With the discovery of huge new reserves of natural gas around the world and the development of new technology to extract it, Russia faces the possibility of moving from a position of market dominance in the European natural gas (NG) market to facing both European and North American competition. Since Soviet times, Russia has had market dominance over European imports of natural gas—the most common European home heating fuel—in both Western and Eastern Europe. (It has controlled as much as 80 percent of the European imports.) But competition very well may be on its way for the economic, technological, political and military reasons outlined below—potentially dropping the Russian market power to 50 percent or below.). (As mentioned in next paragraph, Russian imports account for the largest single amount of EU consumption.)
This obviously is a major and unforeseen change from the past. During the Soviet era and forward, Russia basically controlled European imports of gas through its huge reserves in Siberia and the pipeline network in Ukraine and Belarus. This was a structure of stability, even after the Central European countries broke away from Soviet control and the Soviet Union disintegrated in 1991. But since Russian President Vladimir Putin has been using natural gas supplies as a political weapon against Ukraine and Europe since 2006, Europe began reducing its dependence on Russian gas. Russian imports account for 25% or more of EU consumption. But Ukraine gets about two-thirds of its total natural gas from Russia. (Figures in IAE country sheet)
Ukraine has faced political turmoil over selection of its president in 2004-2006 and again recently. Unlike the “Orange Revolution” of 2004, the 2013-2014 demonstrations protesting the pro-Russian policies of President Yanukovych led to the use of violence against the demonstrators, armed rebellion by Russian separatists and a shooting war with Russia over control of Ukraine’s eastern provinces. This area contains the bulk of its manufacturing and potential petroleum producing capacity.
Worried that Ukraine could shut off deliveries, Russia’s strategy has been to bypass Ukraine pipelines to deliver natural gas to Europe. The Nord Stream pipeline in the North Sea reduced the percent of Russian-exported natural gas going through Ukraine from 80 percent to 50 percent. The proposed South Stream pipeline through the Black Sea to Bulgaria has enough capacity to eliminate Ukraine as a transit point for Russian gas. As a political reaction to Russia’s military actions, the South Stream pipeline currently is on hold.
Russia’s share of the European market may decline faster than previously expected. The nations most dependent on Russian gas–the Baltic countries, Central Europe and Germany–plan to reduce or eliminate purchases of Russian gas by accelerating fracking, off-shore drilling and building NG regasification plants. New sources of gas are coming into the European market. Large new reserves from the U.S., Canada, the eastern Mediterranean and other countries and regions will introduce previously nonexistent competition from greatly increased amounts of exported liquefied natural gas (NG).
Two major groups of countries are potential NG supply competitors: Europe and North America. Both regions have huge potential reserves. In Europe, the development of potential gas reserves depends on the willingness of European national governments to allow domestic companies to engage in “fracking.” The data in this area is preliminary since the oil industry has been studying shale and off-shore fields for only a few years and just now is drilling exploratory wells. The International Energy Agency (IAE) has identified several European countries with substantial reserves, but the speed in which they are developed depends on regulatory approval of fracking and attracting technology to develop the fields. The major players are:
IAE SELECTED STATISTICS
Increased European production, NG imports and conservation could eventually substitute for most or all of Russian imports. But increased production in Europe and on the periphery will weaken Russia’s dominant position as the major exporter. Any new entry has an impact on the margin. Moreover, these countries can deliver gas directly to Western and Central European countries without having to use the Russian-dominated infrastructure in Ukraine. As the U.S. experience with production of automotive gasoline during the New Deal showed, even a small amount of new competition has a negative effect on existing prices. This might lead NG producers to coordinate their production and prices. The US Supreme Court condemned precisely this type of scheme in United States v. Socony-Vacuum Oil Co., 310 U.S. 150 (1940), in which the large gasoline companies agreed to make deals with smaller oil companies as to production and pricing.
Moreover, there will be other new sources of gas coming on line in the next few years from Canada and the United States, since both have will have surplus supplies and are beginning to build plants to produce LNG for export. There are at least eight LNG plant proposals in the U.S. and three in Canada. Two in the U.S. and one in Canada have already been approved for construction. If all of the proposed plants are built, there will be substantial total export capacity in the two countries. Preliminary studies indicate that Canada and U.S. firms can deliver NG to Europe at a lower price than Europe is currently paying Russia.
Increased oil and gas production and sales has been the main driver of Russian economic growth since Putin became president in 2000. Russia desperately needs access to foreign capital and technology to develop its huge untapped reserves of oil and natural gas, to maintain its dominant global position in the long run. Recent Russian military pressure on Ukraine may lead to stronger economic sanctions, including denying Russia access to new technology and foreign capital. Already, Russia’s huge state-controlled oil company Rosneft has been told by European banks that they will not roll over $42 billion in existing debt.
Unless Russia simply wants to fold part of its NG hand, which earns about $45 billion a year in Europe, it thus faces hard choices. In order even to maintain its present market position in the world—let alone dominance—it has to not only develop new NG sources, but also develop more joint ventures and aggressive pricing against the new competition for Russian oil and gas companies. Russia would also like to weaken Ukraine’s value as a transit point and European interest in the internal affairs of Ukraine.
Finally, some observers think that Russian military intervention in not out of the question, as with its “re-annexation” of the Crimea and its use of military force against Georgia in a similar situation. But it seems like a weak reed. As mentioned, Russia already has alienated many European and other countries through its low-level military incursions into Ukraine—both by supporting separatists in the east and occasionally deploying regular army troops inside Ukraine. Although Russia dominates Eastern Europe in terms of military hardware—e.g., tanks, armored personnel carriers, airplanes—other sources are readily available. After all, the United States and its allies currently are in the process of decommissioning equipment from Iraq and Afghanistan, a good part of which already is on its way back to the Northern Hemisphere—and presumably could be diverted relatively easily to Eastern Europe.
None of this is very optimistic, particularly for Russia. Where does it go? Obviously no one really knows. But there will have to be some kind of cooperation between Russia and former Soviet states in Europe to create incentives for all parties to find an acceptable deal. Given the amount of both present and potential trade among Russia, the other former Soviet bloc nations, and the western part of Europe a sine qua non obviously has to be economic and other benefits for all parties. But this depends on how far Putin is willing to go to fulfill Russian nationalist objectives and endanger Russia’s long-term economic interests with risky current political actions.
Assuming that military escalation is not on the horizon, however, it seems likely that most of the Russian-Ukrainian bargaining will focus on the degree of independence of Ukraine’s eastern provinces with the threat of increased economic sanctions in the background. Even if Western and Eastern European countries only pursue policies that increase competition, they will pose a significant long-term threat to Russia.