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April 01, 2022

Russia’s Invasion of Ukraine: Impact on European Energy Markets and Disputes

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RUSSIA’S INVASION OF UKRAINE: IMPACT ON EUROPEAN ENERGY MARKETS AND DISPUTES

The military assault Russia launched against Ukraine on February 24, 2022 has been a destabilizing event of historic magnitude, its humanitarian, political and economic impacts reverberating far beyond the borders of Russia and Ukraine.

The invasion has underscored the extent of Europe’s dependency on Russian energy supplies, as well as the commercial and geopolitical risks such dependency entails. One month into the ongoing war, Europe’s energy markets are roiling from price spikes and, while the continent’s energy needs appear to be met at present, supply shortfalls remain a serious (and ever increasing) risk.

While the EU has stopped short of joining the U.S., the U.K. and others in imposing embargoes on Russian energy, it has introduced far-reaching sanctions on Russia, including Russian oil majors Rosneft, Transneft and Gazprom Neft. At the same time, several European energy majors have announced plans to exit investments related to the Russian energy sector. Compounding this highly volatile situation are the retaliatory actions Russia has taken and may yet take in response.

It appears that the war in Ukraine is also having the effect of accelerating European states’ efforts to eliminate their dependency on Russian energy. On March 8, 2022, the European Commission announced ‘REPowerEU’, “a plan to make Europe independent from Russian fossil fuels well before 2030, starting with gas, in light of Russia’s invasion of Ukraine”.[1] This plan envisages a two-pillared strategy of (1) diversifying gas supplies by increasing pipeline and LNG imports from non-Russian suppliers, and (2) accelerating Europe’s move away from fossil fuels.

This note addresses both the short- and longer-term impacts of Russia’s invasion of Ukraine on Europe’s energy markets, as well as some of the potential areas for dispute and steps that industry players can take to protect themselves.

Key Takeaways

  • Due to Europe’s reliance on Russian energy supplies, Russia’s invasion of Ukraine has significant consequences for European energy markets
  • Short-term impacts include potential energy supply shortfalls and price spikes, increasing the likelihood of disputes under energy supply arrangements
  • European firms exiting energy investments or joint ventures with a Russia nexus also face the risk of disputes, including in relation to divestiture of assets and financing/capital injection commitments
  • Parties should identify and prepare for such disputes, including by carrying out an assessment of their contracts for provisions relating to liability, including force majeure, hardship, liquidated damages, indemnity and adjustment provisions
  • Longer-term impacts include an acceleration toward diversification of energy sources and the review of clean and renewable energy policies

Impacts on European Energy Markets

The EU’s Reliance on Russian Energy Imports. In 2019, the EU produced around 39% of its own energy and imported the rest, with the energy consumed in the EU coming from the following main sources: petroleum products, including crude oil (approx. 36%), natural gas (approx. 22%), renewable energy (approx. 15%), nuclear energy (approx. 13%) and solid fossil fuels (approx. 13%).[2] That same year, petroleum products (of which the main component is crude oil) accounted for almost two thirds of energy imports into the EU, followed by gas (approx. 27%) and solid fossil fuels (approx. 6%).[3]

Europe is highly dependent on Russian energy imports. According to the European Commission, Russia provides more than 40%of the EU’s total gas consumption and accounts for 27%of the EU’s oil imports and 46%of its coal imports.[4]

Potential Natural Gas Shortfalls. At the time of writing, Russian gas continues to flow, seemingly in sufficient quantities to meet demand. There remains, however, the prospect of Russia turning off the tap, including in retaliation for EU sanctions. In this connection, Russia recently issued a decree requiring buyers of Russian gas to pay in rubles from ruble-held Russian bank accounts and has threatened to cut off supplies to customers who do not comply.[5]

Shortfalls could also occur due to damage to energy infrastructure running through Ukraine. For example, Ukraine’s Ukrnafta reported damage to its facilities in Okhtyrka as a result of Russian shelling, and suspended operation of two gas processing plants in the Chernihiv and Sumy regions of Ukraine.[6] While these incidents do not appear to have caused any notable supply issues, the fact remains that Ukraine is an important conduit for natural gas from Russia to Western Europe.

Energy Price Spikes. The threat of supply shortfalls has caused prices of oil, gas and coal in Europe to spike. For example, the price of Brent crude oil has hovered at around $120 per barrel throughout the first month of the conflict,[7] a level not seen for more than a decade. Natural gas and coal have also been trading at record high prices on the European spot markets,[8] with the spot price of gas experiencing further upward pressure in light of Russia’s decision to require all payments for gas deliveries to “unfriendly countries” to be made in rubles.[9]

Withdrawal from Russia-Related Projects. In the wake of the Russian invasion, Germany announced that it was halting certification of Nord Stream 2, the pipeline network running through the Baltic Sea, which was intended to double the flow of Russian gas to Germany.[10] A number of European and other energy majors have since announced their retreat from investments in or concerning Russia. For example:

  • BP has announced that it will divest its 19.75% shareholding in Rosneft and that its two BP-nominated directors would resign from Rosneft’s board;[11]
  • Centrica, the owner of British Gas, has stated that it would exit its gas supply agreements with Russian counterparts, principally Gazprom;[12]
  • Eni has stated that it would sell its stake in the Blue Stream pipeline, which carries Russian gas to Turkey via the Black Sea;[13]
  • Equinor has stated that it was stopping new investments in Russia and would start exiting its Russian joint ventures;[14]
  • Shell has declared its exit from joint ventures with Gazprom and related entities, as well as its involvement in the Nord Stream 2 pipeline project;[15] and
  • TotalEnergies has announced, among other things, that it will no longer be providing capital for the development of projects in Russia, will not be renewing or entering into contracts for the purchase of Russian oil and petroleum products, and will be terminating its Russian oil and gas supply contracts as soon as possible, while gradually phasing out its activities in Russia.[16]

Diversification of Gas Supplies. Since the announcement of REPowerEU, European states have focused more attention on ways to diversify their gas supplies. Poland and Lithuania have agreed to bring forward the opening of the Gas Interconnection Poland-Lithuania (GIPL) pipeline, connecting the two states’ gas transmission networks,[17] while Germany has announced plans to secure gas supply from Qatar.[18] The EU and U.S. have also recently revealed a deal which would see more U.S. LNG delivered to Europe.[19]

In this context, the CEO of Sonatrach has recently stated that the Transmed pipeline running between Algeria and Italy has spare capacity that could be used to increase gas transmission to Europe.[20]

Simultaneously, there is a push by European states to develop more LNG infrastructure so as to curb their dependence on gas supplies from Russia, most of which run through pipelines. Examples include Germany’s plan to build two new LNG terminals,[21] Greece’s plan to construct a new LNG facility near Alexandroupoli,[22] and Estonia’s plan to establish a floating storage and regasification unit.[23]

Review of Carbon Phase-Out and Renewable Energy Policies. While the REPowerEU doubles down on the EU’s longer-term commitment to phase out fossil fuels, there are signs that the war in Ukraine is prompting some European states to slow down their carbon phase-out in the more immediate term to stave off the risk of supply shortfalls where cleaner alternatives may not be ready in time.

Germany is a good example of both types of change. It has been reconsidering its decision to shut down its last three nuclear plants,[24] and is reportedly contemplating a slower-than-planned phase-out of coal-powered energy.[25] At the same time, it has recently announced an acceleration of solar energy projects and is considering boosting tenders for wind energy projects.[26]

Potential Disputes

The developments described above could give rise to several types of disputes:

  • First, if energy shortfalls do occur, they could generate claims across the supply chain. In defending against shortfall claims, sellers and buyers may seek to rely on provisions limiting their liability for failures of performance, such as force majeure or hardship clauses. Parties should also consider preparing standard responses, such as holding letters, and setting up internal taskforces to adopt a coherent and consistent approach in responding to claims where these are likely to arise under various contractual arrangements.
  • Second, energy price spikes could bring about a round of pricing disputes like that seen in the early ‘10s when the decoupling of natural gas and oil prices generated a wave of price review arbitrations. A key difference this time is that many Western European gas supply contracts are now priced on the basis of the spot price of gas at Europe’s main gas hubs, as opposed to the oil-linked pricing that was once the norm. It remains to be seen how (if at all) the contracts now in force are equipped to handle what may be unprecedented levels of volatility in the spot markets. Buyers should take careful note of any price review mechanisms contained in their agreements and assess whether the triggering conditions for requesting a price review may be met.
    For contracts that have no price review clause, buyers and sellers should examine what other contractual mechanisms they may have at their disposal to limit their exposure to price spikes, including stabilization, hardship or force majeure clauses. Just as with a price review mechanism, buyers should analyze the conditions for the application of any relevant provisions with a view to assessing how (if at all) they could be invoked in the current circumstances.
  • Third, Russia’s decision to require payments for gas sales to be made in rubles should prompt buyers to consider a number of issues under their supply contracts. These include, e.g., whether the contract (1) stipulates the currency in which invoices are to be issued, (2) provides for payments to be made during a pending dispute, (3) specifies the country in which the seller’s designated bank to receive payment is located, (4) allows amendments to the contract to be made (and if so, under what conditions), (5) includes a price review provision (and if so, assess whether the requirements for triggering a review are met), or (6) contains other provisions addressing exchange rate and currency-related risks, or defining these risks as force majeure events, etc.
  • Fourth, changes in energy sourcing—whether from Russian-supplied pipeline gas to non-Russian LNG, or from fossil fuels to renewables like wind, solar, nuclear or hydrogen—introduce unique cost elements and may require a recalibration of the price formulas under long-term supply contracts, raising the possibility of disputes over price revision or a party’s ability to perform.
  • Fifth, to meet the REPowerEU goals, European states will need to embark on new construction projects to an extent—and at a pace—never seen before. Some of this work is already underway, including in respect of the new pipelines and LNG infrastructure described above. Other projects, such as the additional new nuclear power plants that France’s President Macron has proposed,[27] or the new wind and solar power installations throughout the continent, are still at a conceptual stage. In all events, project schedules are likely to be compressed and the pressure to deliver operational, defect-free facilities on schedule will be especially high. In these circumstances, there is a heightened risk of disputes arising, including in relation to project delay, disruption and variations to the works, or over purely commercial concerns like project financing. Parties should therefore pay particular attention to schedule-related provisions, including for example those concerning variations, extensions of time and liquidated damages, when negotiating contracts for such projects or dealing with claims arising under such contracts.
  • Sixth, the suspension or withdrawal of investments in or related to Russia has also created fertile ground for disputes. These disputes may concern the proprietary and/or commercial impacts of any divestiture of assets or arise out of non-adherence to commitments to make capital investments on Russia-related projects. In this context, the risk of claims arising between joint venture partners is also heightened, especially where the partnership arrangements are unclear on questions related to the conditions applicable to exiting the joint venture. Russia’s recent steps to enact a law entitling it to nationalize assets of foreign firms that leave the country[28] may also lead foreign investors to initiate arbitrations under Russia’s network of investment treaties, seeking to protect their rights. However, investors who pursue that course may find themselves navigating a quagmire of enforcement issues, including those arising from the sanctions and counter-sanctions regimes discussed below.
  • Finally, for firms that decide not to exit their Russia-related investments, a different set of risks arise. These include potential liability arising from non-compliance with relevant sanctions regimes imposed on Russia or risks arising out of Russia’s countermeasures, which target activities involving “unfriendly” states, including all EU member states, such as restrictions on obtaining loans in foreign currency and conducting real estate or securities transactions, prohibitions on free transfers of foreign currency cash or monetary instruments, and trade restrictions, etc.

Shearman & Sterling’s International Arbitration and Project Development and Finance groups have deep experience across the energy sector, including oil and gas matters (upstream and downstream), nuclear power, hydroelectric power, and renewable energy. We act for multinational corporations, financial institutions, Sovereign States and State-owned companies in contract management, disputes and restructurings concerning, among other things, issues of consortium and joint venture relations, contract cancellations and terminations, construction, price review, tax treatment and stabilization and investment.

Our team also has unrivalled Russia disputes experience. It includes investment and public international law specialists who represented the majority shareholders of the former Yukos Oil Company against Russia, resulting in an historic $50 billion arbitration award in our clients’ favor. We also have substantial experience representing Ukraine and Ukrainian State entities against Russian interests.

Our lawyers also include members of Shearman & Sterling’s dedicated global sanctions team, providing advice and support to companies across a range of sectors and industries in navigating the increasingly complicated web of Russia-related international sanctions.

If your business has any exposure to Russia, we would be happy to work with you to navigate this rapidly evolving situation.

Footnotes

[1] European Commission, “REPowerEU: Joint European action for more affordable, secure and sustainable energy”, March 8, 2022:.
[2] See European Commission
[3] See European Commission
[4] See e.g., REPowerEU, p. 1:
[5] BBC, “Ukraine war: Russia threatens to stop supplying gas if not paid in roubles,” April 1, 2022.
[6] Ukrnafta.com, “Operational information on the status of work of PJSC ‘Ukrnafta,’” February 28, 2022.
[7] The Financial Times, “Renewed concerns about oil outlook push Brent crude above $120,” March 23, 2022.
[8] See e.g., Wood Mackenzie, “Coal prices spike as Russia-Ukraine crisis escalates,” March 3, 2022, The Financial Times, “EU plans to cut Russian gas imports by two-thirds in a year,” March 8, 2022. 
[9] Reuters, “No change in law needed for rouble gas payments – Russian lawmaker,” March 29, 2022.
[10] Reuters, “Germany freezes Nord Stream 2 gas project as Ukraine crisis deepens,” February 22, 2022.
[11] BP.com, “bp to exit Rosneft shareholding,” February 27, 2022.
[12] Reuters, “Britain's Centrica to exit Russia gas supply agreements,” March 1, 2022.
[13] Reuters, “Italy's Eni to sell stake in Blue Stream pipeline co-owned with Gazprom,” March 1, 2022.
[14] Equinor.com, “Equinor to start exiting from Joint Ventures in Russia,” February 28, 2022.
[15] Shell.com, “Shell intends to exist equity partnerships held with Gazprom entities,” February 28, 2022.
[16] TotalEnergies.com, “Russia: TotalEnergies Shares Its Principles of Conduct,” March 22, 2022.
[17] Reuters, “Poland, Lithuania speed up gas link amid Russia supply worries,” February 28, 2022.
[18] The Guardian, “Germany agrees gas deal with Qatar to help end dependency on Russia,” March 20, 2022.
[19] Reuters, “U.S., EU strike LNG deal as Europe seeks to cut Russian gas,” March 25, 2022.
[20] Reuters, “Transmed gas pipeline has spare capacity to increase supply to Europe  Sonatrach,” February 27, 2022.
[21] France 24, “Germany to ‘fast-track’ gas terminals as part of Qatar deal,” March 21, 2022.
[22] Upstreamonline.com, “New LNG import project flagged for Greece,” March 3, 2022.
[23] Upstreamonline.com, “Estonia revives LNG import project to reduce reliance on Russian gas flows,” March 18, 2022.
[24] Vice.com, “Germany Reconsiders Nuclear Energy In Light of Russia’s Invasion of Ukraine,” February 28, 2022.
[25] Euronews, “What are Europe's energy alternatives now that Russian gas is off the cards?” March 30, 2022.
[26] Reuters, “How Europe can kick its Russian gas habit,” March 1, 2022.
[27] The Guardian,  “France to build up to 14 new nuclear reactors by 2050, says Macron,” February 10, 2022.
[28] Reuters, “Russia moves towards nationalising assets of firms that leave – ruling party,” March 9, 2022.

Authors and Contributors

Alex Bevan

Partner

International Arbitration

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Jennifer Younan

Partner

International Arbitration

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Alexander J. Marcopoulos

Counsel

International Arbitration

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Elise Edson

Counsel

International Arbitration

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Lachlan Poustie

Partner

Project Development & Finance

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Kate Buchanan

Associate

Project Development & Finance

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