It’s all about the gas.

The European Union has responded to the Ukrainian Crisis with several waves of sanctions on Russia. These relatively “safe” sanctions, suggest a fear that Russia will use energy as a political tool in response to heavier sanctioning, given Russia’s employment of “energy tactics” in the past and the fact that Russia is currently engaged in an ongoing gas-dispute with Ukraine.

First, a little background. Russia is the eighth largest economy in the world, and is the largest exporter of natural resources in the world, accounting for 10.5% of global exports (WTO 2012). Russia’s economy is highly dependent on its hydrocarbon exports, with revenues from oil and gas production accounting for 52% of federal budget revenues and over 70% of total exports in 2012 (US Energy Information Administration 2012). The state-owned Russian company Gazprom controls 65% of Russia’s natural resources and produces 90% of Russia’s gas (Stegen 2011, 6506).

In June, Russia decided to cut its gas supply to Ukraine, as Gazprom’s price demands were not met and Ukraine’s US$5 billion debt was not repaid. This has, in part, contributed to Gazprom’s 41% decrease in net profits recently released. Gazprom has assured the EU, that Europe’s gas will be delivered as promised. Russia has a history of attempting to use its energy as a policy tool, particularly in its relations with post-Soviet European states including the Georgia, Moldova and Ukraine. Ukraine is particularly important to Russia and Europe, as the “Brotherhood” pipeline (Urengoy-Pomary-Uzhgorod), Russia’s largest transportation route for Russian gas to Western European countries (including Czech republic, Germany, France and Switzerland, Austria, Italy, Hungary and several countries of former Yugoslavia), transits in Ukraine. Approximately 50% percent of Russian gas is routed through Ukraine according to the Oxford Institute for Energy Studies.

Yet, Russia has also closed off its gas supply to the Ukraine in 2006 and 2009. Both times, cuts to the supply of gas coincided with Russian interests in Ukrainian politics, following the election of pro-West candidate Viktor Yuschenko in 2005, and the appointment of Yuschenko’s ally Julia Timoshenko as Prime Minister in 2008. In 2009, the supply cut lasted for 13 days, and its effects were felt beyond Ukrainian borders, when eighteen European countries, including Germany and Italy, reported major drops in or complete cut-offs of their gas supplies. In both cases, Gazprom defended its actions by Ukraine having not paid back its significant debt as required.  Such sporadic supply cuts have exposed Russia as a more volatile and unreliable source of natural gas to Europe.

Europe is heavily reliant on Russian natural resources, and supply cuts are a serious concern. In the EU, for example, 34% of overall natural gas imports, 34.5% of crude oil imports and 27.1% of coal imports originate from Russia (European Commission April 2013, 16). Germany is convincingly Russia’s largest trading partner in terms of natural resources and energy, while Poland, Italy and the UK also rank highly in terms of Russian oil, natural gas and solid fuels imports respectively. EU member states such as Ireland, Cyprus, Luxemburg and Portugal have little to no reliance on Russia for natural resources. Non-EU European states, typically former Soviet Union members, also rely heavily on Russian natural resources. At 2009 levels, the Slovak Republic imported 100% of its natural gas from Russia, while other states exhibited varying levels of dependence on Russian natural gas imports including Belarus (with 99% of natural gas imports originated from Russia), Georgia (88%), Serbia (87%), Montenegro (87%), Ukraine (69%), Turkey (64%), Croatia (37%) and Switzerland (12%) (Forster 2014).

As articulated by Guenther Oettinger, European Energy Commissioner, in mid-August this year, “Our main concern, no doubt, is gas. We have ongoing negotiations between the Russian Federation and Gazprom on one hand, and Ukraine and Naftogaz and our European Commission”. As such, EU sanctions have carefully avoided the gas industry. Initial sanctions imposed by the EU on Russia, in the wake of Crimea’s annexation, involved travel bans on, and the freezing of assets on thirty-three “Russian political elite”, and appeared to lack real consequence for Russia. Sergey Lavrov, Russian Foreign Minister, characterised these sanctions as more symbolic and “detached from reality”. The latest round of EU sanctions were announced on September 12, and are more hard-hitting economically in nature. These involve extending export bans, excluding Russian banks from raising long-term capital in the European Union, the targeting of more senior officials close to Putin and banning of future EU-Russian arms deals.

On September 18, Dmitry Medvedev, the Russian prime minister, announced a tough federal budget prepared in “such difficult circumstances when an economic slowdown was exacerbated by the implementation of sanctions on individual sectors of the economy”. The Ukrainian Crisis has hit the Russian economy hard, with the World Bank predicting that the economy could contract by up to 1.1% without even taking into account the impact of Western sanctions (World Bank 2014). There are concerns that Russia is heading for a recession, given that its GDP contracted by 0.1% in June and 0.2% in July this year. While the IMF does not expect Russia will go into recession this year, they project that Russia’s GDP will grow by 0.2% for 2014, which is considerably less than the 1.3% GDP growth in 2013 and 3.4% GDP growth in 2012. This furthermore suggests a slowing of the Russian economy, prior to the Ukrainian Crisis. Additionally, on September 17, US$1 bought 38.71 Russian roubles, marking the roubles weakest value since 1998 (i.e. the year the currency was restructured). The high dependence of Russia’s economy on hydrocarbon exports will ensure that any decision to cut gas supply to Europe is measured and considered.

It is important that the EU sanctions Russia for its conduct in the Ukraine, if it deems appropriate to do so. However, until viable alternative arrangements can be found for gas supply to Europe, it is important the EU play it smart. This time of uncertainty can present as an opportunity. As mentioned previously, Georgia, Moldova and Ukraine have all been on the receiving end of Russia’s “energy politics”. All three signed individual “trade-and-political agreements” with the EU in June this year, in the wake of Russia’s increased volatility and instability in their neighbourhood. These agreements promote lower trade barriers and democratic reforms. However, this “eastward” movement of Russia’s ex-Soviet neighbours, could also prompt a Russian retaliation against the EU economically, even though that would involve detrimentally impacting its own economy in the process. Russia’s ground-breaking gas deal with China also sees a potential future shift in leverage in power. Will Russia keep its promise and produce the level of gas to Europe agreed in their contracts? It is hoped that the next EU, Russia and Ukrainian trilateral meeting on gas, scheduled for September 26th, will help address the ongoing Russian-Ukrainian gas dispute and its wider implications for the region.

 

 

References

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http://www.reuters.com/article/2014/08/27/us-ukraine-crisis-gas-idUSKBN0GR0W120140827

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