What would be the price for Europe to become independent from Russian energy?

Since the end of February, the world’s most advanced economies have been imposing harsher and harsher sanctions against the Putin regime, and global brands have been leaving the Russian market of 144 million people. In addition, there is one measure that would hurt the Russians very much, that is the trade embargo on Russian energy. Over decades, there could be scenarios where the EU becomes independent from Russia, although, in the natural gas market this could only be achieved partly at the cost of exposure to similarly dubious regimes. The oil situation is somewhat better, but even there a significant price increase is inevitable.

Russia will find new buyers for its oil, natural gas and coal both at home and abroad as some traditional customers reject its deliveries, said President Vladimir Putin.
“With higher crude oil and product prices globally, Russian oil export revenues are estimated to have increased by $1.7 billion in May to about $20 billion,” the Paris-based International Energy Agency said in its monthly oil report in June.

Inheritance

The Russian energy dependence of Europe – including the largest economy, Germany – is far from being new; in fact, trade in energy resources between the then Soviet Union and Europe was already booming in the 1920s and 1930s, with Nazi Germany being a major importer of oil from the Baku area.

Thus, the well-established trading relationship in the case of oil dates back to a hundred years ago, while for natural gas it dates back to sixty years ago.

Naturally, such an old relationship comes with significant road dependency, which cannot be eliminated overnight without serious sacrifice. To date, Russia accounts for 40 percent of Europe’s gas consumption, compared to 27 percent for crude oil. In numbers, this means that last year the EU and Turkey together imported 175 billion cubic metres from Russia (of which the Turks had around 20 billion cubic meters), but in the peak years this was even more, with the previous record being 201 billion cubic meters in 2018. According to an analysis by the Brussels-based energy research institute Bruegel, if necessary, some 80-90 billion cubic meters of this could be cut and replaced from elsewhere in the short term, but the lack of the rest would cause a serious problem.

The level of energy dependence on Russia varies widely between countries, ranging from one hundred to six percent, but the vast majority of European countries receive at least a quarter of the gas they consume from Russia. The most exposed among the large economies are Germany and Italy. Thus, it is not surprising that voices in the German government were quick to say that we need to stay calm when some EU heads of government began to argue that we should not pay for Russian energy with the “blood of Ukrainians”.

If Europe not buying any more Russian gas and/or Russia cutting gas supplies, it would bring hardships for the next three or four years, with severe restrictions in key industries (e.g. steel or fertilizer production), and even in residential use in a colder winter.

According to analysts, we could manage the next winter, that of 2022/23, but after that we would be in serious trouble. In addition, all coal-fired and nuclear power plants in the EU that are about to be shut down or have already been shut down should be restarted, and some suitable power plants should use oil instead of gas. This would clearly be a major setback for Europe’s climate goals, as natural gas combustion has the lowest carbon emissions of all fossil fuels, and a switch back to coal would be a major step backwards from a green perspective.

The world is experiencing the first truly global energy crisis in history. And as the International Energy Agency has been warning for many months, the situation is especially perilous in Europe, which is at the epicentre of the energy market turmoil.

Interdependence

Since the Russian economy is incredibly dependent on the export of raw material, the Putin regime would certainly be seriously crippled if the EU stopped buying energy from them overnight. Russia was already earning $600-700 million a day from gas sales to the EU at the beginning of March, but even before the war this amount was around $200 million, which was impossible to suddenly replace by Russia.

For Russians, the development of the Sino-Russian gas connection seems to be a failure, with the Power of Siberia pipeline, built at a cost of $55-70 billion (by comparison, Nord Stream 2 cost $12 billion), delivering only 10 billion cubic meters last year. According to an agreement between Russia and China made at the beginning of February this year, the original Russian target of 38 billion cubic meters per year in 2014 was fixed for 2025, but even that is nowhere near the European levels.

Moreover, there are rumors that the Chinese have signed a 30-year contract with the Russians in 2014 at a rather low price of around $300 per thousand cubic meters, which is one seventh of the current European price, and if everyone else gets squeamish about Russian raw materials, further bargaining opportunities could open up.

China also wants to avoid being heavily exposed to a country with much less economic power than itself, is trying to diversify its energy imports, and is opening up to Russia cautiously and slowly.

So the Russian economy could easily be bled out by the European embargo, but sanguine declarations or not, there is no reason to believe that the EU will impose an embargo.

Bottleneck

Europe imports natural gas not only in gaseous state, but also in the form of liquefied natural gas (LNG) from more distant countries of the world, mainly the US. The question arises why we cannot switch to LNG on a larger scale in the short term. The main obstacle is the lack of capacity to transport LNG within Europe.

In particular, the interconnector infrastructure is not sufficient for greater use of LNG. For example, the Iberian Peninsula has a capacity of around 69 billion cubic meters of LNG terminals per year, but the crossing capacity between France and Spain has only 5.5 billion cubic meters, so even if we receive the natural gas, we cannot forward it to the interior of the continent at the right speed.

The same problem exists between England and France, and the German-Belgian crossing capacity is not sufficient either. In addition, the direction of the pipelines would have to be changed, so that instead of flowing from east to west the gas flows from west to east. In practice, all this means a lot of internal development, which takes a lot of money and time, provided that there is any political will at all.

The other problem with LNG is that the cost, including delivery, is higher in peacetime than what we are used to with pipeline gas from Russia – although this is not the case at the moment either, at current prices the delivery cost for US LNG is €22-23/MWh, while the European price has gone up to €200/MWh (since the outbreak of the war) and we are competing with Asia for it on the world market. Japan has traditionally been a major user of LNG, but in recent years, China has caught up and taken over the world’s leading position as an LNG importer, so Europe needs to outbid capitalized, energy-hungry economies to gain access to LNG. There are rumors in the industry that in 2018-19, it would have been possible to conclude long-term contracts for US liquefied natural gas at quite favorable prices, but the EU refused to do so at that time. One the one hand, it was caused by the fact that in recent years, EU gas policy has moved away from long-term contracts towards market pricing, and on the other hand, at the time, it seemed as if supplies from Russia via Nord Stream 2 would start shortly – this has not happened since, and the events in Ukraine have certainly put the project on the back burner for a long time.

It stressed the need to maximise gas supplies from other sources; accelerate the deployment of solar and wind; make the most of existing low emissions energy sources, such as renewables and nuclear; ramp up energy efficiency measures in homes and businesses; and take steps to save energy by turning down the thermostat, said Dr Fatih Birol, Executive Director, International Energy Agency.

The oil situation is much more well-oiled

Oil is a much more global market than natural gas, as it can be easily transported in tanks, so any country buying Russian oil would have more alternatives to replace it. Russia currently sells close to 5 million barrels of oil per day and another 2.5-3 million barrels of oil-derived products (fuel oil, diesel). More than half of this comes to Europe via, for example, the Druzhba oil pipeline and tankers, but China is also a relatively large buyer.

Only 3 per cent of total US consumption (together with refined oil products this has gone up to 8 percent in 2021, to 20.4 million barrels per month) is covered by Russian imports – or rather, was covered, since the Biden administration has already decided on the Russian energy embargo. It is possible to replace such a low share from other sources, and even the EU (with its current 27% dependence on Russia) would have hope.

One potential source could soon be Iran, currently still under embargo, which has recently eased relations with the West. If a second nuclear deal is agreed and sanctions against the country are lifted, Iranian oil could return to the world market as early as May or June. Moreover, they have built up significant stocks during the export restrictions, with the latest estimate being 87 million barrels in tankers. This allows them to start shipping larger quantities immediately.

Another option for the US is to revive its oil trade relations with Venezuela. The Latin American country has the world’s largest oil reserves, but in recent years its oil industry has been a shadow of its former self, with the Maduro regime’s state oil company producing only 0.5-1 million barrels a day. This could be raised to 3-4 million barrels in a few years with US technology if the two countries put aside political-ideological differences for economic reasons. Several large US refineries were designed for Venezuelan heavy crude oil in the past anyway, making them optimal markets for the raw material. There are indications that diplomatic relations between the US and Venezuela have eased recently, and the Russia-Ukraine situation could also help break taboos.

But more alternatives for crude oil do not mean that the world will not pay the price for wanting to punish the Putin regime with an oil embargo:

an oil price of $150 per barrel is now by no means an extreme forecast for this year, but more pessimistic estimates go as high as $185-200
— in January it was $84 per barrel, while the price in July was $105.

The oil price is reflected in the price of almost all goods and services because of its extensive use, so the price increase also fuels the already racing inflation around the world.

The road to independence

Europe is in a much more difficult position when it comes to rapidly cutting Russian energy dependence (especially gas imports) – but in the long term, there is hope. Analysts estimate that, with sufficient political will, it would take roughly a decade to achieve a safe separation from Russia, even in natural gas. The EU leadership has now outlined a more ambitious target of complete separation from Russia by 2030, with similar steps to those recommended by the Bruegel Institute and the International Energy Agency. Boosting renewable investment would be a big help in achieving energy independence, but the EU cannot plan exclusively for this in the timeframe under discussion, and significant gas imports will still be needed.

One important step to diversify this would be to expand LNG capacity, as discussed above, and another would be to explore gas deposits outside Russia that are still within reach by pipeline. The largest gas fields in recent years have been found in the Black Sea and in the Mediterranean Sea off Cyprus (the latter of which would cover three years of European gas consumption alone). But to exploit these and to build the pipelines, German foreign policy would also need to start lobbying hard in this direction, and reach an agreement with Turkey, for example, which does not have many energy resources but could become a key distributor through the surrounding areas.

But this would mean replacing Russian dependence with Turkish (or even Iranian or Iraqi), which raises the question how much more beneficial or politically reassuring it would be.

In other words, the EU could change Russian dependence in ten years with a lot of money and a vehement, united foreign policy – in political terms, perhaps even a Russian regime change would be easier to achieve than this. However, it would also help the process if the EU and the markets stopped penalizing fossil industry companies on green grounds, since because of this trend, these operators have recently invested little in new exploration and are not improving existing technologies. However, this did not in itself reduce gas and oil consumption, but entrenched dependence on imports (including Russian imports).