Memorandum by Professor Dieter Helm, University
of Oxford
1. This memorandum addresses one aspect
of the relationship between the European Union and Russia—energy
policy.
THE EU OBJECTIVES
2. The objectives of the European Union
in respect of energy policy are threefold: security of supply,
climate change and competitiveness. Europe relies increasingly
on Russian oil, gas and coal. There are many competing sources
of oil and coal supplies, but gas is—and will remain—primarily
delivered by pipeline and has high storage costs. As the dependency
on imported gas rises, and as the alternative pipeline suppliers
to Europe implicitly collude, Russia's will become correspondently
of greater importance. Events in Ukraine in 2005-06, the sometimes
difficult relationships between the new eastern European members
of the EU and Russia, and the difficulties of meeting domestic
demand in Russia combine to create serious security of supply
problems.
3. These security of supply problems are
likely to be reflected in the price of Europe's energy supplies,
and this will impact on the competitiveness objective.
4. Europe's focus on climate change is also
central to the relationship with Russia. The EU invested considerable
political capital in gaining Russia's ratification of the Kyoto
Protocol, and the rapid expansion of Russia's coal, oil and gas
industries will not only reduce the effectiveness of global action
to combat climate change, but render EU efforts to get Russia
to abate its emissions correspondingly more difficult.
UNDERSTANDING RUSSIAN
OBJECTIVES AND
STRATEGY
5. Russia's objectives differ considerably
from those of the EU. The political and economic transformation
of Russia from the economic turmoil of the 1990s (when it ranked
alongside Mexico in economic significance) to a major power has
been based almost exclusively on fossil fuels. The election of
Putin coincided with a doubling of oil prices, and since 2000
the path has been upwards, solving its foreign exchange difficulties
(post the default in 1998), and enabling its new surpluses to
underpin an expansion of Russian firms (mainly in the energy sphere)
into European markets through a combination of strategic partnerships
and acquisitions. It is in Russia's interest to exploit its fossil
fuels resources further—by extracting the highest price.
For this it needs captured (and secure) customers, a grip on the
supply chain and investment in developing its reserves. Russia
is—and will remain for at least the next decade—primarily
a carbon economy.
6. In pursuit of this objective, Russia
has taken a state capitalist model, so that the political elite,
the governmental institutions and the large monopoly corporations
have become intimately entwined. Gazprom in particular has approached
the European market with a strategy to ensure its markets through
a significant element of control. It has had several components.
The Baltic Pipeline (Nord Stream) has been part of a strategy
to reduce the pivotal role of the Ukraine. The deals with the
Caspian States to send gas north through Russia have undermined
alternative (non-Russian) pipeline proposals to Europe, and the
special relationships with large European companies (notably in
Germany, but also Italy, Austria, The Netherlands and France)
have been developed. Gazprom has bought into European gas network
assets, and it has set up its own direct supply businesses in
a number of key markets. Finally, Gazprom and Russia have been
developing their relationships with potential competitors—notably
in North Africa, but also with Norway.
7. It is hard to see what interest the political
and business elites in Russia have in credible climate change
policies. Though some areas and industries will suffer from global
warming, the carbon economy relies on continuing markets for fossil
fuels, and climate change will open up very considerable opportunities
in the Arctic north. Ice free ports will transform the export
route options, and Arctic reserves will become much more accessible.
For these reasons, recent flag planting and the stepping up of
Arctic military manoeuvres fit within Russia's overall economic
interests.
THE EU APPROACH
TO DATE
8. The difference of objectives is fundamental,
and any relationship between Russia and the EU needs to recognise
these as given. To date, part of the EU's failure to make much
progress on EU-Russian energy relationships can be explained by
three fundamental mistakes. The EU failed to appreciate that objectives
differed; it failed to speak with one voice as its members responded
to Russia's strategies on a bilateral basis, most notably in the
"special relationship" which has grown up between Germany
and Russia; and finally it failed to put its own house in order,
to build strategic energy resilience.
9. During the 1990s, when Russia was at
its weakest, the EU treated Russia as if it were a candidate member
(but without the prospect of membership). In this period—which
coincided with the enthusiasm for liberalised and competitive
energy markets—the EU focussed its energy diplomacy on getting
Russia to ratify the Energy Charter (which it had signed) and
in particular the Transit Protocol. The Commission appeared to
believe that Russia would open up its pipelines to third party
access (TPA), and adopt a liberalised structure. Such a strategy
was associated with the assumption that the penetration of European
and international energy companies into the Russian market—including
the ownership of reserves—was sustainable, given the assumption
that Russia would need western company expertise.
10. This was fundamentally mistaken: Russia's
interests in exploiting its resources rested on what it described
as "security of demand", but actually meant increasing
its market power. TPA was precisely designed to produce the opposite
result—and it was rational and inevitable that Russia would
resist the spirit (and indeed the letter) of the Energy Charter
and the Transit Protocol. Much diplomatic capital was therefore
wasted by the EU.
11. The second failure was that the EU failed
to speak with one voice. Faced with increased upstream market
power from Gazprom in particular, EU member states have pursued
a strategy of bilateral relationships with Russia and Gazprom.
The most important has been Germany. The relationship between
EON and Gazprom is deep and includes share ownership. The Baltic
Pipeline is a German-Russian project (even as other partners enter),
it was approved by Schroder, and he is now its Chairman. Though
there are different tones in the public handling of this relationship
with the Grand Coalition, the relationship continues to deepen.
Other member countries have responded by making their own separate
deals, as the EU as a whole is hamstrung by the special German
relationship. Austria and Italy have been notable in following
in Germany's footsteps, and France has now somewhat belatedly
joined this process. As a result, Russia has been able to largely
ignore further efforts by the EU to get it to ratify the Energy
Charter and the Transit Protocol, and has continued to acquire
downstream assets across the EU.
12. The third failure has been internal
to the EU. Faced with external dependency and market power, the
obvious strategy is to build up internal resilience. Completing
the European electricity and gas networks increases the ability
to render mutual support in the event of a security of supply
physical threat, and it has the additional benefit of reducing
costs through the economies from portfolio effects. Strategic
gas storage—complimenting arrangement for oil strategic
stocks—adds resilience. Diversification of sources of supply
and of electricity generating technologies forms a further dimension—in
particular heading off yet a further dash-for-gas.
13. The Hampton Court proposals, tabled
under the UK Presidency in November 2005, and subsequently partially
incorporated in the EU Green Paper 2006 and EU White paper 2007,
provided a framework for this internal response. Progress however
has been slow—and in the case of strategic gas storage practically
nonexistent.
14. The EU has placed more political emphasis
on climate change, but the link to its relationship with Russia
has not featured in this domain except to argue that increasing
investment in renewables and energy efficiency are also ways of
increasing security of supply.
ENHANCING THE
EU'S APPROACH
15. In reformulating its energy policy towards
Russia, the EU should take the Russian objectives as given, and
focus on ways which increase its bargaining power, rather than
dissipate political capital on trying to turn the Russian energy
market into a mirror of the liberalised and competitive approach
which has been advocated (but not achieved) internally. Third
party access, unbundling and foreign ownership of Russian reserves
are not achievable in the short to medium term.
16. On the assumption that Russia (and Gazprom
in particular) will continue to act as a monopoly supplier, and
seek to extract the maximum economic rent from Europe from its
resources, the EU should actively diversify its supplies. Although
the EU advocates a market-based approach, it should take account
that this is not a level playing field, but rather a highly politicised
energy context, in which the individual choice of companies to
invest further in gas generation is likely in aggregate to produce
an increased dependency for all. The European energy market needs
therefore to price in a security of supply premium, and this is
best achieved through a capacity market.
17. The EU should encourage steps to increase
the internal resilience of its energy sector, and this requires
an acceleration of the integration of European gas and electricity
grids, mutual support arrangements and strategic gas storage.
18. The EU's major political obstacle to
increasing its energy bargaining power lies in the bilateral deals
and relationships being struck between member states and Russia.
"Speaking with one voice" requires EU solidarity, and
this should be explicitly woven into EU foreign policy, and through
a common pooling of long term gas supply contracts.
19. In engaging at the EU level directly
with Russia, reciprocal rules for ownership and investment should
be developed. As Russia insists on its legitimate rights to determine
how and on what terms European companies operate in the Russian
energy sector, similarly it is legitimate to insist that Russian
companies adhere to the EU's internal market rules. Where this
involves limiting the abuse of dominance, anti-competitive behaviour
and structural rules in respect of unbundling, it should be applied
within the EU to Gazprom and other countries. The critical issue
here is to address competition in the European market as a whole,
and not on a country-by-country basis (as at present). Where Russian
companies violate competition law, they should be subject to the
same sanctions, even though in the case of Gazprom this may involve
directly and indirectly imposing fines on the Russian government
in respect to its shares in Gazprom. A first step might be for
the Competition Directorate to launch a competition inquiry into
Gazprom within the EU markets.
20. On climate change, whilst EU foreign
policy should use the various multiple relationships to encourage
Russia to participate in a post-Kyoto climate change regime, the
EU should also focus on those aspects of low carbon technologies
which also increase security of supply.
IMPLICATIONS FOR
UK FOREIGN POLICY
21. UK foreign policy in respect of Russian
energy is in need of a radical overhaul. The UK has focussed almost
exclusively on the Energy Charter and the liberalisation agenda,
and to date has offered only limited support (through the Hampton
Court process) for the focus of energy negotiations with Russia
to be set at the EU level. In particular the UK has put most of
its effects into the unbundling arguments, and as a result positioned
itself at loggerheads with France and Germany. It has not sought
to forge a common external position with these two major powers
towards Russia.
22. Part of the reason for this positioning
is historic—with excess supplies and North Sea reserves,
the UK has had the luxury of considerable self-sufficiency. Having
depleted the North Sea as fast as possible (and at the lowest
historic prices), the UK's energy vulnerability is now considerable.
Whilst the relationships with Norway are important, the influence
of Russia is not thereby much reduced—particularly in respect
of price.
23. The UK needs to increase its energy
policy resources and its knowledge and understanding of both other
EU energy positions and also that of Russia. Energy policy is
increasingly a part of foreign policy for both the EU and the
UK.
24. Recent statements from the ministers
in support of a UK policy of "energy independence" lack
much by way of coherence, but it is noticeable that this "independence"
in defined at the national and not European level. To actively
pursue diversity of supply—rather than rely on the conventional
UK position that this will be delivered by the market—is
a radical policy departure. It needs to be explained, and crafted
to work with the grain of Europe's overall energy policy position.
4 January 2008
| 
