How to reduce Putin’s leverage over Europe

With the United States leading the effort to prevent a Russian invasion of Ukraine, European Union officials are wringing their hands. Europe is not only absent from the table, they complain; its security is on the menu.

But the EU is not equipped to deal with Russian President Vladimir Putin. It seeks to be a postmodern “soft” power, and Putin knows only hard power. And what soft-power instruments the EU has, it cannot attempt to use, because it still depends on Russian gas to keep Europeans’ lights – and heaters – on.

The recently completed Nord Stream 2 pipeline – carrying Russian gas directly to Germany via the Baltic Sea – has gained significant attention as a diplomatic bargaining chip. While some argue that the project has given Russia too much leverage over Europe, others hope that the threat of losing the pipeline, which is not yet operational, can deter Russia from invading Ukraine.

In such discussions, the focus has often been on the responsibility supposedly borne by Germany, the project’s main European advocate. But, given the steady integration of Europe’s national gas markets, this makes little sense. In an integrated market, any action should be carried out at the EU level.

Moreover, in determining what action should be taken, it is important to recognize that Nord Stream 2 is not nearly as significant as it is often portrayed to be. In the long run, the pipeline will have little impact on Europe’s energy security.

For starters, an operational Nord Stream 2 pipeline is unlikely to result in a significant increase in total Russian natural-gas exports to Europe. It will merely enable Russia to reduce its use of pipelines traversing Ukraine, thereby slashing the transit fees that comprise an important part of Ukraine’s budget.

More broadly, the importance of strategic pipelines is being eroded by a shift toward shipping hydrocarbons in the form of liquefied natural gas. LNG exports from the US to Europe have received much attention, but they are just one part of a larger trend. Globally, more gas now is shipped across regions than transferred through pipelines.

Shipping LNG has gained popularity because once it is placed on a special tanker, the distance it must travel makes relatively little difference. As a result, in normal times, prices in Europe and Asia tend to be highly correlated. The cost of shipping LNG remains higher than the cost of shipping oil, and the LNG market’s liquidity – and thus its ability to respond to short-term demand shifts – remains limited. But the trend toward an integrated global market is clear.

Today, Russian gas is still somewhat cheaper for most of Europe. But the political price of dependency – Russia remains the EU’s largest supplier of natural gas – has become unacceptable. The good news is that Europe has the capacity to import enough LNG to offset the loss of Russian gas. The bad news is that it will take some time to mobilize its capabilities.

How, then, can the EU protect itself against the shortterm risk of Russia withholding supplies for political reasons, and even position itself to be able to impose sanctions on the Russian gas sector?

A first simple step would be to require gas suppliers to top up their inventories at the end of the summer. This would not be in their commercial interest, but it would bolster Europe’s energy security. Particular attention should be paid to storage facilities controlled by Russia’s Gazprom, which were filled less than other commercial storage sites last year, leaving the EU vulnerable to acute shortages this winter.

But more is needed. Europe should also create a European Strategic Gas Reserve (ESGR) containing enough supply for about three months of consumption. By giving the EU a buffer to acquire more gas from other producers, a strategic reserve would reduce Europe’s vulnerability to short-term disruptions, including the potential loss of Russian supplies, and strengthen its geopolitical standing.

An ESGR could not be created overnight, and it would require some initial investment. But a substantial store of gas could be accumulated within a few years, and costs should not be excessive, especially at a time of ultra-low interest rates (the EU can still issue ten-year bonds at a few basis points). Estimates based on existing gas reserves indicate that establishing the ESGR would cost about EUR 10 billion ($11.2 billion). Amortized over a decade, that is a distinctly affordable EUR 1 billion per year – about 0.5% of the EU budget.

An ESGR would benefit Ukraine, too. Already, the country can receive gas from Europe through the Brotherhood pipeline that normally transports gas from Russia to Europe, thanks to the pipeline’s “reverse flow” capacity. But, without reserves of its own, the EU cannot do much for Ukraine if Russia renews its threats to cut off Ukraine’s gas supply.

Furthermore, such a reserve would create a more favorable one-sided dependency, with Russia relying heavily on the European market. Earnings from gas exports to Europe comprise a significant share of Russia’s overall export earnings and government revenues, but only a tiny fraction of the European economy.

If the Nord Stream 2 pipeline is allowed to operate – an option that should be considered only if there is no attack on Ukraine – Russia’s dependency on Europe as a reliable customer would also increase. Russia could reduce this dependency on Europe only by constructing costly capacity to export LNG from facilities closer to its fields near the Arctic circle, or by investing in an even more expensive pipeline to China.

The crisis in Ukraine has made clear that, despite all the talk about “strategic autonomy,” the EU remains heavily dependent on US security guarantees. This will not change any time soon. But, by bolstering its energy security, Europe can at least increase its capacity to deploy the few soft-power instruments it has.