The Geopolitical Game of Natural Gas

Europe is experiencing stressful times. Next to new COVID restrictions, the continent is dealing with extremely elevated gas prices. European consumers this winter are hit hard by the massive increase in gas prices that add to the high levels of inflation across the board.

Earlier this month the price of natural gas in the Netherlands hit a record-high of 180 euros per megawatt-hour before coming down to 92 euros at the end of last year.

The U.S. liquified natural gas exports help with transporting more gas to the continent, but it will not offer a structural solution. Many European manufacturers have shut down their operations because the power prices are too high. If the situation worsens various areas of Europe could literally run out of natural gas.

Scaling down European production

The European gas shortage is a complex problem with various causes, but the simplest explanation is that there is a surge of demand for energy as we slowly restart the economy, combined with a reduced supply of gas on the global market.

Why did Dutch gas production reduce so much? The Netherlands is actively participating in the transition towards renewable energy. In 2018 we started phasing out natural gas extraction in Groningen, one of the largest gas reserves in the world.

Another big problem is that the optimistic projections of the energy transition arrive too late, or the gradual closure of Groningen comes too early. To bridge this gap, importing gas is the only temporary solution.

With the Netherlands becoming a net importer of gas, the entire EU becomes more dependent on gas imports from states outside of the EU, mostly Russia, Norway, and Algeria. The map below shows the main sources of EU gas imports and the active gas routes into the EU.

Russia’s role in the crisis

Russia has used natural gas as a geopolitical tool in the past, but at the same time they want to be seen as a trustworthy long-term supplier. Still, Russia is looking at the EU Green Deal and asking themselves what they can do if there is no more long-term future for gas in Europe? In that case, being a trustworthy long-term supplier loses value and the temptation exists to exploit their temporary dominant position as much as possible now.

The data shows a different story. Below you can see that Russian natural gas flows via the Yamal-Europe pipeline to the Mallnow metering station at the Polish-German border recently decreased to the lowest level year-to-date.

Geopolitics of Nord Stream 2

Imagine Nord Stream 2 does get sidelined, who would be the biggest winners and losers in that situation?

Germany

Firstly, this would put Germany in an awkward position. Germany ditched nuclear power and renewable energy only generates a small amount of power for the foreseeable future. If the project gets halted Germany has no direct access to gas and it can’t think of becoming a gas hub for the region.

Others play down the impact and say that Nord Stream 2 is not designed to bring significant new gas to the German market, but rather to circumvent Ukraine by bringing those volumes through Nord Stream 2 instead.

Ukraine and Poland

Ukraine and Poland earn transit revenue that Gazprom pays to send gas via their gas networks to Western Europe. The Nord Stream 2 pipeline bypasses them and weakens their political bargaining power. Ukrainian facilities could become obsolete in that case. Because of this, both countries would benefit tremendously from the pipeline getting sidelined.

Furthermore, the Ukrainian gas infrastructure provides leverage against Russian aggression. They could close the gas pipes if Russia starts a war, in which case The European Union will have to respond and help Ukraine. Ukraine considers Nord Stream 2 a Russian geopolitical weapon and sees their own gas pipes as a defense mechanism.

Russia

The biggest loser if Nord Stream 2 officially gets derailed is Russia. Mainly because in that case Gazprom still relies on the Ukrainian gas transmission system to deliver to the EU markets, thus serving as a deterrent for Russia to further destabilize Ukraine. It would be a huge political blow to the Kremlin.

On the other side, if Russia can keep the controversy around Nord Stream 2 going it is not necessarily negative. It creates a division between the United States and their Western European allies that plays into the hand of Putin.

From Nord Stream 2 to Power Siberia 2

Russia is still reliant on European imports but what if they can replace the EU with other buyers? In that case, the looming energy crisis in Europe will not cause anybody in Russia to lose any sleep.

Instead of Nord Stream 2, Russia is now increasingly focused on Power Siberia 2, a pipeline that goes from Eastern Siberia to Northern China. The final route across Mongolia was officially decided a couple of months ago and construction should begin in 2024.

It does not matter for Gazprom if China will not fully replace the European market, what matters is having a more stable business flow without constant European uncertainty. What matters for China is having another reliable overland supply route. China needs this in case the Cold War 2.0 with the U.S. turns hot, and the U.S. navy blocks maritime shipping of energy sources via Southeast Asia to China.

As an energy superpower, Russia has turned the geopolitical game upside down. Instead of trying to balance with the internally divided EU and NATO countries to sell their natural gas, Russia will be increasingly focused on their Asian customers. Only time will tell if this will be a more stable partnership.

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