Analysis: Energy dependence and supply in Central and Eastern Europe
In this article, economist Miklós Losoncz of Hungary's GKI Economic Research Co. looks at the Central and Eastern European countries' energy status and prospects. The article was published in The Analyst, a new quarterly focussed on the key political, economic and social developments in Central Eastern Europe.
The countries of Central and Eastern Europe (CEE) recently experienced discontinued or mainly in the post-soviet states weakened political influence from Russia. This came long with their transition to market economies and Western-style democracies, and their accession to the European Union, their increased focus on the EU. However, dependence on Russian energy in these states remained unchanged, especially in the case of natural gas and oil. In fact, with energy demands expected to rise as domestic production drops, these countries will be increasingly dependent on imports in the long term.They can only tangibly reduce their energy dependence on Russia, and geographically diversify their gas and oil imports, at the expense of costs so big as to be irreconcilable with economic rationality. Such moves can hardly be justified in a period when political relations between the EU and Central-Eastern European countries, on the one hand, and Russia on the other, are basically amicable. Especially when Russia itself is dependent on energy exports and the accompanying foreign exchange revenues in order to modernise its economy. This fact gives the relationship a quality of mutual dependence.
But this analysis needs to be revised somewhat taking into consideration the events at the end of 2005 and the beginning of 2006. In preparing to renegotiate earlier agreements on the delivery of natural gas for 2006, Russia made an offer to former Soviet states regarding a price increase. The prices have traditionally been significantly below those on the world market. Russia subsidised the price of natural gas in those countries. In 2004, while the average price of natural gas in Western Europe was $140 per thousand cubic metres, gas was sold to former Soviet states as cheap as $541. This slowed down those countries’ movement away from dependence on Russian natural gas imports.
At first glance, the proposal to increase prices could have been seen as a transition to market conditions in bilateral relations. However, different rates of increase for different countries showed that Russia aimed to use gas to exert political pressure.
Russia applied no price rise for Belarus or Azerbaijan, the two states with which it has the best relations. In the case of Georgia and Armenia, the intended price increase was from $80 to $125 per thousand cubic metres, while for Ukraine the hike would have been from $50 to $160. The drastic price increase for Ukraine is not only attributable to economic factors. It is related to elections in Ukraine, due in the spring of 2006, and is intended as a means of political pressure.
A dispute ensued between Russia and Ukraine, due to the fall in gas supplies from Russia to Ukraine, and Ukraine siphoning off gas from Russian deliveries to third countries. The dispute caused gas shortages and temporary supply problems in Western and Eastern Europe. The dispute dramatically brought to the surface the vulnerability of the EU and CEE countries regarding gas supplies from Russia.
The unfavorable impacts of energy supply dependence may be offset by various forms of international cooperation.
Firstly, through participation in multilateral international organisations (OECD, International Energy Agency). Secondly, via cooperation within the EU, with the EU as a partner, or among CEE countries, with a minimum objective of eliminating bottlenecks and connecting national, regional and sub-regional energy markets. Thirdly, by developing and institutionalizing existing relations with Russia in the field of energy and the economy.
Key tools to reduce energy dependence in the short term include stocking policies with a view to increasing storage capacities. In the medium and long term, possible measures include the diversification of imports, finding new supply sources in Central Asia, and importing gas in liquefied form from the Middle East. The lack of delivery infrastructure limits the opportunities for diversifying sources of supply.
Other tools to weaken energy dependence include the liberalization of the domestic energy market, and providing tax and other incentives to reduce energy consumption.
Finally, dependence may diminish through the development of Russia's market economy. The more developed Russia's commodity and financial markets are, the more liberalized its economy is. Therefore, the smaller will be the number and economic weight of companies that are not at all, or only to a small extent, cost-sensitive, and which operate without efficient ownership control. At the same time, Russia will become increasingly in harmony with the standards of multilateral international bodies, for example by entering the WTO, and with EU legislation. All this will result in Russia having less room for maneuver in deploying energy exports to achieve political dominance.
Features of dependence
The total energy dependence of the CEE countries is much smaller than that of the 15-state EU before the 2004 enlargement.
In 2002, the average share of imports in domestic energy consumption in CEE countries was 54%, while the EU average was 77%. However, the CEE average has major variations in the background. Import dependence is lowest in Romania, Bosnia-Herzegovina, Serbia-Montenegro and Poland (about 30%-35%). At the other end of the scale, Belarus, Lithuania, Moldova, Slovakia and Croatia are very dependent on energy imports.
|6 Czech Republic||46.2||102.0||98.7||14.6|
Note: Values over 100 include re-export. Domestic consumption = production + import – export.
Source: OECD database http://www.iea.org/dbtw-wpd/Textbase/stats/index.asp
From a practical point of view, energy dependence should be examined with regard to each of the major resources, such as electricity, coal, gas and oil.
Among primary energy sources, domestic coal production, despite its diminished role due to structural developments in recent years, still has the highest role in Ukraine, the Czech Republic and Poland. These three countries continue to export coal.
Twelve per cent of electricity in CEE countries is imported. This is not significantly higher than the EU-15's 9%. However, the CEE average has major differences in the background. Poland, Romania, Bulgaria, Estonia and Ukraine are almost self-sufficient, while import dependence is significant, with rates over 40%, in Moldova, Latvia and Lithuania. The latter fact is because it was cheaper to produce electric power in other areas of the former Soviet Union. (The indicator under review relates to direct electricity import. Domestic electricity production may also be based on imported energy sources. The share of direct electricity import in total consumption is usually low.)
The share of gas in the primary energy consumption of CEE countries exceeds 25%. In Macedonia, Bosnia-Herzegovina, Slovenia, Lithuania, Estonia, Slovakia, Bulgaria, the Czech Republic, Belarus and Moldova, almost all gas is imported. With the exception of Romania and Croatia, all CEE counties are dependent on gas imports to a large extent. According to energy forecasts, in these countries, the share of gas in primary energy consumption will grow in the medium term. That will increase their import dependence. The marked growth in gas consumption is supported by its environment-friendliness. The adoption of strict EU environmental protection legislation will motivate countries to replace coal - which causes much pollution - with gas.
For most CEE countries, gas pipes lead from Russia. That country is the origin of 75-100% of their gas imports. (Russia’s share in the natural gas consumption of Serbia and Bulgaria is 100%.) In other words, the main supplier has a significant share in imports and in consumption. Dependence is further increased by the fact that in Russia, Gazprom has exclusive rights to export gas2. That company is in majority state ownership, and holds 60% of Russia's and 16% of the world's gas reserves. Russia has one-third of the world’s known natural gas reserves. Moreover, Gazprom controls the world's largest supply network. There are no signs that the Russian government intends to lift Gazprom's export monopoly, although stronger competition among suppliers would probably lower prices.
The unfavourable impact stemming from this situation is somewhat offset by the fact that Poland, Slovakia, the Czech Republic, Ukraine and Belarus fulfil an important transit role in Russia's gas export to Western Europe. These countries have significant revenues from transit fees. Also, the volume of transit supply is expected to grow.
In the case of oil, the highest level of dependence is experienced when a country does not import any oil, because it has no refining capacities at all. Instead of crude oil, Slovenia, Estonia, Latvia, Bosnia-Herzegovina and Moldova import processed oil products, mainly motor fuel. These post-Soviet and post-Yugoslav countries do not have oil refineries. After achieving independence, due to their limited local markets, it made no economic sense to build their own refining capacities.
Import dependence is also significant in CEE countries that have refineries. All these states have imports over 80%, with the exception of Romania (52%) and Serbia-Montenegro (71%). Oil mining on a bigger scale is present only in Romania.
Measures to reduce dependence
Objectives of energy policy in CEE countries are more or less the same as those across the EU. An EU document dealing with energy policy, issued in 1995, has special relevance as regards the current situation. It identified the key objectives of energy policy. It named sustained competitiveness, maintaining energy security and protecting the environment. These objectives continue to be valid.
Import dependence arises in connection with the security of energy supply, as it can cause problems in the supply of energy sources in both the short and long term.
Due to the unfavourable geographic conditions of most countries in the region, domestic production will not provide a long-term tool to reduce dependence on gas and oil or to improve security of supply. Production volumes reveal a declining trend even in countries that have extensive gas and oil reserves.
Also, the ratio of hydrocarbons used in energy consumption is hard to reduce. Increase in coal production is hindered by limited resources and carbon dioxide emissions. More use of nuclear energy is blocked by social resistance.
Renewable energy sources are expensive. The production cost of one kilowatt-hour of electric power is €0.81 from wind turbines, €0.32 on average in gas-fueled power plants, €0.32 in nuclear plants and €0.37 in coal-fueled plants.
But significant gas and oil dependence is not a cause for concern in the long term, taking the volume of global supply into consideration. The sharp rise in oil prices on world markets in recent years is not the consequence of limited supplies. It stems from a dynamic growth in demand, mainly in the US and in China, along with a mismatch between oil types and refinery technologies. Limited refining capacities also play a role. (US and West European refineries are geared to process high-quality, low-sulphur WTI and Brent oil. On the supply side, extraction of low-quality, high-sulphur Saudi Arabian oil is on the rise.)
In Europe, gas reserves outweigh oil stock. Additionally, unlike oil exporters, countries that produce and export gas do not form cartels. So the chances for excess supply in gas is higher than in oil.
Excess supply arises when countries with low costs and vast reserves - which, in European terms, means Russia - increase their production to meet growth in demand, primarily driven by electricity production. Experts on natural gas do not rule out the possibility of excess supply in Europe between 2008 and 2010.
Therefore, the bottleneck is not in supplies, but in the delivery infrastructure, especially in the case of gas where pipes are necessary. The geographical diversification of import sources, lowering the dependence on Russia as the largest exporter, is hindered by the characteristics of the supply network. Gas imports from North Africa and the Middle East are only possible in liquified form. Equipment used to liquify gas, deliver liquified gas, and turn liquified gas back into gas state are very costly. Such investments are not likely to produce a payback, even in the case of regional cooperation. Apart from the expenses, in the case of Poland, Slovakia and Hungary, geographical conditions and the Russian domination of the supply network rule out the possibility of purchasing liquified gas under economical terms.
Exporting gas from Denmark, the Netherlands or Norway is hindered by the characteristics of the European supply network. The existing network connects CEE countries to Russian gas sources. There is no link between the Baltic states and Central Europe, by a narrow definition of the latter, between the Balkan peninsula and Central Europe, and between EU and Central Asia.
In countries that have access to Norwegian, Dutch and Danish gas, import is expensive due to delivery costs. As part of its policy of diversification, Poland buys limited amounts of gas from Denmark and Norway. In theory, Norway could provide the Baltic states with gas, but significant investments would be needed. Also, in Norway, Denmark and the Netherlands gas production is declining, so buying from these countries would not be a long-term solution.
CEE countries are very limited in their ability to reduce their dependence on Russian gas imports. EU forecasts predict a growth in the EU's dependence on Russian gas imports.
In theory, dependence may be reduced by direct foreign investment. However, even if a legal framework existed, companies that are large on a CEE scale are still too small to enter the Russian natural gas sector. Development projects require astronomical amounts of capital. Also, it is very risky to invest in Russian natural gas production as long as the pipe network is owned by Gazprom.
There is a possibility that as a result of the events that occurred in the natural gas market at the end of 2005 and at the beginning of 2006, the role of nuclear plants in energy supply will change. Furthermore, at the end of January 2006, representatives of Poland, the Czech Republic, Slovakia, Austria, Hungary, Slovenia, Croatia and Romania agreed to consider working out a joint plan to reduce dependence on Russian natural gas. Elements of the plan include building gas storage facilities, constructing a smaller intra-regional pipeline network, building terminals in Croatia and in Poland for storing liquefied gas, and accelerating work on the Nabucco pipeline. The latter will link gas sources in the region of the Caspian Sea to a distribution point in Baumgarten in Austria, crossing Turkey, Bulgaria, Romania and Hungary. The biggest factor of uncertainty in the Nabucco plan is political risk relating to former Soviet Central Asian states and Iran, which is greater than in the case of Russia.
Dependence on Russian supplies may be strengthened by the pipeline under the Baltic Sea, an agreement on which was signed in 2005. This aims to create a direct link between Germany and Russia, bypassing the Baltic states and Poland. (Former German chancellor Gerhard Schröder received a place in the management of the German-Russian consortium.
In summary, due to the economic considerations CEE countries are unable to significantly reduce their strategic dependence on Russian gas. New sources are politically more uncertain than Russia. However, no radical decrease in this strategic dependence is needed. That is because the Russian dependence is reciprocal, and most countries in the region are members of the EU, with the rest awaiting EU accession in the future, thus increasing their bargaining power.
Still, diversification and other measures to diminish dependence can mitigate the consequences of short-term supply problems. They also communicate a message: use of the “energy weapon” would be more expensive for the country applying that tool.
As for oil, the supply network built in the COMECON era gives Russia a dominant position in supplying CEE countries. Oil is delivered to Poland, Hungary, the Czech Republic and Slovakia through the "Friendship" pipeline, flowing across Ukraine. As part of their policy for diversification, the Czech Republic and Hungary built a high-pressure oil pipeline in a western direction. Therefore, these countries can import crude via Western Europe, at a premium. Apart from buying oil from Russia, Romania can import from Azerbaijan and Kazakhstan, through its Black Sea ports. The Romanian situation is further tinged by the fact that huge refinery capacities were built in the years of COMECON, which, due to falling demand, are now being operated below optimum capacity.
Certain countries in the region may play transit roles. Bulgaria could have a key role in the delivery of oil from the Caspian Sea, avoiding the overburdened Bosphorus.
Feasibility studies are being run to analyse the possibility of building a pipeline delivering oil from the Caspian to Western Europe, specifically to Thessaloniki in Greece or to Vlore in Albania, or one that would extend from Romania to Trieste in Italy. Poland built an oil terminal in Gdansk, through which oil could be delivered to Germany. Transit delivery is important for the Baltic republics, too. By building a Baltic supply network, they could enable oil imports from Kazakhstan. But Russia's new oil terminal, currently being constructed next to the old terminal in Primorsk near St. Petersburg, could threaten the Baltic states' future transit revenues.
In the case of oil, to achieve diversification of imports, delivery is theoretically possible by rail or sea, as well as by pipeline supply. However, due to high costs, rail delivery in large volumes is not economical. As for delivery by sea, compared to pipeline supply from Russia, oil from the Middle East is less competitive. That is true in terms of both price - Ural oil is cheaper than Brent used in Western Europe - and delivery costs.
An important element of short-term supply security is reserve stock. As members of the International Energy Agency (IEA), Hungary and the Czech Republic participate in a mechanism designed to manage extraordinary situations in energy supplies. One element of crisis management is the obligation to have reserves equaling 90 days' net oil imports. After gaining membership, this will apply to Poland and Slovakia, too. Poland already has significant oil reserves. Although Latvia is not an IEA member, it has the third largest gas storage capacity in Europe. Its reserve represents two and a half years' consumption.
The EU is in the process of preparing legislation on the reserve stocking of gas. The new law would concern the reserve stock that can be used to prevent shortages in crisis situations. A special contradiction is that, while strategic reserves are a large burden on CEE countries, they could prevent shortages only for limited crisis periods. Due to great dependence on a single supplier, the merit of keeping reserve stocks is doubtful.
Import dependence can be best reduced by economizing on energy use, the results of which will materialize in the long term. The energy use required for the production of one unit of GDP can also be reduced by switching to technology-intensive economic growth.
Price and tax systems, too, should serve the purpose of energy savings. Along with ensuring sustainable development, the EU's incentives regarding the promotion of renewable energy resources also aim to reduce import dependence.
International cooperation may contribute to the improvement of supply security, as well. The Energy Charter, adopted in The Hague in 1991, was created with a view to institutionalizing energy relations between Western Europe and the ex-socialist (especially former Soviet) countries, and modernizing energy structures.
An additional objective of the charter was to provide appropriate conditions for Western companies to make investments in the energy sectors of CEE countries. It also aimed to assist the establishment of market economies in the energy sectors of ex-socialist countries.
Finally, through joint action, it strove to increase energy efficiency and improve the protection of the environment. Signatory countries to the charter adopted a treaty in 1995, in which they formulated legally binding legislation regarding the rules on energy trade, competition and investments. Russia has not yet ratified the charter.
An example of regional cooperation is the chapter on economic reconstruction, development and cooperation in the Stability Pact for Southeast Europe, adopted in 1999, based on an initiative from the EU. The European Commission used that as the basis to launch its joint regional market initiative to integrate energy markets.
Countries in the initiative signed a memorandum in December 2003 on the regional energy market of Southeast Europe and its integration into the EU's internal electricity market. That was followed by talks about preparing a treaty on Southeast Europe's energy union. The objective of that was to create a common energy market by harmonizing regulatory and market conditions, and to increase supply security.
In these fields, the region is eligible for funding from the European Investment Bank. Representatives of Bulgaria, Romania and potential EU candidate countries signed the energy union treaty on October 25, 2005.
A special form of international cooperation is the regular dialogue between the EU and Russia, launched in October 2000. This aims to seek new opportunities for cooperation in energy saving, streamlining production and delivery infrastructures, and relations and investments between energy producing and energy consuming countries.
Conclusion: a Hungarian perspective
Energy policy in Hungary aims to create a balance between its various objectives, in line with the concepts Hungary shares with the International Energy Agency, and in compliance with EU legislation.
What are the objectives of Hungary's energy policy?
Firstly, security of supply, to guarantee energy sources of appropriate quality, meeting consumer demand.
Secondly, economic efficiency. There should be a domestic energy market that takes national characteristics into account, operates as part of the single European energy market, is based on market regulations, and serves the interests of economic competitiveness and of customers.
Thirdly, compliance with environmental protection regulations.
In theory, meeting the objectives of Hungary's energy policy objectives contributes both directly and indirectly to the reduction of energy import dependence. This, however, is hindered by a drop in extraction due to the depletion of domestic coal, oil and gas fields. Dramatic depletion of domestic oil and gas reserves is expected around 2010.
Hungary's gas dependence is especially great. The share of natural gas in primary energy consumption is around 40%, second only to the Netherlands within the EU. Imports come from Russia, and according to the contract between Gazprom and Hungarian energy company MOL, Hungary expects to receive an annual 10 billion cubic metres of natural gas by 2015.
In theory, the HAG pipeline, connecting Győr (Western Hungary) to Baumgarten in Austria, could help diversify imports. But even that could only supply Russian gas, at a significant premium compared to direct delivery. Hungary could also connect to the gas pipeline which crosses Slovakia, but again, that would supply Russian gas.
Germany's E.ON-Ruhrgas recently acquired MOL's gas storage and delivery operations. E.ON’s increased bargaining power may, directly or indirectly, contribute to reducing Hungary’s gas dependence or to mitigating its consequences. E.ON-Ruhrgas has some ownership in Gazprom.
In order to reduce import dependence, MOL aims to increase storage capacity. By 2012, the government plans to fill up gas reserves equaling 60 days’ consumption. Legislation requires the building of 1.2 billion cubic meters of storage in Hungary as an addition to the existing 3.4 billion cubic meter capacity. Hungary plans to take part in the building of the Nabucco pipeline, which would bring natural gas from the Caspian Sea region to Europe, and the construction of the liquefied gas terminal to be established on the island of Krk, Croatia.
As the price of natural gas is calculated based on the weighted average price of crude oil over the preceding nine months, the impact of last year’s oil price of around $60 per barrel is being felt in the first half of 2006.
In his visit to Budapest in March 2006, Russian president Vladimir Putin mentioned the prospect of a gas pipeline which would reach Hungary without crossing Ukraine. This would start from the Russian side of the Black Sea and would reach Europe via Turkey. The first section of the Blue Stream pipeline, intended to be a competitor to Nabucco, is operational. It links the Russian distribution point with Ankara under the Black Sea. According to the statements, the northern branch of the pipeline would extend to Austria via Romania and Hungary.
Another prospect that surfaced during the meetings was that Hungary could become a “large distribution centre in Europe”. In relation to that, the building of a “large gas storage facility in Hungary” was mentioned, one that could serve West European consumers. Russia intends to take part in the building of the storage facility, but the conditions are not yet clear.
Furthermore, Hungarian wholesaler MVM signed memoranda with Russian companies.
Over 80% of Hungary’s oil consumption is met by imported oil. The main supplier is Russia’s Lukoil. At the beginning of 2005, Lukoil signed a five-year contract with MOL for delivering 5 million tons of crude oil per year, but it exported 6.4 million tons in 2005.
In theory, oil can be imported from the Middle East via the Adria pipeline. The biggest obstacle is that MOL’s refineries are geared to process Russian oil, and processing other oil would require major investment. Also, Ural type, high-sulphur oil is cheaper than the types used in Western Europe. Buying oil from Russia via pipelines is about 20% cheaper than purchasing from the Mediterranean. As regards the oil industry, which is more liberalized than the gas sector, MOL plans to lower its direct dependence on Russian suppliers through direct investment in Russia.
The ups and downs in Hungarian-Russian political relations after 1989 had no impact on energy imports. But Hungary’s EU accession may have a special double impact.
On the one hand, some aspects of foreign economic policy will be controlled at the EU level. That will limit the room for maneuver in Hungary’s foreign economic policy. Of course, it may increase Hungary’s bargaining power in that Russia will have to talk to the EU regarding certain issues on foreign economic policy.
On the other hand, Hungary’s room for maneuver within the EU may increase through capitalizing on relations with Russia, especially using MOL’s experience, thus establishing Hungary as a mediator in energy policy. Hungary’s increased role in Russia’s foreign economic policy in recent months offers favorable conditions to achieve that.
The article was published in
, a new quarterly focussed on the key political, economic and social developments in Central Eastern Europe.