NO. 6 FEBRUARY 2019 Introduction

US-Russia Policy Hits European Energy Supply The Consequences of Unilateral Sanctions and Growing Market Competition Sascha Lohmann and Kirsten Westphal

Triggered by Russia’s annexation of Crimea and military intervention in Ukraine in early 2014, the governments of the United States (US) and the Russian Federation have since been locked in a geopolitical confrontation, which is largely playing out on the economic stage. In addition to unilateral economic sanctions, the US government is focussing on the export of liquefied (LNG). In doing so, it wants to reduce not only Russian state revenues, but also European dependence on Russian energy im- ports. In this context, the US policy is aimed squarely at the German federal govern- ment, which was described by President Donald J. Trump as a “prisoner of Russia”. The more the European-Russian energy trade is drawn into the conflict between Washington and Moscow, the more serious the consequences are likely to be for European energy supply.

The increased use of economic instruments through Ukraine today with a mix of in- of power in US policy towards Russia is centives and pressure on their European negatively affecting European and German allies. Since 2015, the 2 pro- interests. The current discussion on the ject, with its high political costs (see SWP Nord Stream 2 pipeline, which is currently Research Paper 3/2017), has presented the under construction, has lost sight of the German government with the dilemma of fact that this sanctions policy has a con- how to reconcile legal principles, economic siderable impact on energy relations be- interests as well as foreign and European tween Europe and Russia. This project has policy paradigms. At the same time, US not only been criticised in the European sanctions severely restrict the ability of Union and Germany, but in Washington Germany and Europe to take autonomous too. The US government is exploring ways action. This not only threatens EU cohesion and means to stop this project from being on energy policy but also energy security in completed. terms of providing a competitive, stable and Back in the 1960s and 1980s, US admin- flexible supply on demand. istrations were trying to prevent the con- struction of Russian pipelines running

Unilateral Sanctions as a Tool of The reasons for being listed as an SDN US Russia Policy are set out in four Executive Orders (E.O.) issued by President Obama between March Even during the Cold War, the US govern- and December 2014, and codified into law ment relied primarily on unilateral eco- by Congress in August 2017. These include nomic sanctions to weaken the Soviet “asserting government authority over the leadership in this conflict of systems. This Crimean region without the authorisation sanctions policy started out as a strict uni- of the Ukrainian government, undermining lateral export control regime for dual-use democratic processes or institutions in and military goods which, in coordination Ukraine and threatening the peace, secu- with the Western allies, eventually became rity, stability, sovereignty or territorial in- a multilateral embargo. Washington also tegrity of Ukraine; and also misappropriat- denied the Soviet Union and its successor, ing the state assets of Ukraine or of an eco- the Russian Federation, Most Favoured nomically significant entity in Ukraine” Nation status in bilateral trade relations (E.O. 13,660). High-ranking members of the between 1951 and 1992. Once the Cold War Russian government and their supporters was over, the US government imposed (particularly the so-called oligarchs), but unilateral sanctions on the now Russian also persons active in the Russian defence defence firms for their exports to Iran, sector (E.O. 13,661; 13,662) or trading and thereby excluding them selectively and investing in Crimea (E.O. 13,685) can also temporarily from the US market. Since the be listed as SDNs. end of 2012, the US government has re- The more than 30 unilateral US sanctions fused to issue visas to Russian officials regimes that address, inter alia, the prolifer- accused of human rights abuses and cor- ation of weapons of mass destruction, trans- ruption and has frozen their assets where national crime and a series of state and they are under US jurisdiction. non-state actors have repeatedly targeted The US government imposed far more Russian individuals, organisations and in- extensive sanctions in March 2014 in re- stitutions. Current listings were based on sponse to the incorporation of the Black Sea Russian activities in relation to certain peninsula of Crimea into the Russian Fed- states such as Syria, Iran and North Korea, eration in contravention of international as well as in connection with alleged cyber law, as well as to Moscow’s destabilisation attacks and meddling in the 2016 US presi- policy in eastern Ukraine. Initially, the dential election campaign. Once the US US Departments of Commerce and State Department of State had determined that tightened export controls on dual-use and the Kremlin was involved in the poisoning military goods, technology and services. At of former Russian intelligence officer Sergei the same time, the Office of Foreign Assets Skripal in the UK, Washington imposed Control (OFAC) within the US Department further trade sanctions on Russia, the first of the Treasury began listing Russian indi- wave of which came into force in August viduals and entities belonging to President 2018. Vladimir Putin’s inner circle as Specially Designated Nationals (SDNs) and Blocked Consideration for European Persons. This measure allows any assets interests under Obama they own under US jurisdiction to be fro- zen. In addition, US persons are prohibited President Barack H. Obama proceeded cau- from entering into business relationships tiously in imposing unilateral US sanctions with those listed as SDNs. The prohibition against one of the world’s largest energy is enforced under civil and criminal law exporters. Giving consideration to European and extends to entities that are more than allies’ considerable energy imports from 50 percent owned or controlled by listed Russia, his administration did not target the Russian individuals or entities. ongoing production and exports of Russian

SWP Comment 6 February 2019

2 oil and natural gas. Instead, its punitive ease primary sanctions imposed under the sanctions focused on the long-term develop- four executive orders. Furthermore, the ment and exploitation of oil reserves in the statute required the administration to Arctic and of shale oil. These steps were tighten both primary and secondary sanc- taken in close consultation with the Euro- tions. The latter are not directed against US peans who, in turn, coordinated their uni- persons, but make certain activities by non- lateral sanctions with Washington. US persons ‘sanctionable’. In doing so, From July 2014, the Obama administra- Congress created the legal prerequisites for tion issued new measures, known as sec- being able to impose even more stringent toral sanctions, which were specifically unilateral sanctions as a potentially power- designed to raise the costs of long-term ful tool within a US Russia policy aimed at development of the Russian energy sector. economic containment. If secondary sanc- Pursuant to E.O. 13,662, the OFAC then tions were to be imposed, they would spe- began to place Russian companies in the cifically target Russian energy exports. finance, defence and energy sectors on the The Ukraine Freedom Support Act of 2014 Sectoral Sanctions Identification (SSI) list. (UFSA), amended by section 225 of the Once the list had been published, new CAATSA, authorises the President to ex- financing provided from US persons to clude those foreign persons from the vital those listed on it were restricted as follows: US financial market who make “significant” the current maturity of new debt or equity investments in certain oil projects or finan- may not exceed 14 days for listed Russian cial institutions participating in “significant” financial institution (Directive 1), no more transactions for those projects or for Rus- than 60 days for Russian energy companies sian SDNs. The UFSA now also mandates (Directive 2) and no more than 30 days for the adoption of primary sanctions against Russian defence firms (Directive 3). Further- by prohibiting any medium to more, US persons are prohibited from par- long-term investment by US persons. How- ticipating in the exploration and produc- ever, these measures will not enter into tion of oil in Arctic, deep-sea and shale for- force until the US administration determines mations (Directive 4). Unlike persons listed that the company has been shown to have as SDN, those placed on the SSI list are free withheld significant quantities of natural to dispose of their assets under US jurisdic- gas supplies from Ukraine, Georgia, Mol- tion and US persons may also continue to dova or NATO allies for political reasons. enter into any other transaction with them. Section 232 of the CAATSA is potentially the most serious for European energy sup- Targeting European-Russian ply. This is because it enables the President energy trade to impose secondary sanctions on non-US persons involved in the construction, mod- In August 2017, a bipartisan majority in ernization or repair of energy export pipe- Congress broadened existing sanctions lines if a single investment exceeds one against Russia in response to the Russian million US dollars or if more than five mil- government’s intervention in the Syrian lion US dollars are invested within twelve civil war from September 2015, to Kremlin- months – a magnitude quickly achieved controlled cyberattacks against US author- with capital investment in the energy sec- ities and companies, and to evidence of tor. The list of pipelines potentially affected Moscow’s interference in the 2016 US pre- by this type of sanction not only includes sidential campaign. The Countering America’s the existing Nord Stream pipeline through Adversaries Through Sanctions Act of 2017 the Baltic Sea, but also and (CAATSA), which was also directed at Iran Turkish Stream, both of which pass through and North Korea, was passed against the the Black Sea to Turkey, as well as the polit- explicit will of President Trump. The ically controversial Nord Stream 2 gas pipe- CAATSA curtailed presidential authority to line. In addition, the provisions contained

SWP Comment 6 February 2019

3 in section 232 may also apply to pipelines rocketed following the listing of Rusal, the passing through Belarus and Poland, or, world’s second-largest aluminium producer. paradoxically, even through Ukraine. The If the Defending American Security from Kremlin sanctions could also target LNG export ter- Aggression Act of 2018 were adopted in the minal supplies to Europe and Asia. US Senate, an even greater number of ener- Although the US State Department made gy projects could be threatened by US sanc- it clear in late October 2017 that pipeline tions. projects initiated before 2 August 2017, including any investments made so far, would not be affected by possible secondary Economic Impact sanctions under section 235, the US admin- istration is free to amend the guidance at Since the current US sanctions are designed any time. to complicate future oil and gas exploration In any case, Nord Stream 2 has drawn and extraction for Russian companies, their condemnation from many sides. Since a impact on Russia’s current oil and natural Russian-European consortium decided to gas production and energy exports has so build the pipeline in the summer of 2015, far been rather minimal. However, they the project has been criticised across party have dissuaded companies from investing lines in the US, the EU and Germany. The in expensive projects and developing new German government took the view early on large deposits, instead encouraging them to that this was a commercial project and concentrate on boosting production from would, therefore, be subject only to German previously developed fields and re-opening law and was not a matter for EU regulation. small fields. As a result, current production This position has prompted a phalanx of and exports of crude oil and natural gas in- opponents in Washington, Brussels and creased despite the sanctions. Warsaw to exploit legal remedies and polit- The Yamal project, led by the Russian ical pressure to bring down the project. US energy group and costing 27 billion sanctions could become part of the counter- US dollars, extracts natural gas, transforms measures. it into LNG and then exports it via the Arc- Overall, the adoption of the CAATSA tic port of Sabetta in the east of the Yamal testified to the erosion of consensus on peninsula. Novatek, the China National both sides of the Atlantic as to how to Corporation, the Silk Road Fund respond to Russian aggression. At congres- and French company Total are all involved sional hearings in late summer 2018, mem- in this project. The project was launched at bers complained about the limited impact the end of 2013 and began exporting in of the use of US unilateral sanctions im- 2017. It has an annual capacity of 16.5 mil- posed in close consultation with the EU, lion tonnes of LNG. In January 2018, it even and criticised what they perceived to be a supplied the US city of Everett in Massa- too lax implementation and enforcement chusetts, demonstrating the competitive- by the Trump administration. After the ness of Russian LNG. Despite the current Democrats have taken over the House of sanctions against participants in the Rus- Representatives, the existing sanctions sian project, the sale could legally be bro- could soon be further tightened and ex- kered by a French dealer and shipped on a tended. Events in the Kerch Strait in late French tanker. November 2018 have provided new argu- Among the projects that are directly ments for such a course of action. In fact, affected by the US sanctions is one in the several bills are circulating in Congress, Kara Sea initiated by Russian company some of which provide for listing more Rosneft in conjunction with US company Russian companies as SDNs. The resound- Exxon, a project in the Barents Sea with ing impact of such a move was evident in Italian company ENI and another in the April 2018 when aluminium prices sky- Black Sea with Exxon and ENI. In addition,

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4 the British-Dutch company Shell withdrew ly, the US sanctions are creating a large from the offshore production of natural gas legal grey area with high risks for Western on Sakhalin after the US Department of companies. These risks have to be included Commerce classified the enterprise as an oil into the cost-benefit considerations of com- production project. Overall, the impact of panies doing business in and with Russia. the sanctions on Russia’s energy industry The main focus here is on measures aimed was far less significant than the halving of at the financial sector. As energy relations the oil price between mid-2014 and the end between the United States and Russia have of 2016, which was followed by a sluggish declined, the extraterritorial reach of US recovery in 2017 and 2018. However, the sanctions is particularly serious for third impact of the oil price decline on the ener- parties, especially for European companies. gy industry was largely mitigated by the In fact, US sanctions are putting increasing devaluation of the ruble, as this reduced pressure on European energy companies to company losses. stop engaging in the Russian market, there- Yet, it is uncertain whether Russia will by weakening their market positions. be able to continue exporting the same vol- The resulting vacuum allows competitors umes of oil and gas in the future. Hydraulic from China, India and also from the Middle fracturing is considered an indispensable East to expand their activities. The crux of technology for keeping Russia’s oil produc- the matter is that state-dominated oil and tion at a stable level in the longer term. gas companies can expand their market This technology is needed both for current shares in leaps and bounds, which could brownfields and for the development of have an impact on liberal trade and pricing new non-conventional deposits. US sanc- mechanisms in the medium term. The uni- tions on hydraulic fracturing and non-con- lateral US sanctions against Russia, Iran and ventional production mainly affected joint Venezuela result in state interventions gain- ventures involving Shell and French firm ing ground. Politicisation and the political Total (Bazhenov Formation in Western instrumentalisation of the energy markets Siberia), but also Exxon. is increasing. All of this could have far- The longer US sanctions persist, the reaching consequences for Europe’s energy faster and greater the decline in Russian oil security, which will then depend increas- production could be. The respective invest- ingly on supplies from these state-owned ment cycles are at least five to seven years, companies. but more likely, depending on the size of deposits, 10 to 12 years. This means that after 2022–2025 there could well be a US LNG Exports to Europe sharp fall in Russian oil (and natural gas) production, which could have a lasting The Shale Revolution has made the United impact on already very volatile markets. States a key player in world oil and gas The structural consequences from US markets. Between 2010 and 2017, domestic sanctions also include restricting the global energy companies increased their daily oil activities of Russian corporations and slow- production by 73 percent, according to data ing down their internationalisation activi- from energy company BP. Exports rose by ties – as in the case of privately owned 157 percent. Nearly 28 percent more natu- Lukoil. The state-dominated Russian cor- ral gas was produced during the same porations, on the other hand, benefit from period. In 2017, the United States was the direct recourse to public funds and were world’s largest producer of both crude oil able to further expand their share in Rus- and natural gas. Since Congress lifted the sian exploration and production. The im- export ban on crude oil at the end of 2015, pact of the sanctions is counterproductive exports increased from 465,000 barrels a to the interests of the EU and the US gov- day to just under 1.2 million barrels a day ernment. Moreover and even more serious- in 2017, according to the US Energy Infor-

SWP Comment 6 February 2019

5 mation Administration. The International cement the energy price spread between the Energy Agency forecasts that the US will US and Europe, with negative implications meet 80 percent of global demand growth for Europe as an industrial location and for for crude oil over the next decade. European competitiveness. It would also As oil prices pick up, US oil production have considerable effect on energy prices as will continue to rise and, as a by-product, a whole for private households. more natural gas will be produced. There In the trade dispute between the US and are two terminals in operation in the US, the EU, LNG imports from the US have be- Sabine Pass since 2016 and Corpus Christi come a negotiating item, as the meeting in since November 2018. The two plants have July 2018 between President Trump and the an export capacity of 35 billion cubic metres President of the European Commission, annually and another 55 billion cubic Jean-Claude Juncker, demonstrated. In any metres of capacity are to be added in 2019. case and irrespective of the political noise, This is roughly equivalent to Germany’s LNG has become an increasingly important annual gas consumption. By 2020, export component of the portfolio management capacity could reach around 100 billion and trading business of European import- cubic metres per year. In 2017, more than ers. LNG is one of those commodities where ten percent of US LNG exports went to political and business interests coincide. For Europe. example, in 2013, the German government The availability of secure and compete- guaranteed a loan for an LNG terminal in tive energy in the US shields it from devel- Goldboro, Canada. In Germany, the con- opments on the energy markets. As a result, struction of LNG terminal(s) is currently the US is now self-sufficient, meaning that under discussion with potential sites in the US government has achieved a major Stade, Brunsbüttel and Wilhelmshaven. foreign policy goal and gained considerable There are presently no indications that clout in its international relations. US LNG will be able to undercut the short- US-based production is so huge that term and long-term marginal costs of Rus- bottlenecks exist in the processing and sian pipeline gas in the European market. transport of crude oil and natural gas. In US LNG is still too expensive to be really order to sustain the production boom, US competitive. The European gas market is companies are looking for foreign markets currently the market that absorbs quanti- for their liquefied natural gas. Consequent- ties not purchased elsewhere because other ly, not only are US sanctions based on geo- customers are more attractive since they political considerations to reduce European pay higher prices. The price differences dependence on Russian energy imports, between the Far East and Europe are still they also fuel Washington’s vested econom- significant. LNG in Asia is priced at 9.8 US ic interests, such as reducing the US trade dollars per MmBtu (million British Thermal deficit and creating domestic jobs. For Presi- Units, average for 2018) and at only 7.7 US dent Trump’s policy of ‘America First’, dollars per MmBtu on the British exchange. energy dominance is both the means and In addition, major buyers are all located in the end. With him in the White House, the the northern hemisphere and, therefore, thought has become entrenched that the consumption follows the same seasonal main aim should be the pursuit of profit curve. European LNG terminals can handle and pure profit maximisation and that a capacity of 150 billion cubic metres per balancing the interests of long-time part- annum, but are currently operating at less ners and allies in the field of energy and than a quarter of their capacity. However, (climate) policy is no longer relevant. Ger- if Russian supplies are to be replaced on a many’s export surplus is a thorn in his side. large scale, the terminals could reach their If Berlin had to import more LNG from limits. the US, the balance sheet would shift in European gas consumers have benefited Washington’s favour. This would also from competition in the gas markets result-

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6 ing from the shale gas boom in the US and gas in the EU itself, the need for imports is the surplus of LNG on the markets. Prices already higher than was forecasted just a fell, even though long-term contracts with few years ago. Demand for gas has recov- minimum purchase obligations (take-or- ered in Europe since 2017, and e.g. the pay) with European companies will secure phase-out of coal in Germany will have an Gazprom’s sales in the medium term. Gaz- effect here as well. Thus, it is safe to assume prom’s market share in the EU of around from a market perspective that Russian 35 percent is the result of long-term con- natural gas will cover the EU’s ‘base load’ tracts and price signals. well into the 2020s. After Gazprom sup- But pressure is likely to continue to rise plied a record 194 billion cubic metres to on Europe to import more US LNG. For Europe in 2017, exports are likely to have example, a cross-party majority in Congress increased in 2018. There are three econom- is pushing to prevent the construction and ic reasons for this: not only does Russian operation of Russian gas pipelines. In ad- natural gas come from the largest reservoir dition, in the current trade dispute with in terms of volume, it is also currently the Washington, the Chinese government most cost-effective. The fields in Western recently imposed a ten percent tariff on US Siberia and on the have imports of LNG. excess supplies of between 130 and 150 bil- The increasing focus of US sanctions lion cubic metres per year. Moreover, Gaz- policy on Russian natural gas supplies is prom has the necessary and diversified ex- remarkable. Since oil exports contribute far port infrastructure which allows the com- more to the Russian budget, limiting the pany to react flexibly to competitors. But budgetary scope of the Russian government Russia is also increasingly orienting itself in this area would be far more effective. towards Asia. This will further change the Nevertheless, in December 2018, the Trump setting and the dynamics of the gas mar- administration insisted that production kets, also making diversification an impera- levels not be significantly reduced in the tive for the EU. run-up to the OPEC+ meeting. In doing so, Nevertheless, pressure will continue to the Trump administration had in mind its come from Washington, especially with own electorate and its re-imposed sanctions regard to Nord Stream 2. If this project were against Iran. If it were to target Russian gas hit with secondary sanctions from the US, exports and their market share in the EU the EU would have to rely more on a func- instead, it would not only receive applause tioning Ukrainian transit corridor and buy from Poland, but it would also give US com- LNG. Russia’s export pipelines were run- panies an advantage in the face of intense ning at almost full capacity during the competition for market share. What would period of cold weather in February and be detrimental to European import options March 2018. A strong signal that sufficient from a market point of view would be ad- import capacity will be needed in future. vantageous to the Trump administration. In any case, US secondary sanctions would severely curtail Europe’s ability to act autonomously. It should, therefore, be Conclusions possible to build a consensus in the EU. No matter where Brussels or the Member States The geopolitical dispute between the US stand on Nord Stream 2, the decision about and the Russian Federation threatens the what to do should be a sovereign one for stability of European and German energy Europeans. The impact on EU-based com- supplies. If the US government were to panies described above, or on specialist target Russian gas exports in the future, this European companies laying pipelines for would seriously impact Europe’s industrial offshore and subsea construction, is serious. base and its competitiveness. Considering Not only are private economic interests the rapidly declining production of natural affected by unilateral US sanctions, but also

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7 skills and technical know-how that are stra- tegically important for Europe. In order to guarantee not only their ener- gy supply in the long term but also their strategic autonomy in this important policy area, Europeans need to find a common response to Washington and Moscow. As a first step in this direction, the European Council should swiftly add all the relevant US legal bases to the annex of the EU “block- © Stiftung Wissenschaft ing legislation”. As a precautionary mea- und Politik, 2019 sure, the Instrument in Support of Trade All rights reserved Exchanges (INSTEX) to facilitate payments outside the dollar area should, in addition This Comment reflects to Iran, also include business with Russia. the authors’ views. Finally, the EU and Germany should con- The online version of tinue to focus on diversification, including this publication contains higher LNG imports, not least as a political functioning links to other signal to Washington and Moscow. SWP texts and other relevant sources.

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SWP Stiftung Wissenschaft und Politik German Institute for International and Security Affairs

Ludwigkirchplatz 3–4 10719 Berlin Telephone +49 30 880 07-0 Fax +49 30 880 07-100 www.swp-berlin.org [email protected]

ISSN 1861-1761 doi: 10.18449/2019C06

Translation by Martin Haynes

(English version of SWP-Aktuell 1/2019)

Dr. Sascha Lohmann is an Associate in the Americas research division at SWP. Dr. Kirsten Westphal is Senior Associate in the Global Issues division at SWP.

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