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ISSUE BRIEF 07.18.17 ’s Use of the “Energy Weapon” in

Gabriel Collins, J.D., Baker Botts Fellow in Energy & Environmental Regulatory Affairs, Center for Energy Studies

“Regardless of how the standoff over develops, one lesson is clear: excessive dependence on Russian energy makes Europe weak.” —, former prime minister of (April 2014)

In June 2017, the US Senate voted 98–2 to pass a bill designed to strengthen existing THE DEGREE OF DEPENDENCE ON US sanctions against Russia, including RUSSIAN GAS, BY COUNTRY a provision that would allow sanctions Europe-Russia discussions against those who provide capital, often focus on because services, or other support to projects manipulating crude oil and refined product that build, expand, or even maintain supplies is generally a less effective tactic. 1 Russian energy export pipelines. The fact Crude and related products are each that US policymakers are now openly traded in highly fungible global markets, debating extraterritorial measures to so substitute supplies can be procured and punish those who facilitate Russian energy transported relatively easily in the event exports suggests the two countries’ geo- that Russian exports are interrupted. By economic frictions could escalate, with comparison, lower fungibility has historically If truly commensurate impacts for E&Ps, service constrained work-around options in the companies, and capital providers. prioritized commercial event of natural gas supply disruptions. In concerns over political Transatlantic disputes over projects particular, Central and Eastern European like the proposed -2 (NS-2) consumers’ lower connectivity to LNG and ones, we would expect pipeline—which would increase Russian other potential replacement gas sources to see more consistent gas supplies to Europe—will likely continue has perpetuated dependency on Russian use of legal processes for years to come, as US-Russia geopolitical supplies and made pipelines a natural to enforce agreements competition intensifies and the political strategic fulcrum for the Kremlin. toxicity of Russia-related matters rises in This analysis focuses on key members and settle disputes and Washington. Accordingly, this brief aims of the EU and/or NATO that could be fewer questionably to inform and contextualize the discussion subject to gas supply manipulations as timed price increases by (1) quantifying the potential exposure of part of a Russian attempt to drive a wedge and supply curtailments. key European countries to Russian gas price between Washington and its core European and supply manipulation, (2) showing how partners. Therefore, not all countries in Moscow has used energy as an instrument NATO, or what is often politically defined as of coercive diplomacy since the early “Europe,” are included. 1990s, and (3) briefly assessing the impacts Russian gas imports equaled 23% and future policy implications of Russian of total UK gas demand in 2016, 25% in entities’ past use of the “energy weapon” France, 40% in Italy, 55% in , in and near Europe. 58% in the , 62% in RICE UNIVERSITY’S BAKER INSTITUTE FOR PUBLIC POLICY // ISSUE BRIEF // 07.18.17

FIGURE 1 — KEY EUROPEAN COUNTRIES’ DEPENDENCE ON RUSSIAN GAS

Gas pipelines No appreciable dependence Heavily dependent

NOTE “Dependence” is determined by percentage of direct Russian imports divided by total annual gas demand. Ukraine now uses reverse flows from neighboring states , so its Russian-origin gas supplies are “indirect.” SOURCES BP Statistical Review of World Energy 2017; GADM (countries); Gazprom (pipeline routes and gas import data)

Germany and Hungary, 64% in Poland, 70% in , and 84% in , INSTANCES OF RUSSIAN ENERGY according to data from BP and Russian COERCION IN EUROPE AND THE gas producer Gazprom. If the NS-2 project FORMER SOVIET ZONE comes online, dependence on Russian gas The Kremlin’s use of energy coercion began in and surrounding countries even before the USSR actually dissolved in could rise significantly. The Nord Stream-1 December 1991. For instance, it interrupted pipeline alone supplied gas volumes oil supplies to the Baltic states in 1990 in equivalent to 55% of Germany’s total gas an effort to crush the region’s budding consumption in 2016. If German nuclear independence movements, although to power plants shut down on schedule and no avail.3 Russian energy companies— NS-2 comes online in the 2019–2020 time presumably with the Kremlin’s blessing— frame, Russia’s direct gas links to Germany have gone on to make multiple attempts could by themselves supply more than over the past 25 years to use energy 80% of German gas consumption even supplies to gain leverage over Russia’s at a relatively low pipeline utilization rate neighbors and advance Moscow’s strategic for NS-2.2 priorities. The author has identified at 2 RUSSIA’S USE OF THE “ENERGY WEAPON” IN EUROPE

least 15 discrete instances where Russian or export terminal is deeply suspicious entities used price and physical volume when the troubles just happen to coincide manipulation of crude oil or natural gas with the rejection of a Russian suitor’s supplies—often amid political tensions—to acquisition attempt.7 pressure consumers located in Central Commercial gas suppliers are certainly and Eastern Europe and the former Soviet within their rights to terminate supplies to countries (Figure 2). consumers that have breached contractual Policymakers’ aversion The “true” number of terms by being in arrears.8 Yet the time disruptions Russian entities have caused periods in which a commercial gas supplier to the potential short- in and around the former Soviet zone is in the European marketplace would usually term losses caused by likely significantly higher than the number allow a customer to remain in breach of a gas supply cutoff or a reported in this study. Consider, for instance, the agreement are short—sometime only politically driven price that in 1998 and 1999 alone, Russian oil seven days from the time the supplier puts increase could expose producer interrupted supplies of the consumer on notice.9 Commercially crude oil to ’s Mažeikiai refinery minded gas suppliers expect a rapid and them to manipulation, at least nine times amid a contest between meaningful resolution of contract breaches. undermine their resolve American and Russian interests to acquire The transparent, punctual, and predictable to stand up to Russian 4 a stake in the facility. Smaller disruptions processes they prefer to resolve disputes are revanchism in and near are not always necessarily reported, or they a hallmark of standard commercial behavior. may instead be cast as “commercial” or Gazprom, in contrast, tolerates Europe, and, ultimately, “technical” disputes—even though many massive debts on the part of certain divide and weaken the have political overtones. customers such as of Ukraine for EU and NATO. Price conflicts and debts owed by years, then suddenly imposes stringent customers—frequently exacerbated by payment requirements and raises prices unilateral gas price increases imposed by when geopolitical tensions increase Gazprom—often become the pretext for between the Russian government and supply curtailment. Such moves are part of the consumer government. The Russian a messaging campaign in which ostensibly company’s inconsistent oscillation between commercial factors are used to legitimize forbearance and sharp, severe price and/ gas price and/or supply manipulations that, or supply changes that closely correspond in many instances, are motivated more by geopolitics than by concerns about corporate profitability. For instance, over the course of FIGURE 2 — KNOWN OR PROBABLE POLITICALLY DRIVEN ENERGY less than a week in late March and early SUPPLY OR PRICE MANIPULATIONS BY RUSSIA (1990–2015) April 2014, Gazprom raised the price of gas exports to Ukraine from $268.5 per 2011 1991 1997 2012 2013 2015 1992 1993 1995 2014 1994 2001 2010 1996 1999 1998 1990 2007 2002 2003 2005 2004 2006 2008 2000 thousand cubic meters (mcm) to $385.5 2009 o g per mcm, and ultimately to $485 per Georgia g g g g mcm.5 This rapid price increase was suspiciously timed—coming on the heels o g of Russia’s invasion of Crimea—and Lithuania o o o o o o transcends the bounds of commercial o o o normalcy. Gazprom cited Ukraine’s unpaid Moldova g gas debts as justification for the price hike, Poland g yet Ukraine had consistently owed Gazprom Slovakia g substantial unpaid sums for gas deliveries g since the January 2009 supply crisis was Ukraine g g g g g g g resolved and Gazprom had not previously made significant, sudden changes to gas Instances involving crude oil are shaded gray; those involving natural gas are shaded blue. Interruptions that caused systemic effects on oil or gas supplies in Europe occured during the years highlighted in orange. pricing for supplies into Ukraine.6 Similarly, the timing of “technical difficulties” in an SOURCES BBC; FOI; Keith Smith; ; oil pipeline supplying a specific refinery 3 RICE UNIVERSITY’S BAKER INSTITUTE FOR PUBLIC POLICY // ISSUE BRIEF // 07.18.17

FIGURE 3 — DID RUSSIAN ENERGY COERCION ACHIEVE MOSCOW’S STRATEGIC GOALS?

Estonia Latvia Lithuania Georgia Belarus Ukraine

Exporter consolidates control of energy resources ü ü ü ü ü ü State control over export routes ü ü ü ü ü ü

Preconditions Exporter carries out price hikes and/or supply disruptions ü ü ü ü ü ü

Target state acquiesces/concedes to exporter state demands û û û û ? û

Results Target state diversifies energy supply sources after initial coercion attempts ü ü ü ü û ü

NOTE Question mark indicates that the effectiveness of Russia’s use of the “energy weapon” to achieve its policy objectives was unclear. SOURCES Karen Smith Stegen;10 author’s analysis of Gazprom export volume data

to geopolitical events disturbs consumers immediate aftermath of supply and price and reduces their confidence in Russia as disruptions, the directly affected countries a reliable energy supplier. If Gazprom (and have sometimes had to make tactical ultimately, the Kremlin) truly prioritized concessions to Moscow—such as Ukraine commercial concerns over political ones, paying higher prices for gas in the wake we would expect to see more frequent of the 2009 shutoff, or then-president of and consistent use of legal processes to Ukraine ’s decision to accept enforce agreements and settle disputes gas debt forgiveness in exchange for allowing (i.e., court and arbitration cases) and fewer Russia to retain most of the Black Sea naval questionably timed price increases and fleet after a September 1993 gas shutoff.12 Russia has supply curtailments. Yet over a longer time frame, the demonstrated a Gazprom’s choices can create serious perception that energy supplies have been consequences for gas consumers further politicized can induce consumers to either rising appetite for down the pipeline in Europe. At least three move to new energy sources entirely, or taking strategic risks, of the gas supply manipulations shown in at least to diversify their energy sources and it would be naive Figure 2 caused systemic disruptions deep to reduce exposure to future volume and to think that the into Europe—particularly the January 2009 price risks arising from a single supplier. gas shutoff that Gazprom instituted due to Energy supply and price manipulation in the Kremlin is not willing Ukraine’s gas debt, which caused pressure former Soviet zone has generally driven the to unleash a “bolt from drops as far west as France and forced targeted countries further from Moscow’s the blue” in the natural businesses and schools across southeastern orbit. Historical examples of national gas supply realm. Europe to shut down amid severe cold.11 responses to Russian energy coercion— such as the Lithuanian and Ukrainian experiences—suggest that after a period HOW EFFECTIVE HAS RUSSIAN ENERGY of initial disruption, traders and consumers COERCION BEEN IN ACHIEVING generally rebuild supply channels in ways MOSCOW’S STRATEGIC AIMS? that are more resilient and diversified, and less directly reliant on Russian suppliers. Energy supply disruptions can, in the short In the most extreme cases, using term, cause firms and consumers to incur the “energy weapon” may have actually significant economic losses, which can then backfired by precipitating additional anti- become social problems as well. And in the 4 RUSSIA’S USE OF THE “ENERGY WEAPON” IN EUROPE

Russia sentiments in countries such as Ukraine and Georgia, which emerged FIGURE 4 — CHANGE IN UKRAINE AND LITHUANIA’S DIRECT GAS from domestic political revolutions with IMPORTS FROM RUSSIA (2000–2016) a generally pro-Western, pro-Europe +150 orientation. Despite multiple energy coercion actions, both Ukraine and Georgia eventually experienced armed conflict with +100 Russian military forces and Russian-backed proxies, and the outcomes of these conflicts have generally proven muddled at best for +50 Russian interests. For example, Ukraine and Lithuania have moved decisively to reduce direct 0 gas imports from Russia over the past five years (Figure 4). Ukraine has done so by increasing its imports of gas from Slovakia, Hungary, and Poland via new pipeline -50 interconnections that allow “reverse flows” of gas from west to east at scale for the first time.13 Baseload gas supplies in Central -100 Europe still typically come from Russia but are also often intermingled with volumes from Norway and the Netherlands as pipeline connectivity improves. The mixing SOURCES Gazprom; Naftogaz of Ukraine of gas molecules makes it much harder for Gazprom to single out specific consumer countries for volume—or especially price— supplies from Russia and also gets better manipulation. prices for the volumes it still purchases In effect, Ukraine has substantively from Gazprom. Indeed, once Lithuania’s unlinked itself from direct imports of Litgas signed a term sheet with Norway’s Gazprom molecules but can still procure Statoil for the procurement of LNG, Russian-origin gas. To boot, the price of Gazprom quickly responded with a 23% reverse flow gas supplies is ultimately discount on gas prices.17 The discount determined largely by trading on helped bring Lithuania’s gas prices from European hubs, rather than by Gazprom’s among the highest in Europe down to a monopolistic pricing. European hub prices more market-driven level. can be volatile, but thus far this appears Perhaps the most critical challenges to be a cost Ukraine is willing to pay to of additional Russian gas supplies into distance itself from Gazprom.14 Europe from the NS-2 pipeline arise in For its part, Lithuania’s Klaipėdos Nafta the political arena. Plentiful gas supplies has leased a floating LNG regasification today have impeded attempts to build and storage vessel from Norway’s Höegh the infrastructure necessary to ensure LNG for a 10-year term, with the option long-term, strategic European gas supply of purchasing the vessel once the lease security. For instance, French regulators expires.15 The terminal can potentially said in 2016 that “there is no economic regasify approximately 4 billion cubic need” for an interconnector pipeline meters (bcm) per year, which is roughly crossing the Pyrenees that would help twice Lithuania’s total annual gas needs; better integrate Spain’s substantial LNG in 2016, it sent out 1.46 bcm of gas.16 The regasification capacity with the broader effects on Lithuanian gas security have European market, citing “stable demand been significant, as the country is now and overcapacity in recent years.”18 much less vulnerable to a cutoff of gas

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Failing to deepen Spain’s connection to Europe’s emerging gas hub architecture THE WILD CARD: RUSSIAN USE OF is a serious blow to supply diversification ENERGY COERCION AGAINST A MAJOR efforts. Spain’s six operational LNG receiving WESTERN EUROPEAN CONSUMER terminals and seventh mothballed facility The current dataset lacks information on have a total annual sendout capacity of the most critical potential scenario for nearly 69 bcm of gas per year.19 Spain only energy security planners and analysts: consumed 28 bcm of gas in 2016, which namely, what could happen if Russia suggests that if pipeline infrastructure targeted a larger country that, militarily permitted, the country could boost LNG and economically speaking, is systemically terminal utilization and serve as a gateway important to Europe. Ukraine and Georgia for non-Russian gas into Europe. Spanish did not rise to this level, but Germany, LNG use peaks in the winter. Using the which is poised to dramatically increase maximum peak in the past five years as its intake of Russian gas through a direct the “set point” for determining sustainable bilateral linkage, does. In such cases, the spare sendout capability suggests that if target country’s economic importance and prices rendered the trade economic and leadership role in Europe would potentially there was enough infrastructure capacity magnify the impact of “tactical” concessions to ship the gas, nearly 33 bcm per year of and confer strategic importance on them. additional gas could be sent from Spanish Policymakers’ visceral aversion to the LNG terminals into the European market potential short-term losses caused by a gas without threatening their ability to serve supply cutoff or a politically driven price local consumers (Figure 5). increase could—particularly if dependence on Russian gas increases—expose them to manipulation, undermine their resolve to FIGURE 5 — ACTUAL DAILY GAS SENDOUT FROM SPAIN’S LNG stand up to Russian revanchism in and near TERMINALS VS. THEORETICAL CAPACITY (2012–PRESENT) Europe, and, ultimately, divide and weaken the EU and NATO.20 The psychological reality that the anticipated risk and pain of a potential future event are worse than if the event actually happens matters to the Russia gas dependency discussion for at least three core reasons. First, increased Western European dependence on Russian gas would raise questions about the willingness of some of those countries to aid smaller Central and Eastern European nations, such as the Baltics, in the case of Russian aggression or subversion. This Volume of Dry Natural Gas (MMcm/day) Volume dynamic is especially meaningful because the robustness of the United States’ strategic commitment to NATO—which has traditionally been the alliance’s bulwark— has been called into question on multiple occasions by President . SOURCE Gas Infrastructure Europe History suggests Moscow believes it can get NOTE Data converted from gigawatt hours (GWh) to millions of cubic meters (MMcm) using a away with singling out smaller countries, conversion factor of 0.1 MMcm/GWh on unit converter. as when Russian state-owned oil pipeline company Transneft disrupted oil supplies to Lithuania in 2006 with impunity, even

6 RUSSIA’S USE OF THE “ENERGY WEAPON” IN EUROPE

though the country had been a member natural gas supply realm. Planning and both of NATO and the EU for two years by physically preparing for such a contingency that time. European leaders’ failure to draw can help deter future attempts by Russia to a unified set of red lines creates the risk use gas as a coercive instrument in Western of emboldening Russia to continue using Europe, but Nord Stream-2 risks further energy as a wedge issue. weakening ’s resolve to take Second, implicit threats of energy such measures in a timely fashion. supply interruptions—or enticements such as price discounts to certain firms or countries—could be used to dissuade ENDNOTES key countries from supporting sanctions 1. Patrician Zengerle, “U.S. Senate or other measures opposed by Moscow votes near unanimously for Russia, Iran and sow serious, long-term divisions sanctions,” Reuters, June 15, 2017, within Europe and between the US and its http://reut.rs/2uimUKg; Jordain Carney, partners in NATO and/or the EU. And third, “Senate passes deal to advance Russia Western European leaders’ concerns about sanctions bill,” The Hill, June 29, 2017, energy supply security would also offer http://bit.ly/2v0krSh. the Kremlin a point of vulnerability that 2. This simple estimate assumes could be exploited under the latest Russian that Germany will adhere to its schedule military operational concepts. In particular, of shutting down 1.3 gigawatts (GW) of the Russian government uses influence nuclear capacity in 2017, 1.4 GW in campaigns “to target enemy leadership and 2019, 4 GW in 2021, and 4 GW in 2022 alter their orientation in such a way that (World Nuclear Association, June 2017, they make decisions favorable to Russia and http://bit.ly/2ui79mw). It also assumes take actions that lead to a sense of despair that the NS-2 gas pipeline will be operating within their leadership and establish a base at 55% of capacity in 2022 and that NS-1 for negotiation on Russian terms.”21 will operate at 85% of nameplate capacity. For these reasons, although the Russian NS-1 took five years to reach an average “energy weapon” has not been widely annual capacity utilization of 80%. Nord successful to date in the former Soviet Stream, “Nord Stream Utilisation Averages zone, its use against Western European 80% in 2016–43.8 bcm transported to the countries in various—perhaps more nuanced ” (news release, January 10, and sophisticated—forms still constitutes 2017), http://bit.ly/2uid0Zc. a strategic threat that warrants close 3. Keith Smith, “Russian Energy attention from policymakers in Washington Politics in Poland, Ukraine, and the and throughout Europe. Baltic States,” Center for Strategic and Russian behavior can be unpredictable, International Studies, October 19, 2014, and scenarios that may seem unlikely http://bit.ly/2tR88sK. Smith was the US at present can materialize rapidly in the ambassador to Lithuania from 1997 to future. Just weeks before Russia invaded 2000 and also previously served as a Crimea in 2014, virtually no US or European Foreign Service officer in Estonia (see analysts anticipated such a move. Overnight, http://bit.ly/2tRs66U). assumptions were shattered as the “Little 4. Ibid. Green Men”—unidentified members of 5. Svetlana Burmistrova and Natalia Russian special forces that infiltrated Ukraine Zinets, “UPDATE 3-Russia raises gas prices to organize protests and lead paramilitary for Ukraine by 80 percent,” Reuters, April 3, operations—took control of key installations 2014, http://reut.rs/2tRUQwf. and infrastructure.22 In the past decade, 6. “Gas price for Ukraine set at USD 485 Russia has demonstrated a rising appetite per 1,000 cubic meters from April,” Gazprom, for taking strategic risks, and it would be April 3, 2014, http://bit.ly/2tUlK5b. naive to think that the Kremlin is not willing to unleash a “bolt from the blue” in the

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7. Consider that Transneft’s ironically 18. “French regulator doubts need for named Druzhba (“Friendship”) pipeline was France-Spain Midcat gas pipeline,” Reuters, allegedly damaged in a July 2006 “accident” June 15, 2016, http://reut.rs/2tUgsX5. just as Polish firm PKN Orlen was concluding 19. “LNG in Europe: An Overview of negotiations to buy Lithuania’s Mažeikiu European Import Terminals in 2015,” King & Nafta refinery—which Russia coveted— Spalding LLP, 2015, http://bit.ly/2tU2HYD. from the international subsidiary of Yukos, 20. Psychological studies demonstrate a major Russian private oil producer that the power of loss aversion over human had been nationalized by force two years decision-making, with research suggesting a prior. See, for instance, Judy Dempsey, loss coefficient of about two. In other words, “Lithuanians suspect Russia of dirty tricks,” losing $1 generates a disutility at least as The New York Times, August 7, 2006, great as the utility of gaining $2, meaning http://nyti.ms/2tnIgRR. that human beings tend to substantially 8. See, for instance, “Deemed “overprice” risk in many situations. Patricia Gas Supply Contract: General Terms & Tovar, “The effects of loss aversion on trade Conditions,” (UK market), July 2016, policy: Theory and evidence,” Journal of http://bit.ly/2v0MiBU. International Economics 78, no. 1 (June 9. Ibid. 2009): 154–67, http://bit.ly/2tUoTBC. 10. Karen Smith Stegen,“Deconstructing 21. Lt. Col. A.J.C. Selhorst, “Russia’s the ‘Energy Weapon’: Russia’s Threat to Perception Warfare: The development of Europe as Case Study,” Energy Policy 39 Gerasimov’s doctrine in Estonia and Georgia (2011): 6505-13. and its application in Ukraine,” Militaire 11. “Pipe Down,” , January Spectator 185, no.4 (2016), 8, 2009, http://econ.st/2taWISd; Nikolai http://bit.ly/2tbpSQQ. Chavdarov, “Bulgaria Hit Hardest as Supplies 22. “‘Little Green Men’: A Primer on Dwindle,” , January 7, 2009, Modern Russian Unconventional Warfare, http://bit.ly/2tbnSIk. Ukraine 2013-2014,” United States Army See more issue briefs at: 12. J. Leijonhielm and R. L. Larsson, Special Operations Command, 2015, www.bakerinstitute.org/issue-briefs “Russia’s Strategic Commodities: Energy and http://bit.ly/2to6KKJ. Metals as Security Levers,” Swedish Defense This publication was written by a researcher (or researchers) who Research Agency (FOI), User Report FOI- participated in a Baker Institute project. R—1346—SE, Stockholm, November 2004. AUTHOR Wherever feasible, this research is 13. For an in-depth look at this Gabriel Collins, J.D., is the Baker Botts reviewed by outside experts before it is important development, see Colin Harrison Fellow in Energy & Environmental released. However, the views expressed and Zuzana Princova, “A quiet gas revolution herein are those of the individual Regulatory Affairs for the Baker Institute in Central and Eastern Europe,” Energy Post, author(s), and do not necessarily Center for Energy Studies. He was previously October 29, 2015, http://bit.ly/2urElII. represent the views of Rice University’s an associate attorney at Baker Hostetler, Baker Institute for Public Policy. 14. Anna Shiryaevskaya and Volodymyr LLP, and is the co-founder of the China Verbyany, “Ukraine ‘Happy’ to Pay EU SignPost™ analysis portal. Collins has © 2017 Rice University’s Baker Institute Gas Price in Move Away From Russia,” worked in government and as a private for Public Policy Bloomberg, November 3, 2016, sector global commodity analyst and https://bloom.bg/2v0LZXI. This material may be quoted or investment advisor, authoring more than 15. “Klaipėdos Nafta Concluded FSRU reproduced without prior permission, 100 commodity analysis reports for both provided appropriate credit is given to Contract with Höegh LNG,” Ministry of private clients and publications. the author and Rice University’s Baker Energy of the Republic of Lithuania, March 3, Institute for Public Policy. 2012, http://bit.ly/2sZewLL. 16. “Gas supply from Lithuania’s LNG Cite as: Collins, Gabriel. 2017. Russia’s Use terminal soars in 2016,” LNG World News, of the “Energy Weapon” in Europe. January 11, 2017, http://bit.ly/2umJKzV. Issue brief no. 07.18.17. Rice University’s 17. Justas Jacikas, “The success of LNG Baker Institute for Public Policy, in Baltic market” (presentation at Council Houston, Texas. of European Energy Regulators workshop, Athens, Greece, September 12, 2016). 8