This article is part of our special report EU-Ukraine Relations.
Central and Eastern European gas markets have long suffered from isolation and fragmentation, leaving them vulnerable to both supply disruptions and to monopoly pricing power. However, new research suggests that countries collectively negotiating with gas exporters could remedy this problem, argues economist and energy researcher Edward Hunter Christie.
This commentary was authored exclusively for EURACTIV by Edward Hunter Christie, an economist and Research Partner with the Pan-Europe Institute at the Turku School of Economics (Finland).
"In a recent research report financed by the Austrian Ministry of Economy, 'Vulnerability and Bargaining Power in EU-Russia Gas Relations', I explore three topics that are of interest with respect to security of natural gas supply for Central and Eastern European states.
The first topic concerns vulnerability to physical supply disruptions and the economic case for building infrastructure that reduces that vulnerability.
The second topic – which I tackled jointly with Pavel K. Baev of PRIO (Norway) and Volodymyr Golovko of the Center for Political Analysis (Ukraine) – concerns Ukraine's new relations with the Russian Federation under President [Viktor] Yanukovych, and to what degree Ukraine has been able to translate core national interests into clear policies.
The third topic concerns monopoly pricing power and an economic assessment of what could happen if small, isolated importers of natural gas were to join forces and bargain jointly rather than separately with Gazprom.
The Bulgarian economy suffered from a shock of around 0.35% of GDP due to the January 2009 Russian supply cut. Given that the disruption lasted only two weeks, this would roughly equate to a shock of 9.1% of GDP for the duration of the cut.
Such a degree of vulnerability is clearly unacceptable, and a substantial policy response has taken place, notably at the EU level through the European Energy Programme for Recovery (EEPR), which has already provided decisive levels of EU co-financing for gas interconnectors in Southeast Europe.
As very aptly noted by Dr. Theodoros Tsakiris […] last December ('Balkan gas inter-connectors progress as Borissov grows wary of Nabucco'), new LNG import capacity in combination with a network of interconnectors in the region is the 'cheapest, fastest and most geopolitically risk-free means of limiting the region's dependence on Russian gas imports'.
Moreover. EU co-financing of such projects seems fully justified. It is the best way to overcome the fragmented incentives of national actors in the region while the benefits of market integration and diversification benefit the region as a whole.
The same reasoning should by extension be applicable to the Baltic region, where a similar pattern of market fragmentation is in evidence. EU policymakers should not drop the ball on this issue. It is a European success story in the making.
While gas systems in Central and Eastern Europe should gradually become more integrated and more resilient, a key question remains on the table, namely that of the future of Ukraine as a major transit corridor for Russian gas supplies to Europe.
The administration of President Yanukovych has been subjected to sharp but justified criticism, not least for selective usage of the justice system to shut down political competition and for attacks on the freedom of the media. Corruption also remains at very high levels.
Ukraine's national interests in terms of its external energy policy are, however, well understood by the Yanukovych team. They include: obtaining the cancellation of the South Stream project, attracting investment in Ukraine's Gas Transmission System, securing lower import prices for Russian gas, developing an LNG terminal and expanding domestic gas production.
On the domestic front, domestic gas price reform is gradually taking shape thanks notably to IMF conditionality. This could, with time, open the door towards a more competitive and energy-efficient Ukraine. From the EU perspective, the main lesson is that conditionality can bring positive results.
The third and final topic in the report addresses the concept of 'buyer alliances' for natural gas. The Jacques Delors proposal for a European Energy Community mentions two proposals in that direction: an EU gas purchasing agency or, at a more immediately approachable level, gas purchasing groups. I decided to assess the economic case for the latter using an established theoretical model of bargaining power from the economics literature.
The idea is that two small isolated importers of natural gas facing the same external (monopoly) supplier would cease to negotiate separately for their supply contracts but would join forces instead. Concretely this would mean having a single negotiating team negotiating for the joint delivery volumes for a single (common) import price.
The indicative results from the analysis are thought-provoking. While the profit margins of the importer companies might fall, the average import price typically falls, thus suggesting gains for the consumers at the expense of their national gas companies. Moreover the gains are higher still if one of the importing companies in a buyer alliance simultaneously succeeds in diversifying supply sources.
In that case what happens is that the gains from diversification are transmitted throughout the alliance, rather than benefitting only the company that diversified. This implies that it would be highly beneficial to form such alliances while simultaneously proceeding with shared diversification projects (e.g. a common LNG terminal).
The gains from a buyer alliance operate through the fact of imposing a common import price and of presenting a consolidated demand function. This suggests interesting complementarities with physical interconnection. Ultimately, a combination of those mechanisms may be considered for groups of countries within Central and Eastern Europe."