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In Wielding Natural Gas Price Against Ukraine, Putin May Have Miscalculated

In Wielding Natural Gas Price Against Ukraine, Putin May Have Miscalculated

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By Jacob Glass, ASP Adjunct Fellow

Gas Pipes to EURussian natural gas producer Gazprom announced last week a more than 40 percent increase in the price Ukraine must pay for its energy. The announcement ratchets up pressure on Ukraine’s new government, which imports 60 percent of its natural gas from Russia and is teetering on the brink of financial crisis. Widely seen as punishment for Ukraine’s U-turn toward Europe, the price increase does not come as a surprise to the international community. Since 2006, Russia has twice turned off its gas valves as a way of eliciting political concessions from Ukraine and reminding European countries who supplies them. In this way, Russian President Vladimir Putin has tried to wield Moscow’s monopoly over natural gas supplies to maintain influence over the former Soviet bloc and to leverage energy-dependent European governments.

But the landscape on which this latest energy-based geopolitical battle will be fought is changing. Shifting energy markets and a renewed commitment by Europe to wean itself off Russian gas imports mean that Putin’s calculations may prove costly. Could this spell the end of Putin’s use of natural gas as an instrument of Russian state power?

“This is a radically changed market,” Carlos Pascual, a former American ambassador to Ukraine, who leads the State Department’s Bureau of Energy Resources, said in a recent interview.

Ambassador Pascual is right.

When Russia last interrupted gas exports, European dependence was painfully obvious. Moscow cut gas supplies to Ukraine in 2009 after Kiev failed to agree to Russian price and trade tariff demands. The subsequent crisis led to economic problems in the Balkans and countries such as Hungary and Slovakia, and left many central Europeans without heat in January. At the time, shale gas resources in Europe were not being developed, and the full extent of the American gas revolution was not yet known. In short, Russia was the only game in town, and thus could manipulate the gas market at will.

Now the U.S. Energy Information Administration projects that European countries are sitting atop roughly 470 trillion cubic feet of obtainable gas resources – a vast amount given that Europe consumes only 18 trillion cubic feet per year. Ukraine itself has taken promising steps towards developing domestic production. Last year, Chevron and Royal Dutch Shell each inked deals to invest $350 million in five-year gas exploration programs and $10 billion for drilling development in the western part of the country.

In the United States, advances in hydraulic fracturing, or fracking, have vaulted US production of natural gas past that of Russia. The US gas boom has led both producers and lawmakers to explore the possibility of exporting liquefied natural gas (LNG) to Europe, a move that some say could greatly undermine Russia’s strategic position. To date, American companies have submitted 21 applications to the Department of Energy for exportation to countries that do not have a Free Trade Agreement with the U.S. (countries that do have FTAs are much easier to acquire permits for), six of which have been accepted. Though most American export terminals are in the early stages of development, the first, Sabine Pass, Texas, operated by Cheniere Energy, is scheduled to open late in 2015, bringing with it geopolitical implications that could make US natural gas exports a game changer.

Despite these advancements, a solution to European energy dependence on Russia will not come easily. Much of Europe lacks the infrastructure or the regulatory regime to increase gas production in order to offset imports from Russia. Moreover, “fracking” has attracted controversy from environmentalists and governments across Europe. Countries like the Netherlands, Germany, Denmark, and Ireland all have exceptionally strict (and long) approval processes, borne out of public reluctance, while France and Bulgaria have banned fracking outright. Although US leaders claim they want to supplement Europe with American natural gas, the US may have limited options to counter Russia. The lack of infrastructure on both sides of the Atlantic means that no gas will flow soon. Meanwhile, prices are also a major obstacle – Europe has unused LNG import capacity because the price for LNG is much higher in Asia than in Europe.

Looking ahead only a few years, Russia’s endgame becomes unclear. Just as Europe is dependent on gas imports, Russia is equally – if not more – dependent on gas exports. Energy accounts for roughly 70 percent of Russia’s annual exports, and Gazprom’s gas sales alone are worth 13 percent. Gas profits have been the financial foundation upon which Putin has modernized the Russia military and funded the Sochi Olympics. Without a steady European market for its gas, the Russian economy would suffer dearly.

The wealth generated by gas exports has also allowed Putin to maintain popular support within Russia and ingratiate himself with the country’s business elite. Much of that wealth has been siphoned off by Russian oligarchs and now resides in Cypriot bank accounts or London real estate. But if his geopolitical maneuverings begin to cut into the profits of Gazprom and other gas producers, Putin may no longer be able to count on political support from those who’ve become rich off the state – certainly not if his foreign policy objectives significantly diverge from their commercial ambitions.

Their dependence on Russian gas supplies may serve as a wakeup call for Europe. If so, it has antagonized those in Brussels into taking serious steps to reduce dependence on Moscow. In hitting Ukraine with steep gas price increases, Putin is drawing from his traditional playbook. But as the energy landscape diversifies, this time he may not be thinking enough moves ahead.

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