stepping almost every month, was happy to supply, at a price. At the peak of the crisis in spring 2022 Europe was buying US LNG at $70/mn Btu, or an eye-watering $2.50/m3 – ten to twelve times more than it had been paying Russia.
In August 2022 an even more painful peak price was reached - $99/mn Btu, or $3.50/m3. Over 2022 US suppliers dispatched approximately 100bn m3 of gas to Europe. We can’t find a single data point for the amount spent by European buyers on US LNG but the LNG total, according to Eurostat, is around $400bn and a lot of that ended up with US suppliers. That’s 2% of GDP and double the trade surplus of the entire EU before 2022. Europe went from a trade surplus of $220bn to a trade deficit in 2022 of around $550bn. As EU energy demand fell in 2023 and prices came off their crisis peaks the Union’s balance of trade has recovered, but only to an approximate zero balance. The days of EU trade surpluses appear to have ended.
While paying painfully high prices for US LNG, European markets also cut demand. Industrial demand is reported to have fallen by up to a quarter, while demand across the EU was down by around 54bn m3 in 2022, and will probably turn out 100bn m3 down in 2023.
Truly a roller-coaster of a ride, but where does that leave Europe as a possible gas customer?
In GDP terms, the loss of cheap Russian gas roughly cancels out the EU’s GDP growth trend (an anaemic 1%/yr even in good times), as well as leaving the Union a billion dollars a day poorer.
In strategic risk terms, it means that Europe’s energy mix is now substantially vulnerable to pressures flowing from Washington, which can restrict or stop US LNG exports to the EU at will. Last month (Jan 2024) Washington did indeed float the idea that future plant builds and export licences might be scaled back by decree. The Commission may believe that it has escaped from the risk of Russian geopolitical blackmail, but it has taken on the risk of US geopolitical blackmail in its place.
That understanding is not yet widespread. The orthodox narrative in Europe today is that Moscow switched off its gas supply to punish European countries for supporting Ukraine. Bizarrely, that narrative even went so far as to claim (for a while) that Moscow blew up its own Baltic pipeline to enforce its embargo.
Equally narrowly understood is the fact that Europe’s economies have suffered a major setback from the loss of dirt-cheap raw energy. That loss is being felt most strongly in Germany, where plants are being shuttered and major new plant investments have been switched to the US and Asia where dirt cheap pipeline gas is still available.
The industrial pain will be well-shared with consumers, who are being invited to pay up to $0.50/kWh for power, three times what they were paying before 2022, and ten times what their American cousins are paying even today.
This is the landscape in which the question of whether Europe will again enjoy bulk cheap Russian gas sits.
For Russian gas supplies to restart we would need a willing buyer and a willing seller
On the buy-side, the present government of Germany is showing zero signs of coming back to the Russian gas counter. One driver is its willingness to go along with the Commission’s and Washington’s trope that Moscow wants to extend its invasion of Ukraine to the rest of Western Europe. Just last week Berlin’s defence minister issued a public warning in an interview with Tagesspiel that “…we have to take into account that Vladimir Putin might even attack a NATO country one day...while a Russian attack is not likely "for now, our experts expect a period of five to eight years in which this could be possible."
Another is the German Green Party in Berlin’s coalition, which may have no strong views on a military threat from Russia, but is very happy to jump on the no-Russia bandwagon because it promotes an outcome that they intensely desire – less energy consumption throughout the economy and another reason to decarbonise.
Fear of the “Russian Threat” is not unique to Berlin – the Commission, the White House and Whitehall all echo the idea. In the UK last month the head of the Army even went public on the front page of the country’s leading broadsheet newspaper with a warning that the UK could bring back conscription to head off the Russian threat. Quite how that threat will bridge the 2,500 km (as the drone flies) from the Donbas to Dover he didn’t explain.
At the political level there seems little chance that Europe will become a willing buyer of Russian gas again, at least while the present political consensus prevails. That consensus (that Russia is a present military threat to the EU) is now so deeply embedded as a truth in the mass consciousness that it is hard to see how it could be changed over any time period less than at least half a generation (15 years) or even a full generation (30 years). People as a rule hate admitting that they were wrong, and hate even more admitting that they’ve been deceived.
What may be true of the mass is less true of the minority. One small vocal minority, of Germans, has seen that the Russian “threat” is a chimaera, and have noticed the damage that the loss of cheap gas is inflicting on Germany’s economy, but mass demonstrations at the end of 2022 had no impact on Berlin’s policy choices. This month’s demonstrations in Berlin by German farmers are equally unlikely to change the political consensus in Berlin or elsewhere. It’s hard to escape a conclusion that Germany will not be a willing buyer of cheap Russian gas for two or three decades to come.
What about the willing seller?
Moscow’s budget plans for 2022 and 2023 were certainly discomforted by the European Commission’s ruble ban. Most of Russia’s existing gas export infrastructure heads west, to the EU. However, Russia’s net trade surplus actually rose in 2022, to $280bn, and should come out comfortably above $100bn for 2023.
Its state budget was also able to take the strain. Russia’s finance ministry has released an estimate that 2023’s net deficit ran at $36bn, $10bn less than 2022, compared with estimates of non-frozen reserves and gold somewhere between $200bn and $300bn. Few observers compare those numbers with the deficits, trade balances and reserves of Russia’s western opponents, which are all littered with deep red ink.
Moscow is not sharing what it thinks about the future of its gas exports. In his interview with Tucker Carlson last week President Putin hinted baldly that Moscow would like to restart gas supplies, saying “…we are ready, please…”, but one component of its strategic analysis must be the truth that Europe might once have bought a lot of gas but it paid little for it. Perhaps the loss of a large low-margin market is not the economic disaster that Brussels and Washington would like it to be.
But let us suppose that Moscow decided that it would like to win back a chunk of that European market. What would it think next? Moscow strategists would immediately consider two large strategic obstacles – that its export lines pass through the Baltic seabed, Ukraine and Poland, and that three quarters of the Baltic line are in ruins.
Nord Stream was built originally to allow Moscow to by-pass the Ukraine pipeline system, and so escape Ukraine’s habit of “taxing” gas transits with unauthorised extractions. Would Moscow choose to invest the $20bn plus required to replace its damaged pipeline in the Baltic? Probably not.
Apart from the fact that the profitability of cheap gas supplied through an expensive pipeline is unattractive, it has learnt the hard way that Washington and the UK have no compunction about interrupting that pipeline when it suits them. President Biden stated openly in February 2022 that “…If Russia invades, that means tanks or troops crossing the ... border of Ukraine again, then there will be ... no longer a Nord Stream 2. We will bring an end to it”.
The public domain doesn’t know at present who blew up the pipeline or how, but the most likely mechanism for the very large charges required was a demolition team launched from a nuclear submarine’s special forces delivery system – a garage-sized pressure-proof pod carried outside the submarine’s hull, which is currently deployed only by the US and UK navies. Research by the redoubtable and unimpeachable Seymour Hersch seems to arrive at much the same conclusion. Moscow is certainly sure that that is what happened.
Perhaps that was not the mechanism used, but it could easily become so for the next attack if Nord Stream was rebuilt. Subsea infrastructure (both pipelines and fibre optic cables) stretched out over thousands of km of seabed are effectively beyond protection.
So, even if Moscow wanted to start supplying heavily discounted gas to Europe it would have to conclude that its routes were excessively vulnerable to attack, and very likely to be attacked if geopolitical circumstances changed. Why would it want to go back to all that risk, President Putin’s offhand remark notwithstanding?
With little prospect of either a willing buyer or a willing seller it therefore seems unlikely that Europe will ever again become a major pipeline gas customer of Russia.