What Counts Most in the Energy Wars?

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Natural gas is the critical front in Europe’s ongoing energy wars. Oil supply disruptions will reemerge over the winter if the EU stops buying Russian crude and then oil products, as targeted. Prices will spike, caps or no caps. But these disruptions can be resolved without huge damage to the European, Russian or world economies, as Russia finds new homes for its oil, aided by the strong geopolitical support Moscow enjoys on this front. Gas is different. Whoever turns off the tap, most of the Russian gas now supplying Europe will find no new home. It will remain in the ground, as Russia has little bankable geopolitical support when it comes to gas. Likewise, much of Europe’s gas demand will be destroyed ahead of schedule, by recession and renewables. This is bad for Europe now, bad for Russia later, and very bad for gas's growth prospects.  

Western energy policymakers seem unable to think about oil and natural gas at the same time. Russian policymakers, in contrast, are adept at coordinating moves across oil and gas markets to their advantage. As a result, the West risks turning this winter’s critical campaign in the energy wars into a damaging rout for Europe — and for Western economies more broadly.

The EU is fast approaching self-imposed deadlines of Dec. 5 to drop the bulk of its of Russian crude imports, totaling 1.3 million barrels per day, and of Feb. 5 to halt its 900,000 b/d of Russian oil product imports. If recent experience is any guide, Russia will manipulate gas flows so that oil market disruptions related to these well publicized deadlines coincide with a shortage of natural gas that, at minimum, will push Germany and others into full-scale gas rationing and more factory closures.

Adding to the complication is the convoluted G7 scheme to apply a “cap” — the level yet to be determined — on the price other countries should/could/would pay for Russian oil and still get their tankers insured by EU and UK companies, which have a near-monopoly in this field.

The prime US goal is to keep Russian oil flowing so US voters aren’t irritated by higher gasoline prices during Congressional elections in November. The EU aim is to cap Moscow’s oil revenue so EU voters aren’t further irritated by how well the Russians are doing while they’re suffering. To achieve both goals, Russia has to sell lots of oil at prices that are probably below the already discounted rates they give China, India and others.

This assumes that Russia is bluffing when it says it won’t sell oil to anyone who accepts the caps; that China and India are bluffing when they say they won’t accept a Western-dictated oil price cap; that other insurance options won’t materialize; and that EU and UK insurers will continue to provide coverage to buyers claiming to accept the caps.

None of those things are guaranteed. Getting all of them is implausible. That means oil prices will probably soar just in time for the US elections and that Russia will succeed in making that oil price surge coincide with an even more acute shortage of gas in Europe, thus keeping Russian oil revenues afloat even as sales volumes fall, while sinking the German economy.

Given time, though, Russia should be able to find buyers for most, if not all, the oil rejected by EU members. It has support from China and India on the buy-side, and from Saudi Arabia and Opec-Plus on the supply side. None of these countries appears to be in a mood to let the US and EU tell them what fuel to use or what to pay for it.

Gas A Different Game

Natural gas is politically lower-profile than oil. The impact of high gas prices has been less visible to Western voters historically than gasoline and diesel prices. The international gas trade remains small compared with oil. And its transportation is much more expensive and inflexible. This makes cross-border and national gas markets much more brittle — easier to break and harder to repair. The European gas market and the international LNG market are both well-and-truly broken at this point, as has become very visible to European users.

What this means, among other things, is that Russia no longer has much to lose in this game. Europe was a huge and hugely profitable market for Russia’s enormous gas reserves, but for future intents and purposes, that market is already gone. By announcing their intention to halt purchases of Russian gas as rapidly as possible, the Europeans lost all their bargaining chips. Why worry about being a dependable supplier of customers who are about to drop you?

This is particularly true since Russia doesn’t desperately need the income from gas sales in the short term, given high oil prices and the exorbitant amount Europeans paid for the gas they put into storage over the summer. Those stocks won’t look like such great trump cards in the winter poker game to follow if Russia halts all gas sales within the next couple of months.

Seeing this, all it took was a threat from Moscow to stop selling to anyone adopting a gas price cap for EU member states to drop like a hot potato the Commission proposal that they impose a “cap” on the Russian gas price. Score one for the Russians.

Tumult followed in Brussels. Some countries — mainly ones less dependent on gas — want to cap all gas prices, regardless of source and regardless of the fact that this might cost Europe much-needed spot LNG cargoes. Germany and its heavily Russian-gas-dependent northern neighbors quickly nixed that. Norway has offered to discuss gas pricing, which is helpful.

There Is No Alternative

But truth is, Europe has no good alternative to Russian gas — as has been evident since the beginning. Seeing this, Russia may well decide to remain the cutter, rather than waiting for Europe to make it the cuttee. That will allow Moscow to pick the timing for cutbacks that best serves its aims of debilitating the German manufacturing sector and dividing and weakening the EU as an entity.

None of this is to say that Russia isn’t paying a huge price in terms of future gas sales. It will leave much more gas as “stranded assets” than it would have had it not invaded Ukraine, because it has no good alternative to Europe as a gas customer.

China and India have already taken this year’s absurd gas price spike as evidence that gas isn’t a dependable bridge, and they should move quicker into renewables and stick with coal in the interim. The increases agreed to by China in Russian pipeline gas and LNG purchases this year were already in the cards and won’t begin to make up in volume terms for the loss of Europe. It also radically diminishes growth prospects for LNG and ensures that talk of a long-elusive gas exporters club involving Russia, Iran and perhaps Qatar will remain elusive.

The big question that has no clear answer is what all this will mean to the German and broader European economy and to the EU as a unifying institution. Both are in for tough times in the months ahead and probably extending for at least a couple of years beyond that. The question is whether they will bounce back after mid-decade. That is, indeed, a good question. Of course, the same could be asked about Russia.

For more coverage of the Ukraine crisis, visit Ukraine Crisis: Energy Impact

Sarah Miller is a former editor of Petroleum Intelligence Weekly, World Gas Intelligence and Energy Compass.

Sanctions, Gas Prices, Gas Supply, Gas Demand, Oil Trade, Oil Prices, Ukraine Crisis
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