Europe’s gas crisis: Why a price cap on Russian natural gas works better than a saving plan

This is an opinion article by an external contributor. The views belong to the writer.
Europe’s gas crisis: Why a price cap on Russian natural gas works better than a saving plan

Faced with the risk that Russia will use natural gas as a weapon against the EU and completely cut off supplies ahead of the winter, the European Commission last week unveiled a proposal to reduce consumption across all member states by 15% over August 2022 - March 2023, compared to the similar period in the previous 5 years.

While technically compelling, the proposal has a major flaw: it will sow division among member states, at a moment when European unity in facing Russia’s blackmailing is of paramount importance. As expected, several countries – among them Spain, Portugal, Greece and Poland - have already opposed publicly the proposal, while Hungary’s minister of foreign affairs rushed to Moscow to negotiate a separate deal.

Indeed, the diversification of gas imports and the phasing out of its dependence on Russian fossil fuels is what the EU must aim for. However, the attempts to adopt a new sanctions package on gas imports from Russia this year never managed to achieve unanimous support. The Commission’s latest proposal is likely to fail, too, and for the same reasons. EU can and will achieve the phasing out of its dependence on Russian fossil fuels over several years, but not in 2022.

What one needs to focus on this year is to design measures that unites all EU, politicians and public opinion alike, and deals with a single voice with Russia on gas imports. The way to achieve this goal is a price cap on Russian imports, combined with a solidarity mechanism designed to deter Gazprom from doing what it has been doing so far: cutting selectively gas supplies to divide the EU.

This option has been on the table since a few weeks ago - but the panic triggered by Gazprom’s reduction of supplies to Nord Stream 1 has completely distracted and divided the opinions of the public and decision-makers. This only plays into Kremlin’s hands.

But Kremlin is bluffing. The fundamental error behind our thinking these days is the assumption that the Kremlin has infinite flexibility to cut gas supplies to the EU. But there are physical constraints in the Russian gas system that simply exclude this option.

Russia can only do selective and temporary cuts, to certain countries or certain consumers - not to the entire EU or for the rest of the year. The maximum cuts that Russia affords can be easily weathered by a united EU, which has both the infrastructure and storage to deal with problems across the EU and in each individual country.

Russia’s physical constraints

The gas production is quite rigid. Gas can be stored, up to the maximum storage capacity inside Russia. It can be exported elsewhere, but is limited to the existing infrastructure such as pipelines or LNG terminals. It can be consumed domestically. But Gazprom has already pushed all these options to the limit, as it has been already playing this game for more than one year, since the summer of 2021.

Let’s review the figures. In 2021, Russia’s gas production was 760 billion cubic meters (bcm). It consumed domestically 475, and exported 110 to non-EU partners (China, Turkey, Belarus, Kazakhstan, plus LNG mostly to Asia). It exported 150 bcm to the EU. Having started the summer of 2021 with a historical minimum of 15 bcm in storage (compared to 40 bcm in a regular year), it had an additional spare capacity of 25 bcm which it could manipulate to deplete EU’s storage.

Thus, Russia could only create scarcity on the EU market by delivering low quantities by pipeline to the EU; increasing its domestic consumption, particularly on fertilisers; making use of spare storage capacity; and exporting outside the EU to the limits of the existing infrastructure.

In 2022, the picture looks different. After the cuts to the EU so far, the EU imports are estimated to maximum 120 bcm by end-year. Russia no longer has spare storage capacity. Storage was full in November 2021 and last winter was mild. The consumption in Russia must have dropped by at least 10%, given the catastrophic impact of EU sanctions on industrial production, hence of consumption of gas and gas-fired electricity.

Russia can indeed vary its gas production by some 5% per year (as observed in 2019-2020), but not much more than that. Shutting down production is very expensive and requires works in thousands of gas wells, while unused pipes deteriorate rapidly. Russia has already decreased gas production by 5% so far because of lower demand from the EU. Additional reductions can be done only at exponential marginal costs.

Furthermore, there is no additional capacity to significantly increase exports elsewhere, Putin’s alleged “pivot to Asia” (building pipelines and LNG capacities) can happen in 2025-2030 in the most optimistic scenario. Those future, alternative exports would anyway be made from new gas fields, not from those in North-West Russia exporting to the EU.

Adding these constraints, Russia already has about 60 bcm excess gas for 2022 - which would require an additional 5-10% reduction of production or a significant increase of domestic demand. Russia may push to increase fertiliser production, but there are limitations to that as well. Russia increased already last year its production to available maximum capacity, and any additional output requires quick investments in new factories at significant costs.

A new solidarity mechanism

Thus, Kremlin’s cards are really poor, and the EU, if it stays united, can unilaterally impose its own conditions. It can unilaterally introduce a price cap for all Russian imports, as a kind of sanction, with a very simple solidarity mechanism that will probably never have to be used. Here are the advantages of a Russian gas price cap.

  • It will immediately rally all dissenters inside the EU, including populists. Who can legitimately oppose an initiative that would immediately and visibly cut gas prices to domestic consumers? Can a single member states negotiate a better deal separately with Gazprom, better than the EU with the full weight of its 27 members?
  • It will keep EU citizens focused on Ukraine instead of heating bills. Right now, cynical as this sounds, the biggest risk is political, with the EU electorate's fatigue on the war in Ukraine and its immediate economic concerns. Any measure slashing gas prices in the EU would be extremely popular.
  • It can be legally introduced as a sanction on Russia, overriding price clauses in the existing contracts (which anyway Gazprom had no restraint to violate unilaterally)-
  • Kremlin can still play with selective cuts, but coupling the price cap with a simple solidarity mechanism will deter Gazprom from even trying. The solidarity mechanism would be as follows. If one country experiences cuts, the other counties will intervene immediately to fill the gap, in quantities adapted to available interconnection capacities.
  • This is feasible for a few days or weeks and up to several bcm.The EU as a whole is perfectly capable to deal with the amounts and periods that Russia can slash from now on, both in terms of gas availability in storage and in infrastructure.
  • Even more importantly, it will cut Gazprom's revenue across the board and would be publicly visible as a blow to Russia's capacity to finance the war. Right now, Gazprom cashes in substantially from the volatility on the EU spot markets that it introduced by threats or selective cuts. These push up revenues from all existing contracts. Capping Russian prices would not only be effective, but a moral European response to Russia’s horrible aggression in Ukraine.

Ana Otilia Nutu, Steering Committee Co-Chair of the Eastern Partnership Civil Society Forum (EaP CSF) and Energy Policy Analyst at the Think Tank Expert Forum 

Ana Furtuna, Director of the Secretariat of the Eastern Partnership Civil Society Forum 

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