Executive Summary

European natural gas prices surged to their highest levels since October 2023, after the Ukrainian government’s decision to follow through on its promise to halt the transport of Russian energy to Europe through its territory. The transit deal which was signed in 2019 between Kremlin-owned Gazprom and Ukraine’s Naftogaz expired, marking a major shift in economic trends not just in the region but all across Europe. Furthermore, the problem was compounded by a drop in temperatures across much of the Continent. Ukraine’s refusal to renew the transit deal was an expected but symbolic move after nearly three years of its full-scale war with Russia, and comes after Europe has already drastically cut Moscow’s share of its gas imports. Even as Russian troops and tanks moved into Ukraine in February 2022, Russian natural gas kept flowing through the country’s pipeline network — set up when Ukraine and Russia were both part of the Soviet Union — to Europe, under a five-year agreement. Ukraine’s energy ministry said it ended the deal “in the interests of national security” and President Volodymyr Zelensky called the move “one of Moscow’s greatest defeats.” Whilst it is true that Ukraine profited from the deal through the collection of transit fees and infrastructure taxes, the annulment of the deal will hurt the Russian economy more.

Background

Fossil fuel revenues are a lifeline for the Russian economy, accounting for a significant portion of government funding. Prior to the invasion, Gazprom, Russia’s state-controlled gas company, was responsible for about 45% of EU gas imports. This dependency allowed Russia to leverage its energy resources as a tool of geopolitical influence in the war in Ukraine. In response to the invasion, Western nations implemented a series of sanctions targeting Russia’s energy sector. These measures included price caps on oil exports and restrictions on financing new fossil fuel projects. The EU and G7 countries have sought to lower the price cap from USD 60 per barrel to levels closer to Russia’s production costs (around USD 15), aiming to limit Moscow’s taxable revenues while still allowing some level of oil supply. However, these sanctions have had mixed results. While they have constrained some revenue streams, Russia has adapted by redirecting its oil exports to non-Western markets, particularly India and China, which have significantly increased their imports. Consequently, the Kremlin has never been richer. With an unprecedented stream of revenue worth $37 billion of crude oil sales to India in 2023 alone, the Russian government has been able to replenish its expenditures.

As part of a covert operation to accelerate this process of Europe detaching itself from Russian energy, the Biden administration along with Zelensky’s regime initiated the bombing of the Nord stream pipeline in September, 2022. The underwater bombings and consequent gas leaks occurred on 3 of 4 Nord Stream pipes which were transporting natural gas. They comprised 2 of 23 natural gas pipelines between Russia and Europe. The attack caused major decreases in sales of Russian energy and consequently hurt their economy which depended on these exports.

Scenario Analysis

However this year, Gazprom recorded a $6.9 billion lost for the first time in more than 20 years. Despite increased exports to China and India, the multinational energy corporation is struggling. Many European countries are taking active measures to limit their oil imports from Russia, but this lapsed deal represent 5% of the European Union’s total gas imports. The transit route primarily supplied Slovakia, Austria, and Hungary and provided Ukraine with roughly $800 million a year in transit fees from Russia. Now, after its expiry, Europe receives pipeline gas from Russia via a single route: The Turkstream pipeline, which runs through Turkey and on to Bulgaria, Serbia and Hungary.

The head of the Energy, Climate & Resources at Eurasia Group expected this to happen along with a temporary jump in spot prices when markets reopen eventually. However, since the rapid spikes in inflation in 2022 the European markets are now better prepared to handle these scenarios and have worked with other countries retroactively to mitigate the damage. However, Slovakia’s Prime Minister Robert Fico said on Wednesday that the halt of Russian gas flows via Ukraine will have a “drastic” impact on the EU but not on Russia and that it must not be cheered.

Russia was the European Union’s biggest supplier of natural gas. The bloc has whittled Russia’s share of its pipeline gas imports down from over 40% in 2021 to about 8% in 2023, according to the European Council.

Strategic Recommendations

To fill the gap, Europe has imported vast quantities of liquefied natural gas (LNG) — a chilled, liquid form of natural gas that can be transported via sea tankers — from the United States and other countries, as well as pipeline gas from Norway. The EU has also ramped up imports of Russian LNG to help heat its homes and power its factories, but faces a self-imposed deadline of 2027 and plans to break its dependence on all Russian fossil fuels altogether.

Furthermore, Slovakia’s Prime Minister Robert Fico has threatened to cut financial support for more than 130,000 Ukrainian refugees as a dispute with Ukraine over the Russian gas supplies escalates. This has been interpreted as a negotiation tactic within European politics to punish Ukraine for not causing these energy shortages in Slovakia during a bitter and cold winter. Last month Zelensky accused Fico of helping Putin to “fund the war and weaken Ukraine”.

Europe’s entire energy infrastructure and network has been built over decades, designed primarily to accommodate and cater to cheap Russian gas. The process of staving off Russia altogether will take decades worth of policy changes and billions of dollars of subsidies to facilitate newer suppliers like the USA and Norway. This process cannot be done overnight. Until then, countries like Slovakia and Hungary that are most hurt by this deal expiring must strike newer deals with other partners in Europe.

Conclusion

The expiry of this deal in Ukraine has already created signs of strain in the region. Reuters reported on Wednesday that Transnistria, a breakaway region of Moldova, a non-EU country that also receives Russian gas via Ukraine, had cut heating and hot water supplies to households following the expiry of the transit deal. Whilst Brussels and Vienna cheer this expiry as a geopolitical strategic victory, along with Zelensky, the consequences may hurt some of the most vulnerable communities across Europe.