Trump, the Russia sanctions and Europe’s energy future

24 August 2017

Helen Thompson - Honorary Research Fellow, SPERI, Professor in Political Economy, University of Cambridge

The significant deterioration in US-Russia relations and new sanctions could profoundly impact the EU and its energy needs

The melodrama around Donald Trump has obscured the significance of recent events in American politics to the energy future of Europe. At the end of July President Trump signed into law a bill passed with near unanimity by Congress that, among other things, created the legal basis for extra-territorial sanctions against foreign companies acting in energy partnerships with Russia. Most significantly in this respect, the Countering America’s Adversaries Through Sanctions Act gave the US Treasury the authority to impose fines on European companies participating in Nord Stream 2, a second gas pipeline across the Baltic sea from Vyborg in north-western Russia to Greifswald in north-eastern Germany.

Europe cannot escape the politics of gas. Over the coming decades European countries have no choice but to import more natural gas. The European Union already consumes more than three times as much natural gas as it produces, and production within the European Union and Norway is falling. Around one-third of the gas supplied to the European Union now comes from Russia. This gas presently comes both through land pipelines that run through Ukraine, Belarus and Poland and, since 2011, through the Nord Stream line across the Baltic Sea.

Both the dependency of European states on Russian gas and the means by which it is delivered are matters of intense political conflict within the European Union, particularly since the 2014 Ukraine crisis, the fallout of which ended the South Stream pipeline project that would have delivered some Russian gas across the Black Sea into the Balkans and Italy. On the one side the German, Austrian and the north-western member-state governments believe Russia must remain the primary supplier of Europe’s gas and they do not want to put its delivery at the mercy of Russia-Ukraine relations, not least since the current transit contract between Gazprom, Russia’s majority state-owned gas corporation, and the Ukrainian national energy company ends on 31 December 2019. By contrast, the east European member-states regard continuing dependency on Russian gas as an existential threat to their existence.  When work began on Nord Stream 1 the then Polish Foreign Minister compared the development to the Nazi-Soviet pact. Now these states want to import liquefied natural gas (LNG) from suppliers like the United States, Qatar and Australia. To this end Poland opened a LNG port in 2015. When the first ship carrying US gas arrived in June of this year the Polish Prime Minister declared that Poland could now say it was a sovereign country.

These profound differences already made the realisation of the energy union pronounced by the European Union in 2014 as an aim impossible. But the new American sanctions against Russia add potentially explosive new fire to the situation. The Polish government welcomed the American action, arguing its purpose was justifiably geo-political, namely to protect eastern Europe and Ukraine from Russian aggression. By contrast, the German and Austrian governments denounced the sanctions, attributed commercial motives to the US action, and insisted that it is for European states to decide whom supplies European economies with gas and oil. For his part, the Commission President, Jean-Claude Juncker, who had previously tried to navigate a middle path on Nord Stream 2, warned that the European Union would take counter-measures if any sanctions are applied to European companies.  Ironically, it will be President Trump, if and when he decides whether there should indeed be sanctions over Nord Stream 2, who will now effectively act as the arbiter for an energy question the European Union states have been unable to resolve between themselves.  If he does choose the sanctions route and the Commission insists, as it has promised, on retaliation then the European Union will be thrown into deep internal crisis.

Of course the concerns of eastern European states are easy to understand given their history with Russia and Vladimir Putin’s past willingness to use pipelined gas to coerce other states. Nonetheless, the assumption made by the US Congress that the Europeans can readily retreat from Russian supply is disingenuous. European countries cannot embrace LNG imports, including from the United States, without making economic sacrifices.  Pipelined gas is, quite simply, significantly cheaper than liquefied natural gas. LNG trade requires liquefaction ports at the exporting end and regasification at the importing end. These ports are very capital intensive to run. In the market for LNG European countries would also have to compete with Asian countries that pay an effective premium for the gas they import because, outside China, there are few pipelines, making LNG imports an essential economic requirement. So long as Asian economies remain acutely dependent on LNG imports then Asian premium prices will remain in place and European energy companies will have to match them to procure a reliable share of LNG supply.

Nor is there the slightest guarantee that US LNG exports could over the next decades meet a significant proportion of Europe’s consumption requirements. For all the hype about American shale gas production as a game-changer in international gas markets, the fact remains that the US only became a net exporter of gas earlier this year and most of its exports are pipelined to Mexico whilst US shale gas production is at present unprofitable, sustained only by the extraordinary monetary and financial environment that has prevailed since the beginning of quantitative easing and zero interest rates. Moreover, US shale gas production will exhaust itself more rapidly over the next two decades than conventional supply.

The geopolitical fault-line underpinning Europe’s gas predicaments has been growing since the mid-1970s when west European countries first began to import oil and gas from Russia. It was this energy turn towards Russia that caused the crisis in the Atlantic relationship over the Trans-Siberian pipeline in the early 1980s when the Reagan administration wanted stronger action over the Soviet clampdown in Poland after the formation of Solidarity. The accession of the east European and Baltic states into the European Union two decades later made the internal unity of the European Union itself a new potential pressure point. Now US-Russia relations have deteriorated so far that this long-standing fault-line has broken any pretence that the European Union can have common energy interests and construct an energy union. If Trump comes of his own volition, or under further pressure by Congress, to sanction European companies, the German government in particular will have to decide how far it is willing to strain the European Union and the Atlantic relationship to preserve its energy interests.

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