Recapping European Natural Gas

Calling European natural gas markets this year ‘volatile’ would be an understatement. The year began with a rapid escalation of the Russo-Ukraine conflict with the Russian invasion of the Donbas. The world’s (former) largest exporter of natural gas was then hit with heavy sanctions by the international community, which skyrocketed the commodity’s prices (Bazynska 2022). Meanwhile, massive gas leaks along Nordstream 1 and Nordstream 2 further aggravated the ongoing supply shock, and, based on charts from TradingEconomics, prices have been at their highest since the 2008 Great Recession. The 2022 Conference of the Parties of the UNFCC (COP27) also saw a shift in international energy policy in the final resolution, with natural gas being highlighted as the transitional energy source after carbon-based fossil fuels die out (Volcovici 2022). This piece will break down all three of these events and how they individually contributed to the volatility of the industry this year, before briefly analysing what a moderate COP27 resolution means for the future of climate change action.

Russo-Ukrainian Conflict and Western Sanctions

Russia's unilateral decision to mobilise its forces in Ukraine was immediately condemned by the West. In attempts to de-escalate the situation, the United States and the European Union (EU) put into place an extensive sanctions regime (Bazynska 2022). Rather than directly blocking trade with Russia (through trade embargos), Western sanctions targeted the foreign bank accounts of Russian groups. Not only did this freeze out Russian companies from accessing their funds (which were paid in either euros or dollars and thus held outside Russia), but it also meant that the Russian Central Bank could no longer utilise their foreign reserves or exchange their European assets. SWIFT (the Society for Worldwide Interbank Financial Telecommunication) is the platform that most major banks worldwide use today for the secure messaging required to coordinate financial transactions in different currencies (BBC 2022). With Russia’s removal from this system, the rouble had also been effectively cut off from the foreign exchange market. The EU cut off 10 Russian banks from this system, notably leaving out Gazrprombank, a private bank set up by Gazprom (the Russian national natural gas exporter) to manage payments for natural gas. Understanding Gazprombank’s exemption from the SWIFT ban is paramount for analysing the volatility of natural gas markets this year and will be revisited below. The situation for the rest of the Russian export industries was fairly dismal. The combination of frozen central bank assets and isolated private Russian banks meant that exchanging euros or dollars for roubles was effectively impossible.

Effect of Western Sanctions on Global Trade

The sanctions thus created a complicated situation to maneuver. On the one hand, payment in euros or dollars for natural gas was no longer accessible for Gazprom because of the Central Bank sanctions. Entirely shutting down the Russia-Europe natural gas trade was also untenable for Europe, as many states heavily depended on it to restock reserves coming out of the winter (Cooban 2022). For example, 27 per cent of German energy production is through natural gas, of which Russian imports supplied 55 per cent (Beard 2022). Reserves would be far and few for the winter if they were to be used throughout the year. The Russian government and Gazprom leveraged this need and offered European companies and foreign states the option to pay (Gazprombank) for their natural gas in roubles, effectively circumventing their inability to trade in dollars and euros. This was a departure from the norm of European trade, usually organised in the importing currency or the international U.S. dollar. For states threatened by Russia’s violent expansionism in Ukraine, compromising with Russia was undesirable as it would serve to strengthen the current regime. However, in some states, energy needs were too high to ignore, and they were forced to take this route to access Russian gas while figuring out alternative sources for the future. For example, Poland and Bulgaria had their connections to Russian gas shut off, while countries like Germany focused on gradually reducing their reliance on Russian natural gas, allowing German companies to open new accounts that operate in roubles (Beard 2022). However, energy infrastructure takes years to set up, and while Russia’s proportional share in European gas imports may have fallen, they still contributed an increase of 11.8 million tons of gas compared to 2021 (Cooban 2022). The combination of the upward pressure on global natural gas prices through these supply shocks and the reopening (post-2020 recession) of highly industrial China meant that Gazprom had stronger returns than 2021, with massive revenue increases reported (Kobzeva 2022). Russia was also undercutting global oil prices to incentivise states like India to fill in for lost demand through European and North American oil exports (Menon 2022). Indian imports of Russian crude oil shot up to almost a million barrels a day and have maintained around that level since. Free-flowing Russian oil emboldened the government (and the ruble itself against the western sanctions, providing a cushion for the Russian economy to absorb the blow of being cut off from the western trade markets. China has also gradually moved towards the renminbi (yuan) for international trade, coordinating these transactions over the Crossborder Interbank Payment System (Beijing’s version of SWIFT). Russian banks were still allowed to use CIPS, which meant that they could adopt the renminbi as a trade currency, another blow to the efficacy of western sanctions (Tang 202). China signed new deals for shipping gas from Russia via the Arctic and is finishing construction of the Power of Siberia pipeline, a major natural gas pathway that should allow Russia to become China’s largest supplier for the commodity soon.

Meanwhile, the European natural gas market began to look to North America to meet their demands. However, North American gas comes at a higher price tag, and its newly expanded supply pushed the commodity’s trade price even higher (no doubt another factor in Gazprom’s positive revenue growth). Nevertheless, other industries in Russia were severely hit by the sanctions and isolation from global trade markets, resulting in Russia defaulting on its foreign debt (Cherry 2022). Global natural gas prices rising also created conditions of high inflation worldwide, which made the economic situation in Russia dire. In addition, while North America (or, more specifically, the United States) was able to cover the supply gaps this year, even optimistic projections show a massive shortfall for European reserves next year (Chapa 2022). In 2021, the United States sent 30 per cent of its natural gas to Europe. That share doubled in 2022, skyrocketing domestic prices within the United States, which sowed massive disapproval for the current administration. While these exports were ultimately productive due to their role in lessening the ever-growing deficit, it remains to be seen how the Biden Administration navigates the growing dissent as the 2024 elections approach while also maintaining its diplomatic position supporting European sanctions against Russia. If conditions remain the same as they are, Russia can still expect large volumes of natural gas exports through existing pipelines, new Asian trade routes, and colder winters. On the environmental side, rising natural gas prices and the destruction of the Nordstream project (explored below) should have created appropriate incentives for European governments to explore alternative energy sources more quickly.

Nordstream Leaks

The Nordstream gas leaks significantly hit the natural gas industry’s stability. The pipelines have always been controversial, as they majorly increased European reliance on Russian natural gas. In addition, the channels go through five Baltic states, and their construction causes immense destruction to the environments it runs through, something climate activists have been lobbying against for almost 15 years now (Karm 2008). The gas leaks on 26 September 2022 created another story around these pipelines. The leaks appear to have been caused by unexpected pressure drops, which have now been meaningfully attributed to underwater explosions (Al Jazeera 2022). At the expense of speculation, there are several states with meaningful motives to sabotage these pipelines. Competitive producers like the United States would benefit from Russian natural gas being cut off for Europe. The Russian Federation, already widely condemned by several significant governments, has been mentioned as another potential suspect. There are notable flaws with every side of this speculation that should be taken into account as well. As mentioned above, the Biden Administration was already struggling with high domestic energy prices, which would question their incentive to export. Russia, meanwhile, needs those pipelines intact if it ever plans on being reintegrated as Europe’s reliable supplier of natural gas. Regardless of who bombed the pipelines, the damage has effectively heralded the end of the project. Underwater pipelines corrode rapidly due to the salty seawater, and repairs would take several months. This was the single most significant release of methane in recorded history, which is disastrous for the atmosphere due to methane’s role as a greenhouse gas (MET Group 2022). Coverage of the environmental impact helped quell some of the ecological panics around the leaks, as experts generally agreed that the volume of methane released shouldn’t majorly affect our climate projections (Politico 2022). However, what was lost in efforts to manage public panic was the reasoning behind the minimal impact of this gas leak, which is that the total emissions by European states were already so significant that these leaks were a mere drop in the bucket for analysts creating climate projections. It seems as if European states have now arrived at a consensus on natural gas as a suitable alternative to carbon-based fuels, making it the principal focus of energy policy moving forward. Thus, the collapse of the continent’s purported largest supplier of the non-renewable and extremely destructive commodity became a rallying cry to move away from Russia, not the commodity itself. Even if this initially seemed like a hot-headed climate activist conspiracy, the agreements arising out of the recently concluded COP27 solidified this position.

COP27 and its implications

A lot of focus was devoted to the historical “loss and damage fund” (Reuters 2022) that participating states agreed upon as a result of this year’s conference. Make no mistake; this fund is a landmark decision as it finally acknowledged the disproportionate impacts of climate change faced by developing countries, who were (arguably) the least to blame for the crisis. However, viewing the agreement as a whole, critics quickly recognised the fund as nothing more than an attempt to shield the private energy industry from its growing negative spotlight by throwing money at the problem, not presenting meaningful ways to fix it. The resolution mentioned focusing on “low-emissions energy”, the usual stand-in term for natural gas at these summits. No matter how participants at the conference attempt to sell their constituents on the commodity, natural gas cannot fix emissions. Not only is the released methane from natural gas operations 80 times more effective at warming the atmosphere than carbon dioxide (making arguments based on pure volume of emissions less convincing), fracking destroys natural habitats and pollutes an already diminishing global supply of freshwater (MET Group 2022). The resolution also made no concrete commitments to phase out carbon-based energy, making their pro-natural gas stance dubious. However, it was clear that this year’s conference would result in a sub-optimal resolution from the beginning. In an almost Pythonesque decision, this year’s sponsorship deal for the conference was given to Coca-Cola, one of the world’s largest (if not the largest) polluters (Green 2022). Executives and lobbyists from fossil-fuel industries outnumbered every delegation, including sanctioned Russian natural gas suppliers (Michaelson 2022). Next year’s conference is slated to be held in the United Arab Emirates, a major oil and gas producer, raising further questions on the utility of this yearly summit itself. As popular pressure for action on climate change continues to rise, it remains to be seen how this yearly summit, where principal decisions on climate change are made, can reconcile its historical inadequacy and a culture of compromise for the sake of private industry with the unignorable impacts of their failure.

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