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A choice for Europe: costly US liquified gas versus cheap Russian pipeline gas

The latest anti-Russian sanctions package about to be made law by the US Congress will not materially harm the Russian economy. However it does pose a challenge for Germany and the EU: do they press on buying cheap pipeline gas from Russia or expensive liquified gas from the US.

News that the Republicans and the Democrats in the House of Representatives have agreed on a new sanctions package against Russia will be deeply unwelcome news, and not just or even primarily in Moscow.

The new sanctions package will not have the big impact on the Russian economy that some are expecting.  The Russian economy has sailed through the previous far more severe sectoral sanctions which were imposed on Russia in July 2014, and the collapse in oil prices which took place in the second half of that year.  The result was only a short and shallow recession, out of which Russia is now rapidly emerging.  Indeed there are some who calculate that growth this year will be enough by itself to wipe out all the output loss during the recession, though I do not share this view.

The new sanctions in economic terms do not add significantly to the sanctions which were imposed in 2014.  They appear intended to target the personal assets of super-wealthy Russians – a deeply unpopular class still wrongly referred to as “oligarchs”, though the days of their power in Russia are long gone – and to impede Western and specifically US participation and investment in certain of Russia’s industries, first and foremost those in the extractive sector.

The days when Russian companies looked first and foremost to the West for capital and technology were however brought to an end – by the West itself – in 2014, and the new sanctions do not add materially to what happened then.

As for the “oligarchs” and the obstacles the new sanctions seem intended to place in the way of the privatisation of certain Russian companies – including interestingly the Russian maritime tanker fleet – not only will these not have any serious macroeconomic impact on Russia (with Russia’s consolidated budget apparently in surplus the idea that Russia needs to sell these companies to fill holes in its budget is wrong) but one cannot fail but note the paradox of the US Congress allying with the Russian Communist Party to impede Russian privatisations and to target Russian “oligarchs”.

For years following the coming of President Putin to power the Western and especially the US media ran a shrill campaign warning that President Putin was intent on locking Western investors out of Russia and reversing the privatisation process begun in the 1990s.   It is extremely strange therefore to see the US Congress working hard to achieve that very thing, which Putin as it happens never did.

No doubt that is why significant business sectors in the US – especially the US oil industry which has been hankering to invest in Russia – have made their unhappiness with the new sanctions clear.

Regardless of that the idea that there is insufficient capital and technology in Russia to enable the country to develop its economy successfully on the basis of its own resources is a myth, though one which obviously dies hard.

However if the macroeconomic impact of the new sanctions on Russia will be minimal, the same cannot be said of their political impact, and of the dilemma they pose Europe.

At their simplest the new sanctions will make it all but impossible for the US and Russia to establish normal inter-country relations with each other.

It was only a few years ago that the Congress – very reluctantly and under heavy pressure from the Obama administration and the US business community – rescinded the Jackson-Vanik amendment.  Since then the US has however in effect nullified that step by imposing one set of sanctions on Russia after another, starting with the Magnitsky Act sanctions and now culminating in the latest sanctions package.

The Russians have got the message, which is that normal commercial relations between Russia and the US will never happen.  The point was made very clearly by Russia’s Deputy Foreign Minister Sergey Ryabkov in a television interview on Wednesday

We are aware that those sanctions, which are imposed now, [will not be lifted], whatever we would do. Even if we say we agree to anything and hoist a white flag, anyway hearings and motions will be in full swing.  Senators and Congresspersons will find a million excuses for not lifting anything.

This incidentally explains the tough line Russia is taking over the return of its diplomatic property, which was illegally seized by the Obama administration in a straightforward act of confiscation of what is actually the Russian state’s private property last December.  Here is what Ryabkov had to say about that

We do not allow for any conditions in order to have this property given back to us. It is not a bargaining issue. We are far from seeing merely any signs of preparations for certain deals. We see no reason why such categories should be allowed for because we just need to have ours back.

Since the new sanctions will render it impossible for the Trump administration to return the property or lift the sanctions the Russians lose nothing by taking a tough line on the question of its return.

Whilst political cooperation between the US and Russia remains possible on certain specific issues lingering hopes that one day they might one day establish a normal trading relationship are now surely dead.  Every attempt to achieve such a relationship going back to the detente era of the 1970s has ended in failure because the political opposition in the US is too strong.  As Ryabkov says, there is no reason to think that will ever change, and the Russians clearly no longer believe it will.

However it is in Europe where the new sanctions pose the greatest challenge.

Back in 2014 Angela Merkel and the EU leadership worked closely with the Obama administration to agree the sanctions that the US and the EU would jointly impose on Russia.  This was done so as to ensure that the sanctions did not directly impact on either the US’s or the EU’s fundamental economic interests, though in the event Russia’s apparently unexpected counter-sanctions hurt some EU agricultural producers badly.

The new sanctions are however being imposed without any prior discussion between the US and EU whatsoever.  No one in the US has asked for Angela Merkel’s or the EU’s opinions about them, or has shown the slightest concern for German or European interests.  Instead the sanctions are being imposed for domestic reasons, as a spin-off of the Russiagate scandal, and as part of the feud between the Democrats and the Trump administration.  The result is that they have been negotiated between Democrats and Republicans in Congress without Angela Merkel and the Europeans being consulted about them at all.

The new sanctions explicitly target Russian pipelines projects to Europe, specifically the Nord Stream 2 pipeline recently agreed between Germany and Russia.

Back in April I discussed Nord Stream 2 in detail and explained the rationale behind it – that it provides Germany and Europe with cheaper pipeline gas from Russia than gas they could obtain elsewhere – and the way that recognition of this reality amounted to a Russian victory in Europe’s decades long energy war

As the energy war between the EU and Russia heated up from the mid 2000s, demands – many of them originating in Washington and London, even though the US and UK are not significant importers of Russian gas – for the EU to ‘diversify’ its gas imports away from Russia so as to reduce the EU’s supposedly dangerous dependence on Russia steadily built up.

These led to various schemes to reduce the EU’s ‘dependence’ on Russian gas, including the importing of liquified natural gas from the Persian Gulf and the US, the building of the Nabucco pipeline across Turkey and the Caucasus to Azerbaijan, the importing of gas from the newly discovered gas fields in the eastern Mediterranean, and the importing of gas from north Africa…..

By December 2014, when South Stream was cancelled, all these disputes and conflicts had come to a head.

The European projects to ‘diversify’ away from Russian gas had all failed.

The reason was that all these projects ran into the same problem: they did not provide enough gas to reduce Europe’s need for gas from Russia, and they made no economic sense because the gas they would have provided would have been significantly more expensive than the gas supplied by pipeline from Russia.

In the meantime the Ukrainians during fraught negotiations over gas supplies from Russia over the course of the summer of 2014 once more threatened to siphon off Russian gas passing through Ukrainian pipelines destined for Gazprom’s EU customers.

Meanwhile the Russians for their part were having far more success in diversifying their gas exports to non-European customers than the Europeans were having in reducing their need for imports of gas from Russia.  Specifically in 2014 the Russians announced major projects to build two giant pipelines to supply gas to China.  Though these pipelines have been derided by Western and Russian liberal critics as making no economic sense because the Chinese will pay less for the gas than Russia’s European customers, there is no doubt the Russians will make a profit from the sales, and the fact that they will soon be selling large amounts of gas to China means that they are no longer as dependent on the Europeans as their customers as they once were.

The European country which found itself most exposed was Germany, whose large industrial sector not only requires plentiful supplies of cheap gas but which has also become more gas dependent as Germany has been closing down its coal and nuclear industries.

The result is that despite the sanctions the EU imposed on Russia on German insistence in July 2014, in June 2015 – just a few months after the cancellation of South Stream in December 2014 – and with the full backing of the German government, a new pipeline project linking Germany to Russia across the Baltic was announced, which is Nord Stream 2.  Moreover in order to ensure that this pipeline would be built the Germans agreed to Russia’s demand that it would not be subject to the EU’s Third Energy Package.

The new pipeline predictably provoked a sustained campaign of opposition from a coalition of opponents including those who claimed to be concerned about Europe’s ‘energy dependence’ on Russia, various eastern and central European states unhappy at the loss of transit fees caused by the direct supply of gas to Germany from Russia, other EU states such as Italy unhappy at the way Germany dealt directly with Russia in its own interests whilst simultaneously insisting that other EU states impose sanctions on Russia, and of course Ukraine, which risks being cut out completely as a transit state.

Opposition to Nord Stream 2 was led by the European Commission on the grounds that it was not compatible with the EU’s Third Energy Package and would increase Europe’s dependence on Russian gas.  The Germans and the Russians countered, truthfully if somewhat disingenuously, that Nord Stream 2 is not subject to the Third Energy Package since it does not cross over EU territory as it passes under the Baltic Sea

The reality is that in today’s Europe if the Germans and the Russians agree on something it is going to happen irrespective of whatever others might think or say about it.  The German government could have killed Nord Stream 2 at any time but it chose not to because that would have outraged German industry, already seething over the sanctions imposed on Russia.  That in effect all but guaranteed that despite all the objections Nord Stream 2 would go ahead.

The EU Commission has now dropped its objections to Nord Stream 2 and said Nord Stream 2 is not covered by the Third Energy Package.  This amounts to it raising the white flag, not just in relation to Nord Stream 2 but in respect of the whole energy war.  Suffice to say that it is not a coincidence that at the same time the European Commission’s case against Gazprom seems to be fizzling out.

What this means is that following more than a decade and a half of struggle the Russians have finally and conclusively won the energy war.

Not only will Nord Stream 2 be built as the Russians want – without it being subject to the Third Energy Package – but there is nothing now to stop the Russians building Nord Stream 3 or Nord Stream 4 or as many other pipelines as they want under the Baltic on the same basis.

If the Russians have won the energy war in Europe, it is however now clear that they have not won it in the US.  There powerful forces remain who still wish to disrupt the flow of Russian energy to Europe.

This explains why the new sanctions expressly target Nord Stream 2, with threats of fines of companies which participate in the project.

These actions are quite obviously intended to obstruct or if possible kill off the Nord Stream 2 project, no doubt in part for political reasons, but also in part for commercial ones, with the politically well connected shale industry in the US apparently pressing to sell maritime tanker transported US liquified natural gas to Europe in place of Russian pipeline gas.

However whilst this makes commercial sense for the US shale producers, it makes no commercial sense for the Germans and the Europeans.

In the extract from my previous article which I quoted above I discussed how all the alternatives to Russian pipeline gas which have previously been mooted – “the importing of liquified natural gas from the Persian Gulf and the US, the building of the Nabucco pipeline across Turkey and the Caucasus to Azerbaijan, the importing of gas from the newly discovered gas fields in the eastern Mediterranean, and the importing of gas from north Africa…..” – have failed because the gas they would provide would be significantly more expensive than the gas supplied by pipeline from Russia.

Of these alternatives maritime tanker transported US liquified natural gas must be one of the most expensive, both because of the way it is produced, and because of the way it must be stored and transported.

I would add that given that the US is a major net energy importer it makes little economic sense for the US to export this gas either.  However this is the project the US Congress is now committing itself to.

Here it is important to make one particular point about the US approach not just to sanctions but to US law generally.

If the threats against participation in Nord Stream 2 merely affected US companies the Germans and the Europeans would simply shrug them off and ignore them.  However over the last couple of decades the US has increasingly adopted the view that its domestic law has universal application, and can be enforced by the US authorities on anyone irrespective of nationality anywhere in the world.  That might in theory lead to European companies being fined by the US for doing things – such as participating in the Nord Stream 2 project – far from US territory, and in places such as north west Europe where the US ought to have no jurisdiction.

Not surprisingly the Europeans – the Germans and the Austrians in particular – are furious about all of this.  As they have pointed out, fresh sanctions being imposed on Russia without any consultation are directly impacting on their fundamental economic interests by obliging them to buy expensive US liquified natural gas in preference to cheaper Russian pipeline gas, thereby threatening the competitiveness of their industries.

The German government – including Angela Merkel – has made its strong objections and deep anger especially clear.

Beyond German outrage at the way in which German and European interests are being disregarded, there is also unquestionably further anger at the way the US – or at least the US Congress – is using the current political campaign against Russia to try to force the Europeans to pay a subsidy to the well-connected US shale industry by buying its gas.

So what will happen?

There is no doubt that the US Congress will vote into law its latest sanctions package, with this happening probably on Wednesday.

There has been some talk of Donald Trump vetoing the package.  However given overwhelming majorities for the sanctions package in both the Senate and the House make that unlikely.  Besides if Trump did try to exercise a veto, his veto would presumably be overridden.

It does not however necessarily follow that the sanctions package will kill Nord Stream 2.

Whilst it is all very well for the US Congress to pass a law that might theoretically threaten European companies with fines if they participate in Nord Stream 2, it is quite another matter for the US government to impose such fines on European companies which are participating in a project which is strongly backed by the German government.  That would trigger a huge row, and might lead to retaliatory action by the EU.

Significantly this episode has already provoked the Germans and the Austrians to say that they do not accept that the US has universal jurisdiction over European companies participating in legal projects in Europe far away from the US.

The EU Commission has now issued a public statement strongly condemning the whole approach being taken by the US Congress

…….the Russia/Iran sanctions bill is driven primarily by domestic considerations…..As we have said repeatedly, it is important that any possible new measures are coordinated between international partners to maintain unity among partners on the sanctions. ….We are concerned the measures discussed in the US Congress could have unintended consequences, not only when it comes to Transatlantic/G7 unity, but also on EU economic and energy security interests…This impact could be potentially wide and indiscriminate.  We therefore call on the US Congress/authorities to engage with the partners, including the EU, to ensure coordination and to avoid any unintended consequences of the measures discussed.

There is almost certainly nothing that can now be done to prevent the US Congress from voting this sanctions package into law.  However there must be a strong probability that the Trump administration will heed the EU’s call for consultation before the sanctions package is enforced, and that is likely to shield European companies that are participating in Nord Stream 2.  There seems to be enough leeway in the law to allow this, and it is difficult to believe that even the most hardline Democrats in the Congress will wish to overturn arrangements agreed between the Trump administration and the German government.

That of course depends on Merkel and the German government standing firm on this issue.  With German opinion strongly aroused on this issue, the probability however is that they will.

Regardless of that, this episode shows two further things:

Firstly, the sanctions whey they were imposed on Russia in 2014 were hailed in the West as a great display of Western unity.  On the contrary they are increasingly becoming a source of conflict and argument: within the EU – between northern Europe and southern Europe – and now between the EU and the US.

Secondly, this episode once again exposes Angela Merkel’s folly in agreeing in July 2014 to put US geopolitical objectives in Ukraine above German and EU economic interests.  Ever since Merkel’s authority has been tied to the sanctions she agreed to in July of that year, so that she now finds herself committed to a sanctions policy which is not only contrary to German interests but over which she ultimately has no control.

The result is that she – and Europe and Germany in her wake – are now hostages to decisions made not in Brussels and Berlin but in Washington and Kiev.

That is a disastrous outcome, whose consequences this latest episode are making all too clear.

As Merkel’s nemesis Vladimir Putin might one day point out to her, that is however what happens if you choose to sacrifice your nation’s interests to the demands of your friends.

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Alexander Mercouris
Editor-in-Chief atThe Duran.

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