via LobeLog

by Sara Vakhshouri

The tension between Russia and the West, and particularly the European Union, over Crimea has once again raised questions over the security of energy supplies and the use of energy as a tool of foreign policy and diplomacy. On the one hand, energy exports are a vital source of income for Russia. On the other hand, its massive energy resources and supply dominance in the EU have deterred the EU and US from sanctioning the Russian energy sector.

More than 90 percent of Russian natural gas, and 80 percent of its crude oil exports, go to the EU. Taken together, this accounts for about 50 percent of Russia’s federal budget. Russia supplies about 30 percent of the EU’s natural gas and, crucially, more than half of this is transported via Ukraine. Russian natural gas also plays an important role in Ukraine’s energy basket. Natural gas accounts for 40 percent of Ukraine’s overall energy consumption — more than half of this comes from Russia. Before the Crimean crisis, Ukraine was receiving more than a 30 percent discount on Russian gas, and was also heavily dependent upon Russian crude oil.

Russia’s calculus

The EU and Ukraine’s energy dependency has so far played in Russia’s favor. During the March 25 Nuclear Security Summit in The Hague, US President Barack Obama and EU leaders warned that they would enact broader sanctions against Russia in order to check its expansionist ambition in Ukraine. They mentioned that sanctions could expand to cover whole sectors in Russia including, crucially, its defense and energy industries. However, Moscow knows that in the short-term there is no substitute for its energy supplies, particularly to the EU.

Indeed, the first American liquefied natural gas (LNG) cargo delivery will not be available until late 2015 or early 2016. Some countries in Eastern Europe are also highly dependent on Russian gas transferred via pipeline — as they lack substantial LNG facilities. Yet US crude oil stockpiles in its Strategic Petroleum Reserve (SPR) are also a factor. In 2013, the SPR held 695.9 million barrels of crude oil. At this rate the US could supply 4 million barrels of oil per day (mb/d) for 90 days. This could, conceivably, help offset any fluctuations in prices in the event of an interruption of Russia’s 7.2 mb/d in exports of crude oil.

Regardless, in the medium-term Russia’s moves in Ukraine are going to hurt its interests in European and global energy markets. Gazprom, the Russian giant gas company with ownership of one-fifth of global natural gas reserves, hasn’t yet threatened to cut off its natural gas. But the Crimea crisis has damaged European trust in Russia as a reliable supplier.

The issue of reliable supply, coupled with diversification, is also a crucial factor in any country’s overall energy security. As Winston Churchill said, “safety and certainty in oil lies in variety and variety alone.” European countries have already started rethinking their strategies to diversify their energy suppliers. Russia was planning to increase its natural gas market in Europe by 23 percent in the next two decades, but its annexation of Crimea seems to have strongly damaged its future market share in Europe, particularly when one considers possible imports of American Shale Gas.

Coupled with energy sanctions on Iran, the Ukraine crisis has increased US awareness that their massive shale oil and gas resources could be converted into a strategic weapon and diplomatic tool. Debates on removing the ban on US energy exports have recently spiked and taken on a new intensity. US oil and gas supplies are not going to scare Russian President Vladimir Putin right now, but in the long-term Moscow will need to seriously consider the competition from US exports, which will require new market planning and strategic shifts from Moscow, some of which may be very uncomfortable for the Kremlin.

Still, not everything is bleak for Russia. Asia’s energy market, and particularly China, has always been a long-term objective. In fact, China could be a substitute for possible future European market losses. Last month, Chinese imports of Russian crude oil reached their highest in 7 years: 2.72 million metric tones. This was three times more than the average of Chinese oil imports over the past decade, and made up 12 percent of overall Chinese oil imports. The decline of Iranian imports for China has also shaped this calculus. Historically the third largest supplier of crude oil to China, Iran’s market share there has dropped from 11 percent of China’s oil needs in 2011 to 8 percent this past year. With China facing continued restrictions in importing Iranian crude, it may now see Russia as a reliable source of supply diversification.

Indeed, the tensions between Russia and European countries over Crimea could change the dynamics of global energy flows. Europe is in search of new suppliers; Russia is seeking new energy markets. This changes the traditional suppliers and consumers in the global energy market; it would bring China and Russia closer together, with the effect of solidifying strategic ties and the alliance between Europe and the US. This will also have profound implications for global energy markets and energy security.

Advantage Iran?

Perhaps ironically, Iran could also benefit from these changing dynamics. Europe faces possible energy supply interruptions and high-energy prices in the short-term. With the nuclear-focused negotiations between Iran and world powers known as the P5+1 moving along, some European countries could once again rethink their bans on Iranian oil imports. In other words, any energy supply interruption from Russia due to US and EU sanctions could have the unintended effect of undermining the regime of global sanctions against Iran.

In the short-term, Iran’s massive domestic consumption doesn’t leave much capacity for Iranian exports to Europe to substitute an offset of Russian supplies. But because Iran has the second largest natural gas reserves in the world after Russia, it has always seen Europe as a huge potential market. If Iran succeeds in overcoming sanctions through a constructive nuclear deal with the P5+1, European companies will be more inclined to invest in the Iranian energy industry than ever before. Losing some of its shares in the Asian and Chinese energy market, combined with weaning Russian energy influence in Europe, could give Iran a chance to once again strengthen its energy ties with the West and find a new market for natural gas exports.