Europe’s Never-Ending Natural-Gas Obsession

"Russian gas does not weaken Europe politically, and diversification is not the solution."
Nikos Tsafos

The crisis in Ukraine has pushed Europe’s natural-gas hypochondria to new heights. Normally, the conviction that Russian gas is a political liability and the subsequent calls for "diversification" do little harm, but the rhetoric has now spiked to extreme levels.

The problem is that both the diagnosis and the prescription are wrong: Russian gas does not weaken Europe politically, and diversification is not the solution. Europe should instead focus on boosting its ability to deal with disruptions as the best way to achieve energy security.
The conventional wisdom rests on three claims: Russia could cut or threaten to cut supplies for political gain; gas enriches and emboldens the Kremlin, while threatening Europe’s competitiveness; and commercial ties with Russia undercut a strong and unified European response.

The first claim is the paramount concern, and there is no doubt that a cutoff, intentional or not, would hurt Europe (albeit, the pain would be uneven). But is this real leverage? After all, cutting suppliers is a blunt instrument that escalates a crisis and triggers a reaction—which is why the “gas weapon” has yielded limited political gains for Russia. Ukraine is proof enough: if Russia could control Ukraine through gas, there would be no need for violence. What insulates Europe from a cutoff is not Russia’s need for export revenues, but Europe’s likely retaliation for what could easily be perceived as casus belli.
The second claim is similarly inflated. For one, oil trumps gas in Russia—50 percent of Russia’s export revenues come from oil versus 13 percent from gas. Nor are reduced exports guaranteed to make the Kremlin more conciliatory—politicians often use foreign adventures to distract from economic woes at home. Similarly, there is no evidence that energy costs, for which Europeans unfairly blame Gazprom’s “monopoly,” have undercut European competitiveness; a recent European Commission report found that, “there has been little impact on the EU’s relative competitiveness which could be directly attributed to higher energy prices and the carbon price under the ETS [Emissions Trading Scheme], due to improvements in energy efficiency.”
The third claim—that commercial ties interfere with a pan-European policy—similarly reduces a complex issue (how to deal with Russia) to a single explanatory variable (commercial ties with Russia), even though experience shows us that trade can coexist with or even cause tense political relations. Nor is this solely an energy issue, as the recent furor over French military sales to Russia reminds us. The real concern voiced, however, is about European unity. It is axiomatic that a unified energy policy towards Russia is desirable. But why is that so? European countries have diverse energy profiles and diverse comfort levels in dealing with Russia, so it is hard to see how a common approach might make sense. Moreover, markets require that companies cut their own deals—if not, there is no real competition. Of course, there are some issues best dealt at a European level—but this is different from a common policy towards Russia. It is a policy towards all companies, European or not, rather than a strategy towards Russia.
None of this means that Europe has nothing to worry about, but a somber appraisal of the way that Russian gas affects European politics will lead to smarter policy and avoid overreactions. Nowhere is such correction more necessary than in the persistent call for “diversification.”
Diversification has become shorthand for energy security, even though it is a poor barometer for it. Diversification does not measure how well a country can cope with a crisis. A country can have many suppliers, but if none can provide additional gas in a crisis, then diversification is no good. In fact, European countries have often turned to Russia to offset a shortfall in other supplies (e.g. Libya, Iran, Azerbaijan). In those cases, higher reliance on Russia boosted energy security, as opposed to undermining it.
Diversification can also be costly—after all, diversification means moving away from your usual suppliers, which tend to be the more economical ones. A few years ago, Brazil decided to diversify from Bolivia, but liquefied natural gas (LNG) cost 50 percent more than Bolivian gas in 2013. Poland was similarly ecstatic to sign an LNG contract with Qatar in 2009, but now wants Qatar to lower the price. Diversification for the sake of diversification can turn out to be expensive.
Diversification can also be politically tricky. Many of the countries that supply or might supply Europe bring their own challenges: Algeria, Libya, Egypt, Israel, Cyprus, Yemen, Azerbaijan, Iran, Turkmenistan or Nigeria. Diversification is often assumed to mean replacing “bad” Russian gas with “good” gas, but reality is messier. By courting suppliers, Europe creates new political realities that have to be managed. And diversification can also mean support for practices or fuels with their own environmental (shale, coal) or security (nuclear) baggage. 

Europe should instead focus on resilience—the ability to cope with disruptions. Resilience has physical and intangible aspects. The physical aspects refer to a system’s redundancy and adaptability: can pipelines flow more gas, can they move gas in multiple directions, is there storage to act as a buffer, can ports take in more tankers, can power plants use other fuels (oil or coal)? The intangibles refer to the ease with which companies can use infrastructure when needed. Resilience, of course, requires investment in assets that are used sparingly. It is easier for a country to free ride and then cry “solidarity” when a crisis comes—that is why the emergency response mechanism for oil, for example, requires that all countries do their part and hold a certain amount of oil in storage.
Even so, the European market is more resilient today than it was a few years ago. The infrastructure to import LNG has risen threefold since 2005, and the continent imports more gas from more countries. Storage capacity has increased by a fifth, and there is more gas traded freely rather than under long-term contracts. More importantly, there are more pipelines that can flow gas in both directions (which is critical in a crisis), and there are many proposed pipelines in Eastern and Southern Europe that will help countries cope with a future disruption. European support has been critical in these changes, and Europe is finally seeing the benefits of a more liberalized and better-functioning market that can respond to consumer needs as well as deal with a crisis.

It is now time for the rhetoric to catch up with reality. Thankfully, we may be headed that way. Poland is proof enough. In 2006, Poland’s defense minister labeled the Nord Stream pipeline, which directly connected Russia to Germany, a new “Molotov-Ribbentrop Pact,” the 1939 Soviet-German deal to carve up Poland. In 2014, after Nord Stream was up and running, Poland added some infrastructure to allow it to import gas from Nord Stream via Germany. That is the type of cool, unsensational approach that Europe should take to energy security: less rhetoric and more down-to-earth solutions to specific problems. Only then will Europe see a tangible increase in its energy security.
Nikos Tsafos is a founding partner at enalytica and is currently advising the Alaska state legislature on gas commercialization issues. He was previously a director with PFC Energy, with a portfolio that included overseeing research and gas fundamentals and leading the firm’s global gas consulting practice.

http://nationalinterest.org/feature/europe%E2%80%99s-never-ending-natural-gas-obsession-10645