The recent conflict in Ukraine took an interesting turn today when the Crimean parliament formally applied to join Russia and separate from Ukraine. Many facets of the Russian, Ukrainian, and global economies have been affected by the crisis in Ukraine, but one industry that has gotten a lot of attention in particular is energy, and for good reason. Given the EU’s dependence on Russian natural gas (a majority of which is supplied to the EU through the Brotherhood pipeline that runs through Ukraine), the quickly escalating tension between western leaders and Mr. Putin have raised concerns about the supply and price of natural gas. A sudden jump in gas prices would hurt households and companies across the EU, but as a recent Economist Intelligence Unit report, “Ukraine: The energy impacts,” indicates, the energy risks for the EU are less troubling than they first appear.
The report reveals that EU reliance on Russian natural gas has steadily declined since the mid 1990’s. Due to past pricing disputes with Russia in 2006 and 2009 the EU has made a strong effort to substitute its Russian natural gas consumption with alternatives such as liquefied natural gas, coal, and renewable energy. Furthermore, the EU has been looking to other countries for its natural gas needs. Although Russia still accounts for roughly 30 percent of the EU imports of natural gas, Norway and Algeria are starting to play a larger role. As seen by the following bar graph showing the distribution of EU natural gas imports in 2011 and 2012, Russia’s market share is decreasing:
Although gas and alternative fuel prices may rise slightly, the report emphasizes that the short term effects on the EU’s natural gas supply will not be too worrisome due to three main reasons:
- The Existence of Other Pipelines from Russia to the EU: The Nord Stream pipeline through the Baltic Sea to Germany and the Yamal pipeline through Poland and Belarus offer the EU alternative methods of importing gas from Russia, making the threat of a pipeline shutdown in Ukraine less scary. Mr. Putin could still, in principle, cut off or tighten supply to the EU as a political tool, but as the next reason explains, he is unlikely to do so.
- Russia’s Dependence on EU Natural Gas Demand: The EU is one of the largest buyers of Russia’s natural gas, and therefore significantly contributes to Russian GDP (about 3% of total output). Mr. Putin is unlikely to cut off or tighten supply for too long because the costs of such an action would not outweigh the possible political gains.
- Timing (End of a Mild Winter): Because the crisis comes at the end of a comparatively mild European winter, the EU has had time to stockpile significant natural gas reserves, which could, by themselves, be used to supply the region for a two months at least.
The long term effects are likely to involve an EU effort to rely even less on Russian natural gas. Some potential effects that the report mentions and I have brainstormed are:
- Increased EU Demand for Norwegian and Algerian Gas: I would argue that EU demand for Norwegian gas especially will increase because it provides the EU an effective hedge from political risk. Although Norway is not a part of the EU, it is very closely associated with it and is much less likely to stir up political conflict compared to its larger competitor in the East.
- Increased EU Demand for LNG: Liquefied natural gas is the EU’s most readily available alternative to Russian natural gas, so it is probable that it will start importing more of it. It is even possible that the U.S. shale gas industry stands to benefit from this shift, but this is only realistic in the very long term because building the infrastructure necessary to export LNG to Europe would take a while.