We’re at the end of week five of social distancing and quarantine. We’ve made it to mid-April, so congratulate yourselves on getting this far. It’s been a tough few weeks, but we’re getting through the pandemic one day at a time. Today, we’re welcoming Anna Mikulska, a Senior Fellow at the Foreign Policy Research Institute and Non-Resident Fellow in Energy Studies at the Baker Institute, to discuss all things European energy: the Russia-Saudi oil war, Turkstream, Nord Stream, and the future of energy markets in Europe.
General reminder to our readers to keep up to date with guidelines coming from the U.S. Centers for Disease Control and Prevention; continue to stay home as much as possible; and when you must leave your home and engage with people, be mindful of social distancing practices; and wash your hands frequently with soap for at least 20 seconds.
Thomas Shattuck: Anna, welcome and thank you for doing this! Let’s start off with the OPEC+ deal to stop the oil war between Russia and Saudi Arabia that has ravaged the market for weeks. How did all of this start, and with a deal reached, what happens now?
Anna Mikulska: Thanks for having me! The OPEC+ deal was born in 2016 when it became increasingly clear that OPEC cuts in oil supply are not enough to influence global oil prices. The reason: U.S. shale producers, who—acting under market conditions—would respond to higher oil prices (that were higher due to OPEC cuts) and fill the void. Adding Russia to OPEC cuts was seen as necessary. But this also meant that the OPEC+ cuts were basically helping U.S. shale, which is much more expensive to produce than Saudi or Russian oil. The realization has become possibly more pronounced as OPEC+ cuts were up for renegotiation. Russia was not willing to sacrifice its production/companies that were quite unhappy with American shale’s apparent “free-riding.” The sanctions the U.S. has imposed on Russia earlier—including most recently sanctions on its natural gas pipeline to Europe (Nord Stream 2)—served as additional disincentive. Saudi Arabia has more incentives to work with the U.S. as the latter has provided military and diplomatic support for the region and the nation under the Carter Doctrine. But it knew that OPEC-only cuts would be potentially ineffective.
A price war, on the other hand—even if painful—could be a way to shed more costly competitors in the long run. Little did any of the OPEC+ parties know at the time, the COVID-19 pandemic would make their decisions even more painful for any oil producers, including themselves. That’s why we have seen the agreement: the drop in demand has been so significant that global economies would be unable to absorb the amount of oil that would be produced under price war conditions. Prices have fallen now. Much of the new production has been sent to storage, but once the storage is filled, the oil has nowhere to go and production needs to shut down. The reason is the specific nature of the COVID-19-related economic downturn: economies cannot be incentivized to grow with cheap energy prices; everything is on the lockdown. After all, you don’t see many cars at the pump even though gas prices have fallen to record lows, and you didn’t have many families doing road trips this spring break. It still remains to be seen whether the supply that emerges after the cuts will be absorbed. The newest IEA reports are not encouraging, and we have seen prices of oil falling further this week, despite the cuts being announced.
Shattuck: The United States seemed largely absent from the Russia-Saudi spat. Did the United States play any factor in the discussion and subsequent deal? Can the U.S. do anything to influence either party?
Mikulska: The U.S. is not part of OPEC+ and thus could not be in the middle of the Russia-Saudi spat. It has, however, with all certainty been on Russian and Saudi minds as low prices disproportionately affect U.S. enterprises because U.S. shale is more costly to produce and because it is driven by markets. In fact, when you look at the agreement, the U.S. government did not commit to any specific cuts in production. It asserted that such cuts will happen anyway given the market. The U.S. took more of a moderator or mediator role in the negotiations than a participant. It also helped keeping up appearances to have representatives of all governments where oil is produced in the room. But the U.S. government does not have a direct way to cut the U.S. production in the way that Saudi Arabia or Russia have as both states own their oil companies.
Shattuck: Let’s move on to natural gas. Turkstream has been online for a few months now, linking Russia to Turkey. Can you explain the importance of Turkstream in general? It did replace the South Stream pipeline that was supposed to link Russia’s natural gas to the Balkans, without any connection to Turkey.
Mikulska: Turkstream is the pipeline that replaced the South Stream project. The South Stream project was scrapped in the midst of constructions due to European Union objections related to protecting competition on the European gas market and following the Russian invasion of Crimea and EU sanctions that followed. Turkstream has been, to an extent, a continuation of the South Stream project. It actually uses part of the pipeline constructed for South Stream. It is, however, smaller in terms of capacity—31.5 billion cubic meters (bcm) vs. 65 bcm annually. The 31.5 bcm are delivered in twin pipelines, each with a maximum capacity of 15.75 bcm. One of those pipelines is supposed to serve as supply to Turkey, the other going to the EU. Interesting to note is that Turkey receives a 6% discount on the gas that it receives from Russia via Turkstream. The problem is the TAP pipeline that was supposed to move Russian gas from the Turkish-EU border further into the EU. The TAP pipeline has been delayed until October or so, but now with the COVID-19 pandemic, it’s probably not a given that it will be operational.
Turkstream is an important part of Russia’s strategy to remove its transit of gas via Ukraine. The other part of the strategy is North Stream 2. Also, Turkstream is a counterbalance to delivery of Azeri gas via the TANAP pipeline. As of now, however, Turkstream is highly underutilized, at approximately half of its capacity. Sales will also be challenged, at least in the short term, by low gas prices and abundant gas supply among lower demand due to the COVID-19 pandemic. Longer term, gas via TurkStream will need to compete not only with Azeri gas, but also with liquefied natural gas (LNG) that will be delivered to the region, including via a prospective LNG Terminal in Krk, Croatia.
Shattuck: During construction, the two countries’ relationship soured over the war in Syria, but recently has improved. What role do you see going forward for the pipeline and the bilateral relationship?
Mikulska: The issue underlines the pragmatic attitude that both parties have with respect to natural gas flows. They both look at gas transfers as an opportunity to build their economies and position in the region. For Russia, it means defending its market share in Europe. For Turkey, this means becoming a natural gas hub for Europe. This is why they are willing to overcome obstacles and political disagreements. This is actually not new in Russian natural gas relationships. It’s important to remember that Russian deliveries of gas to Western Europe were set up in the 1960s and have continued without large hiccups until the Iron Curtain fell. The issues began when Russia was not able to control the transit territories, especially Ukraine. That’s when Europe experienced breaks in gas supplies in the 2000s, not in the 1970s or 1980s. Why? That’s a topic for a much longer discussion.
Shattuck: How about other Russian gas supplies into Europe and their competitors? For example, the Nord Stream 2 pipeline from Russia into Germany has been delayed due to U.S. sanctions, does this open the door to more U.S. LNG or other imports?
Mikulska: For now, Russia can still deliver natural gas via Ukraine, thanks to a five-year agreement. The volumes of transfers are lower, but there is nothing that says the countries could not ramp it up if they both agreed upon that. At a time when Ukraine may be strapped for cash even more, it would be probably willing to let additional volumes flow. That being said, to what extent those volumes would be needed, we don’t know—at least in the next year or two. The last two winters have been unseasonably warm; the last-minute agreement on Russia-Ukraine transit and current low natural gas prices have resulted in pretty good stockpiles of natural gas in Europe. That, on top of lower demand, is likely to result in a lower need for exports.
Still, Russia will try to finish Nord Stream 2. Not much is left, but construction has been stopped by the U.S. sanctions on pipe-laying vessels. The companies involved in the project backed out, and Russia does not have a vessel like this ready to step in immediately. The estimates were about one year of delay, so Russian vessels can take over the construction—but it is probable that the delay will be longer given smaller gas demand, the transit agreement with Ukraine, and general economic issues that will be experienced by Russia (and all countries in the world) due to COVID-19 pandemic. As for LNG, from the U.S. or other sources, it is likely to still arrive in Europe. It is crucial, in particular to markets such as that in Southeast and Central & Eastern Europe, to have access to diverse sources, and LNG is one of them. Thus, we have seen, for example, Poland already contracted large amounts of LNG under long-term commitments after its contract with Gazprom expires in 2022. Gazprom will need to compete and will not be able to charge higher prices in the region because alternative supplies can arrive there. In Lithuania, after the country’s floating LNG terminal started operation, prices of natural gas went down on average by 25%. This includes Russian gas that without competitive supply would be more expensive. The gas contracts that Poland has signed with U.S. LNG providers is approximately 25% cheaper than the gas Poland is buying now from Gazprom. If the latter wants to keep its market, then it will need to compete.
Shattuck: Anna, thanks for this great discussion!
The views expressed in this article are those of the author alone and do not necessarily reflect the position of the Foreign Policy Research Institute, a non-partisan organization that seeks to publish well-argued, policy-oriented articles on American foreign policy and national security priorities.