Energy comprises a rather specific area of interstate cooperation, and this is especially true of relations between Russia and the European Union.

This reality is rooted, first, in the fact that stable energy supplies are vital for the development and prosperity of a state, being an essential component of energy security.

Second, energy has an immense potential for integration. In fact, it underlies the formation of the European communities because at the time of the signing of the European Coal and Steel Community Treaty in 1951, coal accounted for 80 percent of the energy balance in the European countries. Furthermore, the production and transportation of natural resources requires considerable investment and capital-intensive infrastructure, which for their part stimulate the signing of long-term contacts between consumers and producers. Finally, relations in the energy sphere can lay the groundwork for long-term contacts in other sectors of the economy, as well as in the realm of politics.

Third, there is a direct interdependence between the EU’s demand for hydrocarbons and Moscow’s need for revenues from the sale of energy resources (the EU buys over 50 percent of Russian oil exports and more than 60 percent of Russia’s natural gas exports). This factor substantially alters the traditional lineup of forces and economic relations between the two parties. In the normal course of things, the EU tends to take an arrogant, condescending view of economic relations, as it attempts to impose its own rules of the game both at the bilateral and multilateral level. Although the EU has made such attempts in the energy sphere, its approach has been rather low-key, while Moscow’s reaction has been fairly tough. Over the past six years, the possibility of signing a separate energy treaty has been mulled continuously.

The above factors explain the high priority that is given to Russian-EU energy relations, especially now that they have fallen on hard times. 

BATTLES ON THE ENERGY FRONT

One indication of the worsening relationship between Russia and the EU in the energy sphere was the April 2006 standoff between the Russian energy giant Gazprom and the UK (EU).

In early 2006, Gazprom had stated it was interested to buy the UK gas supplier Centrica, as well as Scottish Power, an international energy company. Centrica share prices jumped, but the prospect of a Gazprom acquisition worried London. Thus, after several rounds of consultations, it was decided to adopt special legislation to prevent the acquisition of UK enterprises by the Russian company – for energy security considerations. (In 2003, a law was adopted in the UK under which the government may not block a merging of companies or their takeover on the British market for political considerations.)

The disclosure of these measures by The Financial Times predictably provoked a harsh reaction from Gazprom. At a meeting with the ambassadors of EU member countries in Moscow, Gazprom CEO Alexei Miller said his company did not want to face artificial obstacles on the European market that are based on considerations of political expediency. Otherwise, Miller warned, the growth of energy deliveries to Europe would decrease, with Gazprom gradually reorienting itself toward China and the U.S.

A retaliatory response was not long in coming. The European Commission stressed that the EU would not tolerate threats and expected contractual obligations to be met in full. At the same time, it pointed out that Gazprom was free to diversify its deliveries for commercial purposes, but its behavior had once again confirmed European concerns about the stability of supplies from Russia and therefore the need to diversify channels for the delivery of natural gas, as well as natural gas suppliers. Javier Solana, EU High Representative for the common foreign and security policy, drafted a paper entitled “An External Policy To Serve Europe’s Energy Interests.” British Prime Minister Tony Blair, however, said that no one would place obstacles against the Russian company on the UK market, and the conflict was resolved.

The idea of Gazprom moving into the distribution sector arose from the liberalization of natural gas and electricity markets. One outcome of the EU energy sector reform was the abolition of the “destination clause” in Gazprom’s long-term contracts with European gas companies, i.e., the territorial proviso, which does not allow for the re-export of gas. Different gas prices for different European consumers (depending on the distance of transportation) could have led to a situation in which Gazprom products would have started competing with themselves. The only sensible solution in that situation was for the company to move into the distribution sector. It also provided access to sales – the most lucrative segment of the natural gas market. That was the compromise that Gazprom and its partners reached when the destination clause was lifted.

Gazprom’s operation in the distribution sector can also be interpreted as Russia’s departure from its traditional specialization in raw materials and a shift into the export of downstream products and associated services. But that move came up against opposition both in the UK and the EC because it was interpreted as a deviation from the fair competition principle: with no liberalization in sight on the Russian market, the Russian company was planning to take advantage of the reformed EU market. Unsurprisingly in that situation, the EC said it was going to sue Gazprom over violation of fair competition laws.

Russia’s refusal to open up its own market will be perceived by the EC as a move aimed at consolidating its position solely as the EU’s raw materials appendage. Thus, the argument goes, Russia will bar access to both the distribution segment and the market of downstream products. At the same time, it could be argued that the EC is attempting to sell access to the EU’s internal market twice – first, as payment for modification of long-term contracts and, second, as an incentive for the liberalization of Russia’s natural gas market.

Another indication of the Russia-EU confrontation in the energy sphere is the decision on the Shtokman gas condensate field. Discussions around this gas deposit in the Barents Sea, with probable reserves of 3.7 trillion cubic meters, have been ongoing for over 10 years now. The latest stage of the debate started in September 2005 when a short list of candidates for a consortium to develop the field was announced. It included Norwegian Statoil and Norsk Hydro, ChevronTexaco and ConocoPhillips of the U.S., and Total of France. It had been expected that Gazprom would soon announce its decision amongst the candidates.

It has long been assumed that Gazprom needs foreign partners to develop the Shtokman field. First, the field is difficult to develop and would therefore require access to advanced technology. Second, it provides for the transportation of natural gas in liquefied form, mainly to the U.S., and therefore requires LNG technology and access to the American market. Finally, it requires significant financial resources.

Nevertheless, the Russian gas monopoly dragged its feet on the makeup of the consortium. Meanwhile, competition between the potential partners, each of whom had its own perceived advantages, was fueled artificially. The Norwegians were ready to share their extensive experience in operations in the arctic seas, offering production and transportation technology, as well as asset swapping. The French offered asset swapping and LNG technology, while the Americans mainly offered access to the consumer market.

Soon, however, the lineup of forces changed drastically. At a French-German-Russian summit in Compiègne (France, late September 2006), Russian President Vladimir Putin said some of the natural gas produced at the Shtokman field could be delivered to the European market. Observers linked this comment to Moscow’s difficult negotiations with Washington over Russia’s admission to the WTO. As a result, the analysts suggested that preference in the consortium would be given to European companies. 

Then, in the course of his visit to Germany, the Russian president said that the North European Gas Pipeline (Nord Stream), which travels below the Baltic Sea and links Russia and Germany, would be used to carry gas not only from the Yuzhno-Russkoye field (in the Tyumen Region), but subsequently also up to one-half of gas supplies from the Shtokman field. That was taken to mean Gazprom’s refusal to enter the promising LNG market. The Russian president’s statement calmed the Europeans’ fears that Gazprom would simply not have enough resources to fulfill its obligations to European suppliers. 

Finally, on October 9, Gazprom announced that it did not need any partnership to develop the Shtokman field. Apparently the company had failed to find a partner that would offer acceptable terms – that is to say, provide Gazprom with matching assets, both in volume and quality, in exchange for a share in the deposits.

The EU interpreted the decision as yet another attempt by Russia to restrict the liberalization of its energy market. In particular, members of the Norwegian Storting expressed their regret, pointing out that cooperation would benefit all sides. U.S. politicians were more outspoken, saying that Russia’s refusal was well in line with Russia’s policy toward self-isolation, including the isolation of its energy sector, while the International Energy Agency described the decision as an unmistakable sign of nationalism. At an informal meeting between Putin and EU chiefs of state in October 2006, considerable time was devoted to the discussion of this issue, with the Russian side explaining its position in detail.

Finally, the third event that illustrates the state of “energy relations” between Russia and the EU were their negotiations on the Energy Charter Treaty, which Russia and a number of other states signed back in 1994 and that went into force – albeit without Russia’s participation – in 1997.

The Treaty is concerned with four sets of issues.

First, trade in energy resources based on WTO principles.

Second, protection of capital investment at the post-investment stage against all sorts of non-economic risks, as well as profit repatriation guarantees.

Third, transit. Here, the Energy Charter Treaty and Protocol make provisions for free transit across the territory of all signatory states, as well as for international mediation to settle disputes on a temporary basis. Outstanding issues include auctions for available capacities, securing long-term contracts with long-term agreements on the use of capacities, and regional integration provisos. It should also be noted that Gazprom is concerned about the loss of a substantial part of its revenues and control over the Unified Gas Supply System.

Fourth, energy effectiveness.

The Energy Charter Treaty was long viewed as a dead mechanism, but in 2006 the EC and EU member states threw their support behind it. Moreover, the document’s ratification by Russia has become an idée fixe with Brussels’ bureaucracy. This turn of events was largely precipitated by the Ukrainian-Russian crisis in early 2006. In addition, ahead of the G8 summit, where Russia offered its own vision of energy security, it was suggested that the basic principles were already enshrined in the Energy Charter Treaty and that all that was left to be done was to ratify the Charter.

In a letter on behalf of the EU leadership in the run-up to the Sochi Summit in May 2006, EU Energy Commissioner Andris Piebalgs and Austrian Economy Minister Martin Bartenstein (Austria held the EU presidency in the first half of 2006) stressed that the EU was ready to preserve long-term contracts provided that Russia ratified the Energy Charter Treaty. That was yet another example of how the EU, which had already pledged to maintain long-term contracts in working out guidelines for the liberalization of the natural gas market in 1998 and 2003, as well as at a time when the contractual terms had changed, attempted to “sell” that advantageous gas delivery condition to Moscow once again. 

After the May Summit, Vladimir Putin stated in no uncertain terms that Russia wanted to know exactly what it would receive in exchange for the ratification of the treaty, and what benefits it would get in addition to a possible inflow of investment. That was an obvious hint that Russian companies should be given access to the EU consumer market and that the Energy Charter Treaty provisions therefore should be reviewed.

It may be recalled that the EU partially excludes its territory from the effects of the Treaty, sticking to the regional integration clause, which gives precedence to EU internal legislation over the Energy Charter Treaty.

An informal meeting between the Russian leader and the EU heads of state in Lahti (Finland) on October 20, 2006 marked a new trend in the EU approach toward the Energy Charter Treaty. It was proposed that the relevant provisions of the Energy Charter Treaty and Protocol be incorporated into a new legal framework for their relations – i.e., the Strategic Partnership Agreement, negotiations on which are to start in 2007. In other words, the idea is to make the approval of the new legal framework for Russia-EU relations dependent on Russia’s acceptance of corresponding requirements in the energy sphere. This will come into conflict with the stipulation that the Strategic Partnership Agreement proclaims only the basic principles and aims of cooperation, whereas all sector-specific accords are taken outside the framework of the Treaty. Furthermore, this will drastically change the field of negotiations.

A CONCEPTUAL DIVIDE

So what is the reason for the growing confrontation in the energy dialog between Russia and the EU? It is fueled primarily by the widening gap in the sides’ conceptual approaches toward energy cooperation. Importantly, these differences have a serious impact not only within the energy sphere per se, but also on the central problem of Russia-EU relations, that is, laying the legal groundwork for cooperation between Moscow and Brussels after 2007.

The EU’s approach toward energy cooperation was formulated in the early 1990s, about the time when the Energy Charter and the related treaty were signed. At that time, energy legislation within the EU was only emerging so the Partnership and Cooperation Agreement (PCA) between Russia and the EU simply contained a reference to the Energy Charter Treaty as a basis for relations between the partners in the energy sphere. Thus, according to Article 65 (1) of the PCA, “cooperation shall take place within the principles of the market economy and the European Energy Charter, against a background of the progressive integration of the energy markets in Europe,” while Article 105 reaffirms this principle, making a reference to the Charter: “In so far as matters covered by this Agreement are covered by the Energy Charter Treaty and Protocols thereto, such Treaty and Protocols shall upon entry into force apply to such matters but only to the extent that such application is provided for therein.”

The Energy Charter and the Energy Charter Treaty were drawn up with the direct participation of the European Commission. The European community had jurisdiction on matters of trade and transit, and it was therefore essential to get the European Commission involved in the process. Furthermore, the Commission was to ensure that relations in trade, investment, and transit were not in conflict with the emerging liberalization of the energy markets of the EU member states. Finally, these documents were supposed to provide a basis for a fourth community in Europe going beyond the three communities that had been formed in the 1950s, gradually integrating Russia and other post-Soviet countries into a common European space.

Step by step, EU energy legislation began to be codified. On the one hand, it was based on general internal market principles (free movement of goods, services, capital and people, as well as the promotion of competition between all European market players). Furthermore, there were environmental protection requirements that involved substantial costs (today, they account for up to one-third of the final costs of electricity), and therefore companies violating those requirements acquired a significant competitive advantage.

On the other hand, the changes that had occurred in the natural gas and electricity sector, which were the focus of the EC’s reform program for the EU energy system, were similar to those in any other network business sector (telecoms, transport, etc.). The plan involved large-scale liberalization – i.e., separation of producer of goods (services), carrier, and supplier of goods and services from each other.

Because the development of the EU market moved beyond the framework designated in the Energy Charter Treaty, and because Russia was in no hurry to ratify it, the EU started making new conditions for energy cooperation with Russia. The general meaning was that Moscow gradually bring its energy legislation in line with European legislation. As an additional incentive, the idea of regional integration, which exempted the EU from the effects of some of the provisions of the Transit Protocol, was brought into the negotiations on the Protocol to the Energy Charter Treaty.

So the focus in building a unified regulatory mechanism shifted into the sphere of bilateral relations. The EC’s main mechanism was to encourage legislative harmonization as a basis for action by energy companies, which enabled them to operate effectively and provide the EU with the required volume of resources.

A fundamental transformation occurred within a few years: the idealistic vision of the Energy Charter Treaty gave way to the realistic perception of the Charter and the Energy Charter Treaty, as well as energy dialog as a means of ensuring energy security. At the same time, the idealistic belief that liberalization based on EU principles was good for all states, including Russia, remained.

Throughout the 1990s and at the beginning of this century, the European Commission was consistently urging the EU at all intergovernmental conferences to grant the Community the powers to formulate external energy policy, but its pleas were invariably rejected. So all it could do in that situation was to develop its energy legislation and rely on European energy companies. Meanwhile, the ban on access to the EU’s lucrative internal market in the absence of liberalization was, on the one hand, an important economic regulator protecting the European producers against unfair competition and, on the other, an instrument of strengthening their positions on the global energy market.

In this light, the events around Gazprom’s attempt to acquire assets in the UK, and especially the rhetoric coming from the EC, are taking on an altogether different meaning. The EC’s discontent over the Shtokman decision is also understandable: it excludes those European players that are purportedly translating the EU energy security concept into reality.

It should be noted that by striving to impose its legislation, the EU does not limit itself to Russia. It is pursuing the same strategy not only with respect to EU candidate member states (which is only natural) but also in relation to potential recipients of EU energy laws.

Russia’s approach toward energy cooperation evolved over a substantially longer period. Initially, a coherent long-term policy was lacking, with an aggregate of short-term, narrow interests of individual companies or sectors prevailing. Also lacking was an understanding of Russia’s long-term interests in its energy dialog with the EU. That was why the European Commission succeeded in setting the agenda for negotiations by incorporating individual problems that aroused Moscow’s concern. 

The situation only began to turn around in the past few years, as shown by Russia’s negotiations with Germany on the North-European Gas Pipeline project and the development of the related Yuzhno-Russkoye field. The focus started shifting toward the idea of asset swapping – offering a share in Russian natural gas deposits in exchange for access to distribution networks – that is to say, the most lucrative segment of the EU’s natural gas market.

Moscow’s views on energy cooperation were finalized during the preparations for Russia’s G8 presidency (energy being one of the priority subjects there) and during the discussion of the energy security concept. It was stated in no uncertain terms that reliable security guarantees should be provided not only to consumers but also to suppliers. Supplier security guarantees mean that the natural resources that are produced will find their consumer, while investment will be recouped. In other words, this is about long-term obligations for suppliers to produce and deliver energy resources and for consumers to buy them at reasonable prices. At the same time, obligations should not necessarily be formalized in long-term contracts.

In addition to mutual guarantees, development of relations between companies should be ongoing, with reciprocal access for producing enterprises to distribution assets and for importing countries to production assets. Such interpenetration will not only facilitate business diversification but also help involve the commercial segment (private actors) in ensuring energy security on the global level. Therefore, in working to translate their concept into reality, both Russia and the EU rely on close interaction with the energy business.

Russia’s relatively new but long-term energy cooperation concept was reflected in the final energy-related document that was adopted at the G8 Summit in St. Petersburg in July 2006. Furthermore, for the past year it has been the focus of discussion at various meetings between Russian and EU officials.

Unsurprisingly, Gazprom sees the UK situation differently than the EU does. What is important here for the Russian energy company is, first, compensation for alterations in long-term contracts with access to the end-consumer market and, second, access to the distribution segment in exchange for access for foreign companies to Russia’s production sector. In this context, Russia’s refusal to form a consortium to develop the Shtokman field should be read as a declaration that it had not received commensurate assets, while its Western partners underestimate the capacity of its shelf deposits. At the same time, it is also a demonstration of Russia’s new concept of energy cooperation on the practical level.

Finally, Moscow’s position on the Energy Charter Treaty becomes as clear as can be: if it is to abandon its long-established monopoly position, Russia must know exactly what it will get in exchange for that and just how open the European market will become for Russian companies. Moscow is, in effect, saying that it will not seek unilateral action and that compromise on its part calls for reciprocal moves by the EU. This also puts into perspective the statement that the Energy Charter Treaty should first be modified and only then can its ratification be discussed.

A comparative analysis of the two concepts shows, first, that the EU vision is more mature and better thought through: it is better articulated and legally substantiated. But it seems that the obligations of the EU partners are given greater priority than those of the EU itself. Furthermore, the EC is evidently determined to extend the effects of EU legislation to Russia and strengthen its regulatory impact on Russian companies.

By contrast, the Russian approach is largely based on political declarations. It is noteworthy that this is probably the first time that Brussels is coming up against difficulties in setting an agenda.

Second, the EU calls for instituting a common legal environment that will give companies greater freedom of action. At the same time, Russia believes in concluding concrete agreements between concrete companies on concrete, clearly specified assets. This approach was realized on the one hand in Gazprom’s negotiations with Germany’s E.ON Ruhrgas and BASF on the North European Gas Pipeline Project and the Yuzhno-Russkoye gas field, and, on the other hand, in the debate around the Shtokman project. It is a political principle that should be used as a basis for specific projects. A considerable amount of dirigisme is inevitable here.

Third, Russia has raised the issue of compensation for the loss of its exclusive right to control its unique system of natural gas pipelines, as well as its deposits. Meanwhile, the EU keeps talking about the benefits of market relations in general and about the advantages of building a pan-European market. At the same time, Brussels is not ready yet to address the issue of compensation.

Finally, the situation is complicated by the fact that Russia appears to be a rather “consolidated” actor: its policy course is enunciated by the head of state and relevant government ministers, while companies actively implement it. By contrast, the EU is relatively heterogeneous. The aforementioned concept is pursued by the EC but is not always endorsed by EU member states.

Indicative in this respect is Germany’s policy, as well as statements by French President Jacques Chirac at the informal EU meeting in Lahti, to the effect that EU values should not serve as the sole foundation for formulating EU energy policy toward Russia. Such disagreements not so much facilitate the advancement of the Russian position as irritate EU member countries and representatives of EU institutions.

BEYOND ENERGY COOPERATION

Clearly, because of the different views on energy cooperation, Russia and the EU are doomed to the ongoing confrontation in this realm until both sides reach a compromise.

Negotiations on a new agreement will be extremely difficult, and the following factors need to be taken into account:

• Unlike the early 1990s, Russia today is not only opposed to a simple copying of EU laws (as provided for, e.g., in Article 55 of the PCA) but has also put forward an alternative concept. But the European Commission is not ready to abandon its traditional orientation toward the “unilateral transfer” of its legislation. Furthermore, should norms different from those accepted in the EU be codified, the European Court may refuse to approve the treaty. Otherwise, painstaking, prolonged, and capital-intensive efforts will be required to alter certain provisions of European legislation.

• Moscow is not translating its political vision into concrete legal norms. Rather, it is putting forward political projects without fleshing out their technical details. So it is not always clear to technocratic Brussels what it should do with them. A recent EC paper on external energy policy, prepared at the informal meeting in Lahti, on the one hand, acknowledges the differences in approaches between Russia and the EU. On the other hand, it only proposes practical measures that conform to the EU vision of energy dialog. Therefore, Russia and the EU are speaking in different languages not only conceptually but also technically.

• The views of individual EU member countries and institutions seriously differ from each other. This can complicate both the advancement of Russia’s “divide and rule” policy and the negotiating process. A special committee, comprised of national representatives, will watch every step the EC takes, preventing any deviation from a consensus.

Finally, the difference in approaches and the need to search for a compromise between diametric views de facto predetermines the structure of any future agreement. It should not be a big, comprehensive document, encompassing all sectors. This can only be a general agreement (strategic partnership agreement) and a number of sector-specific agreements, which will be used as a platform for a complex compromise between the Russian and the EU vision. In the interest of preserving the balance of forces, different sector-specific agreements can be consolidated into blocks, as is the case with agreements between Switzerland and the EU. In other words, several such agreements can constitute one group conditional on the “guillotine principle.” Under this principle, the tearing up of one agreement will mean the termination of all other agreements in this group. This will provide an additional guarantee that both Moscow and Brussels will fulfill their obligations.