EU fears of being held hostage by Russia over gas come true

Russia cutting off gas supplies to Europe has been one of the EU’s biggest fears. This week has come true.

Moscow blamed the decision to restrict volumes from the Nord Stream 1 pipeline to Germany on sanctions imposed after the Ukraine invasion, specifically those from Canada that left key pumping equipment stranded at a Siemens Energy factory in Montreal.

But few in the West are buying the Moscow line. Russia has access to alternative supply routes to keep export customers supplied, but has refused to use them. With the cuts coinciding with a visit by the leaders of Germany, Italy and France to Kyiv this week, German Vice Chancellor Robert Habeck said any technical problems were clearly a “pretext” for Russia to tighten Europe’s economy.

Fatih Birol, head of the International Energy Agency, said the cuts by state-owned Gazprom appeared to be a “strategic” move by Moscow that would remind Europe not to feel “too safe or too comfortable”.

Georg Zachmann, a senior fellow at think-tank Bruegel, accused Moscow of “trying to play divide and rule”, saying President Vladimir Putin’s regime wanted to “increase its influence over Europe ahead of winter and any eventual deal in Ukraine”.

Unless Russia restores volumes quickly, the industry fears Europe will struggle to store enough gas before the winter months when demand will be highest. But even if full supply returns, this week’s events have finally sunk the once-common belief in the industry that Russia would not unleash the gas weapon against its biggest customers.

The Freeport LNG plant in Quintana, Texas © Maribel Hill via Reuters

What is clear is that Russia’s decision, which reduced the capacity of the NS1 by 60% and led to lower flows to countries from France to Slovakia, has taken the energy crisis into a new and dangerous phase.

“The current situation is one of the worst results we have contemplated,” Edward Morse, an analyst at Citi, said this week, warning that prices would likely need to rise this winter to constrain demand if Russian flows do not return.

Gas prices have already jumped – from very high levels – gaining over 60% this week to around €130 per megawatt hour. This has compounded global anxiety about rising inflation as central banks struggle to rein in rising prices without triggering a widespread economic slowdown.

For some, Russian gas cuts were unavoidable. Europe has made it clear since the February invasion of Ukraine that it wanted to kick its addiction to Russian energy as soon as possible. The percentage of European gas consumption coming from Russia has halved since the war to 20% of the total, according to consultancy ICIS.

The EU has also taken steps to tighten sanctions against Russia, banning seaborne imports of crude oil and banning insurance for any tanker carrying Russian oil, with the UK also on board.

Laurent Ruseckas, a gas market specialist at IHS Markit, said that while Moscow could restore supplies soon, there was a risk of doubling down and making even bigger cuts this winter.

“There is an increasing likelihood that this will be a prelude to the main show,” he said, adding that he feared Moscow saw the potential to weaken sanctions by increasing pressure on Europe’s economy.

European natural gas wholesale price line chart (Dutch TTF, euros per MWh) showing Gazprom cuts boost European gas prices near recent highs

“If there’s an explicit ‘we’ll cut gas if you don’t lift sanctions,’ I’m confident they’ll get a very short answer,” he said. “But I am concerned that there is enough support for this approach in Moscow to make it a very real possibility.”

If Russian gas flows don’t recover soon, Europe would need to step up its search for more maritime cargoes of liquefied natural gas to replace it. But the fragility of this option was exposed in the last fortnight.

A fire at an LNG terminal in Texas, which accounts for nearly 20% of all U.S. liquefaction capacity, has shut the plant down for at least three months and is unlikely to fully return by the end of the year.

Europe has benefited from lower Chinese demand for imported fuel as the country struggles to control the coronavirus, but it is unclear how long this “zero Covid” policy will persist.

With an eye on a potentially difficult winter, Germany was one of the few big economies to launch an efficiency campaign, urging citizens to save energy this summer so there’s more gas available for storage ahead of the colder seasons. Italy, where Gazprom’s supplies are down 15%, could activate an emergency plan to reduce gas usage next week, including reducing supplies to some industrial users. But others, including the UK, have so far refused to make conservation a national priority.

Another option would be to burn more polluting coal and consider other politically challenging policies. The Groningen gas field in the Netherlands was once the largest in Europe, but its production has been limited after causing several large earthquakes that damaged buildings. It is still seen in the industry as an option if there are prolonged shortages.

In the long term, the EU will use more renewables, but there is not enough time to add significant capacity before winter.

Henning Gloystein, an analyst at the Eurasia Group, advised the EU to plan for Russia to completely shut off all gas supplies and increase imports from other sources. “At worst, some sort of gas rationing would be needed to maintain supplies to essential industries and services,” he said.

Some suggested that the EU should go on the offensive. Bruegel’s Zachmann said Europe could force its utilities to effectively cancel any long-term contracts they had with Gazprom. European buyers could then offer to buy a fixed volume of gas at a fixed price, offering Russia better terms for larger volumes.

If Russia decides to stop supply entirely, Europe could respond, “but just sitting like a frog in water and letting the Russians turn up the temperature is not a good plan,” Zachmann said.

“Russia said ‘it’s our gas, it’s our game’, but we need to say ‘it’s our money, it’s our game’.”

Additional reporting by Tom Wilson in London and Amy Kazmin in Rome

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