The Urgent Case for Energy Austerity

gas march

Editor’s note: Don’t miss our comprehensive guide to Russia’s war against Ukraine.

 

Russia’s invasion of Ukraine has already prompted one of the most dramatic international efforts to isolate a major economy in recent memory. Citizens and policy-makers are now calling for an embargo on Russian energy exports, arguing that commodity sales fund Putin’s war machine. On March 8, the Biden administration announced a ban on the import of Russian oil and gas, and on the same day the European Commission announced a plan to cut Russian gas imports by two-thirds this year.

Previously, deep European energy interdependence with Russia contributed to weak Western responses to Moscow’s aggressive behavior. Therefore, it is encouraging to see Western leaders reject this dependence in an effort to change Putin’s calculus. But attempting to quickly expel one of the world’s largest and most integrated commodity exporters from a globalized economy has led us to the precipice of a serious energy crisis. Western governments and citizens have shown courage and determination in their support of Ukraine, but citizens should fully understand and be prepared to bear the costs of policies designed to punish Russia. Given the severity of the impending crisis, developed countries, and in particular states in the European Union, have a strategic, economic, moral, and environmental imperative to begin conserving oil and gas immediately.

Russia’s Energy Chokehold on the Global Economy

Russia is the world’s 11th largest economy and a commodities superpower: It is one of the largest oil producers and exporters, a major natural gas, coal, and uranium exporter, and a market-maker in various cereals, metals, and rare minerals. Dependence on Russian commodities is not evenly distributed — while the United States relies on Russia for a small proportion of its domestic oil consumption, Russia is the European Union’s main supplier of crude oil and provides about 40 percent of Europe’s daily consumption of natural gas and almost half of its solid fuels. As a result, although the effects of curtailing Russian exports will be widespread and global, they will be most keenly felt in Europe. This helps explain why, despite increasing calls to do so, Europe has not joined the United States in an embargo of Russian oil and gas imports.

 

 

Under Vladimir Putin, Moscow spent the last two decades engaging in economic statecraft that resulted in the deep integration of Russia with global markets. In addition to encouraging corruption along the entire energy value chain, the Kremlin cultivated close ties with utilities firms that profited off Europe’s energy dependency. The Kremlin has sometimes engaged in outright energy blackmail, but in most cases Moscow’s hold over the European economy was more insidious. European policymakers also preferred to engage in business as usual rather than risk economic disruption. Particularly since Ostpolitik (the normalization of relations between West Germany and Eastern Europe beginning in 1969), Germany has adopted a predominantly commercial framework for energy security, which saw dividends in strengthening Russia’s integration into the European economy. Thus, despite two Ukrainian gas crises in 2006 and 2009 that resulted in the interruption of gas supplies to Europe, European reliance on Russian hydrocarbons continued growing, entrenching the partners in increasingly deep interdependence. As a result, breaking these ties will be particularly painful.

Indeed, these ties are already being broken and the pain is already being felt. Russian assets have become so toxic that major firms are engaging in self-sanctioning to avoid the reputational risk associated with doing business with Russia. Shell, Exxon, BP, Eni, and Equinor have all announced that they would no longer purchase Russian oil and gas, and three of the world’s largest oilfield service companies have suspended operations in Russia. Perversely, self-sanctioning and open discussions of embargos, even without implementation, have caused commodity prices to spike, resulting in higher consumer energy prices and increased revenues to the Putin regime.

Sharply rising commodity prices resulting from the Russian invasion have prompted comparisons with the 1973 oil crisis. But this energy shock is different, and arguably more serious, as it involves all of the world’s major sources of energy — oil, natural gas, thermal, and coal — at the same time. Together, these sources make up 83 percent of the world’s primary energy consumption. Although there is not yet a major global embargo of Russian energy supplies — U.S. imports of Russian oil account for only 3 percent of consumption — markets are already pricing in a wider disruption. American consumers are seeing almost unprecedented prices at the pump, and European natural gas prices, already at historic highs prior to the war, are extremely volatile. Global coal prices shot to record levels, with analysts forecasting $500 per ton later in 2022. The European Union is already considering emergency measures to limit soaring electricity prices.

Yet the impact of removing Russian energy from the market, either through self-sanctioning and market forces or government decree, is only beginning to be felt. High energy prices drive down consumer demand because people have less money to spend on goods and services. Moreover, spiking energy prices hurt industrial production, affecting sectors including steel, fertilizer, transportation, and more. Energy intensive industries including airlines, shipping, and car manufacturing — which were already hurting due to the pandemic — are demanding government intervention. Industrial production in Europe is already dropping: Europe’s largest producer of aluminum has been forced to reduce output by 15 percent.

High energy prices also disproportionally affect developing and emerging economies, especially those that rely heavily on imported food and fuel. Europe is paying historically high prices for spare volumes of liquified natural gas, pricing out countries like India, Pakistan, and Bangladesh. This leads to disruptive demand destruction as advanced economies use their superior financial firepower to divert scarce energy resources toward western markets. The energy crisis is also contributing to a burgeoning global food crisis, as energy prices are highly correlated with food prices, and both Russia and Ukraine together export nearly a third of the world’s wheat. Turkey and Egypt have already experienced major agricultural delivery disruptions.

The full economic consequences of removing Russian energy from the market — and of destroying the Russian economy through an unprecedented sanctions regime — are as yet unknown. Some economists believe that this energy shock could tip the global economy into a state of stagflation, a dire combination of slow growth and high inflation, or even recession with inflation. Recently the European Central Bank announced that “the risks to the economic outlook have increased substantially,” and cut the growth forecast for 2022. Eurozone inflation rose to 5.8 percent, and U.S. inflation rose to 7.9 percent, its highest point in 40 years. The ripple effects of high energy prices also have political consequences: They could be enough to tip the balance in the upcoming U.S. mid-term elections and are a stumbling block in French President Emmanuel Macron’s quest for re-election.

Confronting the Harsh Reality of Energy Dependence

Despite these challenges, it is clear that if the West is serious about crippling Putin’s war machine, it must finally untie its energy bonds with Russia. But governments should make clear to the public the costs they will bear to do so. Thus far, Western leaders have not sufficiently informed their constituents, preferring to indulge in the false expectation that a market-driven diversification will allow their countries to cope with the consequence of a more-or-less gradual phase down of Russian supplies with minimal pain. But diversification-focused plans run up against the harsh reality of the current global energy crunch.

This is especially the case with Europe’s plan to reduce reliance on Russian natural gas by two-thirds by the end of 2022. Doing so requires replacing about 100 billion cubic meters (bcm), equivalent to the approximate annual gas consumption of Germany and Poland combined. To accomplish this, the European Commission proposes increasing liquefied natural gas imports from global markets by an additional 50 bcm, piped gas from alternative sources by 10 bcm, and boosting biomethane production to 3.5 bcm. Under this plan, an additional 38 bcm will come from increasing energy efficiency and an acceleration of electrification and renewable energy capacity installation.

Although it has been hailed by American policymakers as a panacea to Europe’s energy dependence on Russia, increased liquified natural gas imports cannot fully replace Russian pipeline gas. First, liquefied natural gas import infrastructure is not evenly distributed across the continent, rendering it nearly impossible to supply the most dependent states with extra volumes of liquified natural gas. The global supply is also tight, and export capacity is largely committed to Asian markets through long-term contracts. Before the conflict, Brussels and Washington reached out to Qatar to explore the possibility of buying additional supplies, but Doha’s response was lukewarm at best. For Doha, defaulting on East Asian customers is not a prudent long-term export strategy, and a massive expansion of liquefaction capacity from Qatar’s North Field East project is only anticipated to come onstream in the second half of the decade. In 2022, only 12 bcm of additional liquified natural gas capacity is expected to come onstream globally.

Replacing Russian gas with other sources of pipeline gas will not be easier. Gas transit via the Baltic pipe can only contribute a maximum of 3 bcm before winter. There is relatively significant spare capacity for an additional 19 bcm of gas imports through North African pipelines, but there are major challenges to increasing North African production and exports. Algeria has chronic underinvestment in its gas fields and fast-growing domestic demand, while Libya’s current political crisis may cause state collapse and political violence, risking further deterioration of its energy sector. Political risk to North African gas supplies will also rise with the global food crisis. Spiking wheat prices and food insecurity were major factors contributing to the Arab Spring.

Making matters worse, in addition to supply constraints, the European Union has also signaled that any efficiency gains may be offset by declining European domestic gas production. A proposed energy security mandate to fill nearly empty gas storage to 90 percent by Oct. 1 will be exorbitantly expensive with current gas prices, and will place continued pressure on markets during the spring/summer season.

The effects of reducing Europe’s dependence on Russian gas are global. Under Europe’s roadmap, 100 bcm of Gazprom’s pipeline supply would be left stranded and with nowhere else to go, as rigid infrastructural geography does not allow diversion of these supplies to other markets. As a result, 14 percent of globally traded gas volumes will instantly disappear from the market — triggering a mad scramble for non-Russian liquified natural gas. If Europe wants (much) more, others will need to consume less. Western policymakers must acknowledge and work with the fact that Europe is not the only consumer of liquified natural gas. China, another major importer, is adding 35 bcm of import capacity this year, and Japan — the biggest global importer — will only be able to decrease its demand at the slow pace of its nuclear power plants’ reactivation. Europe and Asia are heading toward fierce energy competition that will disproportionately hit importers in developing and emerging countries in South Asia and South America. The Global South will find itself caught in the crossfire of a full-scale economic war between Russia and the West.

The limits of energy diversification policies are emerging even in the context of oil markets, which are known for their fungibility and brutal efficiency. Even before Russia invaded Ukraine, oil markets were at their tightest in decades — in 2021 the International Energy Agency predicted growing oil consumption until at least 2026. As a consequence of self-sanctioning, Russia encountered problems marketing some of its supply. In addition to the challenge of redirecting oil shipped by pipeline, some tankers carrying Russian oil have been stuck docked outside ports where workers are refusing to unload them. Although China and India are absorbing larger amounts of Russian crude and oil products, market uncertainties may keep prices high regardless — especially considering potential disruptions to oil services in Russia that may reduce overall production.

These stumbling blocks led Washington to conclude that global oil production would need to rise significantly to mitigate the inflationary impact of sanctions. The U.S. ban on the import of about 500,000 barrels per day of Russian oil, against a background of rapidly rising prices at the pump, prompted a sudden attempt by the Biden administration to reconnect with Venezuela, accelerate a nuclear deal with Iran, and beg Gulf countries to increase production. These efforts have so far been unsuccessful, and the possibility of welcoming Iran and Venezuela back from isolation are already causing geopolitical rifts.

A Better Path Forward

Western leaders have decided to embark on a quest for every last drop of non-Russian energy. But these measures will not be sufficient, and they will exacerbate unequal access to energy resources, both within and outside Western states. Desperately trying to increase supplies will damage Western economies, undermine efforts to manage climate change, impose devastating and destabilizing costs on the Global South, and push Washington to deepen relations with new rogue states. Western policymakers have long considered sanctions a relatively low-risk coercive tool. But expansive sanctions against Russia’s energy sector, if sustained, will require a degree of sacrifice from Western citizens that they are unused to paying.

Instead of crafting an energy policy based on outbidding others for non-Russian supplies in a fiercely competitive global market, the Global North should make an organized, collective effort to reduce demand. The winter 2021 energy crisis suggests that price in itself is an insufficient incentive to drive down demand. To avoid catastrophic global consequences, rich countries should begin conserving oil and gas immediately. So far, the lack of emergency measures and clear government communication is deeply concerning.

Western governments now have the opportunity to implement decisive and orderly conservation policies. Not only are compulsory conservation measures necessary to mitigate the negative consequences of a global energy scramble, but they can also generate economic, strategic, and environmental benefits. Governments might consider, for example, mandatory speed limits, car-free weekends, mandatory work-from-home, incentivized public transport, reduced non-essential lights at night, rolling outages, private transport rationing, and mandatory indoor temperature limits. Conserving energy keeps consumer energy prices down, increases energy security, and reduces emissions. The COVID-19 pandemic already helped create some of the infrastructure necessary to make these changes more palatable, including moving vast sectors of the economy to working from home and increasing pedestrian areas in major cities. As the pandemic moves to a new phase, policymakers should consider making some of these changes permanent.

Crucially, in responding to today’s crisis, Western governments should avoid some of the mistakes that exacerbated the 1970s crisis. During the 1970s, efforts by rich nations to manage the energy shock through price caps and slashing fuel taxes, combined with fierce global competition for energy stockpiles, had long-lasting negative consequences. These included a rise in climate- and health-damaging coal consumption, the entrenchment of Euro-Russian gas interdependency, and an increase in resentment in the Global South. Western governments now seem poised to repeat these mistakes: They are focusing on outbidding one another for alternative suppliers, rolling back coal phase outs, and trying to sustain demand by subsidizing fuel prices and cutting taxes on gasoline and diesel. The lessons from the 1970s are clear: A disorderly supply-side-only approach to energy crises is a recipe for future strategic and environmental problems.

Russia’s invasion came so quickly on the heels of the pandemic that politicians have been reluctant to impose restrictions on stir-crazy citizens. Fears of political blowback are already hampering decisive energy action. But Russia’s invasion of Ukraine has reinvigorated the trans-Atlantic relationship and reunited a previously divided liberal community. Americans balked when President Jimmy Carter asked them to reduce energy consumption and “deal with the energy problem on a war footing.” Now Europe, the United States, and others are in a full scale economic war with Russia that will require citizens to make energy sacrifices to support Ukraine’s fight for freedom against despotism. Unlike the 1970s, conservation no longer necessitates “malaise” or a critique of Western materialism. Instead, it has become clear that future progress and prosperity rest on innovative new technologies and renewable energy sources that reduce dependence on authoritarian regimes. The result is an opportunity to spur innovation, especially if Western governments incentivize investment in renewable and nuclear energy technology. Compulsory conservation and energy demand reduction is at once a moral, strategic, and environmental imperative, and will ensure the sustainability and credibility of sanctions policies.

 

 

Emily Holland, Ph.D., is an assistant professor in the Russia Maritime Studies Institute at the Center for Naval Warfare Studies, U.S. Naval War College. Dr. Holland studies the geopolitics of energy, Russian and European foreign policy, U.S.-Russian relations, and populist movements in East-Central Europe and Russia. Her book project, “Poisoned by Gas” elucidates the relationship between foreign policy, domestic politics, and the natural gas trade in Europe and the post-Soviet space. The views expressed here are hers alone and do not express those of the Naval War College, the U.S. Navy, or the Department of Defense. 

Marco Giuli is a researcher in the Center for Environment, Economy and Energy at the Brussels School of Governance and a Scientific Advisor at the Instituto Affari Internaziolnale (IAI) in Rome, where he provides support to the Energy, Climate and Resources Program. Previously, he established and led the Climate and Energy Platform of the European Policy Centre in Brussels. He studies E.U. energy and climate policy, the geopolitics of the energy transition and the political economy of energy. Giuli holds a M.A. in the Economics of European Integration from the University of Bologna.

Image: TASS (Photo by Peter Kovalev)

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