The geopolitics of oil and gas in Europe
By (Mrs) Amb Narinder Chauhan
The Ukraine War has forced a radical rethink in the European Union’s (EU) energy supply architecture. The EU’s current U-turn on Russian energy is historic. Russia has been traditionally a key energy supplier to the EU. In 2021, Russia supplied the EU’s 40% of natural gas demand, 30% of crude oil demand, and 30% of coal demand. Following a strong diversification effort post Ukraine, EU policy makers have looked at the alternative supplies and the bottlenecks in these alternative routes.
Theoretically, the EU can replace 50% of gas imports from Russia within a year by maintaining flows through pipelines from Norway, Algeria, and Azerbaijan. In April this year, an agreement was signed between ENI and Sonatrach to increase Algerian supplies to Italy. The UK can also increase exports to Belgium and the Netherlands. The remaining 50% will need to be compensated by reduced demand.
However, practically speaking, these supply routes were already operating at maximum capacity in 2021 with scope for only marginal additional flows in the short term. Global LNG markets are already extremely tight and an additional demand of 500-950 TWH from the EU will exacerbate the situation. In 2021, worldwide gas trade totaled 5400twh, with China, Japan, and South Korea as the largest importers. The global liquefaction capacity is almost fully utilized. Liquefaction Facilities take multiple years to build and thus in the next 2-3 years the EU must compete with other countries for these limited supplies, leading to possible skyrocketing of natural gas prices which will make it unaffordable for the developing countries and the emerging world.
For oil, if the EU were to completely ban Russian oil, around 3mb/d of Russian crude and 1mb/d of oil products will need to be replaced. OPEC spare capacity ranges upto 4mb/d. Outside of OPEC, the US could at a pinch add another 1.5mb/d. OECD members hold strategic oil reserves of 1,5b barrels which can cover for around a year. EU Industry holdings are another 3b barrels. Therefore, EU embargo on Russian oil can be partially mitigated by drawing upon internal strategic reserves while boosting alternative output. However, the reality is many OPEC members are already struggling to hit production quotas. Like the LNG market, the global oil markets were already tight prior to the Ukraine war. OPEC members cannot already meet existing quotas.
Russian coal can be replaced more easily with alternative supplies, particularly if China and India were to buy more from Russia. The US may also be able to increase its domestic production. However, many exporting countries face constraints in increasing the production and supply of coal, such as Indonesia which this year introduced a temporary ban on coal exports; similarly, Australia has temporary supply interruptions due to wildfires and flooding; Colombia and South Africa are not able to increase exports to their full potential.
The other bottleneck relates to EU import capacities. The non-Russian gas pipeline facilities are already at maximum capacity; there are constraints related to the regasification facility due to technical reasons and unforeseen maintenance work.
Further, for crude oil, the European refineries will find it difficult to process with a different quality of crude. Particularly vulnerable are six large refineries in Poland, Germany, Czechia, Austria, Hungary,and Slovakia, which have historically been dependent on Russian crude. Beyond crude oil, the EU also needs to consider replacing Russian refining capacity that produces diesel, naphtha, and fuel oil. Refineries will face additional challenges of replacing lost supplies of Russian vacuum gas oil to service these runs.
Another bottleneck relates to intra-EU architecture. The availability alone is not enough, the fuels must be able to move from points of import to points of final consumption. And the EU energy market, particularly for natural gas, is dependent on low-cost Russian supplies from the east. The EU gas markets are not designed for supplying all central and eastern Europe from the west and it will be a large challenge to successfully reorient gas flows.
Moreover, the Central and East European pipeline system is designed to bring imports from the east to final consumers. Flows from west to east to fill up storage facilities in countries most dependent on Russian gas will have to be done to prevent pipeline bottlenecks.
For crude oil, it would be challenging to reroute supplies from Gadansk, Rostock and on the Adriatic Sea to feed refineries on the Druzhba pipeline, therefore, additional supplies will have to be met by rail with attendant logistical difficulties. Oil products also need to be transported to the correct place. It would be considerably difficult to transport diesel, for instance, to East Germany in huge quantities through trains and trucks.
Some EU countries still have high shares of coal in their energy mixes and will find it difficult to replace Russian coal. It would be a major challenge for German Industry. Poland is in a better position as much of its demand is met by internal production and it was able to ban Russian coal before the EU did. The EU will be able to replace Russian coal and boost coal demand by offset gas fired production, but this will affect emerging and developing economies by pushing prices higher.
Another bottleneck is politics outside the EU. The LNG business requires 20–25-year contracts to justify the significant investment in Liquefaction plants and receiving terminals, which also supply Asia. Relatively mild winter has kept Asian demand down, should it change, the EU would face a steep challenge of importing larger quantities of LNG.
Though long-term contracts are not so much in the oil market, OPEC has agreed with Russia and Central Asian countries known as OPEC plus, to constrain supply growth to 0.4mb/d per month. Saudi Arabia and the UAE have not agreed to increase production. The question is how much political pressure US and allies may like to exert and where to compromise. Geopolitical tensions, for instance, relating to Yemen, influence this relationship. The Iranian nuclear deal is another controversial point. The US is dealing with Venezuela which means that sanctions on Russia may come at the cost of removing sanctions elsewhere (Venezuela).
Finally, what is technically feasible may not be politically feasible. Notwithstanding infrastructure limitations, EU states will still have to display significant solidarity. Countries with better alternative supply may be reluctant to share scarce gas with countries in worse situations, as had happened during the pandemic when some EU countries banned export of technical equipment.EU will face the challenge of having to closely coordinate to prevent gas disruptions in an environment of rising energy prices. Same goes for oil. Oil will require significant coordination and logistical issues.
In the short term at least, it will not be possible for the EU to replace each oil and gas molecule from Russia one by one. EU policy makers are looking at switching to alternative fuels and by absolute reduction in demand.This wishful thinking contrasts with most EU governments cutting taxes and subsidizing consumption which will become more expensive and lead to bidding wars in Europe.
Large demands for gas come from power, heating, and industrial sectors. While in the long run, accelerated deployment of renewable technologies is the solution, timelines for projects limit short term options. Crisis in a carbon neutral scenario would unfold requiring improvisation. The EU would not be able to reduce Russian supplies by 50%, therefore, demand would need to contract by 20% requiring hard political, logistical, and economic decisions. If these measures are accompanied by renewed impetus for transition towards zero carbon,it will be at great economic and political cost to Russia which might completely lose its leverage on Europe over energy supplies. After all, Europe has benefited by encouraging some amount of rivalry between the US and Russia.
To make Europe climate neutral by 2050, the EU Green deal must pursue one main goal: to reshape the way the EU produces and consumes energy-a process that accounts for 75% of its current GHG emissions. Today, three-fourths of the EU energy mix relies on fossil fuels: oil 35%, natural gas 24%, coal 13.5%. Renewables are growing in share but still play a limited role at 14%, as does nuclear at 12%. Should the European green deal be successfully implemented, the situation will be upturned by 2050. But change will not happen overnight, fossils will still contribute half of the energy mix in 2030. Beyond 2030, oil and natural gas imports are expected to shrink significantly. International reactions to an EU carbon border tax will be another game.
Moreover, Europe may be at war with Russia today, tomorrow it may seek a modus vivendi with its next-door neighbor. As it is, theEU countries are not united on how to punish Russia over Ukraine and may not like to humiliate Russia; after all EU and Russia must co-exist. Further, the emerging internal political contradictions within some member states of the EU such as Italy, Germany and France may yet provide an opportunity to Russia.
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