HOT AIR FOR UKRAINE AND THE EU FROM AUTHORITARIAN PIPELINE POLITICS

The United Nations COP29 climate summit in Baku, Azerbaijan ended last week in a controversial $300 billion a year deal that left many developing nations and climate activists disappointed. But, ironically for a summit intended to address the climate crisis, energy deals were being struck on the sidelines with implications for European energy security. If you’re not a close observer of EU energy affairs, you might be surprised to learn that Russian state-owned gas giant Gazprom continues to send gas through Ukraine to EU customers in Central Europe, primarily to Austria, Hungary and Slovakia, where it meets around two thirds of local energy demand, as well as EU aspirant Moldova. On one level, it’s a surreal detail of the war. But serious money is involved: around 0.5% of Ukrainian GDP and a projected 112 terawatt-hours (TWh) out of a total of 377 TWh Russia is forecast to have supplied to the EU this year. However, the agreement is due to expire at the end of this month and Ukrainian President Volodymyr Zelensky has said the deal will not be extended in 2025. The gas transit system could also be used for Azerbaijani gas, increasing European dependence on another post-Soviet autocracy. The impasse could also be a major opportunity for US liquified natural gas (LNG) producers to increase market share while bolstering Western energy security, but the incoming Trump administration will need to avoid the bullying and coercion seen back in 2017 when former Texas governor Rick Perry made a play for a large piece of the pre-war Ukrainian gas market.

Having talked to energy experts from Azerbaijan, Russia and Ukraine, there’s a collective view that the window is closing for any deal that would keep the Ukrainian route open. Four options appear possible. First, as already mentioned, European buyers could purchase Azerbaijani gas at the Russian border and cut a deal with Ukraine’s pipeline operator to put it in the system. As Azerbaijani gas cannot readily reach the system directly, the only apparent solution would be a swap for Russian gas. Second and third options involve the sale of Azerbaijani or Russian gas through alternate existing pipeline systems – the Southern Gas Corridor or Turkstream networks – although both would require significant capacity expansion, requiring time and capital. Of course, this outcome would deprive Ukraine of any transit income. Finally, Central European countries could opt to cut deals for supplies, including US LNG supplies, from EU countries with sea access and existing infrastructure, namely Germany and Italy.

Of course, these options are not mutually exclusive, but they also underline that nearly three years into Russia’s full-scale invasion of Ukraine, Central European countries have proven unable (or unwilling) to diversify away from Russian gas. As far as can be gleaned from media reporting and source feedback, there are multiple negotiation streams taking place as this article is being written – for example, the State Oil Company of Azerbaijan Republic (SOCAR) with gas companies in Austria and Slovakia, SOCAR with Gazprom, national gas operators with European and US multinationals, and so forth. A swap arrangement would preserve Gazprom revenues, although Reuters reported last week that the company does not expect any direct revenues from Ukraine transit in 2025.

Central’s Europe’s Great Game

The current scramble for gas supplies by national gas companies in Central Europe shouldn’t overshadow the extraordinary gains made in cutting overall European dependence on Russian gas since February 2022. Russia shipped around 15 billion cubic meters of gas via Ukraine in 2023 – only 8% of peak Russian gas flows to Europe via various routes in 2018-19, according to another Reuters report. Recent if long overdue US sanctions on Gazprombank put in place in November make it much harder for Europeans to buy Russian gas. Overall, this is a spectacular reduction and refutation of the European growth model built over the previous two decades under leaders like Germany’s Angela Merkel designed around reliance on cheap Russian gas deliveries. Since the full-scale invasion, Russia has lost out to increased supplies from the US, Norway and Qatar. Azerbaijan, which already supplies Bulgaria, Italy and Greece in the EU and Georgia, Serbia and Turkey in the wider region, is also positioning itself as a preferred supplier to Europe, with current pipeline capacity providing the most immediate challenge to expanding this market.

Beyond supply and production capacity constraints, increasing European dependence on Azerbaijani oil and gas poses some of the same challenges raised by Russian gas. Baku is not Moscow, of course. Its hosting of the COP29 summit gave the regime under President Ilham Aliyev, a former SOCAR executive, crucial international profile and legitimacy. But this has also been accompanied by increased scrutiny.  The regime’s clampdown on climate protesters and declaration by Aliyev that oil and gas are a “gift of God” put a certain pall over the proceedings. Azerbaijan – an authoritarian petrostate – has dozens of political prisoners. It was accused of ethnic cleansing in its recent recovery of territory from Armenian occupation in Nagorno Karabakh as well as forays into internationally recognized land under Yerevan’s control. Finally, there is Baku’s close relationship with Moscow, which has deepened since the latter’s full-scale invasion of Ukraine. Since late 2022, Azerbaijan has been importing Russian gas to meet increased demand due to European sanctions and other efforts to cut dependence on Gazprom.

In sum, Azerbaijan’s role raises geopolitical, as well as serious ethical, economic and environmental, concerns. In fairness, some of these concerns are raised in equal degrees by alternative US and Qatari supplies, especially the environmental impact and cost of long-range LNG deliveries. But while Europe looks to continue to reshape its gas market to adjust to the higher costs and capacity constraints of non-Russian imports, deals like the one Slovakia’s national gas company, SPP, signed with SOCAR recently, are establishing facts on the ground. This envisages the first deliveries via pipeline through Bulgaria, but Slovakia’s president and Aliyev explicitly discussed developing future supplies via the Ukraine gas transit route. This means re-labelled Russian gas, what the Times of London dubbed “a Trojan horse” for Vladimir Putin. Ukrainian sources and analysts cited in the international media around COP 29 all expressed concerns that the swap arrangement will ensure continued Russian leverage even as it provides continued transit revenues for Kyiv.

US opportunities

It is one of the less reported but dramatic developments of recent years that the US has become the largest supplier of gas to Europe (the EU and the UK), accounting for nearly half of European gas imports in 2023, according to the US Energy Information Administration, citing European CEDIGAZ data. The end of gas transit through Ukraine suggests continued inroads for US gas imports, although this will rely on infrastructure in other European countries with seaports and sufficient infrastructure, such as Germany and Poland. Looking beyond the current war, Ukrainian domestic gas production presents opportunities to both meet local demand and some export capacity, especially if Kyiv ever recovers its largest known gas reserves in the Kerch Strait separating Crimea and the mainland (an ExxonMobile deal with Ukraine to develop this field was derailed by Russia’s occupation of Crimea in 2014).

For Ukrainians, however, the previous Trump administration set a troubling precedent, attempting to tie gas deals to political demands for compromising materials on the presidential campaign of Joe Biden. It also included a failed alleged bid by former Energy Secretary and Texas Governor Rick Perry to install figures friendly to certain US LNG companies on the board of directors of Naftogaz, Ukraine’s gas monopoly in charge of both local production and transit (via subsidiary Ukrtransgaz). This sits uneasily with the usual (and correct) Ukrainian complaints that Russia has long used gas supplies as a political weapon against Ukraine.

The contours of the incoming administration’s vision of a US natural gas strategy are still being worked out via leaks in media reports. It is inevitable that a Biden administration freeze on new LNG export permits – a US federal judge has already paused this – will be scrapped, and this appears to be a net positive, at least in narrow economic terms for the US in Europe. However, in addition to potential environmental impacts, the concern is that the Trump administration and its allies in the LNG industry, among both multinationals and independent producers, will put more than an economic price tag on gas supplies. This time around, it appears less likely that Trump and his allies will need or seek political dirt on their opponents. But if the administration tries to force a truce, it seems inevitable that – ironic comparisons to Hunter Biden’s past involvement in the sector aside – its allies will seek once again to dominate gas production and transit. Whether Ukraine will benefit from this, and the EU will be able to free itself of energy imports from kleptocracies – incumbent or incipient – remains to be seen.