Foreign Ministers from Ireland, Lithuania and the Netherlands say the European Union is drafting proposals for an oil embargo on Russia as news of civilian killings continues to flow out of Ukraine.
The EU approved a fifth round of sanctions that included a ban on Russian coal imports, last week. Reuters quoted Josep Borrell, High Representative of the European Union for Foreign Affairs and Security Policy, saying a further ban on Russian oil imports – would constitute an “asymmetric shock.”
With Russian oil making up nearly a quarter of the EU’s crude imports, The Cipher Brief looked to Energy expert Norm Roule for perspective on what this means and what it likely means in the future as Europe has no quick solutions to its energy problem.
The Cipher Brief: The prospect of expanded Western sanctions targeting Russia’s energy sector would work directly against European economic interests. According to some observers, cutting off Russian gas could wipe out growth in Europe's biggest economies, send energy prices to record levels, and propel inflation through the global economy. In light of these consequences, what measures is Europe likely to pursue to demonstrate its disapproval of Russian military actions in Ukraine?
Roule: My sense is Europe will likely continue to gradually increase economic sanctions on Russia, especially as evidence of Russian war crimes and broad destruction of Ukrainian cities roll out. But the economic consequences of quickly shutting off Russian energy will prevent any draconian shifts until Europe – especially Germany – develops a plan to ease the pain of cutting off Russian imports of oil, gas, distillates, and coal.
A hard cutoff of Russian energy would confront Europe with curtailed industrial production, blackouts, an inability to build stockpiles for next winter, and a likely recession. Policymakers will also want to understand the impact further economic sanctions will have on emerging economies and whether India and China will cooperate. Actions that diplomatically isolate Russia will be easier, albeit far less impactful on Russian decision making.
The Cipher Brief: Even before the public exposure of apparent atrocities committed by Russian troops, European leaders – Germany, in particular – were talking about implementing contingency plans to reduce dependence on Russian energy supplies. What do these measures include, and could they be expanded and accelerated?
Roule: I think first it is useful to understand a few things about the energy market. Coal and oil operate in a global market, i.e., country X can produce a product, market that product at a price set by an international market, and sell it anywhere in the world. Gas tends to be a regional market defined by pipeline architecture. Russia’s gas sector is divided into pipelines heading West and another set heading east.
Contract prices are set between Russia and individual purchasers, not by any international standard. The U.S. has considerably more gas than Europe and uses it domestically. That is why gas prices are low in the U.S. while they have skyrocketed to unprecedented levels in Europe. At the same time, Moscow knows that this arrangement makes it vulnerable to any cut off by Europe. Prior to Russia’s invasion of Ukraine, the U.S. administration tried to justify its approval of the Nordstream 2 pipeline, in part, by highlighting the dependence it would impose on Moscow.
We shouldn’t forget that even prior to the Russian war against Ukraine, energy markets saw unprecedented upward price pressure and volatility. In late 2021, there was a widespread sense that the post-COVID economic recovery would require more oil than what was available on the market. Stockpiles worldwide were low. OPEC plus maintained a disciplined approach to production, sticking to a plan and ignoring political pressure from the U.S. and other countries. The U.S. oil industry increased its production last year, but shareholders, tired of years of losses, insisted on limiting growth in favor of returns. The lack of sufficient capital investments in recent years hampered production everywhere outside of Saudi Arabia and the United Arab Emirates. Winter 2021 saw terrific price hikes for oil, gas, and coal, especially in Europe. The U.S. and other countries already looked to releases from strategic oil reserves to cool prices and their inflationary (and political) consequences.
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Last, we are watching the result of a failed policy. Europe has gambled in recent years thinking it could rely on Russia and shift from carbon-intensive energy to green energy sources. It rejected options to invest in infrastructure – including storage – for hydrocarbons. It also tried to draw down its use of nuclear energy. Like America, Europe correctly recognized the need for climate friendly technologies, but failed to develop a transition plan to safeguard its economies during periods of crisis.
The Cipher Brief: What does this mean on the ground?
Roule: Europe does have options to replace Russia-sourced energy imports, but they will be expensive and will take years to develop. The decisions will transform budgets, test political coalitions, and require new economic partnerships around the world.
There will be several simultaneous actions that will play out in the coming months and years. Europe will need to become a larger player in an increasingly seller-friendly market for coal, oil, and especially liquid natural gas (LNG). That won’t be cheap, as it is competing with Asian buyers.
Next, Europe will likely extend the lifespans of existing nuclear power plants and may establish new plants. Then, it will also expand its infrastructure to receive LNG, and the facilities and pipelines needed to regasify and store imports. Of course, we will also see efforts to accelerate green energy projects and climate friendly technologies.
Perhaps the hardest political pill to swallow will be the use of coal. Europe has significantly reduced its capacity to produce this decidedly climate-unfriendly fuel. But a reduction in production didn’t mean a similar reduction in use. Europe instead turned to Russia for its coal needs. Europe now imports about 40% of its coal requirements and around half of that comes from Russia. Other sources exist, as well as other buyers, for Russian coal. But it will take time to sort this out.
The Cipher Brief: Although the present crisis is centered in Europe, global factors are likely to come into play as the U.S., EU, and Russia prepare for shifts – and countermoves – in the energy economy. What role could actors outside the region – especially Middle East oil suppliers – play in the evolving situation?
Roule: First, we should remind ourselves that Russia is one of the world’s largest producers of oil, gas, coal, and metals. It’s unrealistic to think that any outside source exists that could easily replace it. For this reason, I would be careful about overstating the immediate role open to any third-party energy producers.
Coal and oil will be expensive for Europe, but as I said, outside sources do exist. Gas is a different story. The U.S. is working flat out to send as much LNG to Europe as possible. But we won’t be able to increase our exports until additional LNG plants and associated pipelines appear. Middle East gas producers are also producing at their limits. It is possible that Algeria might be able to up production as well as Azerbaijan, but this wouldn’t change Europe’s picture. It is possible that some relief could be provided following an Iran deal, but that won’t be a game changer and a deal remains uncertain.
The Cipher Brief: Are oil-producing states likely to favor the U.S. and its allies, or Russia?
Roule: Oil producers are likely to try to remain outside the conflict, at least for the present. There are a handful of reasons for this.
First, the current administration has done little to build the relationships needed to ask oil producing partners to make hard decisions which will impose a cost on their economies and raise genuine security risks.
The Iran deal has little support in the region and most Sunni states see it as a flawed deal that buys fleeting nuclear concessions at their strategic expense. A deal is seen as a prelude to a better resourced and no less aggressive Iran.
Next, Russia can’t be disconnected from OPEC policy and Gulf security dynamics. Russia is already selling Urals oil at a discount of as much as $30-$32 a barrel. OPEC doesn’t want a price war with Russia. Market stability requires cooperation with Moscow on energy policy. The region has also watched with concern how an aggressor country (Russia) has attacked a neighbor and the best the world could do is provide weapons out of fear of igniting a broader conflict. Add to this the U.S. and West’s flaccid response to Iranian missile attacks and you have a decision-making environment where Gulf oil producers doubt Western commitment to their security in any conflict initiated by Iran.
Now, add the Russia factor. Moscow is important to the region only because of its capacity to act as a malign actor. It is likely to remain the main political supporter of Iran, and probably its primary future arms supplier. Gulf leaders are unwilling to lose the limited influence they have over such an actor given that they are uncertain the U.S. will stand with them against a Russia-empowered Iran the day after.
Washington has shown signs of trying to improve its relationships in the Gulf. Success will take time and remains hostage to the Iran Deal, regional developments, and the administration’s ability to curtail the U.S. Left’s use of the Gulf states and oil as political and social media fodder.
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