Armchair warriors wage a phoney war

10 March 2014

Ignore the pundits and their answer to the Putin problem - the solution to the EU's energy security worries lie in Europe, not the US, argues Derek Brower

FROM London to Washington politicians and commentators have arrived at a solution to their Putin problem. Russia is weak, their argument claims, because it depends on oil and gas revenue. Unleash American energy on the world and watch the Kremlin crumble.

It's a neat answer, because none of the Western powers wants a real war over Crimea, and UK, German, Italian and others' financial interests make them reluctant to back sanctions on Russia. 

John Boehner, speaker of the US House of Representatives, says swifter approval of liquefied natural gas (LNG) exports "is one clear step the US can take to stand by our allies and stand up to Russian aggression". Lisa Murkowski, a senator from Alaska, says oil and gas are now a "strategic asset" for the US, which should "be aware of what we have and how important a tool diplomatically an energy asset can be".


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Big media names are on board. The Wall Street Journal thinks the US can "use energy as a weapon against Putin", sending LNG first to "our good friends in Europe". In the UK's Times newspaper, one commentator thinks the US unconventionals boom could "kill Russia's energy industry". Another in the Daily Telegraph notes that rising US energy output helped with sanctions on Iran. "Should Moscow be the next testing ground for America's E-bomb?" asks an op-ed.

None of this bears much examination. First, there is nothing the US can do, in energy terms, about Ukraine's plight right now. The first shipments of US LNG, from the Sabine Pass terminal in Louisiana, are at least two years away. Aside from a sales agreement with the UK's Centrica, there is no guarantee that much of the gas will end up in Europe, let alone reach Ukraine. As Michael Levi, of the Council on Foreign Relations, points out, it isn't the US government that will sell this LNG. Companies will - in markets where prices are highest. For the foreseeable future, that's Asia.

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Despite that commercial reality, Texan Congressman Ted Poe has just introduced bill HR 4155, "To authorise natural gas exports to certain foreign countries, and for other purposes". His bill, we are told, may be referred to as the "Fight Russian Energy Exploitation (FREE) Act". It is designed to speed LNG sales to Ukraine, even though Ukraine doesn't have an LNG import terminal.

Lifting the ban on US exports of crude oil is a great idea - at least for US producers keen to export into the global market. But despite the success of the US tight oil sector, the country is still the world's second largest oil importer (China overtook it last year), and will be for years. Total imports this year will be about 6 million barrels a day (b/d) - more than Germany, the UK and France, the EU's three biggest consumers, together used last year.

Oil is a global market in which any US exports would barely make a dent. As the US remains a net importer, any oil sent out of the US would have to be replaced by oil brought in. Opening this trade in both directions might bring down global prices a bit. And it might just narrow the differential between WTI and Brent. Can someone explain how that would punish Russia?

Risk premium

Alternatively, runs another idea, the US could use some of the 700 million barrels of oil in its Strategic Petroleum Reserve (SPR) to weaken global prices. This is absurd. Not much of the oil could be released quickly. It wouldn't necessarily compete with Russian Urals exports. Any dip in the SPR's volume would have to be replaced -because, after all, the reserve is there to deal with shortages and emergencies. What about the long-term impact of such a move? Just as the Arab embargo of the 1970s injected a political risk premium into oil prices for decades after, such an SPR move from the US would forever hang over markets when something, somewhere, annoyed American politicians. Does the US really want to toss away its free-market principles on an untested, silly foreign policy tool?

Apparently forgotten in these daft proposals is that the US is now the world's high-cost marginal oil producer. Its tight oil success has come thanks to sustained high oil prices. Engineering some kind of slump - even if it were possible - would put future tight oil supply growth in jeopardy. It would also need the cooperation of producers in the Gulf, especially Saudi Arabia. Is it in any big producer's interests to weaken global oil prices to the kind of level that would hurt Russia?

As the world's biggest oil producer and biggest gas exporter, Russia doesn't have much to fear from any of these ploys. Its gas sales to Europe rose to 162 billion cubic metres (cm) last year, or 33% of the continent's market. It still meets a third of Europe's oil needs. By May, it hopes to have signed a 30-year gas sales agreement with China, to export 38 billion cm.

Lost opportunity

Both Gazprom and Europe can cope without Ukraine's transit of Russian gas to Europe, at least for the short term. The 55 billion cm/y Nord Stream pipeline to Germany has spare capacity should Russia divert exports away from Ukraine. In the medium term, Gazprom will also have South Stream, its 63 billion cm/y link through the Black Sea to Bulgaria and central Europe, on stream by 2015. Europe's dependence on Russian gas - between 50% and 100% for every country, aside from Romania, that lies east of Trieste - is growing. 

The best time to reduce this exposure to Russian gas has passed. The Trans-Adriatic Pipeline, which will pipe up to 12 billion cm/y from Azerbaijan to southern Europe by 2018, is the only real outcome of the EU's efforts to build alternative import routes earlier this century. The grander Nabucco project, which would have opened the so-called southern gas corridor, has failed.

Brussels propagated several fantasies: that the Caspian had enough gas to become a viable competitor to Russian imports; that Iraq, whose associated gas reserves lie in the south, might feed some supply through Turkey to the EU; that Nigeria, lacking its own electricity, would send gas to Europe across the Sahara; or that Turkmenistan gas could flow across the Caspian, even though Russia, a Caspian littoral state, can stop a pipeline being built across the sea. Unstable North Africa was to be the other rival to Russia. But in the past three years its exports to Europe have fallen from 71.6 billion cm to 48.5 billion cm.

All aboard the Gazprom express

Meanwhile, domestic policies across Europe have left any semblance of an EU-wide energy strategy in shreds. Germany's decision to phase out nuclear power has wedded it to Russian gas (and left the continent desperate for coal). Hungary, Austria and the Balkan states backed South Stream, not Nabucco. Gas-rich Netherlands jumped aboard the Gazprom express when Gasunie signed up to Nord Stream and plotted ways to ship Russian gas further west.

Domestic shale gas could make a difference - but not for a decade, at least. Poland, once considered the country with the best prospects and, given Gazprom's domination of its supply, most reason to exploit its shales has failed at the first hurdle. Officials used to working with Russian partners, say some Polish critics, have successfully thwarted their own country's interests. Ukraine's own reserves are years away from production, too.

Shale optimism has since shifted to the UK. In theory, a shale boom there could see some gas move onto the continent. But no one knows how much it will cost; and the volumes are unlikely to knock Russian gas out of the market anyway. Likewise, new LNG receiving terminals in Poland and Croatia will offer alternative supply only on the margin. It is expensive, too. Extra LNG imports into Europe would end up costing 35-40% more than Russian gas, says Goldman Sachs. And thanks to Russian supplies, Europe can't stomach higher prices. Imports of LNG were 86.7 billion cm in 2010, but fell to 45.8 billion last year, as cargoes were diverted to better-priced markets in Asia. Only a decision by Japan to restart its nuclear sector would change that dynamic.

The arrival of new US LNG supplies from six planned export plants may bring down global gas prices over time. But the expectation of those supplies has also hindered other developments: consumers in Asia, awaiting cheaper US gas, have been reluctant to sign new purchase agreements from other planned LNG projects, slowing future upstream plans.  

Europe's economy is also too vulnerable to risk the kind of energy war being talked about so blithely in the US. Ukraine may be less important to EU imports now than it was the gas wars of 2006 and 2009. But a supply interruption would still be a problem. And sanctions on Russian gas would send prices soaring. Another European recession could follow that kind of price shock. Sure, it would hurt Russia as well, because it can't quickly switch its supplies to another market. A trade embargo, says Citi, a bank, would be a "serious negative-sum event". In energy terms, Europe and Russia are in a lock. Whatever other solutions the West comes up with, turning energy into a weapon isn't the answer. 

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