A bear at the throat
The European Union is belatedly grasping the riskiness of its dependence on Russian gas, but it is disunited and short of ideas for how to reduce it
RUSSIA'S president, Vladimir Putin, must be feeling smug. His strategy of using the country's vast natural resources to restore the greatness lost after the break-up of the Soviet Union seems to be paying off. If power is measured by the fear instilled in others—as many Russians believe—he is certainly winning. The Soviet Union relied on its military machine for geopolitical power: its oil and gas were just a way to pay for it. In today's Russia, energy is itself the tool of influence. To use it the Kremlin needs three things: control over Russian energy reserves and production, control over the pipelines snaking across its territory and that of its neighbours, and long-term contracts with European customers that are hard to break. All three are in place. For all the talk of a common strategy towards Russia, the EU is divided and stuck for an answer.
Gazprom, Russia's energy giant, cherished by Mr Putin as a “powerful lever of economic and political influence in the world”, has long-term supply contracts with most European countries, including France, Germany, Italy and Austria. It also has direct access to these countries' domestic markets. The EU reckons that half its gas imports now come from Russia. Newer EU members, such as Hungary and the Czech Republic, are almost entirely dependent on Russian gas. Moreover, a pipeline network that it inherited from the Soviet Union gives Russia control over gas imported from Central Asia. The EU has few ideas for how to deal with its chief energy supplier. “We know we should do something about Russia, but we don't know what,” one Brussels official says. “In the EU we negotiate on the rules, whereas Russia wants to do deals.” The deals are coming thick and fast. Last month, Russia secured one to build an oil pipeline from Bulgaria to Greece that will bypass the Bosporus. Symbolically, it will be the first Russian-controlled pipeline on EU territory. The pipeline will carry Russian and Central Asian oil straight to the EU, avoiding Turkey.
Oil can at least be bought from elsewhere. The bigger worry is about the EU's dependence on Russian gas. The flow of natural gas depends on the routes and control of pipelines, as European consumers were reminded when Russia switched off the gas supply to Ukraine just over a year ago and Ukraine started to steal Russian gas that was destined for the EU. Russia's pipeline routes encircle the EU from the north and south. Russia and Germany have teamed up to build a gas pipeline under the Baltic Sea, bypassing Ukraine and Poland (see map). Gerhard Schröder, a former German chancellor signed up by Mr Putin to preside over this Nord Stream pipeline, claims that it will make Europe safer. But a study by Sweden's Defence Research Agency concludes that it will divide the EU and increase dependence on Russia. It will let the Kremlin turn off gas supplies to Ukraine, Poland and Belarus without affecting “more important” customers. Understandably, Poland is anxious. The pipeline will increase the flow of gas to Germany and hook in countries that do not yet consume much Russian gas, including the Netherlands and Britain.
In the south, Russia has a pipeline across the Black Sea which supplies gas to Turkey. Now Russia wants to extend this Blue Stream pipeline to Hungary. That would compete directly with Europe's own plan to build a pipeline called Nabucco from Turkey to Austria. Nabucco has been one of the EU's few concerted responses to Russian domination of its gas supplies: it would be filled up with gas from Central Asia and thus bypass Russia altogether. But it is now creating more friction than unity.
Last month Hungary's prime minister, Ferenc Gyurcsany, called Nabucco a “long dream”. Instead, he suggested that Hungary would support the extension of Blue Stream. Gazprom already supplies 80% of Hungary's gas and has promised to build a large gas-storage facility that could be a hub for central Europe. “Blue Stream”, enthused Mr Gyurcsany, “is backed by a very strong will and a very strong organisational power.” (When Hungary was accused of undermining the EU's common energy policy, the tart response was that it was impossible to undermine something that did not exist.) As well as controlling pipelines, Gazprom has also been busy buying up pieces of Europe's gas infrastructure. It owns 35% of Wingas, a German distribution company, and also has stakes in the Baltic countries' distributors. It has 10% of the interconnector pipeline between Belgium and Britain and wants a similar share of a British-Dutch link. It is also muscling its way into electricity, oil and liquefied natural gas (LNG) projects. “It is not enough for us to meet 25% of global gas consumption. We want to be the biggest energy company in the world,” Alexander Medvedev, Gazprom's deputy head, has said of his company's modest ambition.
Most European governments have been careful not to alienate Russia. As long as Gazprom plays by the rules, they say, it should be allowed to invest in their markets. Belgium recently said it had no problems with Gazprom owning parts of its infrastructure. Russia, in contrast, has a big problem with foreign companies owning, let alone controlling, any of its natural resources. It has bullied Royal Dutch Shell into ceding control of the Sakhalin-2 project in the far east of the country; it has blocked BP's plan to develop a gas field in eastern Siberia; and it has kept foreign companies out of the development of the giant Shtokman field in the Barents Sea, saying that it will go it alone. In the same spirit, the Kremlin has flatly ruled out ratifying the EU's energy-charter treaty, which would require it to open up its gas pipelines to other countries and other suppliers. The Russians have made a mockery of a joint declaration on energy issued at the G8 summit they chaired in St Petersburg last July. The declaration called for more honesty, competition and transparency. Yet just two days later, Mr Putin enshrined into law Gazprom's monopoly position as the sole exporter of gas.
Then there is the talk of creating a gas equivalent to the OPEC oil-exporters' cartel. On April 9th Russia joined other gas producers in Qatar to discuss the possibility, and offered to lead a study into gas pricing. The next meeting of the group will be in Moscow. With almost 60% of the world's gas concentrated in just three countries —Russia, Iran and Qatar—the notion of a cartel sounds appealing. But fixing prices for a commodity that is not traded on world markets will prove much harder than it has been for oil. Even so, as Mr Putin said earlier this year, “it would be a good idea to co-ordinate our activities.” Gazprom has already signed a memorandum of understanding with Algeria's Sonatrach to co-operate in gas production. This has unnerved European consumers, as Algeria is their third-largest supplier of gas, after Russia and Norway. America, too, is nervous. “Russia's commercial and political shadow over the governments in central Europe makes it harder for us to deal with our allies,” says a senior State Department official.
The EU's dependence on Russian energy is hardly new. Nor is tension between Russia and America. “The Americans were constantly telling us we were too dependent on Russian gas in the 1970s and 1980s,” says Sir Rodric Braithwaite, a former British ambassador to Moscow. Yet, throughout the cold war, Russia remained a reliable gas supplier. Why should things be different now? First, says, Cliff Kupchan, director of the Russian programme at Eurasia Group, a consultancy in Washington, DC, the Soviet Union was politically more predictable than its successor. “It was run by geriatrics, but we knew that one geriatric would succeed another.” Russia's political stability is ephemeral. It relies on Mr Putin's will, not on an institutional transfer of power. With nationalism on the rise, it is anybody's guess who will be in charge of Russia in ten years' time. A second difference is that the energy relationship between the Soviet Union and the West stopped at the border—albeit the border of the Soviet block. The oil and gas ministry, Gazprom's predecessor, did not try to take over any of western Europe's infrastructure. Gazprom has no scruples about using its muscle to buy such assets. Gazprom's desire to control their pipelines has been central to Russia's recent clashes with Ukraine and Belarus. Third, the Soviet energy business was run by technocrats who implemented centrally planned decisions.
Today, it is controlled by former KGB men obsessed with money and power. Gazprom has several ex-KGB members on its board of directors. Rosneft, the state-controlled oil champion, is chaired by a former agent who is now deputy chief of the Kremlin staff. “People in Europe have a natural apprehension about their homes being heated by these people,” says one commentator on Russia. Yet dependence cuts both ways. Europe may depend on Russia for half its gas imports, but Russia is dependent on Europe for the bulk of its export revenues. Repeated threats by the Kremlin to divert the flow of gas to China mean little without pipelines that it would take many years to build. Switching off gas to Europe will never make commercial sense for Gazprom. The fear in some EU countries is that commercial interests may one day become secondary to political ones. Of 55 cut-offs, explicit threats or coercive price actions by Russia since 1991, only 11 had no political underpinnings, according to the Swedish defence study.
Running on empty
If all this is not worrying enough, there is another, more immediate source of concern for the EU: that Russia may be physically unable to produce enough gas to satisfy demand. Even worse than being dependent on a company like Gazprom may be to be dependent on a Gazprom that is short of gas. The output of Gazprom's three super-giant fields, which account for three-quarters of its production, is declining at a rate of some 6-7% a year. Output from a new gas field brought on stream in 2001 has already peaked. Last year, Gazprom decided to develop a massive field in the Yamal peninsula—frozen and barren Arctic land—but that will take years. Meanwhile, Russia's domestic demand for gas is growing by more than 2% a year. For all its swagger, Russia is short of gas, a problem that is already affecting its electricity-generation capacity. This does not reflect any lack of reserves—Russia has the world's biggest—but rather a longstanding failure to invest enough in their development.
Gazprom has argued that it will invest in new fields only if it can pre-sell the output to Europe. Instead it has been spending lavishly on pipelines and downstream assets. This has a certain monopolistic logic. Raking in the middleman's profits from exports is easier and more lucrative than investing billions in developing new fields for a domestic market which, although it consumes two-thirds of Gazprom's production, generates hardly any profits, as regulated Russian gas prices are much lower than most European ones. Meanwhile, Gazprom relies on Central Asia, especially Turkmenistan, to plug the gap in gas supplies, which makes many investors and consumers nervous. A study by UBS, a bank, concludes that Turkmenistan may have signed contracts to supply twice as much gas after 2009 as it can actually produce. The nervousness over potential shortages of gas, though, plays in Gazprom's favour: as with talk of a gas OPEC, it prods the Europeans into striking special deals with Gazprom.
Gazprom's position is reliant on support from Europe's national energy champions such as Gaz de France, ENI of Italy and Ruhrgas of Germany. Companies such as Ruhrgas and Gazprom have each other's interests at heart. Indeed, Ruhrgas owns about 7% of Gazprom, worth some $17 billion, and has a seat on Gazprom's board. ENI and Enel of Italy this month acted directly for Gazprom when they bought the expropriated gas assets of the bankrupt Yukos company in a controversial auction. Under a pre-arranged deal, the two Italian companies agreed to cede control of these assets to Gazprom, which was too cautious to bid in its own name. In return ENI and Enel were given a foothold in Russia's gas fields and possibly a seat on the board of Gazprom's oil company. Gazprom also has long-term gas contracts with ENI, which gives it direct access to Italian consumers. Gazprom has similar arrangements in Germany and France. Vladimir Milov, the head of the Institute of Energy Policy in Moscow, says that the links between Gazprom and its European counterparts amount to a cartel between wholesale buyers and sellers. The losers in this game are European consumers who are forced to pay gas prices that are several times higher than the wholesale price which their national companies pay to Gazprom.
Trying to persuade Russia to break up Gazprom's monopoly is a futile task. The best way to increase the EU's energy security would be for it to liberalise its own market and unbundle its national utilities. This would cut profit margins in gas distribution, and thereby reduce Gazprom's appetite for European domestic assets. It would encourage European network operators to invest in interconnectors between electricity grids and pipeline networks, weakening Russia's ability to play off one customer against another. No wonder Gazprom does not warm to the idea of European energy liberalisation, which it has called “the most absurd idea in the history of the world economy”.
Dependence of different groups of European countries on gas imports from Russia (percentage of imports from the RF in total consumption)
Main export gas pipelines Russia-Europe
The energy security of countries importing energy resources depends largely on the shape and quality of operational transport connections. This is particularly important in the case of natural gas supplies. Natural gas is transported mostly by gas pipelines which permanently connect gas producers and consumers. Thus Europe as a consumer is "tied" to certain gas suppliers for anywhere between a dozen and several tens of years. As their own resources are becoming depleted, the EU Member States get increasingly dependent on import of natural gas.
The present paper discusses the existing and projected gas transport routes from Russia to the EU. The first part deals with the importance of gas exports to the economy of the Russian Federation, and the second delves into the EU Member States' dependence on gas imports. Then this paper examines the differences in perceiving the energy security issue between the old and the new Member States, those differences stemming from the different degrees of their dependence on Russian supplies. In the third part, two new transport route projects for Russian gas supplies to the EU are compared and it is argued that from the point of view of the Community's interests, the Yamal gas pipeline is a better solution than the North European (Trans-Baltic) gas pipeline.
I. The importance of gas exports to Russia
Russia has the world's largest natural gas reserves and it is the largest gas producer and exporter. At the same time it remains significantly dependent on revenues from the sale of energy resources. The gas sector is one of the pillars of Russia's economy, and an important instrument of the Russian Federation's internal and foreign policy. Its importance is founded mostly on the following factors:
* the role of the gas sector in Russia's budget (Gazprom, which monopolises the domestic market and exports, provides approx. 8 percent of Russia's consolidated budget (federal budget and regional budgets), while revenues from gas exports account for approx. 12 percent of the foreign exchange revenue of the RF)
* the role of gas in the Russian Federation's energy balance (more than 50 percent);
* the gas monopoly, like the electricity monopoly, subsidises the Russian economy in a disguised manner (through lower prices);
* Gazprom plays a social role (low domestic prices on gas are an important instrument of the state's welfare policy);
* exporting gas affords Russia certain opportunities in terms of international cooperation and strengthens the country's position.
Europe is the only major consumer of Russian gas presently. The European Union is Russia's most important and most profitable market, in which Russian gas occupies a strong position. The chief objectives of Russia's gas policy in this market are to maintain the presence and to increase the market share of Russian gas. In order to achieve these objectives Gazprom has to ensure stability and reliability of gas supplies. Russian gas reaches Europe via three major land routes. The most important system of export trunk pipelines runs from the Russian Federation across Ukraine and Slovakia to countries in Western Europe (it handles approx. 90 percent of Russian gas exports to Europe). The second major route is the Yamal - Western Europe pipe (the Yamal pipeline) which runs via Belarus and Poland to Germany. The third route runs to the Balkans and Turkey. Thus, the transport of Russian gas to the EU markets is dependent on transit via third countries (mostly Ukraine and Belarus) and diversified only to a very small degree. One of the basic objectives of Russia's gas policy is to diversify export routes.
Among all current new gas pipeline project two seem to be the most important: the Yamal gas pipeline and the North European gas pipeline (also referred to as the Trans-Baltic pipeline). The Yamal gas pipeline project was popular in the 1990s. The route was designed as two branches with a total capacity exceeding 60 billion m3 per year, supplying gas mostly to Poland and Germany. In the mid 1990s Moscow, Berlin and Warsaw were all interested in that project. The first branch was completed with a target capacity of 30 billion m3 and it delivers gas to Poland and Germany. The construction of the second branch has not started yet. Among other reasons, this is because Russia's priorities have changed, and in the late 1990s works were commenced on a project for a different gas pipeline route.
Since 2001, the plan to build the North European gas pipeline on the Baltic Sea bottom, connecting Russia directly with Germany, Great Britain and Scandinavian countries, has been attracting growing interest. That route would reduce Russia's dependence on transit via third countries, especially Ukraine. Implementation of the North European project would certainly postpone the construction of the second branch of the Yamal pipeline via Belarus and Poland. That project has also some obvious downsides such as very high cost and technical complexity of the route construction.
In recent years a concept has been proposed to modify the route of the Yamal pipeline's second branch in what is called the Amber project. It envisages a pipeline from Russia via Latvia, Lithuania and the Kaliningrad Oblast to Poland and Germany (see Map).
II. European Union's dependence on gas imports from Russia
Presently, approx. 1/4 of all primary energy in the EU comes from natural gas. Gas consumption in the Community is increasing steadily. In 2003 it amounted to approx. 480 billion m3, 51 percent of which was imported from outside the EU. The major suppliers of gas to the EU include Norway, Algeria and Russia. A growing proportion of gas is delivered to the EU as LNG (liquefied gas). According to projections of the European Commission's Transport and Energy Directorate, the dependence on external sources of gas will grow (to approx. 75 percent in 2020) as internal consumption is expected to rise and European gas deposits become depleted. In the light of these projections, the largest global and regional gas producer and exporter, i.e. Russia, has an important role to play in the EU's gas supply security concept. Security of supplies depends directly on the security of transport, i.e. the routes of export gas pipelines. Because of the rigid transport infrastructure connections it is difficult to diversify the sources of gas supplies within a short time span. On the average, Russia provides approx. 23 percent of gas consumed in the EU at present. This dependence rose to this level after the recent enlargement in May 2004, at which time regional differences in the geographic structure of gas imports also widened. Before May 2004, the European Union imported 17 percent of its gas from Russia. The major EU consumers of Russian gas before May 2004 included Germany, which depended on Russia for more than 32 percent of its consumption, and Italy and France, which depended on Russia for approx. 25 percent of their gas.
The dependence of the New Member States on Russian gas supplies is several times higher. On the average, they import 73 percent of their annual gas consumption from Russia, but a large group of the new Members (Lithuania, Latvia, Estonia, Slovakia) are completely dependent on gas from Russia. This is why the old Member States and the countries that joined the EU recently have different perceptions of the energy security issue and, in some cases, they have conflicting interests. There is also a fundamental difference between the views of the two groups of countries on the problem of supplies diversification. For the EU Fifteen, increasing gas imports from Russia is one of the basic methods to ensure stable and diversified supplies, and for many of the old Member States Russia may be a new supplier. In their energy policy, these countries put the greatest emphasis on creating optimum conditions for the transport of Russian gas. The New Member States, on the other hand, have no possibility to diversify their supplies presently or in the next several years. For them Russia is and in the medium term will remain the largest and most important gas supplier. Hence, the emphasis of their energy security policy is on counterbalancing the dependence on supplies by expanding their transit role and developing their own transmission networks. This is they only way they can reduce their unilateral dependence on gas imports from the Russian Federation and thus improve their energy security. These countries can hope to diversify their gas supplies only in the long term, with projects such as the Norwegian gas pipeline, Nabucco or gas supplies from Libya.
III. Projects for new export gas pipelines from Russia to the EU: The Yamal pipeline and the North European pipeline
The two gas transport routes from Russia to the EU that are being considered presently both have their advantages and limitations. The North European (Trans-Baltic) pipeline project endorsed by the gas supplier Gazprom bypasses the unstable Belarus. Moreover, European energy companies (especially EON of Germany) have initially expressed interest in its implementation, which improves the chances of the project being successfully financed, and Finland is also interested in the project. However, it is a very costly investment. It is also detrimental from the point of view of the New Member States, i.e. the Baltic States and Poland, because it bypasses their territory, thus diminishing their role as transit countries and their importance to Russia. It deprives these countries of the ability to counterbalance their dependence on the gas supplier with control over gas transit, which is enormously important from the point of view of their energy security.
On the other hand, the Yamal pipeline, and especially the new concept of the second branch of that pipeline, i.e. the Amber project, would increase the energy security of the New Member States while at the same time creating new routes for the transport of Russian gas to Western Europe. It would also be a much less costly investment than the Trans-Baltic pipeline. Its main limitations are that Gazprom is presently not interested in the project, and the project's implementation would require co-ordinated action of many countries via whose territory the projected pipeline is going to run. The Yamal pipeline project is therefore a major challenge for the EU. In order to implement it one will have to persuade the Russian side to approve it, and overcome particular interests of certain European energy companies. Nevertheless, this project appears to be more in keeping with the Union's interests, both economically (it is much cheaper), and security-wise. It would be a practical fulfilment of the principle of solidarity among EU Member States, which is very important but seldom raised in energy discussions. A materialisation of this principle in such concrete shape would certainly be of great significance for the Union's cohesion in the long term and would send an important message to the EU's partners, especially Russia.