A Heated Debate
Europe depends on Russia for natural gas, the fossil fuel critical for heating homes, generating electricity, and powering the European economy. As the continent’s domestic gas production declines, Europe’s demand for gas is increasing as it transitions away from coal, oil, and nuclear energy. In 2018, Europe imported 321 billion cubic meters (bcm), 54 percent of the natural gas it consumed. Russia maintained its place as the continent’s preeminent supplier, accounting for over two-thirds of Europe’s gas imports.
European relations with Russia have soured, however, leading to calls for Europe to diversify its energy supply. The gas crises of 2006 and 2009 culminated in Gazprom, the majority Russian state-owned natural gas giant, momentarily ending gas exports intended for Ukraine in the middle of the winter due to a collapse in contract negotiations. Ukraine responded by siphoning off gas intended for other recipients in Europe, harming its reputation as a reliable transit country. Tensions continued escalating after Russia annexed Crimea in 2015, meddled in European elections, and conducted cyberattacks against Eastern European states. Amidst these controversies, some European politicians worry that Russia could threaten to withhold gas supplies in exchange for political concessions.
The most contentious issue of late is the Nord Stream 2 pipeline (NS2), which would circumvent Ukraine to provide 55 bcm of natural gas to Germany. While German Chancellor Angela Merkel and others see the pipeline as a means to providing energy security and meeting climate goals, Eastern European and American politicians largely see it as a means for Russia to control European politics via Gazprom. Estonia's Foreign Minister warned that gas suppliers such as Russia should be prevented from using “energy as a tool for political pressure." Meanwhile, Polish officials referred to NS2 as “a new hybrid weapon” and a “poisoned pill of European security.” Ukraine’s President Volodymyr Zelensky agrees, claiming that dependence on Russia would weaken Europe’s political power.
On the other hand, Gazprom insists that it has no intention of weaponizing energy against its clients. Its management notes that Russia and Gazprom are heavily reliant on Europe, which accounts for the overwhelming majority of its gas exports––and 20 percent of the Russian state budget. European energy and utility companies such as ENI or E.ON have had longstanding relationships with Gazprom, and their management reflect in interviews that Gazprom has been a reliable partner. With the exceptions of the two gas crises, which can be interpreted as the result of Ukraine refusing to pay higher prices, there is little evidence that Gazprom has acted as anything but a normal profit-maximizing company in its international markets. However, there is stronger evidence that Gazprom acts a political tool within Russia.
Injecting itself into the conversation, the American government took an extraordinary measure to sanction Nord Stream 2, thereby halting its construction. American opposition to the pipeline is vehement and bipartisan: a letter from 40 senators described Russia’s gas business in Europe as “coercion and malign influence” and Rick Perry, former Secretary of Energy, called NS2 “a stake through the heart of European stability and security.”
A Supercooled Entrant
Amidst the heated debate around NS2, liquefied natural gas (LNG) has fundamentally reshaped energy markets in Europe. Traditionally, gas is transported to its customers by pipeline, the way Europe has imported gas from Russia for decades. However, gas can be supercooled to -162ºC to become a liquid, which decreases its volume by a factor of 600 and makes shipping it in special LNG tankers economically feasible.
While Europe confronted a gas shortage, the United States transformed into an energy superpower and the world’s biggest producer of oil and natural gas in the last decade. With American gas supply exceeding demand as a result of fracking, US producers sought to export their gas to Europe and Asia where gas sold for higher prices. The Trump Administration has energetically marketed and encouraged LNG, referring to it as “freedom gas” or “molecules or freedom.” American LNG exports surged by 60 percent in 2019, and the United States is expected to become the largest exporter of LNG by 2024.
Moreover, America is not the only nation with a rapidly growing LNG industry—LNG trade has surged globally, growing at a rate of 8 percent per annum. Australia, Qatar, Russia, Mozambique, and Nigeria are also leading the charge. Global export capacity meanwhile has reached 534 bcm a year, with 141 bcm under construction—together enough to fill European demand two times over.
LNG competes directly with Gazprom for the European market. Conventional wisdom asserts that US LNG is too expensive because companies have to take the extra steps of liquefaction, shipping, and regasification. Yet, Harvard Business School models show that because of Gazprom’s price discrimination, US LNG can compete in Eastern Europe with Russian gas under the right conditions such as weak Asian demand, a high price of oil, and low charter rates. Moreover, Qatari and Nigerian LNG are much less expensive to produce than American LNG and can consistently outcompete Russian piped gas on a long-term marginal cost basis.
A More Energy Secure Europe?
Despite the contentious debate surrounding Nord Stream 2, LNG has meaningfully increased the security of Europe’s energy supply.
First, LNG has contributed to changes to Gazprom’s business strategy. Traditionally, Gazprom’s contracts calculated gas prices using formulas based on the price of oil and included controversial take-or-pay clauses where customers would pay for gas they did not want to receive. These contracts were thus removed from the laws of supply and demand for natural gas. Today, Gazprom’s contracts are shorter in duration, more flexible, and increasingly determined by the price of gas at natural gas hubs instead of the price of oil. In fact, in 2018, Gazprom began selling gas by making one-time deals at natural gas hubs via its Electronic Sales Platform, thereby receiving prices based solely on European market forces. In order to compete with other sources of natural gas such as LNG, Gazprom has adjusted its sales practices in ways that make natural gas prices based on supply and demand and therefore less prone to political involvement.
Moreover, LNG has flooded the European market with gas, dramatically decreasing the price of natural gas at hubs. The excess quantity of LNG is filling Europe’s underground gas storage facilities, which act as “savings accounts” for natural gas. Gazprom itself is continuing to partner with European nations to build more underground gas storage capacity, which should increase the security of supply.
The increase in global LNG supply has also encouraged European nations to build more regasification facilities where they can transform LNG back into regular natural gas. LNG import terminals are expanding rapidly, and Europe’s regasification capacity of 241 bcm far exceeds its imports from Russia. By 2025, the Baltic nations’ regasification capacity will be 266 percent of their domestic consumption. Europe has the infrastructure to import vast quantities of LNG in the unlikely scenario of a major gas crisis with Russia.
Finally, LNG has encouraged various pipeline projects that benefit European security. One such project is the Baltic Interconnector, which links Finland with the LNG importing Baltics. Poland is racing to become a natural gas hub by selling American LNG in Eastern European markets and is supporting various transmission projects to make its dream a reality. In summary, LNG is encouraging Europe to become more interconnected in terms of gas infrastructure—and thereby more secure since each nation can supply the others around it.
LNG is not a panacea for Europe’s energy challenges. Nonetheless, LNG has reshaped European energy markets by providing a feasible alternative and reliable backup to Russian gas. Overdependence on any nation for a good as important as natural gas is unwise, but the demonization of Gazprom appears to be more based on political agendas than reality. After all, if Gazprom were to cut off supplies to Europe for political reasons, its profits would immediately plummet along with the Russian state budget. In the long-run, such a measure would lose the trust built over decades of its most important market and send the Russian economy into recession.
In addition to harming the Russian economy, any decision to weaponize energy would result in political consequences detrimental to Putin’s goals. Depriving European nations of gas for an illegitimate reason would likely unite Europe against Russian aggression and disadvantage Putin-sympathetic candidates like France’s Marine Le Pen. Moreover, such a decision could result in NATO stationing more troops in Eastern Europe, an outcome Putin has publicly criticized.
The United States’ sanctions against NS2 are unlikely to prevent the pipeline’s completion, but the sanctions are likely to further fray transatlantic relations. If the United States is concerned about Europe’s energy security, it should instead encourage Germany to proceed with its four regasification terminals to provide backups to Nord Stream 1 and Nord Stream 2. It should also encourage the expansion of underground storage facilities. However, the United States should be cognizant of the limitations of LNG: for countries like Germany, gas from Russia is much less expensive than American LNG. The United States would be mistaken to expect Germany to snub Russia as its main supplier of natural gas in favor of the United States.
As an alternative approach, the United States could pursue domestic reforms such as banning flaring, or the burning of excess natural gas. Energy companies in Texas acquire natural gas as a byproduct of oil drilling, and they often choose to set the precious natural resource aflame. In addition to contributing to the climate crisis, the 14 bcm of natural gas the United States flared in 2018 constitutes enough energy to power the Baltics three times over. The United States government should create incentives to export this natural gas to places like Europe instead of wasting it and creating unnecessary carbon emissions.
In the end, LNG has provided a superb opportunity for Europe to increase its energy security and for the United States to assert its role as the world’s newest energy superpower. American LNG is nonetheless a small part of US-Russian relations and will not fundamentally alter the interactions between the two countries, though sanctions on NS2 undoubtedly antagonize Russia. Neither complacency nor Gazprom-phobia should dictate European energy policy. Instead, sober analysis of what LNG can and cannot accomplish will strengthen transatlantic relations and provide a more stable future for Europe’s energy economy.
This article is a continuation of a Harvard Business School case study co-written by the author.