Student:FedericoFaleschini ModuleConvenor:VladimirZuev Module:EconomyofPostSovietSpace Programme:JointMasterProgrammewithUniversityofKent 12December2011

EconomicsofEnergySecurityinEurasia: TheEURussiaGasRelation

Introduction Energy security and economics are closely intertwined. Concerns about energy securitymayinfluenceeconomicsindifferentways:forexample,byrestrictingor enlargingmarket competitionor byforcingconsumers topayanhigher pricefor energysuppliesforthesakeofincreasedsecurity.Theimpactontheeconomyof energysecuritychoicesdependsonmanyfactors:theendowmentofnaturalresources ofacountryrelativetoitsenergyconsumption,thegeographicallocationandthe characteristicsoftheenergysourcesthemselvesareamongthemostimportant.The Eurasianspaceisaperfectsettolookintothiscomplexlinkbecauseithostsawide varietyofcountries,manystronglyinfluencedbyenergysecurityconcernsbutwith verydifferentviewsonwhatenergysecurityactuallyis. Theaimofthisessayistoexploretheeconomicconsequencesofenergysecurity strategiesinRussiaandtheEU,themostimportantplayersintheEurasianspace.The analysiswillbefocusedonthegasmarket,becauseofthehigherrelevanceofenergy securityconcernsattachedtotheEURussiagasrelationsinrespecttooilones.The mainargumentoftheessayisthatenergysecurityconcernsareproducingopposite effects in the economic spheres in the EU and Russia and that the outcome is favourabletoRussia,butonlyintheshortandmidterm. Thestructureoftheessayisasfollows.Thefirstpartisgoingtoanalysethedifferent outlook on international energy relations on the part of the EU and Russia. The second part will look into the structural conditions of the gas market. The third sectionconcludes. 1. RussiaandEU:differentconceptionsofenergysecurity

Aspointedoutby Correlj etal. (2008),RussiaandEUclearlyseeinternational relationsinadifferentway.Theydescribetwonarrativesoverthestateoftheworld system: Marketsandinstitutions:ascenariowheretheprocessofglobalisationforces allcountriestointegrateandcooperateinallarenas,especiallytheeconomic one.Thefreeflowofcapitalandgoodsdepoliticizesenergyrelations,making themeasiertomanage; RegionsandEmpires:ascenariowhereregionalblockemergeandcompetefor strategic resources. Energy relations become highly politicized, making conflictsmoredifficulttoresolve. Of course each narrative has powerful implications on the economics of energy security:inthefirstscenarioenergysecurityderivesfromtheintegrationofworld markets and the protection of investment, while in the second scenario energy securityistheoutcomeofapowerstruggleoverthepossessionofenergyresources andfirms'behaviourisinfluencedbypoliticalpressures. Accordingtotheauthors,theEUenergysecuritystrategyinthepostSovieterahas beenalwaysembeddedintheMarketandInstitutionsscenario.Theinitiativeofthe EnergyCharterTreaty (ECT)1 isthemosteloquentexampleoftheEU'seffortof exportingitsmarketbasedrulesandprinciplesintheenergymarket. OntheotherhandtheRussianenergysecuritystrategyaftertherisetopowerof Vladimir Putin has been conceived more and more in terms of the Regions and Empires scenario, as showed by the strong government control over the Russian energyindustry(Kefferptz2009;Christie2009). ThepointmadebytheauthorsisthatindeedtheenergyrelationsbetweentheEUand Russia in the last 10 years have increasingly resembled the Regions and Empire scenario.TheEU,however,haskeptpursuingmarketbasedinstruments(pushforthe enlargementofEUstylelegislation).AssumingthattheRegionsandEmpirescenario is going to last, Finon et al. (2008) highlight a fundamental contradiction in the
1 For an excellent overview of the Energy Charter Treaty history and role see Konoplyanik et al. (2006).

presentEUenergypolicybetweenlongtermimplicationsofmarketliberalizationon theonehandandenergysecurityontheother:unilateralmarketliberalisationinthe energysectoronpartoftheEUindeedisnotcompatiblewithenergysecurityaslong as relatively small retailers must confront a giant company such as Gazprom. Moreovertheopendoorpolicyofthesinglemarketwouldlet Gazprom acquire marketsharesinthedownstreamsectortoo,possiblyincreasingevenmoreitsgripon theEUgasmarket(althoughthismaynotalwaysbethecase2). Afterthegasdisruptionof2006and2009,andfollowingtheentryintotheEUofthe eastern European states (totally immersed into the Regions and Empires scenario becauseoftheirhistoricaldistrustofandfearofRussia),thecallfortheEUitselfto playamoreincisiveroleintheenergymarketshasbeenstronger.Therearehowever twoproblemsrelatedtotheEUspeakingwithasinglevoiceonenergymatters: LargermemberStatesresisttheunbundlingoftheirnationalchampions(i.e. formerStatemonopoliesinthegassector):indeednationalchampionsarewell able tosecure longterm supply contracts without resorting toan EUwide framework; ASingleEuropeanNegotiatingAuthoritywouldbeforcedtolimitcompetition inordertocompensateforthelossofbargainingpowerofthesmaller,post liberalisation retailers (e.g. itwould have tonegotiate longertermcontracts thanitwouldbethecaseinacompetitivemarketwithGazpromasmonopolist supplier). ThefundamentalcontradictionoftheEUEnergyPolicyshowshowstrongthelink between economics and energy security is. In order to understand how these theoretical insights come into play in the actual EURussia energy relations the secondsectionwillfocusonthegasconsumptionfiguresandtheirevolution.
2 The entrance of Gazprom in the downstream sector (sales to end energy users in the EU common market) can indeed even increase competition if Gazproms partner or the company taken over is not the dominant operator. Of course in order to guarantee this pro-competition outcome the regulator (i.e. the Commission) should put in place limits for the acquisitions in the downstream sector by players which have a dominant share in the upstream sector.

2. Structuralconditions:gasdemandandsupply Whilethegeopoliticalorientationissurelyimportant,structuraldemandandsupply conditionsarethebackboneofanyenergyissue.Itisthereforeveryimportantto assesstheseconditionsintheshortandlongruntounderstandwhatconstraintsthe EUandRussiaface,notwithstandingtheirgeopoliticaloutlook. TheforecastsforgasconsumptioninRussiaandtheEUareclear:consumption is goingtoraiseforbothplayers.Howeverthereisnoagreementintheliteratureover theactualconsequencesofsuchadevelopment. InrespecttotheEUconsumption,naturalgasconsumptionisalmostcertainlybound to rise, not only because of the decreasing indigenous reserves but also because climatepolicies(inparticulartheEmissionTradingSystem(EuropeanCommission 2008)areencouraginggasconsumptionoverother,moreCO2intensivefossilfuels. AccordingtofiguresprovidedbyChristie(2009),however,inthebestcasescenario theEUcouldbeabletoslightlydiminishitsgasimportsby2020thankstoathorough implementationofits20/20/20plan(EuropeanCommission2008) 3.InrespecttoEU energysecuritythemostimportantpointistheunequaldependenceonRussiangas by the various member States: while the biggest importers (Germany, Italy and France)havearelativelylowshareofRussiangasintotalenergyconsumptionbuta largeshareofEUgasconsumption,allEasternEuropeanmemberStatesimportlower volumesbuttheirdependenceonRussiangasismuchhigher(seeGoldthau 2008): thisunbalanceentailsyetanotherdifficultyfortheEUenergysecuritypolicy,with thedilemmabetweenliberalisationandtheneedforanEuropeanSingleNegotiating Authoritystillvalid.Moreover,althoughtheimplementationofrenewableenergieson
3 It is not clear whether these predictions are still valid after the decision by Germany to anticipate the phasing-out of its nuclear power plants and the anti-nuclear referendum in Italy, both closely related to the Fukushima nuclear disaster (see Spiegel Online International (2011) and The Guardian (2011)). Considering the lower CO2 intensity of natural gas in respect to coal (the only abundant fossil resource in the EU), it may well be that imports of natural gas are going to increase anyway.

alargescalewillhelptoreduceEUenergydependency,theirpromotionrequires stronggovernmentsupport,thereforeinfluencingtheenergymarketinthedirection ofaplannedeconomy. Russia'sgasconsumptionontheotherhandissettoriseinallforecasts,duetothe growthoftheRussianeconomyanditsveryhighenergyintensity(i.e.energy/GDP). AccordingtoprojectionsbytheRussiangovernment(quotedin ibidem:688),the consumptionofgasin2020isgoingtoraisefrom16%(inthepessimisticscenario)to 28%(intheoptimisticscenario)inrespectto2008levels(andthisisassumingenergy efficiencymeasureswillbeputinplace).Theparadoxisthatmanyanalysts(e.g. ibidem)andinstitutions(e.g.IEA2006)questiontheabilityofGazpromtomeetthe increaseddemand,bothathomeandabroad,becauseofthelackofinvestmentsinto its ageing infrastructure and into research and development of new fields. To understandthesignificanceofthisclaimsfor Gazprom,oneshouldbearinminda specificcharacteristicoftheRussiangasmarket:itishighlypoliticized(i.e.itdoes not work according to market principles) to subsidize household and industrial consumption,forcingGazpromtomakeallofitsprofitsthroughexports.Whatisthe rationalethenbehindthislackofinvestments,whichcouldpotentiallycapthegrowth ofGazprom'srevenues? Scholarspointtothemonopolystatusof Gazprom (Riley2006,Finon etal. 2008, Goldthau2008,Lihuto(ed.)2009)whichstiflesanyneed(orcall)formodernisation. Inadditionthepossibilityof buyingthebulkof theCentralAsiancountries'gas production to cover eventual shortages is another significant disincentive on investments.Howeverinthelongerrun(after2020)thisstrategywon'tbesustainable and without massive investments in the Russian energy industry as a whole and withoutstrongreductionsinenergyintensity,meetingtherisinginternaldemandand the(likely)risingexternalonewillproveincreasinglydifficult.Again,itiseasytosee howtheconceptionofenergysecurityframedintotheRegionsandEmpiresapproach haspowerfuleconomicimpactsbydistortingmarketcompetition:indeedaccordingto

Goldthau(2008)therealriskforEUenergysecurityarescarceinvestmentsintothe Russiangasindustry,ratherthanEUrelianceonRussiaimports. Finon etal. (2008)provideadetailedaccountofthethreatof Gazprom totheEU securityofsupply: Monopoly power on shortterm markets: although Gazprom could use its dominant position to force shortterm gas price hikes, this possibility is generallydiscardedinfavouroflongtermcontractswichlinkthepriceofgas tothepriceofoil; Monopolypowerinthelongtermmarket:inrespecttotheissueofwhether Russiaisconsciouslyunderinvestinginordertoincreaselongtermgasprices, theauthorsclaimthatsuchastrategyisnotfeasiblesincebarrierstoentryin theEuropeangasmarketarenotexcessivelyhighfor Gazprom competitors: thereforeasustainedperiodofhighpriceswouldencourageNorway,Algeria andLNGsupplierstoincreasetheirproduction; Collusionwithothermajorgasproducers:thecreationofagascartelwould significantlyrisethepossibilityofmonopolypowerinthelongtermmarket. Howevertheauthorsshowthatthecharacteristicsofthegasindustry(high fixedcosts,fixedpipelinestructure)preventtheformationofaglobalcartel:it istoodifficulttoharmonisetheinterestofthemajorplayers. WhiletheremightbemixedevidenceabouttheviabilityofRussia's Regionsand Empiresstrategyinthelongerrun,itisimpossibletoignorethatintheshortRussia hastheupperhandduetothestrategiccommoditycharacterofgasandthescarce integrationofnationalmarketsamongEUmemberStates(Liuhto2009).Althoughit is certainly possible to identify a relation of interdependence (Russia has no possibilities in the medium term to diversify its exportsmarkets because of the insufficientresourcesdevolvedtodevelopmentofnewinfrastructure(Finon etal. 2008)),itisfairtosaythatRussiacancopelongerwithoutEUrevenuesthantheEU

canwithoutRussiangas. 3. Conclusion:EUillusionsatRussia'sgain,atleastforthemediumterm Thisessayhaslookedintotheeconomicimplicationsofenergysecurityconceptions andmeasuresinthegasrelationsamongtheEUandRussia.Thefirstsectionhas analysed how the different outlook on energy relations and the world system in generalinfluencethepolicyproposals(andtherelatedeconomicmeasures)inthe energysecurityfield.Thesecondpartoftheessayhasshownwhatarethestructural characteristicsofthegasmarketwhichlimitbothambitionsandpossibilitiesofboth partiesintheimplementationoftheirrespectiveenergysecuritypolicies. ThemainfindingofthisessayisthattheEU'sillusiontostillliveinaMarketand Institutions scenarioisnotpayingoff,norinpoliticalnorineconomicterms.The insistenceoftheEUontheunilateralliberalisationofmarketsequalstoalossin energysecurityandadubiousadvantageineconomicterms,consideringthatthe unbundlingofbigretailercompaniesdoesnotprovidetheEUmemberStateswith sufficientleverageinrespecttoGazprom'srequestsandthattheEUitselfisnotable yet to act as a Single Negotiating Authority. The structural factors (consumption patterns,pipelinenetwork,)andtheclimatepoliciesmakeanagreementonshared principlesandruleswithRussiaimperativeinordertoattainthedualgoalofenergy securityandCO2emissionreductioninthelongperiod. OntheotherhandRussiamaycomeoutasawinnerintheshortandmediumterm, but the detrimental economic effects of its energy security policy of resource nationalismwilltaketheirtollinthelongrun.Theincapacitytochanneleffectively the badly needed investments into the maintenance of the old infrastructures, the construction of new ones and the development of new gas fields will make the Russiangasindustryincreasinglyuncompetitiveandmorevulnerable.

A new approach is needed on both sides, to fully tap the enormous potential economicandenvironmentalbenefitsofapositiveandproactiveEURussiarelation.

BIBLIOGHRAPHYinalphabeticalorder
ChristieE.(2009),EuropeansecurityofgassupplyAnewwayforward,in LiuhtoK.(ed.)(2009),TheEURussiagasconnection:Pipes,politicsandproblems, Electronic Publications of PanEuropean Institute, vol. 8/2009, Turku School of Economics:PanEuropeanInstitute,pp.322 CorreljA.,vanderLindeC.(2006),Energysupplysecurityandgeopolitics: AEuropeanperspective,EnergyPolicy,vol.34,pp.53243 European Commission (2008), 20 20 by 2020 : Europe's climate change opportunity(COM(2008)30final),Bruxelles:EuropeanCommission FinonD.,Locatelli C.(2008), RussianandEuropeangasinterdependence: Couldcontractualtradechannelgeopolitics?,EnergyPolicy,vol.36,pp.42342 Goldthau A. (2008), Rhetoric versus reality: Russian threats to European energysupply,EnergyPolicy,vol.36,pp.68692 IEA(InternationalEnergyAgency)(2006), OptimisingRussianNaturalGas. ReformandClimatePolicy,Paris:OECD/InternationalEnergyAgency Kefferptz R. (2009), EURussian natural gas relations Pipeline politics, mutualdependency,andthequestionofdiversification ,inLiuhtoK.(ed.)(2009), TheEURussiagasconnection:Pipes,politicsandproblems,ElectronicPublications ofPanEuropeanInstitute,vol.8/2009,TurkuSchoolofEconomics:PanEuropean Institute,pp.92108 Konoplyanik A., Wlde T. (2006), Energy Charter Treaty and its Role in InternationalEnergy,JournalofEnergy&NaturalResourcesLaw,vol.24,pp.523 58 LiuhtoK.(ed.)(2009), TheEURussiagasconnection:Pipes,politicsand problems , Electronic Publications of PanEuropean Institute, vol. 8/2009, Turku SchoolofEconomics:PanEuropeanInstitute RileyA.(2006), TheComingoftheRussianGasDeficit:Consequencesand

Solutions , CEPS Policy Briefs, n. 116, Brussels: Centre for European Policy Studiess SpiegelOnlineInternational(2011),GermanytoPhaseOutNuclearPowerby 2022,www.spiegel.de/international,30/05/2011(accessed11/12/2011)
http://www.spiegel.de/international/germany/0,1518,765594,00.html

The Guardian (2011), What Italy's nuclear referendum means for climate change,guardian.co.uk,15/06/2011(accessed11/12/2011)
http://www.guardian.co.uk/environment/blog/2011/jun/15/italynuclearreferendum