Oil and Gas in the Capitals

	Vol. 230 No. 4
ØYSTEIN NORENG, CONTRIBUTING EDITOR, NORTH SEA

Europe’s natural gas worries: A tripartite mess in two ways  

The winter 2008–2009 natural gas crisis, as Russian gas supplies through Ukraine to Europe were halted, reveals weaknesses in the energy policy of the European Union. The EU not only suffers from disagreement and rivalry among 29 member states, but also between the various branches of the Brussels-based European Commission. Indeed, in the EU, energy is a matter of responsibility for at least three directorates-general: the Competition Directorate (DG-COMP), the Transportation and Energy Directorate (DG-TREN) and the External Relations Directorate (DG-RELEX).

With regard to natural gas, DG-COMP is responsible for ensuring competition in the gas business among member countries, DG-TREN for ensuring physical supplies, and DG-RELEX for relations with suppliers in the Middle East, Central Asia, the Caspian, Norway, Russia and North Africa. The three directorates do not always coordinate their actions. Enforcing competition in gas markets compromises security of supply based on long-term contracts. Safeguarding supplies involves political relations with exporter and transit countries. Here, the EU institutions and politicians have failed.

The recent gas crisis should have come as no surprise. Gas prices in the continental European market are subject to regular revision. Prices are mostly indexed to those of crude oil and fuel oil, but with a time lag of 6 to 12 months. Consequently, the steep oil price rise of 2007–08 subsequently raised contractual gas prices to continental Europe. For Ukraine, the major transit country, the burden was compounded by Russian insistence on prices adjusted to the European market, no longer granting preferential ex-Soviet Union discounts. Ukraine evidently had problems not only paying new, higher gas prices, but also settling outstanding (undisputed) debts for past supplies.

Even though an agreement has been reached and gas flows have resumed, the underlying insecurities are still present, which is risky for all three parties.

The crisis revealed the vulnerability of the EU gas market. The dependence on single sources and transit routes enhances the supply risk. As a rule, an open market with equal access to infrastructure is better able to secure supplies than a market fragmented by bilateral deals and restricted access to pipelines. This argument should strengthen DG-COMP, but DG-TREN needs to enforce the completion of a gas trunkline network throughout the EU, better diversifying sources and spreading the supply risk more evenly and more thinly.

It is remarkable that DG-TREN did not, as far as is known, make any moves to preempt the recent gas crisis. Apparently, the understanding was that business would go on as usual, regardless of the price revision. Better foresight might have inspired DG-TREN to contact Russia and Ukraine by summer 2008 to facilitate a tripartite understanding.

Furthermore, DG-TREN might have engaged DG-RELEX in a comprehensive approach to both countries. The EU has an evident interest in good relations between Russia and Ukraine to secure its own energy supplies. This approach was out of the question, however, in the aftermath of Russia’s short war with Georgia, during which political discourse was about an allegedly aggressive Russia and the need to get Ukraine into NATO, and possibly also the EU. Russia’s response was to demand European market prices for deliveries to Ukraine as well as the immediate reimbursement of outstanding debt, and it enforced the claims by physically cutting supplies. Remarkably, this seems to have surprised those who had evoked the specter of a hostile Russia. From a geopolitical perspective, the crisis was a sign that Ukraine’s position between the EU and Russia is unsettled; with Ukraine firmly tied to either, the crisis would hardly have occurred.

The EU, Russia and Ukraine are locked into a tripartite relationship; they depend upon each other and can harm each other, but at a cost to themselves. By shutting off gas, Russia did considerable harm to its EU customers as to Ukraine, but it also lost revenues and in the longer run compromised its position in the EU energy market by appearing unreliable. By not accepting Russia’s demands and causing the interruption of gas flows, Ukraine harmed Russia as well as the EU customers, and it hit itself by suffering an energy shortfall, compromising its long-term position as a transit country. Through its passivity and lack of foresight, the EU harmed its importer and consumer interests.

One way out for the EU would be to improve relations with Russia and facilitate the construction of new direct pipelines circumventing Ukraine, Belarus and other potential transit countries. This seems to be the preference of the major European energy companies. More direct deals would strengthen Russia’s position and make Ukraine a less crucial transit country to the EU. The Eastern Europeans, who depend on Russian gas, are opposed.

Another way out would be to put a ceiling on EU dependence on Russian gas and instead give preference to supplies from Iran, North Africa, Norway and overseas by LNG, as well as boosting nuclear power. This would strengthen the bargaining position of Algiers, Oslo and Tehran, and the shipping community. It is favored by the Eastern Europeans and by cold-war nostalgics.

A third way out would be to develop more comprehensive relations with Russia, balancing Russia’s needs for export revenues with Europe’s interests in the Russian market for industrial goods. Closer economic integration might yield considerable synergy gains, and would make the Ukraine issue less divisive. This solution seems to be the preference of the European business community, particularly in Germany. Increased integration  would hopefully also favor political integration. It would be compatible with US President Barack Obama’s new policy of engaging Russia. Eventually, if the EU institutions fail in this respect, leading member states would most likely take the initiative. This would confirm Germany’s position as the chief driver, not only of Europe’s economy, but also of its foreign policy. With US assistance, Germany might overcome Eastern European opposition to closer links with Russia.     

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