A new report from the Oxford Institute for Energy Studies (OIES) contends that, in light of the Ukraine crisis, the EU should allow Gazprom to use its great new pipelines South Stream and Nord Stream for itself and not be required to grant access to third parties. But the Center for Security Studies (CSS) ETH Zürch, argues the opposite in a new report of its own. It says the EU should adopt a strict regulatory policy towards South Stream and subject all of Gazprom’s activities to intense legal scrutiny. Energy Post editor Karel Beckman believes CSS is right that the EU should play hardball with Russia. But it should not see Russia as an enemy.
The Ukraine crisis has led to a lot of debate about what the implications are for the European gas market and how to deal with possible threats to gas supplies, both in the short and long term. Fortunately, some real experts have now shone their lights on these matters (they tend to lag a little behind the quick but poorly informed newspaper pundits).
“What the Ukraine crisis means for gas markets”, a new paper from the Oxford Institute for Energy Studies (OIES), looks at the current gas supply situation with regard to Russia, Ukraine and Europe and also in detail at the precarious position of the Ukrainian national gas company Naftogaz. This company ran up debts of $3.3. billion in 2013 to Gazprom, of which only a part were paid back. Under the pro-Russian president Viktor Yanukovich the Russians were willing to accommodate Naftogaz, but they may not be so forthcoming with the new management.
OIES notes that Russian imports comprise some 30% of European gas needs. About 50% of Russian to Europe transits via Ukraine (a few years ago this was still 80%), meaning that a disruption of Ukrainian transit would affect just 15% of total gas supplies. However, some countries are more dependent on Ukrainian transit than others. The most affected EU member state is Italy, with substantial supplies also going to Austria, Hungary, Bulgaria, Greece, former Yugoslavia, Turkey and Germany.
Thanks to various measures taken since the last Ukrainian gas supply crisis in 2009 – in particular increased possibilities of “reverse flow” transit (i.e. from West to East) – Europe is in a much better position to diversify supplies than it was a few years ago. If Ukrainian transit is blocked, supplies through Nord Stream can be increased and shipped via the Czech Republic and Slovakia to the Baumgarten Hub in Austria, serving the South European market.
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Italy has additional import options and today gets only 20% of its gas from Russia. Most countries also have built up storage capacities, e.g. Hungary and Slovakia over 80 days and Bulgaria and the Czech Republic over 40 days. Only Greece and Romania have no storage, but Greece can source additional LNG. OIES concludes that in the event of a disruption “Europe would be able to balance its needs through additional imports, use of storage and interconnections and, with Russia able to use alternative routes, to offset at least part of the volumes lost.”
Some might argue that the real threat is not disruption of Ukrainian transit but a Russian “boycott” of the whole of Europe, for political reasons. OIES, however, notes that Russia (and in particular Gazprom) is heavily dependent on gas export revenues. In 2013, Gazprom exported 86 bcm (billion cubic meters) of gas through Ukraine at an average price of $387/mcm (million cubic meters), implying revenues of $33.3 billion. This was 53% of all of Gazprom’s sales to Europe. “The company would clearly be hit very hard by any interruption to its European exports via Ukraine”, notes OIES.
In the long term the effects could even be worse, “if European customers decide to redouble efforts to diversify away from Russian gas to alternative sources of supply or alternative fuels”.
In addition, direct sales to Ukraine are also quite significant for Gazprom, estimated at $10.7 billion in 2013. The effect on the overall Russian budget would be much less of course, if only because oil is a far more important revenue generator for the country, as OIES notes.
All of this applies to the short-term outlook, which is reassuring in any case with spring and summer approaching in Europe. In the longer term, however, notes OIES, Europe needs to ensure stability of its gas supplies. The question is, how.
For OIES there is no question that Europe will remain dependent to an important extent on Russia. According to OIES, this implies that the EU should support Gazprom’s efforts to diversify away from Ukraine, in particular through the Nord Stream and South Stream pipelines. “The current situation strengthens the rationale for the South Stream pipeline, which would bring Russian gas across the Black Sea to Bulgaria,” notes the OIES report.
South Stream of course is being built by Russia with the express intention to circumvent Ukraine. Gazprom has already taken a positive final investment decision (FID) on the giant 63 bcm pipeline and is steaming ahead with the project. But, as OIES puts it, “a regulatory problem remains: Gazprom might not be able to book and utilise full capacity in the onshore extensions of both Nord Stream and South Stream, as the EU Third Package for gas requires inter alia third party access (TPA) unless an exemption is granted”.
As regards Nord Stream, the German regulator, the Bundesnetzagentur (BnetzA), has already granted an exemption to Gazprom for the OPAL pipeline, a crucial extension of Nord Stream running through Germany alongside the German eastern border. The Germans permit Gazprom 100% access to OPAL. The EU, however, has yet to rule on OPAL. Indeed, the European Commission announced on 10 March that it wants to further investigate this project before making a decision.
The same applies to South Stream. Energy Commissioner Günther Oettinger said on 10 March that the EU would “delay” a decision on South Stream in response to Russian actions in Ukraine. In December of last year the European Commission announced that the “intergovernmental agreements” concluded between Russia and the governments of EU member states which the pipeline crosses, are not in line with the Third Package. Meanwhile, Gazprom has not yet applied for an exemption for South Stream, despite the fact that it has already taken an FID on the project.
According to OIES, there are now two possible outcomes of this issue: what it calls an “economic” and a “political” outcome. The “commercially logical” outcome, says OIES, would be that “the uncertainty surrounding Ukraine would be a decisive factor contributing towards speeding up the development of regulatory procedures (as part of the Third Package and without the need for an exemption) enabling construction and utilisation of new cross-border pipeline capacity in Europe”. In other words, the EU should do what it can to ensure that South Stream gets built as quickly as possible, and not require third-party access to the pipeline.
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But OIES fears another, “political” scenario may develop: “a reduction of EU-Russia cooperation on gas issues, and about the routes by which gas can brought into Europe”. This would happen if the EU decided to retaliate against perceived Russian aggression in Ukraine, and would throw regulatory obstacles in the way of South Stream. According the OIES researchers, such a political scenario should not prevail over the “more economically rational solution”. They warn that this could “have very substantial economic costs for both Europe and Russia.”
With their recommendation, OIES finds itself in direct opposition to Jonas Grätz of the Century for Security Studies (CSS) at ETH Zürich and Iana Dreyer of the European Union Institute for Security Studies (EUISS) in Paris.
In a new paper published by CSS, “After Ukraine: Enhancing Europe’s Gas Security”, the two authors argue that the EU should rather throw the full regulatory weight of the Third Package at South Stream.
They note that Europe’s dependency on Russian gas “poses security risks, which are magnified by attempts of Russia’s Gazprom to hold sway over Europe’s gas deliveries”.
Russia, they say, follows a deliberate policy aimed at maximum control over the European market. It actively resists “market reforms in the EU that would increase competition and interconnectedness”. Its new pipelines, Nord Stream and South Stream, are part of a strategic Russian plan to “cement dependence”, “neutralize Ukraine”, “enhance Russia as a centre of gravity in the post-Soviet space” and “to align the Balkans and EU states with Moscow’s foreign policy.”
The EU “cannot afford to be complacent” about this behaviour, say Grätz and Dreyer. “The EU’s key aim should be to subject the gas relationship with Russia to the logic of its internal gas market. Competitive markets should do the job of determining imports and ex¬ports, and not company monopolies and foreign interests.”
They point out that Russia is also the EU’s main supplier of oil and a large supplier of coal, but this does not affect political relations, since Russia is not in a position to dominate these two “more competitive and fungible markets”. This is the kind of relationship the EU should aim for in the gas market as well, they argue – and “competi¬tive gas markets are the primary tools to get there: By bet¬ter leveraging Gazprom’s dependence on the EU’s gas de¬mand, Gazprom should be nudged towards competitive behavior. The ultimate goal is to reduce monopoly profits, incentivizing Russia to become more competitive in its natural gas sector.”
Grätz and Dreyer note that EU market reforms have already led to remarkable results. “Spot markets have spread from the UK all over north¬western Europe, helped by the current economic slump and a global boom in sea-borne LNG trade. LNG diversifies sources and routes of supply, reducing gas markets’ traditional exclusive reli¬ance on pipelines. In light of these markets, European util¬ities have recently been able renegotiate some of their long-term contracts with the big three suppliers – Norway, Algeria and even reluctant Russia. And thanks to intercon¬nections, the EU’s capacity to react to supply shortfalls has been enhanced.”
But they warn that “Gazprom’s clout in the EU could be growing again: Liberalization also meant that Gazprom was able to invest directly or indirectly in national utilities or gas trad¬ing companies throughout the EU. In contrast to the pre¬vious national monopoly model, this meant that Gazprom would control investment and gas sourcing strategies in the EU, whereas EU companies cannot do the same in Russia. Enforcement of the EU’s rules is thus of para¬mount importance to keep Gazprom’s power in check.”
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Market developments also favour Russia at the moment. As a result, the EU’s reforms are “at risk of being undermined.” This makes it all the more important that the EU “strictly adhere” to its internal market policy. In this context, Russia’s big pipeline projects in Europe, Nord Stream and South Stream, are “central test cases”, as is the antitrust lawsuit against Gazprom.
So what should the EU do? One recommendation of the authors is that the EU should clearly “set the rules of the game” for interdependency: “According to current scenar¬ios, the EU will likely be relying on more Russian gas in the future. This would not be a disaster, if the EU does its homework. The EU’s hand will be strengthened if deci¬sion-makers do not shun other energy sources. The EU and its member states should thus make clear to Moscow that they have a choice: If Moscow continues to refuse the free market, the future role of gas in the energy mix will be limited in order to reduce risks. As a positive roadmap, the role of gas could grow if Moscow liberalizes its exports and investment regime, protects EU investors, opens up access to its pipelines, and stops hindering EU attempts at diver¬sification.”
Secondly, Grätz and Dreyer call on EU leaders “to stay consistent in the vision of a competi¬tive EU gas market. Even if key companies from Italy, France, and Germany are lending Gazprom a helping hand, the EU has to be clear that this pipeline [i.e. South Stream] is value-destructive both from an economic and foreign policy viewpoint.”
If the EU cannot stop this project, they add, “there can be no compromise on exemptions for South Stream. The pub¬lic interest in a competitive market is more valuable than corporate interests. Any exemption will help Gazprom to turn the pipeline into a tool for monopolizing gas markets, even more so as its new final destination will likely be the Baumgarten hub in Austria. The EU Commission has to bring the bilateral pipeline agreements with Moscow in accordance with EU rules.”
In addition, “the EU anti¬trust case must be drawn to a conclusion thoroughly. All of this needs the firm backing of European capitals. They must become fully aware of the negative geopolitical im¬plications of compromising with Gazprom on these issues.”
Clearly, the recommendations from CSS and EUISS are the polar opposite of what the OIES suggests. The reason for this difference of opinion is apparently that OIES regards implementation of the Third Package as a “political outcome”. The Oxford researchers instead prefer an “economic”, i.e. market-based approach. From a market perspective, it may be argued that the new Russian pipelines enhance security of supply for Europe, because they create additional transit routes. This is so even if Gazprom reserves these routes for itself.
The problem with the OIES’ line of thinking is that it can hardly be denied that Russia uses gas in many ways as a political instrument. Thus, for example, while Gazprom is able to expand downstream in Europe, the Russian gas market is not open in the same way to European companies. A genuinely competitive market, therefore, has to come about through the implementation of regulations aimed at creating a level playing field, as Grätz and Dreyer argue. It seems odd that the OIES researchers ignore this.
If Grätz and Dreyer are surely correct that the EU should play hardball with the Russians, this by no means implies that Europe should regard Russia as an “enemy”, as many commentators in western media would like to us to do. Western countries have always approached energy issues in political and strategic terms, but according to some people for Russia different rules apply. That is nonsense. As Grätz and Dreyer write, “the EU has to stick to its vision of a competitive market and not deviate from its own rules”. That is all there is to it. In that sense, fortunately, both reports refrain from cheap moralising.
By Karel Beckman