A hydrocarbon pipeline directed westward is cut off by the Kremlin for political purposes. A decline in the oil price threatens the economic norms that underpin domestic political stability across the Russian Federation. The transatlantic community, emerging from crisis, reassesses its relationship with Moscow. These three events, all which took place at the outset of 2009, forged two key pillars that have helped U.S. and European policymakers understand the Kremlin’s energy playbook: first, that the Russian Federation uses its oil reserves to generate state revenues, and gas for political leverage and malign influence; second, that the beginning of 2020 probably would feature a widespread gas crisis in Europe due to a Russian cutoff of the Ukrainian gas transmission system (GTS). But well into 2020, with the global COVID-19 crisis raging, Russian President Vladimir Putin has taken actions in the energy sector toward Ukraine, the Balkan region, Belarus, and oil exporters — including the United States — that fundamentally challenge these assumptions and are destined to shape thinking across the transatlantic community for years to come.
No Encore of Europe’s 2009 Gas Crisis?
Moscow’s 2020 energy policy certainly rhymes with the Kremlin’s energy plays from early 2009. Like today, Russia in 2009 was over-reliant on hydrocarbon export revenues to support its economy. A 60% decline in the price of oil compared to the previous year drove then prime minister Putin to attempt to sharply increase gas prices in Ukraine. This led to a cost dispute between Russia’s Gazprom and Ukraine’s Naftogaz that resulted in a cutoff of the Ukrainian GTS for over two weeks in January 2009 and precipitated gas supply shortages for nearly twenty European countries. For Putin, the cutoff also placed pressure on Kyiv to end its bid for NATO accession and its broader Euro-Atlantic aspirations, viewed by Moscow as an unacceptable drift westward.
Watchers of Europe’s energy security braced themselves for an encore performance at the beginning of 2020. After all, the development Gazprom’s proposed Nord Stream 2 pipeline, aimed at ending or significantly decreasing gas transit via Ukraine in favor of the Baltic Sea link, continued apace deep into autumn 2019. Additionally, even by mid-December the hopes for an agreement between Gazprom and Naftogaz for continued gas transit via Ukraine remained bleak. These provided Kremlin-controlled Gazprom with significant leverage to press Ukraine into a short-term gas transit extension aimed at merely bridging the gap between the end of the previous contract and the operationalization of Nord Stream 2, and at undesirable terms.
However, on December 20, the 2020 U.S. National Defense Authorization Act (NDAA) came into force bolstered by significant bipartisan support. The act contained limited, technology-calibrated sanctions aimed at halting the physical construction of Nord Stream 2. The U.S. action had immediate positive impact: first, the principal pipelaying vessel for the project, Allseas’ Pioneering Spirit, suspended its construction operations as the sanctions were signed into law, and departed the Baltic Sea in the days following; second, on New Year’s Eve, Gazprom signed a fresh five-year gas transit contract with Naftogaz. In the deal, Gazprom also finally agreed to pay Naftogaz nearly $3 billion in required damages owing to the February 2018 Stockholm Arbitration Tribunal ruling that censured Gazprom’s failure to deliver gas transit volumes under the original 2009 contract.
But another gas challenge remained for the EU and Ukraine. Already completed, and hence unaffected by the 2020 NDAA sanctions, Gazprom’s dual-pipeline TurkStream project came online on January 1. Although both lines are smaller than Nord Stream 2’s proposed 55 billion cubic meter per year (bcma) capacity, at just 15.75 bcma each, they already have had the regional effect that the Kremlin intended. The first line, designed to supply the Turkish domestic market, is operating to maintain the stability of Russia’s gas position in Turkey, in response to Ankara’s decision for the past several years to increase its gas diversification via alternative LNG and pipeline imports.
TurkStream’s second line, which now enters Bulgaria and may ultimately reach Central Europe via Serbia, is aimed at reducing Russian gas transit via Ukraine by making redundant the traditional Trans-Balkan line route. Data released on April 2 by Ukraine’s Gas Transmission System Operator illustrates the severity of TurkStream’s impact: compared to the first quarter of 2019, there has been an overall 70% decrease of gas volumes coming from Russia via the Ukrainian GTS to the Balkan region. That the volumes have largely been transferred to reach the Eastern Balkans via the second line of TurkStream should be a reminder that both TurkStream and Nord Stream 2 are actually not aimed at bringing significant new gas volumes to Europe, but to make good on the Kremlin’s aim to end or significantly decrease gas transit via Ukraine as soon as technically feasible.
TurkStream’s limited volume coupled with the continued progress toward diversification pipelines in the region and Nord Stream 2 sanctions, however, means that 2020 has not yet had a marquee gas cutoff crisis as anticipated. Upending expectation, however, Mr. Putin has already presided over a major oil cutoff, against the Kremlin’s own “oil for revenue, gas for influence” model.
Energy Tensions with Belarus
On January 3, Kremlin-controlled oil firm Transneft announced the suspension of oil deliveries to neighboring Belarus. Since the fall of the Soviet Union, Minsk has relied on the Russian Federation for more than 80% of its oil and gas demand, and 90% of its crude oil imports. The cutoff was seen a way to pressure Belarusian President Alexander Lukashenko to further integrate his country with the Russian Federation, and possibly present an avenue to extend Mr. Putin’s rule by presiding over a merged state.
Here, Moscow’s Belarusian oil cutoff failed just as publicly as its Ukrainian gas cutoff a decade ago. Minsk rapidly took steps to diversify its oil imports, including a rail shipment from Norway in January. In February, two tankers of Azeri oil transited to Belarus via the Black Sea and then to Ukrainian pipelines operated by Ukrtransnafta. Furthermore, during a February 1 visit to Minsk, U.S. Secretary of State Pompeo assured his Belarusian counterparts that the United States could deliver oil and gas volumes to the country to help it survive the current crisis. Both actions broke Minsk’s logjam with Moscow: on April 6, Transneft announced that it would resume supplies to Belarusian refineries.
With Moscow’s standoff with Minsk underway, Putin then unveiled his most chaotic energy market play so far this year: flouting a March 2016 agreement entered into with OPEC and nearly a dozen non-OPEC oil producers to limit crude production aimed at stabilizing flagging energy prices that came to be known as OPEC+. While the 2016 agreement was successful in bringing regularity to global oil prices, the sharp drop in demand precipitated by the growing COVID-19 pandemic in early 2020 requited further production cuts to stabilize the global price environment. Given that hydrocarbons represent nearly 60% of Russian exports, market watchers anticipated that Moscow would accede to a deal with OPEC members when they met in Vienna on March 6.
Instead, reportedly eyeing an opportunity to inflict pain on the U.S. shale industry, Kremlin representatives refused to agree to proposed cuts, leading to weeks of posturing between Russian and Saudi officials, both vowing unconstrained increases in crude production. The move had the predictable result of cratering the global oil market and indeed impacted the U.S. shale industry (the West Texas Intermediate benchmark per barrel oil price dropped from the mid-$40 range at the beginning of March down to as low as $20 in the following weeks leading to sharply dropping corporate values and bankruptcies among U.S. shale producers).
Viewed through the lens of recent Russian energy disinformation tropes, the targeting of U.S. shale is hardly surprising even in light of the economic self-harm in Moscow’s act. Since the United States has been on the trajectory of becoming a net energy exporter over the past several years, the Kremlin has at times seemed obsessed with undermining the U.S. energy market, often basing policy decisions as a response to its false propaganda. For example, Gazprom and its allies have long advanced the false claim that U.S. actions to stop the Nord Stream 2 pipeline are allegedly a bid by Washington to seize a supposed net gas market that would be vacated in the absence of the pipeline. The Kremlin claims this even though Nord Stream 2 is designed to circumvent the Ukrainian GTS rather than deliver significant new volumes of gas to European customers. With the pipeline stopped, these gas volumes are largely continuing to flow via Ukraine rather than opening a net gas market to be filled by U.S. LNG, debunking Moscow’s claim. Russia’s own logical energy fallacies have nonetheless been effective, duping Moscow-based commentators into claiming a direct linkage between the 2020 NDAA sanctions that stopped Nord Stream 2 and Russia’s supposed retaliation in the form of its production split from previous OPEC+ norms. Their hope in forcing this connection is to dupe U.S. officials into a false trade of lifting Nord Stream 2 sanctions for production cuts.
Washington would be wise not to take the bait. Such short-term thinking by the Kremlin will result in a far greater disruption of Russian economic stability in the coming years than it will have success in ending the U.S. shale industry once and for all. In the short-term, U.S. shale producers will likely suffer. However, the diversification of the U.S. economy, which has not until very recently depended on hydrocarbon exports as a significant driver of its GDP, will blunt broader impacts on the United States. Furthermore, the price environment may advance technological innovation within the U.S. shale community that could strengthen the industry to operate at lower price benchmarks over the long term.
For Russia, however, the timing of this oil production maneuver could not be worse. For starters, Russian officials and commentators have pointed to Moscow’s sizable foreign currency reserves that total roughly $570 billion, as well as its $150 billion national wealth fund — a windfall resulting from Russian hydrocarbon revenues that followed the 2016 OPEC+ arrangement itself. In spite of bold claims by Russia’s Ministry of Finance that the country could ride out the low-price storm for a decade by dedicating $1.7 billion per month to domestic energy industry subsidies, eating into these cash reserves for the long run is an exceedingly poor political strategy for the Kremlin.
In his annual February national address, Mr. Putin vowed to increase social spending across the Russian Federation given declining living standards that have led to his own flagging approval numbers of late. This pledge is compounded by the sharp devaluation of the ruble that followed the Kremlin’s OPEC+ play, which will limit Russia’s international purchasing power. The situation is especially troubling from a humanitarian perspective, as the country will need to finance COVID-19 related social health programs and likely take steps akin to the historic national bailouts that are being enacted by governments elsewhere. Both programs would need to draw from the very same cash reserves that would be needed to subsidize the Russian oil industry. Not to mention that the historic drop in demand resulting from the COVID-19 crisis has already led to a crunch in storage space for oil volumes worldwide, meaning that there is a physical limit to unconstrained Russian oil production.
Thus, it remains unlikely that Moscow can sustain its current oil production posture in the long term. It has already resulted in an agreement among OPEC+ states on April 12 for a reduction of oil production from May to June representing 10% of supply worldwide. While this short-term cut may still be unable to bring about full price stabilization given the level of preexisting glut in the market, it is a sign of the Kremlin’s own realization that extending its oil production gambit would ultimately fail.
The Way Ahead
The United States should therefore not be duped by the false choice set up by the Kremlin’s rhetorical linkage between Russia’s oil plays and dropping national security sanctions — especially those related to Russia’s aggressive posture toward Ukraine and the transatlantic community. Washington should instead look to short-term practical economic measures to help alleviate the crisis, such as considering purchases of U.S. domestic hydrocarbons to bolster the U.S. strategic petroleum reserve or offering federal physical storage capacity to domestic producers. Overall, however, U.S. and European experts should continue to recalibrate their expectations of Russian energy motivations for the coming decade. Moscow’s wild energy activities in 2020 have so far exacerbated the global economic tumult already in progress. And if history is a guide, it will continue to do so.
Dr. Benjamin L. Schmitt is Postdoctoral Research Fellow at Harvard University and former European Energy Security Advisor at the U.S. Department of State.Photo: “Meeting on rocket and space sector development, held via videoconference.” by Kremlin.ru under CC BY 4.0.
Dr. Benjamin L. Schmitt
April 13, 2020
Europe’s Edge is an online journal covering crucial topics in the transatlantic policy debate. All opinions are those of the author and do not necessarily represent the position or views of the institutions they represent or the Center for European Policy Analysis.