19.03.2015
Energy Control Room for the Whole of Eurasia
№1 2015 January/March
Stanislav Pritchin

PhD in History; he is a research fellow at the Center for Central Asia and Caucasus Studies, Institute of Oriental Studies, Russian Academy of Sciences.

How to Break the Russia-EU Energy Clinch

The Ukrainian crisis has brought Russian-European relations to a head, affecting many areas including the energy sector. In response to downright opposition from the European Union, Russia has cancelled the South Stream project. In turn, the European Commission is devising another plan to reduce the EU’s dependence on Russia. In particular, it is discussing an idea to establish an EU energy union and work out a unified oil and gas purchasing policy for European companies. A “non-aggression energy pact” could be a way out of this stalemate between the neighbors. This pact would register the current level of cooperation  and lay out plans for starting a discussion on a new format of their interaction in the future.

Two factors, however, stand in the way of these hopes: the Ukrainian crisis which is still acute, and the new European Commission’s desire to live up to the expectations put on it. The previous experience shows that EU officials, at least during their first few years in office, propose and make the most radical anti-Russian moves in the energy sector. However, Russia has a chance to take a step towards the EU without losing its strategic positions. On the one hand,  Moscow has decided to change its approaches in relations with the European Union and to focus in the future on the delivery of natural gas only to the united  Europe’s border. On the other hand, partial access for Central Asian and South Caucasian partners to Russia’s gas pipeline infrastructure could strengthen its position still further. In this case, without contravening EU requirements, Russia could be not only a major gas supplier for Europe, but also a full-fledged energy hub for Eurasia.

Regulation and limitation oF the freedom of suppliers as the EU’s main energy instrument

As regards energy cooperation, relations between Russia and the European Union have always been difficult. Each party believed that its resource – natural gas in Russia, and gas consumers in Europe – is more valuable than that of the other partner. The Ukrainian crisis has transformed the relatively constructive dialogue into a zero sum game in which both parties are ready to sustain some losses if the other side can suffer even more.

Nevertheless, they remain highly interdependent in terms of energy supplies. For example, Russian gas accounted for 30 percent of the EU’s energy balance in 2013, a record high level in the last few years. Gazprom supplied 162.7 billion cubic meters of gas to Europe and Turkey. Overall, according to Gazprom estimates, the European market in 2013 amounted to 476 billion cubic meters of gas (together with Turkey, 541 billion cubic meters). In 2012, gas consumption in Europe and Turkey had reached 529 billion cubic meters. Such high dependence on one supplier is a matter of serious concern for European officials. For many years, the European Union has been looking for effective means to reduce this dependence.

The Energy Charter  has become the main legal instrument for that. It is designed to limit the monopoly and the growing political influence of suppliers. Since  Gazprom is the principal partner of the EU in the energy sector and historically it has been pursuing an active policy to increase gas supply to Europe and gain access to the European end consumers, it would not be hard to guess that the Charter has always been aimed at curbing the Russian company’s ambitions.

Guided by this document, Brussels is holding back any attempts by Moscow to build gas transportation infrastructure bypassing transit countries. While resistance to  South Stream eventually led to Russia’s decision to scrap the project, there is still some uncertainty about the Nord Stream project as well, although it is undoubtedly beneficial for the EU. Legal restrictions prevent Gazprom from making full use of the pipeline. Under the Charter, the Russian company can only use 50 percent of the capacity of the OPAL gas pipeline, specially built to connect Nord Stream with the EU infrastructure, even though there are no other suppliers for this pipeline. Also, the EU has said “no” to the pipeline’s extension to the UK for fear of increased dependence on Gazprom. At present, Nord Stream operates at only half of its rated capacity of 55 billion cubic meters of gas. For example, in 2013 the pipeline transported 23.77 billion cubic meters of gas.

To Russia, the EU policy looks more than strange. Russian Energy Minister Alexander Novak said in a recent interview to Kommersant: “We have offered our services to Europeans to build a gas pipeline to the center of Europe, with Gazprom funding the project. Unfortunately, our European colleagues do not realize that such large projects cannot be regulated in the same way as the construction of their own gas distribution network.” In other words, Russia offers to carry out gas transportation projects to ensure the European Union’s energy security without the latter’s financial participation, but meets not only reluctance on the part of Brussels but also its active opposition. The main reason stated by EU officials is excessive dependence on Russia.

In terms of real independence from Russia, the European Commission’s policy appears to be too pragmatic, to put it mildly. The European Union does not initiate projects and does not allocate funds for their implementation; its participation is limited to moral and political support. For example, European countries build regasification plants on their own. The ambitious Nabucco project, despite the high political stakes involved, never got off the ground due to the lack of real steps by EU executive bodies and European companies. Among the new projects currently in progress or planned for the future, none of them has been initiated by the EU or is being implemented with its direct participation. For example, the Southern Energy Corridor, mentioned in the European Commission’s official documents and statements, is based on Azerbaijani projects for gas supplies via Georgia, Turkey and Greece to Italy, which the State Oil Company of the Azerbaijan Republic (SOCAR) is building together with its partners.

Following Russia’s decision to abandon the South Stream project, European officials once again dusted off the Trans-Caspian Gas Pipeline project which should connect Turkmenistan’s gas system with Azerbaijan’s infrastructure to ensure Turkmen gas supplies to Europe and thus reduce its dependence on Russian gas. The European Commission has said that the Trans-Caspian pipeline should become a part of the Southern Energy Corridor. However, this idea is completely devoid of economic viability. Firstly, the pipeline infrastructure now being built from Azerbaijan to the border of Turkey and the EU is planned to transport gas from the Shah Deniz Stage 2 field only. Assuming that investors are found for the Trans-Caspian Gas Pipeline, the capacity of the Trans-Anatolian Gas Pipeline and the Azerbaijan-Georgia-Turkey section would have to be increased significantly. Secondly, an oversupply of gas transported via Turkey – Azerbaijani gas and Russian gas redirected from South Stream – will create a situation where even five billion cubic meters of gas from Turkmenistan can benefit neither Russia nor Azerbaijan  as they will only increase competition for the consumer. Even American analysts note that only Russian gas supplies, rather than Turkmen ones, via Turkey, can be economically justified. Moreover, none of the EU officials has ever spoken about the economic feasibility of hypothetical Turkmen gas supplies to Europe. The cost of gas to be delivered from Central Asia would be huge, considering the shipment distance and the amount of investment required. Official Brussels’ stance on the Trans-Caspian project once again demonstrates that even the most expensive gas from any country but Russia or supplied bypassing it would be more preferable for the European Union.

In carrying out their energy policy EU officials place the emphasis, above all, on regulation rather than actual creation of independent infrastructure. This approach creates many problems for Russia as a key supplier. In fact, each new European Commission begins its work with conspicuous anti-Russian moves. The previous European Commissioner for Energy, Günther Oettinger, was no exception, although with time he became a constructive partner and negotiator. The present European Commission was formed amid the Ukrainian crisis, and this factor affected the choice of candidates. In a rather complicated system of distribution of powers, Maroš Šef?ovi? of Slovakia was named Vice President of the European Commission in charge of the energy policy. The creation of this special post in the top EU leadership bespeaks the importance attached to the energy issue. There are several more officials in the new European Commission who supervise energy issues one way or another.

One of Šef?ovi?’s key responsibilities is to coordinate his colleagues’ work and the implementation of the EU energy union concept presented in February 2015. The purpose of the new initiative is to create a single and stable energy system in the European Union by establishing rules and procedures for providing mutual aid and support in case of problems with energy suppliers. There are also plans to build gas storage facilities, develop an extensive network of European gas pipelines, and promote green energy in European countries. The next step in creating a full-fledged energy union will be the development of a single procurement policy. The EU initiatives are aimed at strengthening the EU’s position in negotiations with energy suppliers and, above all, Russia. Even partial implementation of these measures will seriously impact all suppliers and their ability to maneuver, without exception.

Russia changes approaches to European market

The Russian leadership and the Gazprom management have surprised their Western partners by seriously changing their approaches to the European market. Whereas before the current crisis the Russian company had pursued a policy of active expansion, sought access to end consumers, and claimed an exclusive status for itself as the main gas supplier to the EU, everything changed on December 1, 2014 during Vladimir Putin’s visit to Ankara. Following talks with his Turkish counterpart Recep Tayyip Erdogan, the Russian president announced the decision to stop the construction of the South Stream gas pipeline under the Black Sea to Bulgaria and to build a submarine pipeline to Turkey instead. The main news, however, was that Russia would build the gas pipeline infrastructure only to the European Union’s border, leaving it to EU countries themselves to further develop gas pipelines and supply gas to the end consumers. Later, Gazprom’s chief executive Alexei Miller and Russia’s Energy Minister Alexander Novak made it clear that it was not an improvisation but a well thought-out move agreed by the Russian leadership and the Gazprom management.

By so doing Russia met the requirements of the EU’s Third Energy Package. The unpleasant side of the Russian decision for the European Commission is not so much the need to independently invest substantial amounts of money in the development of domestic gas pipelines( although this is also a factor) as the significant strengthening of Ankara’s role in ensuring the energy security of Europe. If all Russian and Azerbaijani projects are implemented, up to 10 percent of all gas consumed by the European Union will be supplied via Turkey.

However, it seems that the scrapping of such an expensive project as South Stream, which involves high political risks, was a well thought-out decision prompted not only by the unfavorable financial situation for Russia. There were some additional reasons, among them the strengthening of Russia’s bargaining position in negotiations with Brussels on the expansion of the Nord Stream project and the use of the European OPAL distribution pipeline. It was not accidental that just a few days after Putin’s visit to Ankara, Gazprom spokesman Sergei Kupriyanov said that, despite the delay in obtaining the European Commission’s permission for using 50 percent of the pipeline’s capacity, the Russian gas major was still hoping to get the go-ahead for running it at full capacity in order to make the best of Nord Stream. At the same time, the Russian company, again meeting the Energy Charter’s requirements, said it had agreed to cancel an asset swap with its German partner BASF, a deal that would have given Gazprom full control of a jointly operated European gas trading and storage business.

The results of European Commission Vice President Maroš Šef?ovi?’s visit to Moscow and his talks with Gazprom CEO Alexei Miller and members of the Russian government show that a big game over the “Turkish Stream” and future cooperation between the European Union and Russia is only beginning. Miller said after talks with Šef?ovi? that by 2020 the Turkish route would allow his company to redirect all Russian gas exports and that Europeans would simply have to extend their infrastructure to the border with Turkey in order to receive Russian gas under current contracts. This statement seemed to surprise the European Commission official who said that Russia was risking its reputation of a reliable supplier because the current contracts required it to deliver gas to Central Europe. Speaking of plans to supply 50 billion cubic meters of gas via Turkey, he said Russia would have to find a more economically substantiated decision.

While trading strong statements, making demarches and steering its own political course conspicuously independent from the European Union, Gazprom should nevertheless reach an understanding with its European partners, primarily on the expansion of the Nord Stream project. When making the decision to build a pipeline via Turkey, Russia made allowances for additional political risks. Russian-Turkish cooperation on the Blue Stream gas pipeline project has had a negative experience when Ankara unilaterally revised the agreements reached by the two countries. Considering Turkey’s ambitions to become a major energy hub, the risk of using the pipeline as political leverage may grow in the future. One should bear in mind that by 2018-2020, when the construction of the so-called Turkish Stream is scheduled to be completed, markets in Southern Europe will start receiving Azerbaijani gas from the Shah Deniz Stage 2 field in the amount of 10 billion cubic meters. In the medium term, there is a high probability that Iraqi and Iranian gas will begin to be supplied to the EU via Turkey. Given strained relations between Brussels and Ankara, at some point Turkey may use gas transit as an instrument of pressure.

In this context, Russia’s emphasis on Nord Stream is understandable. But it should take additional steps to reduce transit risks from Turkey and restriction risks from the EU.

Given the high level of personal trust between the Russian and Azerbaijani presidents, it would be advisable for Moscow and Baku to informally coordinate their simultaneous entry into the Southern European market and work out a joint plan of action in case Turkey suddenly decides to use its transit capabilities as a political tool.

To strengthen its position in the European and global markets, Russia can use the rapidly developing LNG projects at home. The branched network of regasification terminals in Europe can allow Russia to use its LNG projects, above all the Yamal project, to full capacity without major investments in the pipeline infrastructure. The Energy Ministry’s coordinating role would help to avoid competition among Russian suppliers and supplement the existing pipeline projects with LNG supplies.

Eurasia’s gas remote control

As stated above, possible formation of an EU energy union will create new conditions for Russia and require it to find out-of-the-box solutions in order to retain strong positions in negotiations with Brussels. In addition to the aforementioned possible measures (LNG development and the extension of Nord Stream), Russia can open its gas transportation infrastructure to Central Asian and Azerbaijani gas. Several years ago, before the Baku-Tbilisi-Erzurum gas pipeline was built, SOCAR made a proposal to Gazprom, suggesting that Azerbaijani gas could be transported via Russia to the EU in volumes and directions that would not directly compete with the Russian company.

Naturally, the proposal was rejected. However, now there are all prerequisites for its implementation. On the one hand, if we look at Gazprom’s purchases of Central Asian gas, which the company buys at market prices, we can see them gradually going down. In 2007, Russia bought 42.6 billion cubic meters of gas from Turkmenistan, 9.6 billion cubic meters of gas from Uzbekistan, and 8.5 billion cubic meters of gas from Kazakhstan. In 2013, Russia imported 10.95 billion cubic meters of gas from Turkmenistan, 5.66 billion cubic meters of gas from Uzbekistan, 11.87 billion cubic meters of gas from Kazakhstan, and 1.38 billion cubic meters of gas from Azerbaijan (gas purchases from Azerbaijan began in 2010 at 0.8 billion cubic meters and peaked to 1.6 billion cubic meters in 2012). In other words, a slight growth was registered only in gas imports from Kazakhstan. Moreover, in October 2014 the Russian press published reports, never confirmed officially though, that Gazprom might soon stop importing gas from Uzbekistan and Turkmenistan. The sharp decline in gas purchases, specifically from Turkmenistan, was blamed on the negative profitability of gas imports from Central Asia during the transition to market prices. In fact, Gazprom buys Central Asian gas at market prices and then transports it to European consumers basically at its own expense. In this situation, it would be economically beneficial for Russia to open part of its pipelines to Central Asian countries as this would guarantee stable and predictable transit fees for gas delivery by the Russian gas transportation system. Naturally, amounts of gas to be exported in such a way and its destinations should be agreed upon in long-term contracts in order to avoid competition between Russian and Central Asian gas producers.

In view of the plans to create an energy union, a possibility to conclude direct gas supply contracts with Central Asian countries would, no doubt, be a positive development for the European Union. From the legal point of view, it would remove existing complaints about Russian projects, such as Nord Stream, by bringing in alternative suppliers. Russia’s predictable transit policy could ultimately render irrelevant the construction of expensive and politicized bypass gas pipelines, such as the Trans-Caspian one from Turkmenistan to Azerbaijan.

On the other hand, Gazprom’s Central Asian strategy states that the company is planning to strengthen its position in the region. In reality, however, China’s role in Central Asia is growing tremendously due to its active and systemic efforts in the region. For example, the summer of 2014 saw the commissioning of the third line of the Central Asia-China gas pipeline, with a design capacity of 25 billion cubic meters of gas. Currently, China buys the greater part of gas in the region. Contract prices were never disclosed, but since the agreements for gas supply to China were signed along with Chinese multi-billion-dollar loans extended to Central Asian countries during the crisis, it would be safe to say that they were well below the market price.

But the current situation is only a stage in the Chinese expansion. The construction of the fourth string of the pipeline has already begun. With a design capacity of 25 billion cubic meters, it will start in Turkmenistan and go via Uzbekistan, Tajikistan and Kyrgyzstan. This project may completely reshape the regional gas market, with China becoming a full-fledged coordinator of energy flows. For example, the pipeline will bring Turkmen gas to Kyrgyzstan and Tajikistan and thereby deprive Uzbekistan of its leverage. Chinese experts believe that in conditions of large-scale economic cooperation Tashkent will not be able to say “no” to Beijing and will allow the construction of a transit gas pipeline via its territory.

The emerging situation will allow Central Asian countries to redirect their exports up north via Russia in order to make up for the risks associated with China as a single major buyer. The possibility to conclude direct gas supply agreements with EU countries will enable Kazakhstan, Uzbekistan and Turkmenistan to reduce export risks and establish direct economic dialogue with the European Union in the gas sector.

Once Russia’s eastern projects become operational, its pipeline infrastructure will be able to transport gas both to the European and the Asia-Pacific region. Opening up this infrastructure to other suppliers will turn Russia into a major Eurasian gas hub.

Russia and Europe: common interests

Obviously, both Russia and the European Union are vitally interested in transparent, predictable and mutually unpoliticized cooperation in the energy sector. However, transit countries – Ukraine and Turkey – have their own interests that only complicate the already difficult relations between Moscow and Brussels.

Russia and the EU should finally realize that their neighborhood is a fact of life that cannot be changed. The same holds true for their energy interdependence. Naturally, both parties are interested in reducing this dependence, but clearly this cannot be done overnight; nor would it be be possible to build a new Iron Curtain in order to become completely isolated from each other and to stop all cooperation. During the Cold War, Russia and Europe successfully cooperated in the energy sector, even though the United States was opposed to that. Today, it would be crucial for Russia and Europe to restore the pragmatism that enabled them to cooperate successfully in the energy sector last century and start looking for the best mutually advantageous and mutually respectful format of interaction. Without that, relations between the neighbors are bound to go through one crisis after another, accompanied by ever growing mutual distrust and antagonism.