The implications of the Russia–Ukraine conflict for energy security and climate change

The implications of the Ukraine–Russia conflict for energy security and climate change

Dieter Helm

26th January 2022

With 100,000 troops, Russia’s objectives could not be clearer. Putin wants to rebuild a buffer of autocratic states around his border, halt NATO’s advances, and put an end to so-called colour revolutions. Belarus, Kazakhstan and Ukraine form the inner core, and it is no accident that it is these former Soviet Union states that Gorbachev tried to hold on to as the Berlin Wall came down. Continued cyber attacks and subversion in Estonia, Latvia and Lithuania, and even Poland, are part of the game plan, as is the prising of Germany away from its Eastern neighbours, not least through the Nord Stream pipelines.

It could not be clearer. The added twist is China, and its support for Putin. China also has territorial ambitions and the desire to prop up its autocratic state from internal and external challenges. Hence the suppression of the Uighurs, the suppression of democracy in Hong Kong, and the ominous noises about Taiwan. Together, Putin and Xi Jinping want to make the world safer for autocrats.

What emerges is not an isolated crisis, but rather part of a continuing strategy since 2000, and which is likely to play out over the next 20–30 years. The current Ukrainian crisis is but one episode in a very long game, right back to the early manipulation of supplies through the Ukrainian pipeline, to the Crimea annexation, the destabilisation of the Donbas, the aim of Nord Stream to bypass Ukraine (and the Eastern European buyers of Russian gas), and the power play on the energy contract to Moldova.

All of the above should be a wake-up call not just to NATO and the EU about the military and democratic challenges, but also about the twin energy aspects: energy security and climate change mitigation. Amazingly, the former has only just reached the eyes and ears of European governments, and the latter did not feature at all in all the posturing at COP26. In the case of the UK, it is seemingly deaf to the implications for security of supply (the UK thinks it is about quantity not price) and for climate change, wedded as it is to unilateral territorial carbon production targets.

The security of supply implications

The gas market has been quietly transforming itself from a purely regional set of markets, into a global trading market. This is what the UK and the EU have been working towards since the late 1990s, trying to demolish the long-term contracts model for supply with spot wholesale markets. Even faced with Gazprom’s repeated defence of long-term take-or-pay contracts (which it continues to honour), the EU has managed to prise away much of the trade to the spot markets, and, as Gazprom has pointed out repeatedly, this is a market where no one has the obligation to supply. Surprise, surprise, when the politics suits Putin, it is not supplying.

The EU might have consoled themselves with the idea that Gazprom will always supply where there is demand, provided the price is north of its marginal costs. In a perfectly competitive market, it would – because there are always other suppliers waiting in the wings to soak up demand. Competition disciplines the players. But even the most cursory of looks at the EU gas market tells us that pipelines dominate LNG, the rival supplies from Dutch and British North Sea gas are dwindling, and, in a wholesale market, the possibility of increasing supplies gives Gazprom a powerful strategic threat against rivals. Furthermore, LNG costs money to create new terminals, and the strategic threat to them from more pipeline gas remains. Think what the overcapacity - Nord Stream1 + Nord Stream 2 + the Ukrainian pipelines in Russian hands - could do to undermine LNG investments. Remember, too, that Russian gas has (much) lower marginal costs.

At the UK end, the Secretary of State is keen to tell us that we have physical security of gas supply, because we have Norwegian gas + remaining North Sea gas + LNG from countries like Qatar. This is naive and simplistic. What the Secretary of State should say is that we have physical security of supply, provided we are prepared to pay the marginal price in global gas markets. In other words, provided the UK outbids China to buy Qatari LNG, and outbids China to buy US shale gas exports, then of course the ships will sail to Milford Haven. Similarly, Norway will supply – at the EU market price.

The bit of 101 economics that has escaped the government is that there is always a price at which supply = demand. Not only is it always possible to outbid rivals, but as the gas price goes up, so eventually demand goes down. It is just a question of how much pain the UK wants to endure.

From the Russian perspective, reducing supply to the wholesale market has twin benefits: it not only reinforces the push for long-term contracts and rewards those with them, but it also drives up the price. A back of the envelope calculation would probably show that the increase in price this winter paid to Gazprom more than compensates for the reduced volumes supplied. Indeed, invading Ukraine may actually be self-financing.

Disunity on the EU side has helped the Russian position. Instead of matching the market power of producers by clubbing together, presenting a united front and ensuring that there is in effect a single buyer, the EU has left Russia able to pick off countries, with Germany central to Russia’s approach, and thereby able to effect a divide-and-rule strategy.

The German–Russian “special relationship” is not new. It is centuries old – based upon raw materials (timber, then coal, then oil, then gas) in exchange for manufactured goods (machine tools, then military equipment, then cars and consumer goods), from Peter the Great, through to the interwar years and the notorious Hitler–Stalin Pact, Ostpolitik and now the Nord Stream relationship, typified by Gerhard Schröder, who negotiated the deal, then chaired the pipeline company and then Rosneft. It is no accident that the SPD, which dominates the current German coalition, is urging a much softer line on the current Ukrainian crisis (notwithstanding the Green’s tougher line).

What to do about security of supply? The obvious answer is to stop digging, making the hole deeper. Stopping Nord Stream 2 is the obvious first step. Allowing it to go ahead is game, set and match to Putin. It cements his strategic control over Ukraine and draws Germany further into his orbit, as he turns from destabilising Ukraine to the former Baltic Soviet States and Poland. No wonder these all oppose Nord Stream 2.

This might happen in the short run, but it is hard to see that a fact on the ground (the pipeline now exists and is completed, notwithstanding the various confused attempts by Trump and Biden to sanction the companies involved) is going to stay empty. This means there are then two second-best options. The first is to band together to ensure that gas is made available to all and any purchasers at the same price and to offer complete support for any country whose gas supplies, price and terms differ from any other. Specifically, Germany would have to share all and every molecule of Russian gas with every other member of the EU, and specifically the gas would be offered to Poland, the Baltic States and Moldova. In theory the EU’s Internal Energy Market directives should do this job; in practice they remain more aspirations than outcomes.

The second is to diversify – the strategy always adopted after the event in energy markets when suppliers exert too much market power (for example, as happened after the OPEC price shocks of the 1970s). This option is multidimensional: diversify gas supplies; and diversify from gas.

The former takes time and requires government to commit. Building lots of LNG terminals and the supporting infrastructure needs the guarantee of a long-term return. The EU and the UK can do much to make a lot more terminals happen, but only if they are not at the same time trying a fast-track phase-out of gas as part of their climate policies. They may have good reasons to do the latter, but they cannot simultaneously expect new investments in their security of supply from private investors.

The problem right now is where the gas is to come from if not Russia, given that there is already quite a lot of LNG capacity. The answer is obvious: European production in the North Sea (Norway and the UK predominantly), the US shale gas surpluses, and Qatar. Further out, the world is awash with shale rock formations with shale gas potential, including around the EU’s borders, notably in North Africa.

All of this takes a gas strategy and gas policies. It requires governments to prioritise home production, and it will require storage and strategic reserves. None of this happens purely as a result of private investment and market forces. It takes government decisions, actions and contractual commitments.

The trouble is that the EU – and especially the UK – are going in the opposite direction, opposing further offshore developments and encouraging the ESG pressures to disinvest from gas. In the UK, the closure of the Rough storage field went ahead without intervention. Gas has been neglected, and it has been a deliberate rather than a benign neglect. All of this would be fine if it was true that the dash for renewables meant that gas could quickly drop away, rather than be essential for the transition to net zero.

Before we get to the climate change side of gas security, let’s tackle the other dimension of diversification: engaging politically with Qatar and the US. The key point here is that the UK wants Qatar to guarantee contracts supplied to the UK in the event that there are higher prices elsewhere, for example in South East Asia, and similarly from the US (otherwise the UK could simply outbid others to secure Qatar gas). Why would Qatar do this? Why should it voluntarily commit to a lower revenue to be nice to the British government?

When it comes to oil, it is understandable that the Saudi Arabians might want to be nice to Biden because Saudi Arabia wants the US’s support against Iran, and access to UK banking and financial institutions (just like Russian oligarchs like London for their money). But Qatar is very small, and with bigger fish to fry, including China, and it has its problems with Saudi Arabia. The question is: what has the UK got to offer in exchange?

The US supplies are possibly a more promising case. All that shale gas which the UK government is sceptical about, environmentalists and the climate change activists hate so much, could be a more reliable supply, not least because of the political payoffs from the “special relationship”, notably in opposing Russia. The trouble here is that the US government does not produce gas; private companies do. The form of the guarantee from the US state would have to be crafted in terms of powers over private companies. At the margin, the whole point of a US–UK arrangement would be precisely to stabilise prices, and therefore undermine commercial opportunities at times of market stress, like now. There is no US Gas Co. to do a deal with a national British Gas controlled by the US and UK governments respectively. (And the recent release of strategic oil stocks by Biden creates a worrying example of short-term politics over market credibility.)

That leaves options for getting out of gas – substituting to other energy sources. The trouble with this argument is that gas has lots and lots of advantages. It flows in pipes, can be liquefied, emits a lot less carbon than coal or oil, is very flexible as a fuel for electricity generation and for heating, and is great for the petrochemical industries. That is why, post 1990 when it became legal to burn gas in power stations in the US, EU and the UK, there was a dash for gas for electricity generation, as well as a dash for gas for heating and a dash for gas for petrochemicals. Diversifying away from gas for heating brings lots of extra costs, alternatives to gas for power generation are less competitive than their advocates typically claim (notably when account is taken of the intermittency of renewables and the costs of nuclear), and the demand for petrochemicals continues to rise sharply without obvious substitutes.

It is a bit late to point out that depleting the North Sea gas fields as fast as possible may not have been such a sensible policy, but the limits to diversification do suggest that simply switching from domestic supplies to replace them with Russian or other gas is not quite as simple as the disinvestment campaigns suggest.

Climate change

This brings us to the implications of the Russia–Ukraine conflict for climate change and its impact on the over-optimism at Glasgow COP. The conflict as it has evolved has seen the US, the EU and the UK all concentrate on fossil fuels and their supplies, on keeping down the prices of gas, electricity and also oil to the consumers (and voters). Biden was simultaneously promising to take the US on a decarbonising path whilst begging Saudi Arabia to increase oil production, and the US has not gone down the path of banning further licences for fossil fuels on Federal lands. Indeed, like Obama, Biden’s actions are largely benign for the US fossil-fuel industries. Obama presided over the great expansion of the shale industry, taking the US back to 10mbd production. Biden is presiding over a further increase above the 10mbd. The two will go down in US recent history as the most pro-fossil fuels in their actions, often in contradiction to their words.

In the EU, it is coal that is the immediate beneficiary of the Russia–Ukraine conflict. Germany par excellence stands out, but so too does Poland and a number of other EU member states. The switch to gas is what enabled the EU and the US to improve their carbon emissions, and especially the US – shale gas has been a great carbon emissions reducer. The gas displaced the coal. Now the gas price has increased, the remaining coal capacity is being turned back to. Security of supply, and especially consumer prices, turns out to be more important than carbon emissions.

In the UK, the reason the gas crisis has been so much worse than almost anywhere else is that more of the coal is closed (though not all of DRAX, which has been flat out). The decision to exit coal has been a great move from a climate change perspective, the most important dimension of the UK’s mitigation strategy, and the one example of leadership. It would all have been much simpler if the UK (and others) could go from coal to renewables. But what the renewables drive neglected was the need to have a coincidental and supportive strategy for dealing with intermittency (whilst also at the same time closing much of existing nuclear capacity). Although there are lots of technological options out there, most will not make much difference for this decade, and most look to be more expensive than gas. Simply neglecting the gas security position, and in particular its price dimension, leaves the UK with what I have elsewhere called its “first net zero energy crisis”.[1]

The other option, resorted to after the OPEC-induced price shocks of the 1970s, is more nuclear. Nuclear has a number of attractions. It is baseload and delivers a lot of power (provided there is a supply of uranium – currently Kazakhstan is the world’s most important source). France took the nuclear path with over 50 reactors, as did Japan. Germany and the UK also went for nuclear, to combine into an energy mix with coal.

The nuclear industry smells the chance of a renaissance in the face of both the carbon and the security of supply contexts. It sees itself as win–win. Yet the important point to bear in mind is that, however desirable or not, this is essentially longer-term. And by the time that a lot of new nuclear could have been built, there will also be lots of other technologies, not least to handle the Achilles heel of renewables: its intermittency. Nuclear is always 5 to 10 years away. The intermittency is right now.

The challenge for the US, the EU and the UK is how much climate change dominates energy security concerns. The trouble is that the populations have all been fed a political, lobbyist and media narrative that decarbonisation is low-cost. In this first net zero energy price crisis, they are discovering that this is not true.

One possible casualty is that the decarbonisation agenda will start to slip – still a priority, but a medium-term one, if and when the energy price challenges have settled down. Security trumps carbon.

What may encourage this shift of political focus is that the autocracies that are being defended in the Russian–Ukraine conflict, and the new alliance between Russia and China in support, are also the very countries where the future of the climate is going to be determined, more so than in the EU and the UK, or even the US. These countries have less regard for the future of the climate as against their immediate survival. That much was clear at the Glasgow COP. China did not play ball, and Russa was never going to. Both are overwhelmingly fossil-fuel economies, and the likely fruit of their current embraces is the new gas pipeline from the Yamal and West Siberia direct to China, and a great oil relationship. Geopolitics is central to climate change, not just the other way around.

The world’s autocracies – Russia, China, Iran, Iraq, Saudi Arabia, Libya, to name but a few – as well as the unstable Brazil, matter a great deal when it comes to the 2˚C target. None of these is likely to do anything like what is required for the 2˚C target limit, let alone the 1.5˚C target. Indeed, quite the opposite in the case of Russia and China. China burns half the world’s coal, and a number of countries are in the business of supplying coal to China. It is building more new coal power stations than the EU plus the US are closing. Its emissions are rising, not falling.

Just a few months after the Glasgow COP26, the front line of Ukraine is more decisive for the future of the climate change targets than the thousands of attendees. The great speeches of those at Glasgow look even hollower now.

What is to be done? The answer in part goes to the heart of the nationally determined contributions (NDCs) and the UN framework. The COPs are still all about territorial carbon production targets, and not carbon consumption. There is no attempt to actually stop causing climate change. Net zero territorial carbon production targets do not do this. They try to stop those emissions inside a country that are properly measured from going up. They do nothing about imported carbon-intensive goods from the likes of China and Russia (based upon coal production in many cases), they do nothing about the damage to carbon sequestration, notably from agriculture, and they typically leave out most of the emissions from soils and peats.

When it comes to China and Russia, the carbon border tax route is a serious threat, and so it should be. The UK, the EU and the US citizens should strive to stop causing more climate change, and they should treat trade accordingly. Then the great game of autocracy at home, and the export of carbon-intensive production abroad, and in Russia’s case the export of carbon fuels, should come with a carbon cost. It should be part of the geopolitics of climate change policies.

The real lessons to come from the Ukraine–Russia military crisis and the current energy prices crisis are as follows. Diversification, yes, but in a managed and secure way, which means a serious gas security policy. Decarbonisation, yes, but with a proper incorporation of carbon imports, and hence a carbon consumption target. But be in no doubt: Russia and China do not have benign intentions in either of these. Russia is not interested in making the West more secure; China wants to push back the US; neither wants carbon border taxes and adjustments. Putin does not appear to care much about climate change (and the opening-up of the Artic is seen as an opportunity), and China is not prepared to prioritise carbon mitigation over the survival of its autocracy. This sort of realism ought to have been front of mind for the delegates at COP26 in Glasgow. Perhaps then Obama (who made a speech about what should be done, rather than what he actually did) and Biden might have been more convincing, and the dangerous complacency engineered by the claims of triumph by the UK hosts might have been more muted. Energy realism is what is required, not naive optimism.



 

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