EU energy security beyond Ukraine: towards holistic diversification[1]

Filippos Proedrou

Abstract

The aim of the article is to explore the risks emanating from the EU’s gas security architecture, based on the twin pillars of diversification and enforced interdependence, in the context and aftermath of the crisis in Ukraine. Interdependence with external suppliers has been hit hard by the diversification rhetoric and rationale and given a crucial blow with the fallout in Ukraine and Russia’s opening to the East. Diversification, on the other hand, has added resilience to the EU gas market, but far from ensures the EU’s gas security in the mid- to long-term. The article thus argues that energy security is in need of a broader and more pragmatic understanding of diversification that will critically expand to renewables, energy conservation and efficiency. The pressing sustainability needs add further urgency to the switch from supply- to demand-side energy policies.

Keywords

Russia, interdependence, diversification, single market, sustainability, demand-side policies

  1. Introduction

Energy security has been at the forefront of EU policy-making for a decade now after a substantial period when it was taken for granted. In order to make sense of the goal of energy policies, i.e. energy security, it is essential to see the term as consisting of three concrete, but inherently interconnected, dimensions. The first and most important is security of supplies, meaning that adequate quantities of energy that meet consumption needs enter the market. The second is that energy is not only adequate, but also affordable. It is important to note that affordability is a very relevant term that assumes different content in different contexts. Although energy prices have gone up substantially since 2003, the overarching goal of security of supplies has been met, even at a higher price for households, companies and industry, and, as a consequence, for the competitiveness of the European economy. Thirdly, energy security encompasses all the more a sustainability component, referring mainly to a state of energy sufficiency and affordability that does not come at a significant environmental cost. The primary concern here has traditionally been accidents at refineries, tankers and nuclear factories, and oil leaks at various stages of the market chain. Although numerous such mishaps have taken place, security of supplies has persisted. The sustainability pillar is nowadays ultimately linked to resource scarcity and climate change, which obviously casts doubt on the validity of the existing energy paradigm.[2]

The aim of this article is to discuss the fruitfulness and efficiency of the EU energy strategy in achieving security of supplies in the gas sector. It delineates the fundamental policies of the EU gas security strategy, discusses their linkages and trade-offs, and examines them under the new context created by the EU-Russia fallout in Ukraine. In doing so, it draws from mainstream energy security literature that focuses on supply-side policies, political and economic ties with exporters and market-competition mechanisms, and explores the EU’s gas security architecture that is centred upon the supplementary, but also antithetical, policies of enforced interdependence and diversification. After examining the merits and deficiencies of the traditional importers-exporters relations, it adopts a wider understanding of diversification supplemented by the deregulation project, arguing that the pursuit of more suppliers/ routes/ sources is congruent and intertwined with the project of a single, market-based energy space for the EU. The article locates the vulnerabilities and risks inherent in the current gas architecture, which are amplified with the Ukrainian crisis, and, drawing from the ecological economics literature, suggests a broader understanding of diversification that shifts emphasis from supply- to demand-side policies. The EU’s gas architecture, it is argued, should extend well beyond the goal of multiple gas suppliers through multiple routes of supply, to a significantly diversified, ‘green’ and efficient energy mix.

EU energy security strategy is understood as the sum of member-state policies at the national level (e.g., selection of energy mix, relations with certain suppliers), as well as policies at the Community level, such as legislation on the single energy market, competition rules, a stronger supervisory role for the Commission etc. The Lisbon treaty has rendered energy security a shared competence, and thus it can only be examined under the dual lenses of member-state and community-level policies. It should not be lost that these actors work together with, and under the pressure of, energy companies that aim at profitability in the gas business, as well as under external constrains, such as the regional and global gas markets, wider political developments etc.[3]

The article proceeds as follows. An in-depth discussion of diversification and enforced interdependence ensues that highlights their weaknesses and strong points. Next, we turn to explore the short- to mid-term repercussions of the crisis in Ukraine to Europe’s security of supplies. The third chapter suggests an imporoved policy framework informed both by the theoretical discussion of the first chapter, as well as the empirical one of the second.

  1. EU gas security architecture: Diversification vs. enforced interdependence

Security of gas supplies has traditionally been pursued through long-term take-or-pay contracts with big gas producers such as Russia, Norway and Algeria. Due to the nature of the gas market, where gas is mainly transported through pipelines and thus suppliers and consumers are bound in an interdependent relationship, clinging into certain producers made a lot of economic sense. Neighboring Soviet Union and Russia was a perfect fit for central and eastern Europe; Norway for northern Europe; and Algeria for southern Europe. It should not be forgotten that initially contracts with these producers were diversification moves away from turbulent and increasingly unreliable Middle East and OPEC exporters.[4]

Once the initial contracts were signed and the infrastructure established, furthering and deepening these relations seemed mutually beneficial. As a result, contracts were renewed at higher volumes, and new infrastructural capacity was added to the evolving gas trade between regional gas exporters and European member-states. Security of supplies was served by the strong mutuality of interest between sellers and buyers that became interdependent (even if at many cases asymmetrically) for energy imports and markets/ revenues. From the importers’ point of view, binding suppliers further into the European market seemed essential in the face of high gas demand growth. This policy was given further impetus bythe evolving LNG technology that created the dynamics for a gradually globalizing gas market and could thus tempt gas exporters away from the European market for economic, political and tactical reasons. Enforced interdependence thus became the cornerstone of the growing European gas market.[5]

At this point, it is important to broaden our analytical focus. It was not only states, but also companies, both public-owned, state-supported national champions and private energy enterprises that were in search for suppliers/ markets. Thus, when talking about the special Russo-German relations, for example, one should include the role of big energy companies such as E.ON Ruhrgas and Wintershall. In the same context, the role of French Total, Austrian OMV and Italian ENI in fostering close ties with Gazprom should also not be forboden.[6]

The enforced interdependence pillar of energy security was challenged by the competition and diversification rationale of the European Commission and various member-states.[7] Starting with the latter, diversification translates into having diverse sources of energy, diverse suppliers, as well as diverse routes of supply. In this context, a balanced energy mix and import portfolio ensures that any shortages emanating from one source or supplier through a certain route can be easily replaced by an equivalent increase of the rest of the sources/ suppliers. In fact, turning to gas in the 60s served as a first step to diversify the energy mix and acquire energy at low prices, a policy that came into full strength since the 70s and the energy price hike after the OPEC embargo. Nevertheless, a diversified import portfolio in the gas market seems highly problematic in the face of a shortage of abundant external suppliers. Besides the three main gas exporters to Europe, gas can reach the European market from a number of exporters albeit not at big volumes, preferential prices and right away. In particular,

  • Libya and Egypt supply the EU gas market albeit at small quantities.
  • Azerbaijan is gradually emerging as a fourth supplier, but its market share remains one-digit. The scheduled construction of the Transadriatic (TAP) and Transanatolian (TANAP) pipelines may increase the quantities of Azeri gas entering the European market, albeit the initial predictions of the 90s remain far from materializable for the near future.
  • Eastern Caspian gas remains landlocked and thus, for the mid-term, cannot reach European destinations.
  • European states import LNG from distant exporters, but once again this does not amount to very much. Shale gas loads can arrive from the US no sooner than in a couple of years’ time. Potential buyers, nonetheless, will have to compete with the high prices Asian importers pay.
  • Eastern Mediterranean gas could increase gas supplies, but further explorations and decisions on infrastructure will determine volumes and prices in the next years.[8]

The diversification rationale, however, goes much deeper. It is embedded into the architecture of an integrated European energy market. In particular, since the Single European Act and the completion of the common market in the mid-90s, the emphasis has been on integrated, single, competitive markets. This was far from the case in the energy field, where nation-states carved out bilateral deals with exporters in order to meet their energy needs. As a result, we could talk of exclusively national gas markets that functioned isolated from one another. Monopolies and monopsonies were running the market; space for alternative market players and the dynamics of competition were almost absent in most EU member-states (excluding Britain and the Nordic ones). The Commission legislation (directives on the electricity and gas markets, the Third Energy Package) paved the way for the creation of a single regulatory framework in the European gas market that would allow for market forces both to work against monopolies and ensuing artificially set high prices in isolated markets, as well as facilitate security of supplies from diverse suppliers.[9] The Third Energy Package, in particular, through the unbundling legislation and the enforcement of the third party access clause in gas infrastructure aimed to introduce mandatory diversification into the EU gas market. The goal was to belittle the power of external suppliers by means of allowing for market forces and competition to function and, this way, to enhance security of supplies.[10] The European Commission has, indicatively, been successful in this in the case of Nord Stream. The pipeline that came into stream as recently as 2011 and connects directly Russia with Germany carries Russian gas at a bit over half its total capacity of 55 billion cubic meters (bcm). This is so due to Gazprom’s obligation to allow space in the grid to third suppliers and the parallel reluctance of the European Commission to allow a 100 per cent exemption from the third party clause.[11]

This deregulation policy overturned the prevailing order of the gas market in Europe and undid the fundamentals of security of supplies. Unsurprisingly, it met with fierce resistance from a number of actors: incumbent gas companies, member-states and gas exporters to Europe. At a theoretical/ rhetorical level, dividing lines were created. On the one hand stood most central and south European states that theorized energy security as a public good and hence believed politically-mediated, state-to-state deals were the best means to enhance security of supplies. On the other hand stood the northern states that liberalized their markets even before the Commission legislation, in the understanding that energy is a market product and security of supplies can best be served through market mechanisms of competition, supply and demand.[12]

These two worlds have converged, but not entirely, in a hybrid gas market (Stern, 2014) with the folowing characteristics:

  • Oil-linked long-term contracts have persisted as the main contractual means. Their duration, however, has been scaled down significantly, in order to allow for adequate quantities to enter liquid gas markets, where prices are not oil-linked, but set through gas supply-demand considerations.[13]
  • Within the policy framework of a unified gas market, destination clauses attached to these long-term contracts have been abolished, allowing intra-member-state gas trade of excesss quantities to take place.[14]
  • A remnant of the Cold war, a clause according to which no member-state was allowed to get more than 30 per cent of its gas supply from Russia, was abolished in the face of the eastern enlargement of 2004. A supply shortage was thus averted for a number of ex Soviet socialist republics and satellites that get their gas mainly, if not exclusively, from Russia.[15]
  • The unbundling regulation, which mandated for the division of supplier and transimission companies, as well as the third party access clause which obliges pipeline operators to allow free space for multiple suppliers to ship their gas through the grid, further curtailed the leverage of gas behemoths in the gas market forcing them to step back from their quasi-monopolistic position.[16]

All these moves constitute significant built-in diversification dynamics that have contributed to the resilience of the European gas market in two distinct ways. Firstly, a large, interconnected gas market has been created that currently benefits from a gas glut and the boost of US shale gas exports in the form of lower gas prices in European gas hubs. These developments also place downwards pressures in prices in oil-linked contracts through renegotiated terms.[17] Secondly, interconnections provide a shield to consumers against shortages that may emerge in specific national markets that up to now could not be supplied by fellow member-states.[18] This is extremely important for eastern EU members, which fear Russian belligerent tactics and have suffered supply cuts in the past. Interconnectivity with central Europe, supplemented by the new EU-wide gas regulation that mandates solidarity in the event of an energy crisis, strengthens security of supplies in the vulnerable eastern frontier of the EU.[19]

Nevertheless, the merits of these policies can only be seen in case overall supply meets overall EU demand. The emerging uncertainty is whether the EU will be in a position to acquire in the short- to long-term the gas quantities it will need. For example, while the third party access clause prevents Gazprom from using the whole capacity of Nord Stream, the remaining capacity remains idle, since no other supplier is in position to ship its gas through it. This does not amount to a very efficient solution. To put it in other words, in the absence of a number of significant gas exporters in the EU, the danger persists that the European market may be well regaluted, but short of gas. This is so, to sum up, due to intensified global competition for resources; the absence of reliable regional suppliers besides the main three; and, last but not least, the contractual constrains the European liberalization project inflicts on its external suppliers. The Ukrainian crisis adds a number of further risks, to the study of which we now turn.

  1. The fallout in Ukraine and its impact on EU-Russia energy relations

Although the European gas strategy in practice revolves around close ties with big gas exporters, especially Russia, its rhetoric heavily underlines its intent to diversify its import portfolio. This can be explained in terms of a strong aversion against high dependence and subsequent vulnerabilities, underpinned by political considerations. At the same time, the diversification rhetoric highlights fears that Russia itself could proceed to diversify its export markets thus not fulflilling European gas needs in the near future. Although justified, however, the diversification rhetoric has reasonably pushed Russia to seriously consider diversifying its export portfolio. It is for these reasons that we can talk of an EU-Russia energy security dilemma[20], in which the fear that one may diversify against the other leads the other to think and act in similar ways. Thus far, as we saw in the previous chapter, the reality of stable, strong ties with Gazprom weakened European resolve to diversify away from Russia. The diversification rhetoric thus remained a mere nuisance to Moscow, since diversification remained by and large unmaterialized.