For decades Moscow has used its natural gas exports as a principal means of projecting economic and political influence in Europe. Selectively allowing or denying access to Russian natural gas supplies has given Moscow considerable leverage in shaping the political and security posture of countries dependent on those supplies.
European dependence on Russian energy has proved to be Moscow's most reliable tool to shape the behaviors of other countries — though Moscow has other means by which to project its influence. In order for this tool to work, however, Russia must possess a meaningful market share — and Russia's share profile is set to decrease dramatically. By 2014, two large liquefied natural gas (LNG) facilities will come online in Western Europe. These facilities largely will remove Russia's market presence in several Western European markets by substantially undercutting Russia's price on natural gas. A third facility in Poland could eventually make that country an energy transit state for the rest of Central Europe. The expanded LNG production could pinch Russian finances as well as diminish Moscow's political leverage.
The two Western European LNG facilities — in Rotterdam, the Netherlands, and Dunkirk, France — can already manage 12 billion cubic meters (bcm) per year of LNG imports. By the end of 2014 they will be capable of importing 34 bcm, a quantity sufficient to end Russian natural gas penetration into France, the Netherlands, and Belgium, with 22 bcm left over. Infrastructure is already in place to facilitate exports elsewhere in Europe from the receiving terminals in Rotterdam and Dunkirk.
Some of the excess 22 bcm may go to Switzerland, but with Switzerland only importing 0.3 bcm of Russian natural gas, the impact on Moscow's market share will be minimal. More concerning for Russia is the prospect that excess natural gas will head to northwestern Germany — specifically to the heavily industrialized Rhine region — where it will compete directly with Russian natural gas. The Western Europe-sourced LNG will likely do extremely well in that competition, as LNG imported at Rotterdam is price-equivalent to Russian natural gas in Europe.
Russia has seen this coming and in preparation has been lowering its asking price for natural gas. This now stands at $308 per thousand cubic meters (tcm) — a discount of about one-third compared to one year ago. The Russian price is now equivalent to imports at Rotterdam, which currently trade in the $290-$350 range. However, this does not include transport costs. Russia tacks on a $400 per tcm surcharge to cover the costs of shipping natural gas from production sites in western Siberia — a charge Moscow is now reconsidering. Rotterdam, by contrast, sits at the heart of Europe. Unless Russia lowers its transit fees, even the newly discounted price of Russian natural gas will double that of LNG-derived gas.
Decisions on choosing energy suppliers are not made in a vacuum, and Russia has worked hard to cultivate personal and business relationships with political figures in importer countries. Moscow has also used its dominant position in the European energy market to acquire transport infrastructure, purchasing pieces of pipeline networks throughout Europe. But even considering Moscow's well-established ties to political leaders, it is difficult to see many Europeans choosing to pay Russia double the cost of natural gas imported via LNG terminals.
The worst-case scenario for Russia would see the 22 bcm of LNG-sourced supplies displace an equal amount of Russian supplies — that would deny Russia some $15 billion in income. That scenario is unlikely — Russia will more likely lose out on between $5 billion to $10 billion of German income. Germany has committed itself to shifting its energy mix away from nuclear and coal-fired power plants. This will increase Germany's short-term demand for natural gas, which could mitigate the effect on Russia's 50 percent market share in Germany. It is not quite an all-or-nothing game. The direction Germany takes its energy consumption over the next three years, in response to the rising availability of cheaper LNG, will give critical insights into the value Germany places on its relationship with Russia.
Dunkirk and Rotterdam are not the only facilities under construction that are changing the energy balance of Europe. A third facility is located in the Polish port of Swinoujscie. This facility should also be completed by 2014, with an initial capacity of 5 bcm — about half of Poland's annual demand. Warsaw has launched the terminal with the express purpose of mitigating its dependence upon Russian energy. Success at Swinoujscie would certainly encourage Poland to expand its use of LNG, and Poland might even — albeit several years from now at a minimum — become a transit state for LNG-sourced fuel to reach interior Central European states.
None of this necessarily spells disaster for Russia. Moscow exports just over 200 bcm to Europe annually; France and the Low Countries are not considered core to Russian economic strategies; and the new French, Dutch and Polish facilities combined directly threaten to displace only 12 percent of the European market. Italy and Turkey — two of Russia's most lucrative markets — are so far largely unaffected by the increasing attractiveness of LNG, and Russia will most certainly not leave the German market without a considerable struggle. Still, the changes should have a demonstrable impact on Russian finances. Russia's preemptive price cuts reduced its income by some $6 billion. LNG will directly deny Russia another $9 billion to $10 billion in income from France, Belgium, the Netherlands and Poland. And that's before factoring in any potential loss of German market share.
But as important as the economic hit will be, the political hit will hurt even more. Germans and Central Europeans have known for the past decade that their sole meaningful option for energy security lies with Russia, and Moscow demands a political price for that security. The newfound cheapness of LNG suggests that this may change, and as Europe's use of LNG expands it cannot help but diminish the political leverage that Russia has grown accustomed to wielding.