Europe Program

Policy Brief

March 2015
Summary: The ongoing Ukraine
crisis has further politicized
Russian energy trade with
Europe and added a geopolitical
dimension to already strained
Eurasian gas relations. Fearing
natural gas interruptions and
Moscows political influence,
Europes leaders are keen
to phase out Russian gas.
But Europe will not have to
survive without Russian gas
due to the size of its market,
its attractiveness for Gazprom
and other suppliers, and for the
crucial importance to Russia
for gas exports. Rather than
aiming at curbing Russian gas
imports, Europeans should make
sure that if they buy Gazproms
molecules, the latter should not
come attached to Moscows
political agenda. For this, the
completion of the internal
market is a precondition,
competition policy represents
the tool, and the Commission
is the watchdog waving the big
regulatory stick if required. This
is, eventually, what the goal of
the much-debated Energy Union
should be.

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Vol. 2, No. 3

Can Europe Survive Without

Russias Natural Gas?
Part I: Maybe, But It Should Not Have To
by Andreas Goldthau
Energy Geopolitics Are Back
in Europe
Geopolitics are back in European
affairs. Russias land grab in Crimea
marks the first time since World
War II that European borders have
been redrawn with the help of
(barely hidden) outside intervention. The Kremlins ongoing support
for separatists in Eastern Ukraine
and its claims on former Soviet
Union countries as a Russian sphere
of influence suggest that Moscows
foreign policy ambitions will not end
on its southwestern shore. European
capitals, therefore, have renewed
concerns related to the security of
EU gas supplies. European leaders
have vivid memories of January 2009
when Russian gas supplies were cut
for 13 days, affecting a total of 16 EU
member states. Clearly, the ongoing
Ukraine crisis has further politicized
Russian energy trade with Europe,
and added a geopolitical dimension to
already strained Eurasian gas relations.
To be sure, Russian gas has probably
never been just another commodity;
if it has, this changed in 2006, when
Russia for the first time stopped gas

deliveries through Ukraine. Gazprom

provides about 30 percent of EU gas
supplies, and up to 100 percent of
gas consumption of some Eastern
EU member states. There, in the past,
Moscow has used what amounts to
discriminatory pricing strategies but
also energy rents to divide and rule,
both among countries in the region
but also between them and Brussels. That way, the Kremlin had lured
Budapest, Sofia but also Western capitals such as Rome into Moscow-sponsored pipeline projects in what the
EU would like to become a Southern
Corridor for gas from alternative,
non-Russian sources.
And yet, the situation of 2015 is
markedly different compared to
pre-Crimea times. While Brussels
and Washington have for some years
promoted alternative supplies of gas
to the EU, energy has now emerged
as the most prominent subject for
strategizing on how to deal with
the Kremlins increasingly assertive foreign policy in what it calls
the Near Abroad. In short, energy
has become both a tool for Western
foreign policy toward Russia, and an
end thereof. Both are indicators for a

Europe Program

Policy Brief
grand strategy in geopolitics,1 which clearly marks a new
level in EU external energy affairs. Energy has become a
tool in the sense that the West uses Russias dependence
on energy revenues to try to make Moscow change course.
The Russian energy sector, providing for some 50 percent
of state income, was therefore made a prime target of
Western sanctions on Russia. Energy has become an end
of EU energy policy in the sense that replacing Russian
gas as much as possible is now considered an appropriate
means for strengthening Europes hand vis--vis Moscow.
In line with the liberal market paradigm, the EU had hitherto sought to increase the blocs resilience against supply
shocks by integrating European gas markets from Lisbon
to Tallinn, and from Helsinki to Athens, mostly leaving
it to energy companies to take care of imports. Now, gas
supplies themselves may become the target of European
policy, which would mark a clear shift in strategy. This
point is driven home by deliberations about common
purchase vehicles in the shape of an Energy Union, as
proposed by now-Council President Donald Tusk.2 This
suggests that the EU may no longer only seek to set the
rules for gas purchases and sales, but also to decide where
the volumes come from, and at what price they enter the
common market.
Cutting Russian Gas Out of the European Energy
Market: Costs and Consequences
The question arises whether this strategy is feasible, and
whether it is smart. For the sake of simplicity, let us assume
that key features of European gas markets can be ignored:
the fact that maturing European gas fields imply growing

Gas supplies themselves may

become the target of European
policy, which would mark a clear
shift in strategy.
1 OSullivan, Meghan. The Entanglement of Energy, Grand Strategy, and International
Security. In Wiley Handbook of Global Energy Policy, edited by A. Goldthau. London:
Wiley Blackwell. 2013
2 Tusk, Donald. A United Europe Can End Russias Energy Stranglehold. Financial
Times, April 21, 2014.

import needs even at flat or falling demand going forward;

and that existing long-term contracts with Russia hardwire more than 100 billion cubic meters (bcm) into the
European import portfolio well into the 2020s.3 Even in
such a simple world, reducing or even eliminating Russian
gas from European consumption still requires replacing
Gazproms molecules. This comes at a cost. Domestic
European supplies will not do the trick here, as Norways
production is already near its limits, Dutch supplies are
capped by law, and U.K. production is in decline. New
pipelines from alternative suppliers have long lead times,
and the prospects of additional gas from Northern Africa
and the Caspian stretch far into the future for reasons
related to domestic political turmoil in the Arab world
and limited supply options to feed into the envisaged
Southern Corridor. In the short and medium term,
alternative supplies would therefore predominantly have
to come from liquefied natural gas (LNG). With currently
around 200 bcm of available European LNG regasification
capacity, the problem here does not lie in infrastructure
(although certain EU members currently lack connections
to bring this gas to their markets). Available capacity would
certainly be sufficient to replace the roughly 140 bcm of gas
that Gazprom sent westwards in 2014. Instead, European
regasification terminals presently running at only one fifth
or less of their capacity indicate that LNG exporters prefer
higher-priced Asian markets in lieu of European ones.
This, in turn, points to a significant premium looming
for European consumers were they to replace Russian gas
with -162C cargos from Qatar, Algeria, Australia, or the
United States going forward. A 2013 snapshot reveals that
while the United States Henry Hub price marker kept on
hovering around the $3 per million British thermal units
(MMBTU) range, Europe paid $10 and Japan around $16.
Put differently, the price for European consumers to pay
for increasing energy security through replacing Russian
gas would have meant spending around five times as much
on gas bills as the United States. At the time, the overall
price tag of eliminating Russian gas imports was estimated
at some $215 billion, according to research firm Sanford

3 Dickel, Ralf, Elham Hassanzadeh, James Henderson, Anouk Honor, Laura El-Katiri,
Simon Pirani, Howard Rogers, Jonathan Stern, and Katja Yafimava. Reducing European
Dependence on Russian Gas: Distinguishing Natural Gas Security from Geopolitics.
Oxford Institute for Energy Studies Paper NG 92, 2014.

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Policy Brief
C. Bernstein.4 To be sure, the situation improved in 2014,
when European hub prices came down, as did Asian LNG
import prices. The National Balancing Point (NBP) spot
marker fell below $7 per MMBTU in early 2015, and LNG
prices saw $10 in Japan. Significant expansion of global
liquefaction capacity in 2015 might further bring down
Asian prices and stimulate additional European imports
(though arguably some LNG trains might eventually not go
online in the new pricing environment). What is more, the
soft oil market will further depress oil-indexed price levels
of Russian gas (which still make up for some 50 percent of
contracted volumes), with the typical time lag of about half
a year. This represents an improvement for the European
supply outlook. Still, both the German border price and
NBP hub prices are roughly twice U.S. levels, and Asian
prices three times that. At the very end, it is the profit
motive that drives European gas imports and not political
preferences, and European industry keeps lamenting about
the growing competitive edge U.S. businesses enjoy already
today, thanks to low energy prices. LNG imports will therefore not approach replacing Russian supplies.

industry with across-the-board coverage in energy services

at administered prices, rather than market-based ones.
That way, political preferences can translate into commercial choices over the origins of gas imports, while incurred
losses are socialized through taxes or other levies. While
not unthinkable, such a move would effectively undo more
than 20 years of EU energy sector reform. Three consecutive Energy Packages of European legislation were based
on the idea that privatizing the energy sector would not
only enhance competition and give consumers choice
but also trigger efficiency gains and innovation in the
energy industry. Much along the same lines, moves toward
centralizing gas purchase, establishing a monopsony and
pooling consumer power in the shape of the Commission
(or yet another EU bureaucracy) negotiating for individual
member states would undermine the very principles upon
which European integration is based. In short, the EU
would turn its back on the market paradigm.5

Therefore, if it were to become a viable option for replacing

Russian gas, LNG intake would need to be made compulsory for European utilities, at least to a certain extent.
Effectively, this amounts to obliging consumers to take
gas volumes in the form of LNG regardless of whether
cheaper (piped gas) alternatives are available; and it means
that molecules from, say, Qatar, are given preference
over others, specifically the ones originating in Siberia.
In addition to the costs that consumers will have to bear,
such a policy clearly runs counter to EU single market
frameworks. Short of alternatives, European countries
could also return to the public utility model of old: stateowned energy monopolists that provide the population and

To be sure, the EU could also consider replacing Russian

gas with other sources, via fuel switching. While there
are limits in the short term, there clearly is potential
in replacing gas with oil for heating households, or in
fostering domestically available resources in electricity
production an option that would presumably find
friends, notably in Eastern European countries. Depending
on the estimates, Russian gas could thus partially give way
to Polish hard coal or Bulgarian lignite. (Germany fostering
renewables indeed replaces gas, although rather unwillingly as the original intention was to target coal instead, in
addition to nuclear). This move, however, means trading
climate for security goals. Not only would this move
seriously put in question the carbon emission targets the
EU has agreed on, up to 2020 and beyond, it would also
endanger the EUs leadership role in the run-up to the 2015
Conference of the Parties Paris summit, arguably the final
chance for the global community to come to terms on a
post-Kyoto carbon regime. Climate policy represents one
of the few policy areas where the EU exerts true leadership and where it has a track record of successfully shaping
global policy. It is therefore the one area where the EU
can hardly afford to lose its standing and impact, notably
against the backdrop of rising Asian economies and a
looming shift in global negotiating power.

4 Bloomberg. Europe Gas Options Seen Limited by Costs at $200 Billion. May 7,
2014.

5 Goldthau, Andreas, and Tim Boersma. The Ukraine Challenge and Europes Energy
Needs Collide. The National Interest, September 10, 2014.

It is the profit motive that drives

European gas imports and not
political preferences.

Europe Program

Policy Brief
Policy Implications: Market Carrots
and Regulatory Sticks
So what is the way forward for EU energy security? The
answer lies in enticing external gas suppliers with attractive
carrots, and in balancing these carrots with effective sticks.
In terms of carrots, the attractiveness for external suppliers
is the size of the 450 bcm EU gas market, the worlds largest
in terms of import potential. In addition to remaining
attractive despite expected flat demand going forward,
Europe will be the one market that Gazprom cannot do
without for a long time to come. Russias Eastern Strategy,
and its attempts to pivot to Asian markets, so far remain
a loss-making exercise. Despite its immense value, the
much-acclaimed 30-year $400 billion deal on 38 bcm of
annual gas deliveries struck between Russia and China in
May 2014 seems unlikely to be a profit generating endeavor
for Moscow. Gazproms domestic Russian market where
the company sells two-thirds of overall output remains
hardly profitable either. By contrast, the European market
remains the companys cash cow, and accounts for the
majority of the $73 billion in revenues that Gazprom makes
in gas exports.6 European sales are crucial to fund new
upstream projects in Eastern Siberia, to push the China
pivot, and to put in place related infrastructure. In other
words, Europe is the one market Gazprom cannot let go, a
reason why Moscow was so keen on making South Stream,
a $40 billion project that was designed to circumvent
Ukraine as a transit country, a reality.
In light of all this, an EU energy policy strategy to replace
Russian gas would at best be second-best for European
energy security going forward. Not only are the security
gains unclear, costs will certainly be incurred by European
consumers and industry. More importantly, Europe will not
have to survive without Russian gas due to the size of its
market, its attractiveness for Gazprom and other suppliers,
and for the crucial importance to Russia for gas exports.
For this carrot to work in Europes favor, however, a stick
is also needed. This is the EUs competition policy and is
represented by its watchdog, the EU Commission. Indeed,
the EU has put in place a comprehensive set of rules that
define the level playing field for domestic and foreign
companies, and has developed a sophisticated regula6 EIA. Today in Energy: Oil and Natural Gas Sales Accounted for 68% of Russias Total
Export Revenues in 2013. July 23, 2014.

Europe will not have to survive

without Russian gas due
to the size of its market, its
attractiveness for Gazprom and
other suppliers, and for the crucial
importance to Russia for gas
exports.
tory apparatus to govern the internal market, also in the
energy sector. And yet, numerous pending investigations
by the Commission against EU member states for not fully
transposing the 2009 Third Energy Package into national
law, and infringement procedures opened against Bulgaria
and Romania, vividly illustrate that the EU energy market
is still incomplete and competition tools often prove blunt.
While progress has been made, national markets are far
from fully connected, a shortcoming that the EU hopes
to remedy by way of funding some of the currently 248
projects of common interest that the Commission has
identified in energy infrastructure. Hub trading dominates
in the north but gas-on-gas competition remains limited in
the south with hub activity at low levels. National energy
agendas, finally, all too often trump common European
energy goals, as epitomized by the fact that some EU
members backed Russias South Stream pipeline despite its
clear inconsistency with EU norms. Europes energy security therefore hinges on fostering internal market reforms,
strengthening intra-European gas infrastructure, and
creating a fungible common gas market to which external
suppliers such as Russia are invited to come and play, but
play according to EU competition rules. As a good regulatory state, the EU should also support pipeline infrastructure from alternative sources, including the Caspian. This
is not only for geopolitical purposes but also because of
their public goods characteristics. The market alone will
not put them in place. As a corollary, completing the single
market requires strengthening the hand of EU regulatory
authorities and notably of the EU Commission to

Europe Program

Policy Brief
enforce EU law vis--vis external suppliers and also individual member states should they chose to violate common
market principles.
This approach, in fact, has already started to yield a
successful track record. The Russia-sponsored South
Stream pipeline was brought to a halt by regulators not
politicians, grey Brussels-based bureaucrats who enforced
EU law pertaining to unbundling gas sales from transport,
making Bulgaria and other countries backing the project
eventually change course. Likewise, the pending EU antitrust case against Gazprom piecemeal to many observers
will likely force the monopolist to fundamentally alter
its business model in Europe. In short, rather than aiming
at curbing Russian gas imports, Europeans should make
sure that if they buy Gazproms molecules, the latter should
not come attached to Moscows political agenda. For this,
the completion of the internal market is a precondition,
competition policy represents the tool, and the Commission is the watchdog waving the big regulatory stick if
required. As the anti-trust cases against Microsoft and
Google have demonstrated, the Commission has the power
to take on monopolists, whether in the IT or the energy
sector. This power derives from a sizeable market and its
mandate to safeguard it.
This is, eventually, what the goal of the much-debated
Energy Union should be. Rather than giving in to antimarket reflexes such as common purchase vehicles, EU
leaders should seize the momentum and push the Energy
Union with a view to completing the internal market
project and to further empowering the EU Commission so
that it can build on its regulatory apparatus by funding the
energy infrastructure that is necessary to create a fungible
pan-European gas market. A completed internal market in
energy that is coupled with robust regulatory governance
at the EU level will come with increased resilience against
supply shocks. As a corollary, there will be no more room
for Russia or any other external supplier to divide and rule.
And the single voice in energy, often called for by security
analysts and EU politicians, will materialize in the shape
of EU decisions, communications, and recommendations.

This policy brief is one of two that answers the question Can Europe
Survive Without Russias Natural Gas? published under GMFs
Central and Eastern European Energy Security Forum. The analysis
derives from discussions at the workshop Regional Strategies for
Energy Security in light of the Ukrainian Crisis, organized by GMF
in Warsaw, Poland, in December 2014. The views expressed in GMF
publications and commentary are the views of the author alone.

About the Author

Andreas Goldthau is a professor of public policy at Central European
University, associate with the Geopolitics of Energy Project at Harvards Belfer Center for Science and International Affairs, and a fellow
with the Global Public Policy Institute.

About the Europe Program

The Europe Program aims to enhance understanding of the challenges facing the European Union and the potential implications for the
transatlantic relationship. Analysis, research, and policy recommendations are designed to understand the dichotomy of disintegration
and deepening of the EU and to help improve the political, economic,
financial, and social stability of the EU and its member states. In 2014,
the Europe Program focuses on integration and disintegration in the
EU, the deepening of the euro area, the changing role of Germany in
Europe and the world, as well as challenges in the EUs neighborhood.

About GMF
The German Marshall Fund of the United States (GMF) strengthens
transatlantic cooperation on regional, national, and global challenges
and opportunities in the spirit of the Marshall Plan. GMF does this by
supporting individuals and institutions working in the transatlantic
sphere, by convening leaders and members of the policy and business
communities, by contributing research and analysis on transatlantic
topics, and by providing exchange opportunities to foster renewed
commitment to the transatlantic relationship. In addition, GMF supports a number of initiatives to strengthen democracies. Founded in
1972 as a non-partisan, non-profit organization through a gift from
Germany as a permanent memorial to Marshall Plan assistance, GMF
maintains a strong presence on both sides of the Atlantic. In addition
to its headquarters in Washington, DC, GMF has offices in Berlin,
Paris, Brussels, Belgrade, Ankara, Bucharest, and Warsaw. GMF also
has smaller representations in Bratislava, Turin, and Stockholm.