Russian Gas Reliance in Europe Skewing Sanctions Debate

European leaders, while calling Ukraine’s May 25 presidential election a success, are still facing a deeper dilemma: how to free their countries from an addiction to Russian energy.

Pro-European billionaire Petro Poroshenko’s victory has relieved the immediate pressure on the U.S. and the European Union to impose tougher sanctions against Russia. Swedish Prime Minister Fredrik Reinfeldt said he didn’t expect the 28-nation bloc’s leaders to discuss punitive measures at a summit in Brussels today.

“I think we are going to welcome the fact that Petro Poroshenko has a very clear mandate from the Ukrainian people, that we foresee respect on the Russian side,” he told reporters before the evening gathering.

At the same time, Polish Prime Minister Donald Tusk urged further pressure on the government in Moscow.

“No one will opt to impose new sanctions right away, but we should unanimously say that Europe is ready for further sanctions if Russia doesn’t give up its policy to support separatists,” he told reporters.

The European and American reluctance to escalate in the wake of an election that was at least a partial success, a U.S. official said yesterday, suggests that by finally tempering his actions and rhetoric, Russian President Vladimir Putin may have achieved much of what he sought in Ukraine.

Changing Mix

Russia’s ever-changing mix of covert action, economic threats and the annexation of Crimea, followed by soothing words, the official said, has exposed the divergence of U.S. and European Union views on Russia and the EU members’ conflicting interests there, especially on energy.

“The energy crisis is a test of what the EU really is,” Tusk said on May 21, calling it “a duel” over what’s more important: “bilateral relations with Russia or relations within the EU.” The only way to be “an equal partner to big suppliers” is to form a united front.

Europe’s energy dependence “ties the EU’s hands a great deal -- you really have widely divergent views,” said Charles Ebinger, director of the energy security initiative at the Brookings Institution in Washington, in an interview. Fears about losing Russian natural gas have made sanctions “very weak and, in the end, fairly meaningless.”

The European Commission will publish an energy security road map tomorrow that EU leaders will consider at a June 26-27 summit.

Russia’s Threat

Russia’s threat to cut off gas supplies to Ukraine if the country doesn’t pay its back bills and agree to prepay for future supplies at a higher price presents problems for the EU, which gets half its Russian gas -- 15 percent of its total supply -- through Ukraine’s Soviet-era pipelines.

Russia cut the flow to Ukraine over price disputes in 2006 and 2009, and other European nations suffered when state-backed OAO Gazprom accused Ukraine of using gas meant for other nations, with some countries temporarily losing electricity during the winter.

Europe’s reliance on Russian energy has made it difficult to reach the necessary consensus on how to respond to Putin’s actions stoking unrest in eastern Ukraine and annexing the Crimean peninsula, EU diplomats said.

Russia provides 30 percent of the European Union’s natural gas, and the 28-nation bloc has few options to replace a cutoff by Russia this winter, according to a draft energy security document seen by Bloomberg News.

Russian Dependents

Twelve EU member states get more than 50 percent of their gas from Russia, including four -- Lithuania, Estonia, Finland, and Latvia -- that depend on Gazprom as their sole supplier, according to Eurogas, a Brussels-based lobby group. Europe also imported 32 percent of the continent’s total crude oil consumption last year from Russia, according to the Paris-based International Energy Agency.

The chief executive officer of Germany’s largest power producer, RWE AG’s Peter Terium, said in a May 23 interview that it’s “sensible” to hold back on punishing Russia. “We’re treading on eggshells. You need to maneuver very carefully in order not to escalate.”

While tacitly acknowledging that Russia would suffer from cutting off energy supplies to the rest of Europe, Economy Minister Alexei Ulyukayev said last week that industrywide sanctions will never happen because “our partners will suffer also, especially when it comes to Europe, which is very much dependent on the energy supply from Russia.”

Struggling Economy

Russia is struggling to steady its $2 trillion economy in the face of dramatic capital outflows, market instability and a ruble that’s more than 4 percent down against the dollar this year.

Oil and gas account for 70 percent of Russia’s annual exports and more than half its federal budget, according to the U.S. Energy Information Administration. The country exports 80 percent of its oil and more than 70 percent of its gas to the EU, and that revenue keeps Russia’s economy afloat, the European Commission’s Barroso said in Brussels.

European diplomats acknowledge that the symbiotic energy relationship makes punitive measures unpalatable. “We have stressed very firmly over the last months that energy must not be abused as a political weapon,” Barroso said last week.

Many of the EU’s members strongly oppose sanctions that would limit energy deliveries from Russia. Instead, they favor efforts to engage Russia in dialogue and boost stability and democracy in Ukraine, according to several European diplomats in Washington and Brussels who weren’t authorized to be quoted.

‘Security Threat’

“The farther east you go -- Poland, Slovakia, Bulgaria, Romania, Hungary, the Baltic states -- you have a much higher dependence on Russian energy,” and those nations see over-reliance “as a direct security threat,” said Ebinger, who has advised European governments on energy policy.

While the EU in the last two months has frozen assets of scores of Ukrainians and Russians accused of fueling unrest and two energy companies that were expropriated by Russia when it annexed Crimea, Europe hasn’t imposed any sanctions that would block trade with Russia.

Slovak Premier Robert Fico last week said his government, which agreed to transport gas from Western Europe to Ukraine under a reverse flow deal, “isn’t inclined” toward more sanctions. Europe, he said, shouldn’t be “pushed into some global conflict. It would be a suicide for the economy.”

Price Impact

Irish communications, energy and natural resources Minister Pat Rabbitte said in an interview that while he thinks Russia is unlikely to cut supplies, if it did, “It’d almost inevitably have an impact on price” across Europe.

As Europe pulls out of a recession, gas shortages would hit heating, electricity and industrial production, and rattle confidence. Again, though, the effects would be uneven and potentially divisive.

Some countries, including Latvia and Germany, have stored many months of supplies and could withstand a short-term shutoff more easily, officials say; others have few reserves.

Still, the Ukraine crisis has added urgency to proposals for greater European energy security, a movement that in the long term would reduce Russia’s leverage. Expanding inventories, developing reverse flows, expanding renewable energy sources, improving efficiency and forming a common reserve could reduce the short-term shock from any Russian cut-off as the EU sets its energy and climate policies for the decade starting in 2020.

Divided Europe

Here, too, Europe is divided. A group of predominantly eastern and central EU nations led by Poland argue that the crisis shows Europe should invest in domestic energy, such as coal and shale gas.

Many western states, including Germany and Denmark, say that stricter emissions standards, more renewable energy and higher efficiency would cut imports and accelerate a shift to a low-carbon economy.

If Russia makes good on its threat to cut off gas to Ukraine, the Nord Stream pipeline between Vyborg, Russia, and Greifswald, Germany, is an alternate route to get Russian gas to the rest of Europe, and interconnectors would allow gas to flow among neighbors.

While Norwegian, Algerian or British gas could replace some losses from Russia, prices are higher, and those nations have existing customers. Developing a southern corridor from the Caspian Sea region and Iraq, and increased liquefied natural gas imports from Qatar and the U.S. are longer-term fixes.

LNG Terminal

Poland, with its history of tense relations with Russia, has invested in an LNG terminal to wean itself off Russian gas, and Lithuania has said it will do the same. Investing in infrastructure for LNG from Qatar or the U.S. is costly, however, and other EU members have balked at the price.

The divisions within the EU over the costs to member states’ economies extend beyond the energy sector. The U.K. and Cyprus are among those concerned about financial sanctions that would imperil capital flows between their banks and Russian institutions; in the first three quarters of 2013, $16 billion flowed to Russia from British banks and $12.9 billion from Cypriot banks, according to data compiled by Bloomberg. In the same period, $61 billion flowed from Russia to the British Virgin Islands, and $7.5 billion went to Cyprus.

French Ships

French officials are worried about a $1.6 billion sale of two Mistral helicopter carriers to Russia that would be imperiled by an arms ban. Greece, Italy and other Southern European states profit from Russian tourism and luxury-goods purchases, and are advocating more diplomacy and less punitive action.

Whenever there’s a crisis with Russia, especially over energy, “suddenly it’s all hands on deck,” Amanda Paul, an analyst at the European Policy Centre in Brussels, said in an interview. “Frenzy lasts for a short period of time, and then we get back into our usual way of doing things: very slowly, not necessarily united.”