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The End of Russia’s Influence on European Energy?

In early March we wrote an article on the Ukraine crisis where we compared the current energy standoff to similar Russo-Ukranian conflicts in 2005 and 2009.

We spoke of a renewed sense of optimism amongst central European nations that the impact would be mitigated as the energy markets had moved on in a short few years thanks to increased LNG capabilities and a burgeoning supply of shale gas extraction.

Whilst we saw reassurance in these changed dynamics, we also cautioned that until relations returned to ‘normal’ risks remained, not least in market sensitivity.

On the 10th April then, we heard what no one wanted to hear, Russian President Vladimir Putin wrote to 18 world leaders warning them that his nation’s policy towards Ukraine would include a total shut down of Russian gas supplies to the Ukraine and that the Central and Western European leaders could expect their gas deliveries to be similarly impacted.

Putin claimed Russia had saved Ukraine over £10 billion in five years by virtue of the deals struck as part of a claimed £21 billion subsidy to the Ukranian economy. Contentiously Putin also laid claim to the fact that Ukraine had failed to pay £11 billion in unspecified “fines” to Russia, and had failed to pay for its Russian gas supply since August 2013 racking up a £1.5 billion debt in the meantime.

Against this backdrop, already Russia had announced a 44% increase in the cost of gas supplied to Ukraine as their ‘bad debt’ status brought commercial pressure to bear.

Putin’s letter however laid increasingly stark his warnings of consequences for the whole of Europe, saying:

“Right from day one of Ukraine’s existence as an independent state [Russia has underpinned the] stability of the Ukrainian economy by supplying it with natural gas at cut-rate prices [through] unprecedented privileges and discounts.

“In the event of further violation of the conditions of payment [Gazprom] would completely or partially cease gas deliveries.

“Undoubtedly, this is an extreme measure. We fully realise that this increases the risk of siphoning off natural gas passing through Ukraine’s territory and heading to European consumers.

“We also realise that this may make it difficult for Ukraine to accumulate sufficient gas reserves for use in the autumn and winter.

“The fact that our European partners have unilaterally withdrawn from the concerted efforts to resolve the Ukrainian crisis, and even from holding consultations with the Russian side, leaves Russia no alternative.

“We believe it is vital to hold, without delay, consultations at the level of ministers of economics, finances and energy in order to work out concerted actions to stabilise Ukraine’s economy and to ensure delivery and transit of Russian natural gas.”

Putin added that regardless of any other stipulation, Russia would now only supply the volume of gas that Ukraine had paid for “one month” in advance.

That payment would be required to be made to Gazprom, the former Russian energy ministry and now a European wide energy giant.

This blurring of politics and commerce places a shadow over energy security and Russia’s role in Europe.

The direct dependence of European states on Russian gas varies widely, we in the UK do not have any direct dependency whilst further east it is estimated that Hungary source up to 80% of their gas supplies from Russia.

Direct dependence is not the end of the story however; as naturally a shortage in central Europe will force up prices and make those areas with scant supply an attractive market in which to sell surplus, or indeed not so surplus gas supplies.

It is this dynamic that could see the UK export a larger proportion of its gas production to central Europe in order to take advantage of buoyant prices. In turn this could impact UK supplies and drive prices upwards.

It is also clear that Gazprom, despite its pivotal role in the dispute, will not turn out as a winner. Their increasing reliance on western European markets means that actions such as those threatened by Putin will lead to a loss in revenues and more importantly inflict significant damage to their reputation as a reliable supplier of energy to Europe.

Whilst there is cause for concern, as was the situation in March, the mild winter has meant gas reserves are high across Europe, as storage has not had to be called upon across recent months. This combined with alternative sources such as LNG, shale gas extraction and the Caspian Sea supplies, means that many commentators still expect the impact to be limited despite the escalating threats.

Indeed the brinkmanship being displayed by Russia with regards direct impacts on western Europe is likely to be just that, not only will Gazprom’s reputation suffer but also that of Russia as a reliable, trustworthy source of energy.

For all the hyperbole, Russia has proved a consistent and helpful partner for Western Europe’s energy needs. Even in a time of some crisis Putin would be playing a very dangerous game, threatening to diminish Russia’s strategic importance to Europe. Once this has gone, so will Russia’s relevance, something that Putin even at his most obstreperous would not want.

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