Smart use of the „gas weapon” favors the Russian side - interview on the energy emergency

Smart use of the „gas weapon” favors the Russian side - interview on the energy emergency

The figures show that the sanctions are negatively affecting both the Russian and the European sides – Máté Litkei, Director of the Climate Policy Institute, told Hype&Hyper. Interview with Máté Litkei and Géza Sebestyén on the energy emergency, sanctions, and the uncertain future.

For gas, Russia is much more dependent on Europe than Europe is on Russia. 83% of the Russian gas exports go to Europe, meaning that in practice, the full activation of the so-called „gas weapon” by Moscow would cause more significant losses on the Russian side than on the European one. Of course, some heavily dependent European countries will not be able to fully replace Russian gas any time soon, such as Hungary, Slovakia, or Germany, but the gas business is currently in the interest of both parties. It is especially ominous for Moscow that only 46 percent of the European Union’s gas imports come from Russia, and recently the American LNG (liquefied natural gas) exports have taken the lead over Russian pipeline gas, with 5.5 billion cubic meters per month. If these trends persist as a consequence of the war, when would the moment come when Russia must act as 60% of its budget comes from energy exports now?

Géza Sebestyén: I would like to emphasize that the picture is much more nuanced. The nature of the two types of dependency is completely different. Russia’s dependence is material, while Europe’s is economic, concerning the population’s quality of life. If tomorrow Russian gas supplies were to stop at the initiative of either party, it would mean that the Russians would have less money coming in, while a significant proportion of European homes would be left cold, and our economy would suffer a dramatic blow, resulting in mass unemployment and poverty as a consequence. Moscow could always compensate for its loss of revenue by borrowing money from the global markets, but at the moment, Europe would be unable to replace Russian gas. The two sides indeed depend on each other; however, one side’s issues are relatively easy to manage while the other has intractable problems. Not to mention that cutting off Russian gas completely would not be in line with the much-vaunted European solidarity since while gas accounts for roughly a third of the energy mix in some countries, such as Italy, the Netherlands, or Hungary, others use no or minimal amounts of gas, like Malta, Cyprus, Sweden, or Finland. In other words, the shutdown of gas supplies would have dramatic consequences in some Member States, while there would be no direct impact in other countries. It is also very important to note that the smart use of the gas weapon clearly favors the Russian side. As we can already see now, the current Dutch TTF gas price is more than four times higher than a year ago and roughly twenty times higher than two years ago. This means that much less Russian gas is coming to the EU now, but the EU is paying much more for this less gas than it used to pay for a larger amount. So, at the moment, Russia is using up its gas reserves more slowly, yet it has more revenue overall, as reflected in its record high current account balance, while Europe is paying more but receiving less gas. In other words, the current plight means that only the European Union is hurt by what is happening, while Russia benefits from the situation.

Máté Litkei: We need to address the issue of natural gas and crude oil separately. Transporting natural gas over long distances is much more challenging than transporting oil or coal. The simplest solution is to build a pipeline, which requires a large initial investment but then allows cost-effective transport. After the 1973 oil crisis, the Soviet Union supplied the Comecon countries with natural gas through a newly built pipeline from the Yamalo-Nenets Autonomous Okrug. The interdependence of Russia and Europe, especially Central and Eastern Europe, regarding natural gas dates back to this period. LNG transport with tank ships could not and did not even aim to compete with the already built pipeline transport system. Russia has been the largest exporter of natural gas for many years thanks to the gas pipeline network inherited from the Soviet Union, as its share of LNG exports is just over 16 percent, making it „only” the world’s fourth largest LNG exporter. This shows that this strong link regarding natural gas between the two regions will not be broken any time soon, and rising natural gas prices are currently offsetting declining export volumes. However, the situation is entirely different for the transport of crude oil. Although transport through the Druzhba (Friendship) pipeline is easier for all parties, oil can easily be transported anywhere by tankers or rail. As a consequence, the different benchmarks of oil (North Sea Brent Crude, West Texas Intermediate, Urals oil) compete with each other, and their stock market prices have moved together with a few dollars difference until the Russo-Ukrainian war. Since February, the price of Russian oil compared with the first two benchmarks has fallen roughly 30 percent due to a sudden surge in European demand for non-Russian oil. Nonetheless, at the current price of $67 per barrel, oil exports are still generating significant revenues for Russia, and Russian oil continues to be in high demand from Asian and even European and American importers.

According to the Kremlin’s own data, total Russian oil and gas revenues in May were half of what they were in April, and no such statistics have been released since the plunge in May. The price-sensitive Chinese and Indian buyers have already taken advantage of the sanctioned countries’ exigence, and if they smell blood from Moscow, they may buy up natural resources on even worse terms. In the long term, how serious are Western sanctions likely to be for Moscow, and can Russia’s turn to the East be successful?

ML: Bloomberg recently published an analysis of where tankers transport Russian oil. Based on vessel traffic, Russia’s seaborne oil exports have not decreased at all, remaining between 3 and 3.5 million barrels per day. Asia is taking over all the oil Europe does not want to buy. According to Kpler’s commodity market analysts, India’s oil purchases from Russia have already more than doubled in May compared to the previous month, reaching a record of over 840,000 barrels per day. Moreover, oil transport to Europe through the pipeline network is still temporarily exempt from sanctions. The International Energy Agency said in May that Russia’s oil revenues have risen by 50 percent since the beginning of the year to $20 billion a month, with most of the exports still going to the EU. Despite the falling Russian imports due to the sanctions, Moscow’s current account surplus hits new record highs because of the rising energy prices. The figures show that the sanctions negatively affect both the Russian and European sides, but they will not break the Russian economy. The revenue drop in May is likely to be temporary; the reason behind it is possibly the periodic settlement of accounts, meaning that few customers had to settle their accounts with Russia that month. What the sanctions will achieve, however, is to bring Russia and China, which have not previously enjoyed a smooth relationship, closer together politically and economically. This means a global economic and security policy threat as the Western companies’ services could eventually be replaced by Chinese companies’ services while Russia supplies China and other Asian countries with cheap energy, raw materials, and modern military technology. This development could easily lead to an economic downturn in Europe, and the breakdown of Sino-Western relations could also jeopardize global climate targets. Russian exports will make fossil energy cheaper for China, India, and other developing economies, thus, hampering the expansion of renewables and nuclear power. By contrast, the EU’s climate neutrality will not lead to significant global emissions reductions, as our emissions are already just over 9% globally.

SG: Firstly, gas consumption is typically down in May, and secondly, gas prices in Europe were also down in May compared to April. Considering these factors, the decline in revenues is not surprising. But volume and prices are clearly expected to rise from now on, soaring Russia’s revenues. Almost all the analyses I know of conclude that Russia’s oil and gas revenues have increased compared to the same months in the past, despite the war and sanctions. This is also reflected in the unprecedented record high current account balance. What is more, as I indicated above, revenues can be replaced by loans at any time. So, I do not think that anyone would smell blood, or at least not from the direction of Russia. China and India are obviously trying to take advantage of the current situation, but I would not talk about an emergency situation in Russia.

In the current situation, Central and Eastern Europe, with its limited infrastructural capacity, must look for new opportunities in the long term. What developments are needed to reduce dependence, at least partially, on oil and gas?

ML: The difficulty for both energy carriers is that Hungary is a landlocked country. Therefore, Hungary’s energy import depends on the goodwill of other countries. For example, regarding the transportation of crude oil by marine shipping, it is up to the Croatian side to decide whether to expand the necessary cross-border capacity of the Adria oil pipeline. The Adria oil pipeline was not designed to cover all MOL refineries’ needs but to complement the Russian import supply route with less quantity the further the refinery is from the Adriatic Sea. This means that higher capacity is available for the refineries the Druzhba pipeline does not reach (Sisak refinery in Croatia and the Bosnian and Serbian refineries), but the Hungarian branch has only a limited capacity. Even if the Adria oil pipeline is extended, it will also have to be resolved that the refineries in Százhalombatta and Bratislava are designed to refine a blend of sour Russian oil that is always available from the Russians of the same quality. Following the annexation of Crimea, MOL has completed a major investment to make its Danube Refinery in Százhalombatta capable of refining an oil mix which third is from marine crude oil. However, to fully replace the Urals oil blends, the infrastructure to mix the oil must also be built, in addition to the transformation of the refineries. This alone would cost hundreds of millions of euros, while the EU wants to phase out petroleum-based fuels already in the medium term, which raises questions about the return on investment. The situation for natural gas supply is similar in many respects, but there are some very significant differences regarding the future. A similar point is that we currently have only 1 billion cubic meters of booked capacity at the Krk terminal in Croatia, which is only one-tenth of the Hungarian gas consumption. Thus, the maritime transport route is not an alternative to pipeline gas. On the other hand, an important difference is that much of the natural gas used is for heating homes and generating electricity. And in these areas, there are many alternatives to Russian energy carriers; for example, in energy production, the lifetime extension of the Paks Nuclear Power Plant, the building of new nuclear units in Paks, increasing the production of renewable energy, the continued operation of the lignite-fired units of the Mátra Power Plant, and, in the long term, the spread of green hydrogen. Furthermore, it is also easy to heat buildings with electricity instead of natural gas, and by insulating our houses, we can reduce our energy demand by up to a tenth, whether it is natural gas or electricity.

Russian oil exports to Hungary, Slovakia, and Czechia were recently stopped for a few days on the Druzhba pipeline. There was a lot of confusion over the issue, but MOL finally paid the transit fee instead of the Russians. What happened exactly? What is in the interests of the Russian and Ukrainian sides?

GS: What exactly happened is something that only the players involved know. But it is a fact that it is in the interest of all parties (Russia, Ukraine, and European countries) that the oil through the Druzhba pipeline comes in order as it means a source of revenue for Russia and Ukraine and a vital raw material for the European countries. The Russian side’s ability to pay is likely to have been hampered both by the Russo-Ukrainian war’s impact on the parties’ attitudes and by the sanctions against Russian banks. In my opinion, the solution was good. Oil flows can resume, and the Russian and Ukrainian parties will receive their money. I guess the transit fee paid by MOL will be settled in the form of some discount or rebate between the Russian and Hungarian sides.

How badly would our economy be affected if oil imports stopped completely?

ML: To answer this question, it is essential to clarify the reason for the cut-off of oil supplies. It would cause unmanageable difficulties in the short term if the Russians were to halt European oil supplies. It would take years for MOL to switch to refining different crude oil types completely. It is less bad if there are some obstacles, but the Russians want to deliver. The EU’s 6th sanctions package allows us to import even Urals oil via other means, including through the other Member States, in the event of a disruption in the crude oil supply through the pipelines. In this case, the challenge would be to build a new supply route if the supply through Ukraine is halted. In the interim period, the domestic oil and fuel security stocks, which according to the Hungarian Hydrocarbon Stockpiling Association, currently stand at 618.5 kilotons of crude oil, 431.1 kilotons of natural gas oil, and 231.1 kilotons of petrol, would help. This quantity is equivalent to more than 800 million liters of fuel, which alone covers the country’s three-month consumption, and the available crude oil stock allows for the production of roughly the same amount of fuel. It should also be mentioned that the MOL Group owns the refinery in Rijeka, which is not dependent on Russian supplies, and that OMV also delivers fuel from the Schwechat refinery to its own stations during regular operation; in addition, there would be other importers at higher prices.

GS: I assume you think about the stop of the Russian oil supply, which means two-thirds of Hungary’s crude oil import, representing 90% of total domestic consumption. So, the disappearance of Russian oil would eliminate 60% of the total consumption quantity overnight. Of course, Russia is not the only exporter of oil, and this raw material – unlike gas – is relatively easy to transport by rail, tank truck, or even ship, meaning that pipelines are not that important for its import. So, at least in theory, Russian oil can be substituted by oil from other countries. However, there are two major problems. The smaller one is the price. Since the war broke out, Russian oil has been $30 a barrel cheaper than Brent crude oil. This price difference would imply that the cost of 60% of the oil used by Hungary would increase by almost 40% if Russian oil were to be replaced, which would mean an immediate price increase of more than 20% for the average domestic oil price. Therefore, there would be inflationary pressure. But there is an even bigger problem: MOL’s refineries are essentially designed to process Russian Export Blend Crude Oil (REB/REBCO). If the REBCO supply stops, the refineries must be closed. The transition to alternative sources would take 2-4 years and millions of euros of investment for the Hungarian oil and gas giant. The impact on the security of Hungarian fuel supply and prices would be unpredictable.

Energy-saving measures have been introduced in many European countries. In Germany, no public buildings can be heated above 19 degrees Celsius in winter, and some swimming pools will be closed. How much energy can be saved by such measures? Can they make a significant difference in the state of energy emergency?

ML: The Commission’s original plan was that if each Member State saved 15 percent of its gas consumption, the amount of gas saved could compensate for the amount lost on Nord Stream. In other words, if everyone introduces energy-saving measures, the German economy will still have enough natural gas, and they can even close their three remaining nuclear power plants. This idea was more or less sustainable in terms of numbers until the volume of gas transported through the Nord Stream dropped from 40 percent to 20 percent. New winds are blowing in Germany now, with 80 percent of the population in favor of nuclear power if it means avoiding higher electricity prices. The German government is still officially waiting for the results of the energy market stress test announced by Olaf Scholz to make a decision, but it would be a surprise if the results do not support the continued operation of nuclear power plants. Returning to the specific measures, I would strongly support some of them, such as closed doors in shops, and the use of closed fridges in shops could also be made mandatory. On the other hand, other measures are excessive and unenforceable in their current form, meaning they will surely fail. To give an example: in several countries, public buildings, shops, and cinemas will be heated to a maximum of 19 degrees Celsius during the winter. The aim of avoiding excessive heating is supportable, as each degree Celsius means roughly six percent more energy use. However, the implementation plans are wrong. Firstly, it is impossible to control and enforce it; secondly, it ignores different working conditions and human needs. For some people, this temperature is comfortable, but for others, it means sitting in an office wearing a coat all the time, and they will be sick more often. There are many ways to save energy: smart thermostats, fans, shutters, insulation, etc. I see the solution more in subsidies and information campaigns than in the use of coercion to reduce heating and hot water use.

The EU Treaties talk about the solidarity between the Member States. How does energy solidarity relate to this principle? Can it be a viable model, or are we only talking about pressure from the irresponsible German energy policy?

ML: The new institutional framework of energy solidarity that is expected to be put in place is based on national solidarity, but it goes beyond its scope by making it more concrete. The Commission has proposed a new Council Regulation that would add another competence of the Member States to the competence of the EU in the name of solidarity. The new regulation sets a target for all Member States to reduce their gas consumption by 15% between 1 August 2022 and 31 March 2023 compared to their average consumption in the past five years. The proposal was initially intended to allow the Commission to declare an „EU alert,” at which point the 15% reduction target would become mandatory. The Commission would have been entitled to decide on the reallocation of the gas savings in the spirit of solidarity. The Regulation, which finally entered into force on 5 August, no longer states the obligation to transfer gas but only refers to it in the text and only gives the Commission the right to initiate an EU alert, which requires a qualified majority in the Council to be adopted. The most significant problem with the Regulation as it stands now is that it does not take into account the different circumstances of the Member States. Many Member States stock up on the gas they need in advance, but others use up the available supplies immediately. In some Member States, a high proportion of the population heats with natural gas, while this proportion is marginal in other countries. Some have a high share of natural gas in their energy mix, while in others, it is minimal. Hungary is involved in all these differences, with low domestic production, a huge storage capacity of around two-thirds of annual consumption, around 85 percent of residential properties connected to the natural gas pipeline network, and a quarter of the electricity generated from natural gas sources. Saving 15 percent of natural gas requires a much greater sacrifice from us than from the Member States that are less dependent on fossil gas because, for example, their population does not heat with gas.

GS: I think a uniform 15 percent reduction in gas consumption goes completely against the principle of solidarity. As mentioned above, some Member States do not use gas, while others rely heavily on this energy source. A uniform reduction in Hungary, the Netherlands, and Italy would reduce the available energy by around 6%, which could result in a similar level of decline in GDP and employment. By contrast, Cyprus, Malta, or Sweden would barely feel the restrictions. Similarly, it would be against the principle of solidarity if the gas reserves of some states were to be reallocated to other countries. This would clearly be disproportionately disadvantageous to the prepared countries with substantial storage capacity, like Hungary, Austria, or Latvia, from which gas could be reallocated. At the same time, it is also very much to the advantage of countries that have not spent a single penny on natural gas storage capacity facilities, such as Ireland, Luxembourg, Slovenia, Greece, Cyprus, Lithuania, Estonia, and Finland.

Máté Litkei graduated as an agricultural environmental management engineer at the Hungarian University of Agricultural and Life Sciences (formerly Szent István University) in Gödöllő. He specialized in territorial development and continued his studies in public governance at the National University of Public Service. He pursued his career as a policy analyst, focusing on European and domestic climate policy. He joined the Climate Policy Institute as a Researcher, later becoming a Senior Policy Analyst and then Director.

Géza Sebestyén was previously an Associate Professor at the Kodolányi János University of Applied Sciences and the Corvinus University of Budapest and a lecturer at the University of Szeged. He has also held positions such as Research Director at the OECONOMUS Economic Research Institute, Member of the Board of Directors of MKB Venture Capital Fund Management, and Member of the Advisory Board of the Pallas Athéné Domus Scientiae Foundation. He is a mathematician and economist who has taught as a guest lecturer at the Munich Business School in Germany, Baku Stock Exchange in Azerbaijan, ESSCA in France, International Training Center for Bankers, Vienna University of Economics and Business (WU) in Austria, World Bank, J. Selye University in Komárno, Slovakia (2003-2005) and the Institute of Mathematics at ELTE. He obtained his Ph.D. from the Corvinus University of Budapest; his research topic was dynamic stochastic asset liability management in banking. He is currently Head of the Economic Policy Workshop of Mathias Corvinus Collegium.

Grafika: Molnár Roland / Hypeandhyper