Re-thinking Europe’s gas supplies after 2009’s Russia-Ukraine crisis

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“The current debate on energy security between the EU and Russia – which has to-date yielded much drama but little success – will remain extremely dynamic and could perhaps help to amplify the debate on global energy governance” in 2010, predicts Anna Aseeva, a graduate of the Geneva Institute of International and Development Studies.

The following contribution was sent to EURACTIV by Anna Aseeva, a graduate of the Geneva Institute of International and Development Studies. 

“In January 2009, the full European Parliament discussed the latest Russia-Ukraine gas crisis. Members from all sides agreed that Russia and Ukraine had forfeited their status as reliable gas suppliers. Given that this statement is dated as of 26 January 2009, the puzzling part of the story is why Russia and Ukraine were not on the European Union’s (EU) list of unreliable energy suppliers already – i.e. why weren’t they placed there after the first ‘gas war’ in January 2006? 

The answer is obvious. The problem that Europe faces is that, for the moment, there are very few alternatives to buying Russian gas. According to the International Energy Agency (IEA), the EU imports 50% of the energy it consumes, a figure that could rise to 70% by 2030. About 44% of all imported gas comes from Russia (16% from Norway and 15% from Algeria; the rest comes from Central Asia, Libya and Nigeria). 80% of that Russian gas goes through Ukraine. 

The situation worsened last summer after the Russia-Georgia conflict, which affected the traffic of the Caspian pipeline, Baku-Tbilisi-Ceyhan (BTC), running through Georgia from Azerbaijan to Turkey. The South Caucasus pipeline, Baku-Tbilisi-Erzurum (BTE), which runs from Azerbaijan through Georgia, still sends very limited quantities of gas to Europe. Meanwhile, the Nabucco pipeline, which is supposed to transport approximately 31 billion cubic metres of gas annually from the Caspian Sea to Europe in 2020, is still under construction. Apparently, it’s time for Europe to re-think its gas supply. 

At the outset, it is worth mentioning that there are two explanations for Russia’s behaviour in Ukraine. The first is the ‘commercial’ interpretation, which views the conflict as a commercial dispute. According to this explanation, Russia – during the height of its command-economy era – priced its natural gas sales to the former Soviet republics and former Eastern European satellites at levels that were well below market prices. As Gazprom (Russia’s state-owned natural gas monopoly) gradually liberalised and integrated into free-market economy relations, it started to generate its revenues more and more from exports, and less and less from the old price-controlled sales. It therefore acquired a strong interest in raising prices for its former political customers up to market levels. 

But attempts to raise prices in Ukraine have been met by Ukrainian refusals to pay bills. Hence, Gazprom has done what any commercial entity would do when a customer refuses to pay: it has shut the customer off. While the ‘commercial’ argument may have been relatively credible between 2006 and 2008, recent developments – particularly the fact that price increases seem to have been concentrated on politically difficult governments – make it harder to accept at present. 

The second explanation is a ‘strategic’ argument. This view deems Russian behaviour in Ukraine to be politically motivated – a kind of censure for the Ukraine’s flirtation with the West through its interest in NATO. The Russia-Georgia conflict, which affected the traffic of the BTC, only seems to have strengthened this hypothesis. 

In sum, perhaps the truth lies somewhere in between benevolent and malevolent interpretations. Indeed, Gazprom seems to behave as any other commercial entity would in such a situation. Yet at the same time one should bear in mind that such state-owned companies as Gazprom and Rosneft can also be influenced to some extent by the course of Russian foreign policy. This influence may be exerted partly through the state’s controlling share in those companies (which directly affects the composition of their boards) and partly through informal pressure. 

Thus, four alternatives of gas supplies were discussed by the European Parliament and academia in January 2009: namely, South Stream, Nabucco, Nabucco-Light, and Liquefied Natural Gas (LNG). Each of these four alternatives will be briefly analysed in turn. 

South Stream

This project was launched in 2007 by Italian company ENI and Russian giant Gazprom. According to the latest updates on the pipeline’s official website, it is nowadays designed to transport 63 billion cubic metres of Russian gas annually to Europe. In 2009 it was expected to connect Russia to Italy. On 6 August 2009, Turkey and Russia signed the agreement allowing the pipeline to go through the Turkish waters of the Black Sea. 

The project could allow Gazprom to control gas fields in the Caspian Sea and Kazakhstan, particularly if attempts by the United States and the EU to expand the alternative pipeline Nabucco (which excludes Gazprom’s participation) should fail. 

Its main disadvantage is that it would run 900km along the bottom of the Black Sea at depths of 2km – a very expensive technology. With an estimated cost of EUR 15 billion, the project must somehow be made economical. 

Two scenarios are possible here – a monopolist situation and a free-market one. A monopolist might be able to pass the project’s costs on to his customers. Hence, from a monopolist point of view, the simplest way to do this is to increase gas prices. It appears that the eventual burden would lie on European gas consumers. Taking into account the two above interpretations – ‘commercial’ and ‘strategic’ – of Russian behaviour, even these monopolist observations could be explained alternatively by either of them but from different angles. 

Following the ‘commercial’ argument, Gazprom is merely trying to avoid untrustworthy customers. However, from the ‘strategic’ point of view, Gazprom’s plan aims to avoid precisely – and only – those former Soviet republics and former Eastern European satellites that are clearly pro-US. Consequently, in monopolist situation the EU would be paying heavy costs for a new pipeline just because Ukraine and Gazprom cannot find common ground. A counterargument asserts that in a competitive market, such unnecessary extra costs would have to be borne by the seller, since prices would be set in the marketplace. In addition, current markets seem to suggest that it would be very difficult to pass the excess costs from South Stream on to customers. For example, in 2008 Gazprom finally gave European market prices to Turkmenistan and Kazakstan, thereby reducing their incentive to find a non-Russian outlet. 

Nabucco

The pipeline aims to transport gas from the Caspian region to Austria, across the Turkish-Georgian and the Turkish-Iranian borders. The gas would be transported via Turkey, Bulgaria, Romania and Hungary. According to the project’s official website, its approximate cost is EUR 7.9 billion. Contrary to its rival South Stream, Nabucco will run essentially on land. 

Yet apparently the reluctance of the private sector to finance the project on the one hand, and the August 2008 conflict between Georgia and Russia on the other, have created a funding problem for Nabucco. The shortfall is large enough to make the future of the project doubtful. 

However, in doing a basic cost-benefit analysis it seems that private investors are at present reluctant to finance the project not due to the instability of the relevant regions and/or the uncertain legal status of the Caspian Sea, but for a very practical reason: no pipeline can be financed without “through-put agreements” – agreements that oblige the shipper to pay debt service on the line regardless of how much it is used. 

The problem is that there is not enough gas supply to keep the pipeline filled and thereby make it economical to operate. In short, in addition to the lack of financing, the pipeline does not appear to have enough gas sources – contrary to its competitor South Stream. 

Nabucco Light 

This project is supposed to involve the use of the existing South Caucasus Pipeline (SCP) and Turkish pipeline systems to deliver Central Asian gas to the EU. By extending the Turkish-Greek Interconnector to Italy and improving the transit capacity of the pipelines, it is expected that more Central Asian gas could be carried to Europe. 

According to some European energy experts, this project’s probable advantages are the following: it would likely bring Central Asian gas to Europe more quickly; it would probably be cheaper to implement than building the Nabucco pipeline; and it could be developed to a greater degree in tandem with emergent gas supplies. The counter-argument to these presumed merits is that it is still too early to evaluate whether Nabucco Light is truly the “cheaper route option” posited by European academics and MEPs. At present the project is still in the planning phase. The costs of transit through Turkey and Greece, along with corresponding contractual guarantees, would need to be negotiated first. 

To summarise, the EU is apparently facing the choice between South Stream, which could provide gas in sufficient quantities but mainly from Russia, and Nabucco or Nabucco Light, which would transport perhaps much less gas but from Central Asia. On the other hand, one could presume that both Nabucco and Nabucco Light are only jokers, which the EU uses in order to have enough bargaining power in energy negotiations with Russia. 

Regarding the LNG option, this consists of the delivery of gas in liquid form, via ship, to LNG re-gasification facilities in Europe mainly from a LNG liquefaction plant in Turkey. This method would require the extension of the SCP gas pipeline to the port of Ceyhan on the Turkish coast. As some European energy experts correctly note, this solution would be costlier for Europe than would Nabucco. It is worth adding that the LNG option would be even costlier for the EU than South Stream on account of two underlying difficulties. 

First, there would inevitably be high fixed costs involved in the provisioning of a large number of gas carriers and the development of the entire infrastructure of special landing terminals; and second, the system of long-term contracts and their constant renewal would need to be set up. 

Though the LNG option is quite complex and thus controversial, it presents not only difficulties but also numerous merits. Indeed, for coastal regions, such as the Mediterranean countries and the Low Countries, under certain circumstances LNG may be even more financially viable than pipeline supply. 

On the contrary, LNG does not help landlocked Central Europe except as it replaces more distant pipeline movements to Northwest Europe. In an optimum economic world, a combination of LNG and pipeline supply would be an ideal solution. In addition, European LNG imports are up substantially and Gazprom’s deliveries are way down. In fact, some of Gazprom’s customers have gone into take-or-pay obligations (a specific provision, inserted into a contract, binding that one party has the obligation of either taking delivery of goods or paying a precise amount specified in the provision), preferring alternative supplies in a soft market and willing to make cash payments for gas not taken. 

The fact that Gazprom appears to be willing to ignore take-or-pay obligations in order to maintain the goodwill of its European customers implies that the commercial interpretation of the Russia-Ukraine crisis is not totally unreasonable. 

Last but not least, it is worth mentioning recent progress on another Russian joker that is quickly becoming reality – the Nord Stream gas pipeline. 

However, here the word ‘joker’ has a different meaning than previously (namely regarding Nabucco and Nabucco Light): through a free-market prism Gazprom’s investments are designed to demonstrate to the EU – at Gazprom’s charge – that it is a reliable supplier, despite its troubles with Ukraine. 

Although the Nord Stream option was not considered at all by MEPs and academics in January 2009 (because it is obviously not a coherent alternative for the EU as a whole) it deserves a brief overview. 

Next spring the first pipeline segments will likely be dropped to the sea floor and the pipeline will run through Russian, Finnish, Swedish, Danish and German waters. Nord Stream will transport up to 55 billion cubic metres of gas each year. Its cost is finally fixed at approximately EUR 8.5 billion. Nord Stream clearly reflects Germany’s individual line, namely, that it is supporting Russia in this quite geopolitical project, as the pipeline would bring Russian natural gas across the Baltic Sea directly to Germany. 

Even pro-Western current Chancellor Angela Merkel stated in a letter to the president of the European Commission: “The Nord Stream and the South Stream are necessary to satisfy Europe’s demand for gas. It is essential that the projects are supported by all the EU countries”. No sooner said than done. The key littoral states of the Baltic Sea – namely, Finland, Sweden and Denmark, which had usually been sceptical about the pipeline – finally signed off on the project on 5 November 2009. The fact that some bullying was necessary to bring these states in line seems to reinforce the established assertion that for the moment there is unfortunately no European unity on energy security. 

Again, taking into account the prospect that Nabucco is not economically realistic, and if the Germans or Scandinavians believe that it is not, what is their incentive to overlook their own national interests? Thus, to date sovereign, namely economic, interests of individual European states appear to prevail over a united European security position. As to the observation (made in relation to the South Stream project) that at present Russia seems to have a firm intention to avoid transit through countries with ‘unfriendly’ governments, recent Nord Stream developments bear this out. The pipeline now bypasses Ukraine, Belarus, the Baltic states and Poland. 

In conclusion, it is expected that the current debate on energy security between the EU and Russia – which has to-date yielded much drama but little success – will remain extremely dynamic and could perhaps help to amplify the debate on global energy governance. This could provide an additional basis for further discussions regarding the future bilateral framework in the field of energy, to be discussed under the new EU-Russia Partnership and Cooperation Agreement (PCA).” 

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