Energy crisis set to change both Europe's and Russia's futures

But a transformed, post-conflict energy model could be better for itself and its neighbours

The Orenburg gas processing plant of Gazprom in the Orenburg Region, Russia. Without lucrative international contracts, Gazprom’s ability to subsidise gas for its home market will be undercut. Reuters
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The remarkable Ukrainian advances against Russian forces in the past few days could be a turning point in the war. Away from the military conflict, another landscape is changing: the energy economy. Its outcome will profoundly transform both Europe and Russia.

It remains to be seen how much more territory Kyiv will regain; whether it will move towards occupied Crimea and the strategic Azov Sea coast, or whether Russian resistance will stiffen.

It seems unlikely that any settlement will be reached to revive significant shipments of Russian gas to Europe over the next year — or that the Europeans will again return to complacency. The 13-day halt in supplies through Ukraine in 2009 was the first warning; the annexation of Crimea in 2014 was the second.

But it was only after February 24 this year that Europe moved decisively to break its dependence on gas from Russia — and even that has been enforced more by Gazprom. Supplies through the Nord Stream 1 pipeline to Germany have been halted indefinitely until sanctions are lifted. Flows through Poland have been at zero for months; a little continues through Ukraine, surprisingly enough.

Europe’s response will have three stages. This winter is the most critical. Germany and the UK, among others, have prepared huge financial packages to cushion the shock to households and businesses. Almost every EU member has already reached the target of filling 80 per cent storage by November. Two new floating terminals to import liquefied natural gas have arrived in the Netherlands, and Germany should start three more shortly. Beyond this, Europeans should pray for a warmer winter.

The second phase comes over the next three years. Little new LNG production will start up worldwide over this period. Perhaps a little more gas will arrive by pipeline in Europe from North Africa, the Middle East and the Caspian.

As such, the wholesale replacement of Russian gas will require consuming less both in Europe and elsewhere. The deployment of renewable electricity will be hugely accelerated, but much energy-intensive industry in Europe will close, perhaps for ever, to be relocated to areas with cheaper gas. Homes will be renovated and gas boilers replaced by electrically-driven heat pumps, so that gas used in heating drops.

Asian countries that hoped to use LNG to end energy shortages and clear, smoggy skies will have to keep burning coal, or go without.

From 2026 onwards, major new LNG projects in Qatar, the UAE, the US, Australia, Canada and Mozambique should start up. Large-scale exports of hydrogen from the Middle East and North Africa could begin to replace gas in Europe. Nuclear power may be revived.

Perhaps some Russian gas will again flow west, in a political situation situation that is radically different from the present. However, it is hard to imagine Brussels or Berlin will again want 40 per cent of their imports to come from Siberia again. Moscow’s standard response has been plans to reorient to China, which already buys about 10 per cent of its gas exports (Europe, including Turkey, taking the lion’s share).

But this year’s episode will make Beijing too wary of over-reliance on its western neighbour. Russia’s sales to Europe are the equivalent of all China’s imports — which are currently sensibly diversified between Russia, central Asia and LNG into its eastern littoral.

China is in a position to strike a hard bargain. Gazprom's eastern sales were already only half as profitable as those to Europe and require massive, costly and long-distance pipelines through harsh terrain. Without lucrative international contracts, Gazprom’s ability to subsidise gas for its home market will be undercut.

In oil, the G7’s concept of capping prices paid for Russian oil is questionable. But sanctions and the coming EU ban will limit Russian exports. A lack of technology and finance will cut production in the longer term, as declines of mature fields accelerate and development of the next generation of remote, costly Russian fields in East Siberia and the Arctic offshore is stymied. Even just before the war and Covid-19 pandemic, a study from two Moscow energy institutes foresaw a 15 per cent drop in Russian output by 2040, accompanied by a near-doubling of average production costs.

Opec wanted for decades to bring Russia into its system and the wider grouping has proved successful at managing supply and demand dynamics. However, with Russia producing well below its assigned level, its impact on short-term market management is more limited.

Climate policy was already an ever-growing danger to Russia’s oil, gas and coal exports up to 2050. The war ended any chance of replacing them with hydrogen sales to Europe — an area where Russia could have enjoyed a competitive advantage.

Apart from hydropower, its use of renewable energy is feeble — representing only 0.5 per cent of its electricity, and half that of much smaller Ukraine. China, Japan, Europe and the US dominate the research and manufacturing of new energy systems, from solar cells to advanced batteries and electric vehicles. One area of success, nuclear reactor exports by Rosatom, has had its prospects altered.

Reorientation from reliance on exporting fossil fuels and minerals will be lengthy and hard. But a transformed post-conflict energy model for Russia could be better for itself and its neighbours.

Robin M Mills is chief executive of Qamar Energy and author of The Myth of the Oil Crisis

Updated: September 12, 2022, 3:30 AM
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