How reliant is Europe on Russian energy?
Lasse Sinikallas, our director of macroeconomics, shares his analysis on whether Europe’s reliance on Russian energy resources 12 months on
Now that we have passed the eleventh month since Russia’s unlawful attack on Ukraine, we decided to look at how the Russia used energy against Europe.
A threat on energy supply
It is widely believed that a key part of the Kremlin’s strategy in the attack on Ukraine was to use Europe’s heavy and long-standing dependency on Russian energy (oil, natural gas, electric power) to prevent European countries from intervening beyond the typical “deeply condemn” statements expressed about any violation of international order. Under an unstated threat that any sanctions or support from the EU would prompt countermeasures from Russia on energy supplies — which would cause a severe crisis in the EU, something politicians would avoid at almost any cost — the Kremlin assumed it could constrain Europe’s response.
A historical precedent for this approach was set 50 years ago. The 1973 oil crisis originated in exactly the same way: to prevent countries from supporting Israel in the Yom Kippur War, Arab nations embargoed oil shipments to countries doing so, a strategy that had been defined in the planning stages of the war. The Kremlin’s assumption was most likely bolstered by Europe’s response to its violations of the sovereign territory of Georgia in 2008 and Ukraine in 2014; sanctions had been applied, but they were limited and had little impact.
So, what ultimately happened?
Russia began to restrict liquid natural gas (LNG) supplies to Europe in the beginning of 2021 and particularly after July, after which EU inventory levels had dropped (Figure 1). Russia’s share of total EU natural gas imports started to decline in mid-2021 (Figure 2). The share of Russian LNG in EU natural gas imports was about 40% for the majority of 2021, but it fell through 2022 to only 8% during the first weeks of 2023, according to data provided by Bruegel Datasets.
However, although Russian gas imports declined, total EU gas imports remained the same and even increased after Russian attack. European countries found other suppliers, set up new networks and accelerated their plans to shift away from fossil fuels, all of which prevented Russia from holding Europe hostage by restricting energy supplies.
Additionally, thanks to energy conservation and a mild winter, inventories of LNG in the EU are at fairly normal levels and the price of natural gas has plummeted from the peaks seen in 2022 – even below the levels seen after June 2021. Because natural gas has been the key driver for the extraordinarily high prices for exchange-traded electrical power in the EU — the highest price production sets the price for the spot market — the substantial decrease in natural gas prices now seen at the peak of the European winter are also pushing electricity prices down toward more normal levels.
However, it is important to remember that gas and electric power are only one segment of the industrial and domestic energy supply chain. Another important segment is fuels used in goods transport, which in Europe is heavily dependent on diesel trucks. At present, although prices of exchange-traded diesel fuel in Germany remain elevated compared with the levels seen in 2015-21, current prices are much closer to those posted in 2014 than the peaks in 2022.
So, the energy price crisis never materialized.
Lastly, the lower prices of energy within the EU, illustrated in Figure 3 by the German exchange prices of natural gas and diesel fuel, also indicate that energy-driven inflation is likely to be rather minimal during 2023 — possibly even negative. It will, however, take a while for this impact to make its way through the industrial and domestic supply chains, due to forward contracts and hedging. One should also not forget that energy hasn’t been the only driver for inflation; there are pressures coming from the labor market as well.
A leap forward in reducing reliance on Russian fossil fuels
In the end, the threat of cutting energy supplies did not prevent the EU, EU member states, the UK or the US from supporting Ukraine, and the European economy did not collapse under the pressure of higher energy prices.
There was an immediate crisis, a price that had to be paid, and a severe impact, but the move away from being so heavily dependent on Russian fossil fuels took a leap forward, which with new import infrastructure coming on line lessens the reliance on Russian energy.
It is also clear that European industrial, domestic and transport energy sectors are taking a giant step away from the use of fossil fuels altogether — a development that could be compared with the emergence of the North Sea oil industry that got a boost from the 1970’s oil crisis. For example, the vast amount of wind and available and accessible land in Northern Europe could give that region and its various energy-intensive businesses an edge in the access to green energy.
Even though the energy market is likely to normalize in Europe as spring approaches, one should not forget the ongoing everyday struggle and suffering of the Ukrainian people in their nearly year-long effort to expel an invader from their country. Their bravery and courage have pushed Europe to sever its dependency on an energy provider that tried to use that reliance as a weapon in its unlawful invasion of a sovereign nation.
Lasse Sinikallas, Director, Macroeconomics, is the author of the Monthly Economic Commentary and the ‘Macroeconomic outlook’ chapters in Fastmarkets Forest Products’ five-year and 15-year forecasts. Speak to our team about our short- and long-term forecasts to see how they can help your business plan ahead.