Energy in the Ukraine -- Sanctions Equation

The United States along with allied governments is considering the imposition of economic sanctions on Russia in response to its actions in Ukraine. It is a strategy that trails skeptical question marks. The historical record tells us that sanctions rarely are effective. They can cause much pain and suffering but do not change the policies of governments as intended. From Japan before Pearl Harbor to Cold War China, to North Korea, Iraq and Iran in more recent times, their ineffectualness has been demonstrated. South Africa is the exception -- as were the conditions there. The willfulness of states to act in accordance with their self-defined basic interests is the main reason for the recurrent failure of sanctions. This is especially true of authoritarian regimes that have the means to contain social unrest. There also are economic factors at work. The essential nature of economic relations is that they are the expression of the parties' mutual interests (except in the case of slavery or other forms of coerced employment). That is to say, they entail mutual gain - even if the benefits are unequal or asymmetrical and leave one party feeling the outcomes as unfair. Trade dealings certainly fall within this category. And it is on matters of trade that American policy currently is focused. For it is far harder to impose curbs on financial transactions, e.g. freezing assets or denying access to banking facilities. The latter require near unanimity among countries where financial institutions are chartered. Already, we have learned that Great Britain has decided to resist the proposed imposition of financial sanctions out of fear for their impact on the City of London which is the foundation stone of the British economy. Commodity trade with Russia is the center of attention - for obvious reasons. The Russian economy is heavily dependent on the export of natural resources, oil and natural gas above all. They provide the bulk of the country's foreign exchange earnings, employ a large fraction of the nation's industrial workers, and are the main source of the state's tax revenues. The numbers paint a striking portrait o the Russian economy.Russia is the second-largest producer of dry natural gas and third-largest liquid fuels producer in the world; oil and gas revenues account for more than 50% of the federal budget revenues. Russia's economic growth continues to be driven by energy exports, given its high oil and gas production and the elevated prices for those commodities. Oil and gas revenues accounted for 52% of federal budget revenues and over 70% of total exports in 2012, according to PFC Energy. Russia was the world's third-largest producer of oil (after Saudi Arabia and the United States) Preliminary data for 2013 show that Russia still is the third-ranked producer of total liquids, with average production at 10.5 million barrels per day (bbl/d) through September 2013. Russia was the second-largest producer of natural gas in 2012 (second to the United States). Russia has roughly 7.2 million bbl/d of total liquid fuels available for export. The large majority of Russian exports (84%) went to European countries, particularly Germany, Netherlands, and Poland. Around 18% of Russia's oil exports were destined for Asia, while the remainder went mostly to the Americas. Russia's crude oil exports to North America and South America have been largely displaced by increases in crude oil production in the United States and Canada. More than 80% of Russia's oil is exported via the Transneft pipeline system, and the remainder is shipped via rail and on vessels that load at independently-owned terminals. Russia also exports fairly sizeable volumes of oil products. Russia exported about 1.2 million bbl/d of fuel oil and an additional 889,000 bbl/d of diesel in 2012. It exported smaller volumes of gasoline (52,000 bbl/d) and liquefied petroleum gas (56,000 bbl/d) during the same year.Natural gas exports Russia sends about 76% of its natural gas exports to customers in Western Europe, with Germany, Turkey, Italy, France, and the United Kingdom receiving the bulk of them. Smaller volumes of natural gas are also shipped via the Gazprom pipeline network to Austria, Finland, and Greece. Europe is Russia's main energy export market. 75% goes to Western Europe, with Germany being the biggest importer, while 24% goes to Eastern Europe. Fully 25% of the European Union members' total natural gas consumption is met by Russia. This energy symbiosis dates from the early 1980s when the EU and the then Soviet Union entered into a collaborate project to construct a natural gas pipeline. Early on, the project figured in a major diplomatic dispute. In the wake of the Kremlin inspired crackdown on Poland's Solidarity movement, the United States' urged its suspension as a way to penalize Moscow. Western European governments united in opposition to the American plan. They argued forcefully that the criticality of Russian natural gas to their economies meant that disruption or prolonged delay would severely hamper growth. Moreover, a primary justification for the collaborative deal was to reduce the degree of energy dependence on the turbulent Middle East. The economic pain inflicted by the 1973-74 embargo on oil sales by the Arab members of OPEC at the time of the Yom Kippur War had left a searing memory. It provided the impetus for devising an energy strategy that diversified sources. Hence, the European conflict with the United States as to what were appropriate instruments of influence to be deployed against the Soviet Union. A similar situation may now be presenting itself. Although the Obama administration has not yet called for a boycott of Russian energy exports, it may look in that direction given the unlikelihood that other trade sanctions will dissuade Vladimir Putin from continuing to pursue as assertive policy in Ukraine. Just as the Cameron government in Britain shies away from financial sanctions due to the deleterious effect that they would have on the economy (and his political prospects in next year's elections), so too are all European leaders sensitive to the high price that their countries would pay were they to interfere with the mutually beneficial energy commerce they have with Russia. There is no doubt that on some objective scale of measurement, Russia stands to suffer more economic loss from such a disruption than does Europe. However, economic sensitivity per se does not translate into commensurate vulnerability to the pressure exerted by economic sanctions. There are crucial intervening variables of a political nature. They concern the strength of governmental leadership, how responsive it is to public sentiment, the means at their disposition to contain or repress dissent, and their ability to arouse a nationalist response. Success in fostering the feeling that the motherland is being mistreated and disrespected by foreign powers can strengthen the collective resolve not to give in to economic sanctions whatever the price paid.A New U.S. Strategy The current structure of the international energy market is unfavorable to any Western policy that aims to a) reduce Europe's dependence on the energy imports from Russia, and b) thereby, to reduce Moscow's leverage while increasing that that of the United States and its allies. This circumstance has prompted Washington officials to draw up plans whereby the logic of the markets can be reversed. Their centerpiece is the expansion of natural gas production via fracking and other non-conventional methods, an emphasis on exports to Europe that would markedly reduce reliance on Russian sources, and the promotion of fracking in Ukraine and Poland. This long-term plan acquired immediacy with the outbreak of hostilities in Ukraine. Many in Washington were looking anxiously for methods to shift the balance of influence between Russia and the West. Freeing Europe from the energy leverage exercised by Moscow has struck many as an attractive possibility. A New York Times lead editorial opined that the Energy Department should "speed up its review of export applications, and Congress could help by easing restrictions on exports." Others go further. "In WW II, we were the arsenal of democracy; I think we're going to be the arsenal of energy" so proclaims the former director of energy issues at the NSC, Robert McNally. Increased supplies from the United States are creating "a radically changed market" that will undercut Russia's influence, according to Carlos Pascal who heads the State Department's Bureau of Energy Resources (and former ambassador to Ukraine. The Bureau was set up in 2011 and with a staff of 85 is dedicated to exploiting the American energy boom to strengthen its geopolitical influence. Curbing Russia's own use of the energy instrument was the primary objective from the outset. Energy, in short, was one element in the United States' grand strategy of weakening Russia as a player on the international scene and curtailing its global influence. This has been the prevailing view ever since Vladimir Putin began to demonstrate his goal of reestablishing Russia as an autonomous power in world affairs. Minimizing the United States' own dependence on oil from the Middle East has been the second foreign policy consideration. The key to doing so is the building of export capacity - transporting Canadian oil via the proposed Keystone pipeline, extending natural gas pipelines, and constructing facilities on the Gulf Coast for Liquid Natural Gas (LNG). The national security factor has figured prominently in the Obama administration's deliberations about the cost/benefits of investing in these projects - along with environmental concerns, and the loss to American natural gas users of the present price advantage they derive from domestic production.* The strategy has included an aggressive campaign to promote fracking in Western as well as Eastern Europe. That has meant lobbying governments, industry and public opinion. Tangible results have been modest to date. Fracking in Ukraine and Poland is in the cards but a number of Western European countries, e.g. Germany and France, have imposed outright prohibitions, while the British government's planned limited trial runs have met with fierce resistance. The hope in Washington is that the Ukraine crisis will spur actions in both the United States and in European capitals to develop production and international trade. The effects of this on the immediate situation will be negligible. There is no spigot that can be turned on. It will be years before the United States will be technically able to export natural gas. By that time, the Ukraine's fate will be determined one way or another. Moreover, even over the long-term there are significant obstacles to a meaningful transformation of the European energy picture. First, the political opposition to fracking in Western Europe seems to be a fixed element not susceptible to change due to events in Ukraine. Second, leading governments there are reluctant to make the major capital investments in port and transport facilities that would be required to handle very large LNG imports from North America. Third, the level of concern there about Russia using energy exports as a political tool against them is quite low. For their view of Putin's ambitions is guarded; they reject the notion favored in Washington that the West is facing a strategic challenge something like that of the Soviet Union in the old days. Their response to Hillary Clinton's alarmist cry that Putin was behaving like Hitler in the 1930s has been to view it derisively. Fourth, the Western Europeans' main interest in natural gas imports from the United States, such as it is, is commercial. They wish to avoid having their industries handicapped in competition with their American rivals by wide differentiations in cost of natural gas. At present, there is little evidence of their suffering much from that seeming disadvantage. Conclusion At the present, it is highly unlikely that the Western governments will seek to use energy commerce with Russia as an instrument of leverage with Russia. The cost-benefit calculations that lead to devalue that tactic conceivably could change were the crisis to deepen. A move by Russia into the mainly Russian speaking eastern part of Ukraine in an attempt to impose a permanent division of the country would raise the stakes immeasurably. This good reason, though, to downplay the possibility of that happening since the wider implications of such an escalation do not correspond to Russia's national interests. The downside of a calculated escalation heavily outweigh any benefits that the Kremlin may reasonably envisage. The United States will be unable to export substantial quantities of natural gas until late in the decade. Its present capacity is only 5 bcm with another 20 bcm under construction. Expanding export terminals is a long and costly process. That is one reason why, as the International Energy Agency has explained "Gas remains stubbornly resistant to globalisation....downstream markets, industry and regulatory structure retain their region-specific natures." The report goes on to say: "In Europe, persistent macro-economic weakness, low carbon prices and non-market-based renewable policies squeeze gas between cheap coal and growing renewables." (IEA GAS Medium-Term Market Report 2013) At the receiving end, Liquefied Natural Gas (LNG) import capacity additions have slowed to a crawl. "The outlook remains relatively bleak for the....LNG terminals currently at the planning stage." Moreover, LNG project costs have been steadily rising over the past few years and all are typically completed a year or more behind schedule.

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