Pipeline Sabotage
Share on LinkedIn4 Oct 2022
The recent news regarding explosions damaging the Nord Stream 1 and 2 pipelines is a concerning escalation of the weaponization of energy in Europe. While speculation is rampant as to who could have been behind this event, the implications for the European energy markets are equally important.
Prior to this act of sabotage, it was our considered view that there were two principal outcomes to the current European energy crisis. Of course, we understand that there are numerous potential outcomes to such a complex situation; however, these two potential outcomes were by far the most likely.
Likely Outcomes
The first assumed a typical or harsher than usual winter, causing one or more principal members of the EU to seek a compromise or resolution with Russia concerning the Ukraine war. This compromise might look like a ceasing of hostilities at some predetermined boundary lines and a partial lifting of economic sanctions in return for the shipment of a minimum level of gas for a fixed period. Not commenting on this outcome's political, moral, or ethical aspects, but solely on the energy market impact, such an outcome would result in a significant drop in European energy prices. Moreover, this scenario would allow Europe time to plan and implement an orderly transition away from its dependence on Russian energy. Clearly, this path would not sit well with Ukraine, but without the West's support, it would be difficult for Ukraine to continue to prosecute the war.
The second scenario is that Europe has a typical or mild winter and is able to struggle through the next several months on its energy inventories and LNG shipments. Under this scenario, the Ukraine war would continue apace, and Europe would exit the winter period with depleted energy stores and struggle in the spring and summer to rebuild its energy supplies to prepare for the subsequent winter. In this scenario, energy prices would remain extraordinarily high, continuing to put pressure on governments, businesses, and domestic consumers and act as a significant drag on the regional economy.
Did Russia Do It?
Many have pointed a finger at Russia as the perpetrator causing the explosion that damaged the Nord Stream pipelines. However, in assessing this situation rationally, we find it difficult to agree with this conclusion. Clearly, the ability to restart the flow of gas into Europe is Russia's greatest bargaining chip in any future negotiations relating to Ukraine. Consequently, why would Russia (or, more specifically, Putin) undermine its future negotiating leverage? While anything is possible, it makes little strategic sense. On the contrary, it seems more likely that this act of sabotage was committed by a party that wished to ensure that no member of Europe would weaken and seek a compromise with Russia as winter wore on, energy prices increased, and the regional economy slowed. By damaging the pipeline, the perpetrator, in effect, attempted to eliminate a possible off-ramp to the crisis.
The sabotage of the Nord Stream pipelines changes the probabilities of our outcome analysis. If Russia cannot ship gas to Europe in meaningful quantities, it has little to negotiate with, particularly in light of its recent setbacks on the battlefield. Therefore, the recent act of sabotage reduces the likelihood of a compromise in the coming months – most likely the underlying reason for the deed. Although a compromise remains possible utilizing other pipelines (via Belarus and Ukraine) and Russia recently reported that line B of the Nord Stream 2 was undamaged and ready to ship gas. No compromise in the coming months means Europe is looking at a very hard winter and a difficult 2023 as it will be challenged to find alternative energy supplies to rebuild its energy stores to ready itself for the next winter season.
More: Energy Market Commentary, Nord Stream 1, Nord Stream 2
