It used energy exports as a lever for the annexation of Crimea and to support separatists in Eastern Ukraine. Heavy dependence by Ukraine and many EU countries on Russian natural gas exports makes those countries vulnerable to a cutoff of Russian supplies. The importance of pipelines to transport natural gas makes it difficult for users to switch suppliers quickly in the event of an actual or prospective supply interruption. This vulnerability of the buyer is sometimes called the “holdup problem”. It takes years to install new transport infrastructure and rearrange trading partners and improve energy efficiency by users, so there is little that can be done by users to weaken Russia’s current strong negotiating position for natural gas. However, now is the time for Europeans and their allies to make commitments that would increase their future energy security. Voluntary trade between Russia and members of the European Union is mutually beneficial if both parties carry out their promises to buy and sell specified quantities without interruption. However, Russia has demonstrated its willingness to violate economic agreements by using energy as a lever to secure political/military objectives.
WHAT CAN THE UNITED STATES DO TO HELP EUROPEAN ALLIES?
The shale boom has made the U.S. a major producer of oil and natural gas and a potential exporter of liquefied natural gas (LNG). The International Energy Agency has forecast that the U.S. will become the world’s largest producer of natural gas by 2015 and the largest producer of oil by 2017. U.S. exports of refined products, such as gasoline, have already increased, but exports of natural gas and crude oil remain limited by export restrictions that date from the 1970s, when conditions were very different. The U.S. government could contribute to trans-Atlantic energy security by immediately ending limits on exports of crude oil and natural gas. Exports of natural gas require construction of terminals to convert natural gas to LNG, and terminals require permission from the Federal Energy Regulatory Commission. The process could be streamlined by automatically approving or waiving licensing. Relaxing export restrictions would increase energy security among Atlantic allies, and it would increase the efficiency of the world energy market. Efficiency gains come from narrowing price differences between the US and Europe, which would allow Europeans to pay less and Americans to receive more for natural gas. Recent geographical gas price differences have been large. In February, natural gas prices in the US were around $5 per million BTUs, and in Asia LNG prices were $20 per million BTUs. (Financial Times).
There are also bottlenecks in transporting natural gas and oil within the US, demonstrated by large regional price differences. Restrictions on domestic and international pipelines could be removed, including the Keystone XL pipeline. Permission for the Keystone pipeline has already been delayed for 5 years, and the latest report from the U.S. State Department finds no significant problems with the proposed Keystone pipeline relative to the thousands of miles of pipelines that already exist in the U.S. (Anderson). There is opposition from leaders of the Democratic Congress (Senator Harry Reid and Congresswoman Nancy Pelosi), but there is also support from some Democrats, including Senator Mary Landrieu of Louisiana.
Among traditional Democrats constituents, certain environmental groups strongly oppose the pipeline, but certain labor unions favor the project. Terry O’Sullivan, of the Laborers’ International Union, supports the pipeline, and he has been outspoken in his criticism of the Administration for the delay. He called the delay “gutless” and a “low blow to the working men and women of our country” (O’Sullivan). The recent State Dept study finds no environmental objection to the construction phase of the pipeline and no net difference in carbon emissions, whether the pipeline is built or not. However, without the pipeline, more oil is moving by rail, and a series of disastrous derailings illustrates the greater danger from rail versus pipeline transportation.
Some American populists oppose crude oil exports because they might increase the domestic price of gasoline. However, a paper by Brown and Mason concluded that, because of bottlenecks in domestic infrastructure, removing export restraints on crude oil would likely lower the price of gasoline. Crude oil exports are also opposed by certain business users, such as Dow Chemical and Alcoa.
U.S. businesses are not currently allowed to export natural gas to any country lacking a trade agreement with the U.S., but this rule is subject to change (Financial Times). In the last week, Energy Secretary Ernest Moniz and White House counselor, John Podesta both stated that the export restrictions are now under review (Wall Street Journal).
HOW CAN THE EUROPEAN UNION INCREASE ENERGY SECURITY?
The EU could reduce reliance on Russian natural gas by improving facilities for importing LNG from other sources, including the US. Poland and Lithuania have LNG terminals under construction at Baltic Sea ports (Swinoujscie, Poland and Klaipeda, Lithuania) but prices are not currently competitive with Russian gas from pipelines. However, if world prices of natural gas fall enough, LNG at Baltic ports could become competitive in the future. Major new supplies of gas are expected from Australia and Eastern Siberia, as well as the U.S. Proponents of European LNG terminals consider the projects to be investments in future energy security, and the European Commission has offered financial support for both Polish and Lithuanian projects and for gas distribution infrastructure that connects pipelines within the EU to the Baltic terminals. Some energy experts claim US LNG exports would more profitably be shipped to Asia, but in the long-run gas is a fungible commodity. One more BTU shipped to Asia (such as Russian natural gas from Eastern Siberia) frees up a BTU in Asia that could be diverted to Europe.
In the long run, energy security could be improved by expanding pipelines to and within Europe. There has already been a kind of battle of proposed pipelines. To improve their bargaining power, EU members could negotiate jointly with Gazprom, as proposed by Polish President, Donald Tusk. Greater access to LNG in the long-run could also improve EU bargaining power with Gazprom. Policies that restrict demand for natural gas would also be helpful, including making aid to Ukraine conditional on ending large subsidies to energy use. Perverse incentives contribute to Ukraine being one of the largest users of energy per unit of GDP in the world. The European Commission has encouraged the development of shale energy, but certain member governments have been more restrictive. Bulgaria has banned fracking (Financial Times).
RESISTANCE BY EU MEMBERS TO A COMMON POLICY
European NATO members have been criticized for being free riders relative to the U.S. for military security. Free riding for energy security is also a problem facing EU members. Countries are very different in terms of dependence on Russia for energy imports and dependence on the Russian market for EU non-energy exports. For example, Germany is a large importer of Russian gas, but the Nord pipeline under the Baltic Sea travels directly to Germany without passing through Ukraine. Germany is also a major exporter and investor in Russia, and prominent German businessmen have spoken publicly against restricting trade and investment with Russia. Poland and the Baltic countries are currently heavily dependent on Russian gas, and they are among the leaders in acting to diversify sources of supply. Other countries, such as the UK are energy exporters, but their financial institutions are heavily involved with Russian institutions. Also, EU member energy policies can influence their demands for natural gas and their dependence on Russian suppliers. Germany and France now have very different policies toward nuclear power, a substitute for natural gas. Some EU members actively promote renewable energy, but recently there has been a sharp increase in coal imports from the United States.
JOINT ACTION BY THE UNITED STATES AND THE EUROPEAN UNION
The US and EU can adopt an energy pact as proposed by Portuguese Secretary of State for European Affairs, Bruno Macaes (2014). It would increase energy security by immediately eliminating restrictions on energy trade between the US and the EU. By beginning now and committing to free trade in energy in the future, private businesses and government agencies responsible for infrastructure could make investments now that will take time to complete. The US government could speed investment in LNG terminals by streamlining reviews by the U.S. Energy Department and the Federal Energy Regulatory Commission. A free trade agreement for energy would overcome the current U.S. restriction on energy exports to countries without trade agreements with the U.S. Joint commitments by the U.S. and the EU should make energy security more likely to succeed than unilateral actions by the two parties. Some EU members, such as Germany, might be more willing to support investments in LNG terminals than economic sanctions against Russia. An energy agreement between the EU and the U.S. could easily be extended to Canada, Mexico, and Norway, countries that already have trade agreements with the US, EU, or both.
A trade agreement in energy could become part of a much broader Trans-Atlantic Trade and Investment Partnership (TTIP) that is currently being negotiated. The TTIP is broader and more complex, and it is likely to take more time to complete than an energy agreement. Current crisis conditions involving Ukraine and Russia could induce the U.S. and the EU to quickly reach an agreement on energy. For the U.S. there would be efficiency gains as well as greater energy security from both the narrower energy agreement and the broader TTIP.
RUSSIA: TOTAL GAINS FROM TRADE AND THEIR DISTRIBUTION
The political and economic institutions of Mr. Putin’s Russia have been described as extractive (Acemoglu and Robinson). They provide power and wealth to the leaders and their supporters at the expense of the general population. For example, for every dollar gained by the Russian leaders, other Russians (masses) lose three dollars. The country is poorer by $2 because of the extractive institutions, but if the leaders care only about the welfare of their supporters who gain $1, they have no incentive to change their policies. The use of energy as a lever would serve the interests of the leaders as long as the losses to leaders are not too great (gross losses more than $1).
Prior to the Ukrainian crisis, Russia did become more integrated with the West through its energy exports, its imports, and its use of financial services. The gains to Russia were large, and forecasts of GDP growth for Russia have declined since Russia’s aggressive actions in the Ukraine. Russia joined the World Trade Organization, and Russian leaders continue to state that members should be bound by the rules. Indeed, Russia has taken a case to the WTO claiming that Western sanctions against Russian businesses violate WTO rules. Russian business leaders have complained about the potential losses from diminished trade. Some of the loudest statements about the gains from Russian trade and potential losses from sanctions have come from prominent Germans (Gerhard Schroeder and Helmut Schmidt) who represent Russian businesses. So there are some groups in Russia who might urge less aggressive military policy in order to keep the gains from trade they are now receiving. German economist, Hans Werner Sinn has even proposed an EU-Russia free trade agreement, something Putin himself once proposed in 2010 (Sinn).
Whether trade is a deterrent to war is a very old question that has particular relevance to Europe. There is some statistical evidence in favor of the proposition, but it is rather weak. When the European Union was formed in 1957, some supporters claimed that it would reduce the probability of another costly war between Germany and France. Many critics were skeptical not just about the war deterrence, but also about the durability of the trade agreement between traditional rivals. Today, more than 50 years later, free trade continues to prevail among the 7 original members, membership has expanded to 28 countries, and Germany and France have not fought another war. Many factors may have contributed to peace, but greater economic integration is likely to be one of them. Is it possible that closer economic ties with the West would reduce the probability of military confrontation between Russia and the West? Given Russia’s extractive political and economic institutions, the answer depends partly on whether the losses from diminished trade and investment would be concentrated among the leaders and their supporters.
Russia is currently a large energy exporter to the EU, but they have demonstrated that they are an unreliable source. They have used regional monopoly power as a lever to secure political/military gains. The European Union and the United States would achieve greater energy security from a Trans-Atlantic Energy Pact. The main gains would be in the future, but commitments must begin now to induce investors to begin building the necessary infrastructure. Waiting for the next crisis is too late. A Trans-Atlantic Energy Compact would reduce the vulnerability of member countries, and it would increase efficiency by eliminating impediments to foreign and domestic energy trade. Future aggressive actions by Russia will be influenced by the perceived gains to leaders and their supporters relative to losses to the same leaders and supporters from diminished trade and investment with the rest of the world.