Don’t Make Ukraine About Energy

As tensions in Ukraine continue to rise, G7 countries have decided to impose new sanctions on Russia. Sanctions targeting the energy sector, which account for roughly 25 percent of Russian GDP and half the country's budget revenues, have increasingly gained support. Yet, energy sanctions are not the way to go, as the price will be too high—not for Russia, but for Europe. Instead, policy strategies should aim at disentangling energy from indisputable security aspects surrounding the Ukraine crisis.

Impact on Global Oil Prices

For starters, proponents of energy sanctions should consider what it will mean for global oil prices if, say, just a third of Russia's current 10 mmbd crude output is taken off the market. This would probably trigger a stock-draw from the OECD countries' strategic oil reserves. Short of that, sanctions targeting the Russian oil sector will likely lead to a price hike, hurting the world economy—but not necessarily the Russian budget. This also holds for the U.S.: abundant resource production does not make the country less exposed to global price shocks. It is also worth considering the large financial interests that are at stake for U.S. private sector firms and European banks holding large Russian assets.

Europeans Will Bear the Cost

Second, the costs of energy sanctions will be unevenly distributed. To put it bluntly: Europeans will pay the price. The European gas market is not resilient enough to deal adequately with a potential Russian gas-cutoff, whether as a response to energy sanctions or their effect. Substantial investments are still required to better connect currently scattered markets. Also, national regulatory regimes have not been harmonized, and most of the gas markets in Eastern Europe cannot absorb a supply shock. What's more, the often proposed exports of U.S. liquefied natural gas (LNG) will not be available in any conceivable near term time horizon Even if they were available they would not come to Europe's rescue but instead go to Asia because of higher prices there, a reason why Cheniere's CEO Charif Souki called the idea “nonsense.”

Isolating Russia is Impossible

Finally, the idea of isolating Russia, notably through energy sanctions, is unrealistic. As tensions between Europe/U.S. and Russia continue to rise, Russian energy delegations recently visited Egypt, Kuwait, India, Japan, South Korea and Vietnam. Sanctions will push Russia further East in its search for alternative markets. In May, the next round of talks between the Russians and the Chinese are scheduled, and this may well be the moment where the two sides consummate a deal, after a decade of tough negotiations. Russia may be encouraged to give up on a price premium to gain long term business partners. “Isolating” Russia through energy sanctions is therefore not a viable strategy. Costs are certainly high, benefits unclear and Russia will firmly turn to other consumer markets. Industry outcries from Finland through Germany to Italy confirm that there is no broad interest in Europe to walk down this path. Also, the hesitant stance that both U.S. and EU politicians have demonstrated so far, indicate that there is no real willingness to get tough on Russia, for exactly these good reasons.

The Ukraine crisis is a security issue and should be dealt with as one. Policy strategies are therefore well advised to disentangle them from energy trade. It is in the European interest to be vocal about this. Establishing collective energy purchase vehicles, as recently proposed by Polish Prime Minister Tusk, are not the way forward. Rather than undoing twenty years of energy market reforms, EU policies should craft long term strategies accounting for the bloc's strong import dependence, but based on the liberal paradigm. Besides a continued push for energy efficiency gains this includes further market integration and harmonization across Europe, notably regarding Eastern “energy islands.” It includes strengthening EU competition authorities so that they can show their teeth—toward Gazprom or any other supplier abusing its dominant market position. It also includes enhancing Europe-wide infrastructure thus making individual member states more resilient against supply shocks. Supply diversification, most likely by paying higher prices, is also part of that comprehensive strategy, albeit through Caspian energy sources or, possibly, eventually also U.S. LNG.

This strategy is long term, and it will put the EU in a position to deal with its lopsided import dependence. Energy sanctions, however, and moreover short term fixes such as “energy unions,” will endanger the common market project. When G7 leaders take actions, they should heed this.