STUDENT: Federico Faleschini (student number: 10902214) DEGREE: Master of Arts in International Relations (International Double Award) YEAR:

2011/2012 WORD COUNT: 14000

Energy Efficiency as an EU Foreign Policy Tool: Possible Impact on Russia

Table of contents
Introduction.......................................................................................................................1
i. ii. Research design: theoretical framework..........................................................................................1 Research design: operationalisation of key concepts and research hypothesis definition..............3

The development of the EU Energy Policy and Energy Efficiency............................6

1.1 Europeanisation of Energy Policy and role of EE...........................................................................6 1.2 The EU External Energy Policy: a multifaceted initiative..............................................................8 1.2.1 1.2.2 1.2.3 The Energy Charter Treaty..................................................................................8 The EU External Energy Policy and the Carbon Market initiative.....................9 The EU-Russia Energy Dialogue and the Partnership for Modernisation........12

Energy (in)efficiency in Russia: causes and potential for improvement...................14

2.1 Structural causes of energy intensity: economy and society.........................................................14 2.2 Institutional aspects of energy intensity: (lack of) economic and legislative incentives...............17 2.2.1 2.2.2 Energy tariffs and subsidies..............................................................................17 Energy Efficiency Legislation and Policy.........................................................18

2.3 Energy Efficiency potential in Russia...........................................................................................22

Policy options at the EU-Russia relations level.........................................................28

3.1 Options at the multilateral level.....................................................................................................28 3.1.1 3.1.2 The Energy Charter Treaty and the impact of Russia's WTO accession...........28 Joint Implementation: a great potential hampered on both sides......................30

3.2 Options at the bilateral level (Energy Dialogue)...........................................................................33 3.3 Barriers and how to remove (or soften) them through cooperation on EE.................................35

Conclusion.................................................................................................................40

Appendix 1......................................................................................................................42 Appendix 2......................................................................................................................43 Appendix 3......................................................................................................................47 Appendix 4......................................................................................................................49 Appendix 5......................................................................................................................50

References.......................................................................................................................52

INTRODUCTION
In today's carbon constrained world, energy efficiency is becoming more and more important as a tool to limit global warming within acceptable limits. At the same time a new line of strategical thinking is appearing that promotes energy efficiency as a clever, durable and mutually beneficial way to improve relations between energy consumers and producers. Among these relations the EU-Russia relation is tremendously important, being the EU the largest importer of energy and Russia the largest exporter of energy in the world. The potential to be extracted from a successful EU-Russia partnership on improving energy efficiency is immense. The dissertation is dedicated to this topic. The main argument is that cooperation in Energy Efficiency between the EU and Russia holds the largest potential of any area in the Energy sector and should be much more forcefully pursued by the EU, since it can dramatically improve its very own energy security and propel its status as leader in the fight against climate change. i. Research design: theoretical framework The EU is conceptualised as a normative power as defined by Manners (2002, 2006) and more precisely as a Regional Normative Hegemon as defined by Haukkala (2008). Manners (2002) sees the EU as an entity other than the Westphalian nation-state and argues that to understand its true nature the discussion must move away from traditional, nation-centric concepts of civilian and military power/capabilities. Normative power is defined as the ability to shape conceptions of normal in international relations (ibidem), a concept not dissimilar from the Gramscian concept of hegemony1. Such an approach is at work in the EU-Russia relation over clean energy and environmental issues, as it is the EU which is more actively involved into international environmental negotiations and is shaping the concept of normal (i.e. sustainable development) in this field, with Russia taking a much

At the same time the normative power of the EU can be inscribed into the hegemonic discourse at the international level of Global Governance such as developed by Brand (2005).

more passive stance (Charap et al. 2010). Haukkala (2008) starts its analysis from the concept of normative power Europe as defined by Manners but adopts a descriptive rather than a normative stance. His article is particularly interesting because it critically analyses the European Neighbourhood Policy and the effects of the normative stance of the EU external action when decoupled from the perspective of accession. The highly asymmetrical relations between the EU and candidate countries impose heavy burdens on the latter (i.e. there is a strong element of coercion), which are bearable only in light of the advantages linked to full EU membership2. While the EU is openly playing an hegemonic role only in its regional context, at the same time it is also trying quite aggressively to promote its values on the global level (i.e. it is applying soft power): the link between legitimacy of its normative power and the enlargement process is a strong constraint on the EU's freedom of movement in respect to other major international State actors and in the relation with these actors themselves. The relationship between the EU and Russia can indeed be seen in many areas in this light: by applying a high level of conditionality to its external relations with Russia without offering concrete prospective benefits, the EU is not able to apply effectively its normative power. At the same time the conceptualisation of the EU as Normative Power allows to identify a preference on part of the EU for multilateral instruments and forums rather than power policies. Such a preference derives from the soft nature of the EU's power and has important implications for the EU's relations with Russia. Indeed as Boute (2012) argues the Commission may have well introduced the topic of EE (where it already had vast competences even before the Lisbon Treaty) into the External Energy Strategy to sneak in the realm of external energy relations, long considered to be a privileged area of power politics.

Prange-Gsthl (2009) lists three factors which could motivate III countries with no clear membership prospect to accept the export of the EU rule: the identification motive, the independence motive and the economic motive. Unfortunately for the EU, none of this motives could apply to Russia.

ii. Research design: definition of key concepts and research hypothesis Having defined the theoretical framework, the key concepts of Energy Efficiency (EE) and (tool of) foreign policy must be defined and operationalised in order to spell the research hypothesis. EE can be defined in different ways according to the sector taken into consideration. Relying on Patterson (1996), this study mainly refers to economic-thermodynamic indicators of EE3. In these indicators the input is measured in thermodynamic units and the output in economic units. The main indicators of this group are the energy/GDP and energy/Y(/roubles/...) ratio (also known as energy intensity of respectively an economy/country and sector) and the GDP/energy ration (measuring the energy productivity of an economy/country). The main problem with these class of indicators is that per se they don't distinguish between improvements in technical EE and other factors which can influence energy consumption (e.g. changes in the sectoral composition of the economy towards less energy-intensive sectors). Being this dissertation in the realm of international relations, this class of indicators is the most useful since it allows comparison of entire economies and allows to calculate monetary costs and benefits of EE measures. In addition when assessing the performance of specific sectors the physical-thermodynamic indicators come into play. Indeed the Energy Charter Treaty (ECT)'s Protocol on EE and Related Environmental Aspects (PEEREA) (ECT Secretariat 2004) defines EE in physicalthermodynamic terms: article 2.6 defines Improving EE [as] maintain the same unit [and quality/performance] of output [] while reducing the amount of energy required to produce that output. On the other hand the EU Commission in its Energy Efficiency Plan 2011 (EC 2011a) adopts the same definition (same output with less input and/or more output with same input) but mingles it with the concept of energy savings [i.e.] a broader concept that also includes consumption reduction through behaviour change or decreased economic activity (ibidem: 2, footnote 2). In practice these two terms and concepts are deemed interchangeable and are used as equivalents, not only in the EU legal system but also in the Russian one (see chapter
3 See Appendix 1 for a description of all types of EE indicators.

2.2). This study will follow the same convention and refer both to EE and energy savings (ES), according to the circumstances and the dataset. The most relevant definition of EE however may be that of full-fledged source of energy, as stated in article 1.1 of the PEEREA and the Energy Efficiency Plan 2011. EE is indeed a full-fledged source of energy because it can be conceived as an alternative to building new generation capacity, especially where end-use energy inefficiency is high. Thus, EE is operationalised as a proper source of energy and can be measured in negajoules, i.e. the energy consumption avoided through enhanced energy efficiency (ibidem: 2, footnote 3). In this dissertation EE is also operationalised as a tool of [EU] foreign policy. By this I mean that investments into EE can be seen as strategic by the EU since they can concur to achieve not only internal political goals in the sphere of energy and climate policy but also external goals. Two major EU goals in the energy sector are improving Energy Security and be a leader in Climat Change Mitigation. Given the complexity of energy security in today's Europe, I adopt the definition by Kirchner et al. (2010: 864): the availability of energy in various forms, in sufficient quantity and at affordable prices, delivered in an environmentally friendly, sustainable manner which is also free from serious risk of major disruption of service.. How could cooperation on EE help to meet both goals? In respect to energy security concerns, an improvement in Russia's EE would free considerable resources for export, thus eliminating concerns over future energy supplies shortages by Russia. In addition, climate security, an essential component of energy security and indivisible at the world level, would also be greatly increased by the reduction of Russia's emissions; In respect to climate change mitigation, addressing Russia's current very high energy intensity would help the EU improve its international profile at climate change negotiations and would provide a cheaper way to achieve its ES targets through the Joint Implementation scheme. Given that EE enhancement can indeed serve the EU foreign policy goals the question to answer is whether the EU allocates enough importance to cooperation in 4

the EE field. Another important question is whether cooperation in EE can create a positive relationship between Russia and the EU. Therefore I formulate the research question as follows: Research Question: Does the EU allocates enough importance to EE as an instrument of foreign policy in its relation with Russia? The question will be answered in two steps. First, the current stumbling blocks in the EU-Russia relation will be identified. Second, the potential of cooperation in EE to remove these stumbling blocks will be assessed.

THE DEVELOPMENT OF THE EU ENERGY POLICY AND THE ROLE OF ENERGY EFFICIENCY
1.1

Europeanisation of Energy Policy and Role of EE

Ever since the Treaty of Maastricht came into force, the EU has played a significant role in the development of international energy markets in Europe. In line with the liberal agenda openly advocated by the EU in every sector, the EU pushes for the creation of a truly interconnected continental energy market and the unbundling of vertically integrated undertakings. In addition, the EU has taken an interventionist role in the promotion of renewable energy and energy services and has also issued numerous directives related to EE requirements in power generation, construction and manufacturing. The EU is therefore strongly shaping all markets through its energy and climate policy. The liberalisation of the EU gas and electricity markets is covered in detail in Appendix 2, since an in-depth review of such a complicated process is out of depth for the goal of this dissertation. The section therefore focuses on how the EU is shaping markets beyond liberalisation through the promotion of energy efficiency and renewable energy sources and then assesses the place of EE within the EU energy policy.

The measures the EU adopted in the field of EE and renewable energy sources are quite different, since renewable energies are of course much more influenced the liberalisation level of the EU energy markets, while directives on EE mainly contain demand side management measures (I.e. push consumers towards more energy efficient products)4 and continuously updated technical standards (to force the production of more energy efficient energy-using appliances). Targets in both areas were set by the famous 20/20/20 Strategy (EC 2008), the main documentof the EU's climate policy. The most notable directives are the following: Renewable Energy Directive (directive 2009/28/EC): the pillar of the system
4 See Gillingham et al. (2009) for a comprehensive overview of the economic rationale of EE policies.

is an EU-level goal (by 2020: 20% of total final consumption generated by renewable energy sources and 10% of total final consumption in transportation generated by biofuels) combined with different national targets (art. 3, 4 includes rules for the drafting of National Renewable Energy Plans) and mechanisms for cooperation among Member States (art. 6-11). It also establishes the possibility of cooperation between member States and third countries through international frameworks (e.g. Joint Implementation mechanism with Transition Countries). The directive is dependent on the liberalisation of the energy markets to grant access to the network to renewable energy; Cogeneration Directive (2004/8/EC), Energy Services Directive

(2006/32/EC), Ecodesign Directive (2009/125/EC), Energy Labelling Directive (2010/30/EU) and Energy Performance of Buildings Directive (2010/31/EU): all these directives strongly shape markets by enforcing progressively stricter standards on manufacturing, construction and energy industries. Overall they leave more discretion to national authorities in respect to targets and penalties setting, also because the success of EE measures is in no small part dependent on the consumers' behaviour. In terms of market influence the stronger measures are the obligation pending on member States' public sector to consider EE in their spending decisions (Labelling and Building directives), the support to cogeneration plants (i.e. producing heat and electricity at the same time) and the introduction of mandatory EE requirements for buildings and electronic appliances.

In terms of energy policy, the Energy 2020 strategy (EC 2010) puts (the increase in) EE as the first priority in the internal market. In the internal market therefore EE is the new cornerstone of the EU energy and climate policy. Indeed the Energy Efficiency Plan 2011 (EC 2011a) defines EE as [potentially] Europe's biggest energy resource (ibidem: 2). It is fair to say that in the EU the topic of EE has been given implemented systematically and it has been given attention at the highest political level. For a detailed presentation of the contents of the EU policy documents

in terms of EE please see Annex 3.

1.2

The EU External Energy Policy: a multifaceted initiative

The first document proposing a common EU External Energy Policy was the Green Paper on Energy Policy (EC 2000). While this was the first tentative to define a common strategic European approach to international energy relations (IER), it was not the first time that European countries had tried to devise a systematic approach. Indeed since 1994 the Energy Charter Treaty (ECT), a brainchild of the European countries, represents the most serious tentative to channel IER into an international contractual law framework. The ECT and the External Energy Policy therefore can be seen as two partially overlapping instruments which reflect the EU's values and praxis in the sphere of IER. Parallel to these two initiatives, the EU has always been an active participants in the international negotiations on climate change and in particular a major player in the Carbon Market initiatives.
1.2.1

The Energy Charter Treaty

The ECT was written between June 1990 and December 1994, in an atmosphere of enthusiasm over the huge potential offered by the end of the Cold War in the field of East-West energy relations. Many of the countries of the Former Soviet Union were endowed with rich natural resources but necessitated huge investments to continue to exploit them after the complete economic disarray caused by the dissolution of the Soviet system. Given the balance of power at the time the ECT text mainly addresses Western concerns and basically was intended as a legal document to provide the legal context necessary to unlock European investment into the ageing and extremely inefficient energy industry of Post-Soviet countries. Such a context at the time was an ordo-liberal order, based on good practises and incorporating environmental concerns (Konoplyanik et al. 2006: 528). The ECT therefore may be seen as a diluted version of the strongly liberal rules adopted by the EU in the energy field: it points to merely facilitate investments and transactions and it does not and can not compel member States to liberalise their own domestic market, although it does imply that 8

liberalisation is the best way forward (ibidem: 532; Konoplyanik 2009). Although the ECT was intended to be a commonly accepted foundation (ibidem: 524) the frictions between the EU approach and Russia's one became evident as soon as high oil prices helped Russia regain confidence and autonomy. According to the ordo-liberal narrative, investments into production and transport infrastructures would on the one hand give consumers the opportunity to switch between suppliers and on the other hand give suppliers access to multiple markets. Recently however the Russian legislator has taken a much different stance in respect to access for foreign investors to sectors deemed of strategic importance: under the Law of the Russian Federation on Foreign Investments in Companies Having Strategic Importance for State Security and Defence (Rossiskaya Gazeta 2008) foreign companies and/or Russian companies with foreign participation suffer from severe restrictions in the access to subsoil blocks [i.e. hydrocarbon and mineral fields] of federal significance (ibidem) compared to the conditions enjoyed by Russian State companies. Such a rule is clearly at odds with the broad definition of investments of the ECT (article 1.6). Over the history of the Treaty however the major point of disagreement between the EU and Russia was the Transit Protocol (ECT Secretariat 2003), specifically the so-called REIO (Regional Economic Integration Organisation) clause, i.e. making the Transit Protocol provisions count for the EU as a whole rather than for every single Member State (Belyi et al. 2011; Konoplyanik 2009: 20-21). These tensions, together with the two Russian-Ukrainian gas crisis of 2006 and 2009, led Russia to drop the provisional application of the ECT starting from 18 October 2009. Since then negotiations have been ongoing on the prospects to adapt the ECT to suit both EU's and Russia's concerns (Belyi et al. 2011). Looking at the history of the Treaty negotiations are going to be long and though, and the words used by the European Commission in the latest External Energy Policy (see next section) refers with sufficiency to the potential role of Russia: The EU considers it would be mutually beneficial if Russia plays a full role in this multilateral framework [i.e. the ECT] (EC 2011c: 13). However it must be said that criticism of the behaviour of Russia within the ECT negotiations does not come from the EU only but also from Russian academics and practitioners alike. See e.g. Belyi et al. (2011: 391), Konoplyanik (2006: 540, footnote 23), Konoplyanik (2009: 32-39)

This changes of course also affect the Protocol on EE and Related Environmental Aspects, which is not in force any more in Russia. The content of such Protocol will be further discussed in the 3rd chapter.
1.2.2

The EU External Energy Policy and the Carbon Market

initiative The Lisbon Treaty set out three main objectives for the EU energy policy: security of supply, competitiveness and sustainability (Article 194 of the Treaty on the functioning of the European Union (Official Journal of the EU 2008)). Following this new centrality of energy issues into the legal foundation of the EU and the 2009 Russian-Ukrainian gas crisis, the Commission has issued two major policy documents: the Energy 2020 strategy (EC 2010) and the the latest EU External Energy Policy (EC 2011c). The Energy 2020 strategy the onus is definitely put on what can be called the EU strategy of self-centred multilateralism (Belyi et al. 2011: 397), i.e. the continuous drive of the EU to export its energy acquis not only to willing partners (e.g. those included in the European Neighbourhood Partnership or in the Energy Community Treaty process) but also to approximate international legislation to the acquis, while at the same time making conditional to the reception of the acquis. The 2011 External Energy Policy (EEP) document translates into policy directions the external energy priority as outlined by the Energy 2020 strategy. It is important to note that the EEP is viewed as a complement to the internal -strongly liberalisedenergy market: The EU external energy policy is crucial to complete the internal energy market (EC 2011c: 2). As such, the document identifies 4 priorities: Building up the external dimension of [the] internal energy market (EC 2011: 4-9): specifically, in respect to Russia-EU relations: step up the negotiations to conclude the New Agreement, effectively implement the Partnership for Modernisation (see section 1.2.3), engage Russia in the drafting and implementation of the EU 2050 Energy Roadmap, cooperate in the Baltic region to agree on technical rules for the energy network; technical assistance

10

 Strengthening partnership for secure, safe, sustainable and competitive energy (ibidem: 9-14); specifically, in respect to the ECT: extend its geographical coverage but without changing its contents (self-centred multilateralism is clearly present in this approach); Improving access to sustainable energy for developing countries (ibidem: 14-16); Better promoting EU policies beyond its borders (ibidem: 16-18): notably, by adapting policies and schemes to different (classes of) partners and by creating a single EU voice in Energy matters within international organisations (on the one hand through information sharing about Member States' strategies towards third countries and on the other hand by enforcing the Principle of sincere cooperation, including the duty to ensure unity [of the EU representation by Member States] (ibidem: 17). In respect to the place of EE in EU-Russia relations at the External Energy Policy level, the importance of the Russia-EU energy relation is acknowledged by the latest External Energy Policy in a dedicated section (EC 2011c: 8) but EE does not appear to be the most salient issue: the greatest attention indeed is given to the need to agree on the overarching New Agreement in order to proceed with the market convergence process. Turning to carbon markets, the EU is a world leader in the carbon market initiative. As of 2010 the EU+3 (Norway, Iceland and Liechtenstein) Emission Trading System (ETS) was the only relevant carbon market worldwide. The ETS covers especially big emitters in the industrial and energy sector and is expected to account on its own for a 21% GHG emission reduction by 2020 compared to 2005 levels (WB 2011: 24). The EU has also shown its strong determination in implementing the ETS by extending the system to cover the emissions of the airline sector, a very contentious issue with third countries therefore not an easy decision to take on the political level (ibidem: 28). The EU is also committed to a reform and expansion of carbon markets, supporting the evolution to a so-called Sector-based CDM5.
5 See the proposal of the EU in WB (2011: 15) and see the description of the concept of sectoral CDM in Samaniego et al. (2002)

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Another arena where the EU has taken a very active stance are the so-called Flexibility Mechanisms of the Kyoto protocol, i.e. the Clean Development Mechanism (CDM) and the Joint Implementation (JI) schemes. Both schemes are in theory devised to help achieve the largest reduction of GHG emissions at least economic cost in industrialized (Annex 1) countries and at the same time promoting technology transfer in developing and especially least developed countries 6. Both schemes thus work on the principle that industrialised countries can implement GHG emission-abating measures in third countries to reach their own emission reduction target. Since the focus is on the EU-Russia relation only JI (the scheme dedicated to transition economies) will be considered. The history and potential for EU-Russia cooperation in the JI scheme will be analysed more in depth in section 3.1.2.
1.2.3

The EU-Russia Energy Dialogue and the Partnership for

Modernisation The EU-Russia Energy Dialogue is a regular dialogue, established under the Partnership and Cooperation Agreement7 at the EU-Russia Summit in Paris on 30th of October 2000. Such a dialogue aimed at [enabling] progress to be made in the definition of an EU-Russia energy partnership (EC 2011b: 63). Since 2007 the work of the Dialogue is organised in 3 groups, which meet regularly and on average multiple times per year: Joint Thematic Group (JTG) on Energy Strategies, Scenarios and Forecasts, with a Sub-Group on Energy Economics; JTG on Energy Market Developments, with a sub-group on Infrastructures since 2009 (the group covers also investments and trade); JTG on Energy Efficiency.
6 7 See Schneider et al. (2008) on the relevant potential of CDM for technology transfer. The EU-Russia Partnership and Cooperation Agreement (PCA) is still the legal basis for any form of cooperation between the two actors (EC 2011b: 63). The PCA was signed in 1994 and should have lasted until 2007, when both parties agreed to start negotiations on a New Agreement where energy would have a fundamental importance. At present (May 2012) the negotiations are still ongoing; in the meantime the PCA continues to be in force and represents the legal basis of relations.

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In addition to the Working Groups, a Permanent Partnership Council takes place once a year: the Dialogue thus is highly institutionalised. The 10 th Anniversary Conference (ibidem) has been the occasion to revive the results of the partnership. The common will to continue the cooperation was expressed very strongly by the key participants as highlighted in the Joint Report EU-Russia Energy Dialogue 20002010: Opportunities for our future Energy Partnership (ibidem: 62-69). Such a will was and is no doubt supported by the consensus present among Conference participants about two important facts: the interdependence of EU and Russia and the increasingly important role that gas will play in the EU's future energy mix, due to its abundance and low CO2 emissions. Taking also in consideration the increased competences in the energy sector given to the EU by the Treaty of Lisbon, it is clear that the EU-Russia Energy Dialogue enjoys strong political backing and an increasing attention on the part of the energy industry, all elements which bode well for its future. The third chapter will focus on the activities of the Thematic Group on EE. The Partnership for Modernisation is another initiative recently born out of the PCA. It was established at the EU-Russia Summit of Rostov-na-Don on 1 th of June 2010 and aims at channelling financial resources and involve the business community into the activities of the existing sectoral dialogues (i.e. Energy Dialogue included) (Council of the EU 2010). The most relevant International Financial Institutions (IFIs) that have been officially involved up to now are the European Investment Bank and its Russian homologue, the Russian Bank for Development and Foreign Economic Affairs (Vnesheconombank 2011), while the privileged business forum is the Round Table of Industrialists. A list of projects has been drafted in December 2010 (EU delegation to Russia 2010) covering a very wide range of topics (the list essentially corresponds to the projects planned by the Joint Thematic Groups).

13

ENERGY (IN)EFFICIENCY IN RUSSIA: CAUSES AND POTENTIAL FOR IMPROVEMENT

Russia has by far the highest energy intensity among G20 countries: twice as high as the one of the USA, China and South Korea and three times as high as the one of Japan, Germany and France. Russia compares poorly also to other Post-Soviet countries, since between 1990 and 2005 its energy intensity diminished at a slower pace than most other post-Soviet countries (WBGr 2008: 28). Indeed a World Bank report (ibidem) found out that 25% of Russia's emissions are not justified by international comparison (see Appendix 4 for the comparison). Therefore there must be factors specific to Russia accounting for this very high energy intensity. I divide these factors into structural causes and institutional aspects of energy intensity: Structural causes are grounded in the structural (sectoral) composition of the Russian economy, the state of energy infrastructures and in the cultural and behavioural attitudes towards EE and related topics; Institutional aspects are grounded in the (lack of) economic incentives for EE and in the legislative framework. After having assessed these factors the chapter explores the potential for EE in every sector of the Russian economy.
2.1

Structural causes of energy intensity: economy and society

The Soviet legacy of heavy industry and cheap energy is at the hearth of today Russia's high energy intensity: as Belyi et al. (2011b: 1) say Soviet command economy required an availability of cheap energy for economic growth therefore EE has almost never been incorporated into Russian culture and mores for the best part of the last 100 years. Bornstein (1985), Chistovich (1990) and Nove (1986) (quoted in Martinot 1998), highlight six major negative (in terms of low EE) characteristics of the Soviet planning system: (a) enterprise managers lacked incentives to minimize production costs; (b) energy quotas and allocations resulted in energy being wasted or dumped to maintain allocations [this system is still in place among public organisations and bodies see footnote 11]; (c) technological change was 14

inhibited by a lack of incentives to innovate and because any changes could mean problems in obtaining new inputs and greater risks in meeting production targets; (d) single-enterprise monopolistic production of many goods meant that goods were always in demand no matter what their characteristics; (e) the drives to produce large quantities of apartments in the 1950s and 1960s left quality and energy characteristics as secondary priorities []; and (f ) large centralized district heating systems were assumed to have advantages a priori, and potentially more-efficient alternatives were never considered. On the other hand Closson (2011) lists the negative consequences of Russia's Soviet past and especially the negative impact of the dependency on energy sources exports on the quality of institutions. Considering this very unfavourable basis, it is easy to see why the Russian economy is still so strikingly inefficient. Although energy inefficiency is widespread in all sectors of economic activity in Russia8, the problem is compounded by the over-reliance of the entire Russian economy on heavy industry and -especially- the Fuel and Energy Complex (FEC) (another legacy of the Soviet system). Comprehensive accounts of the transition process and the Soviet industrial legacy are Gaddy (1996) and, on a more theoretical level, Roland (2000). Such a broad subject is clearly out of reach for this dissertation, therefore the focus will be circumscribed to the role of the FEC and in particular to the gas sector. The gas sector is chosen because of its centrality in Russia's economy, politics and society9: it is a good example of sub-optimal management practises reflected not least in high energy inefficiency. According to slund (2010), Gazprom is Russia's largest corporation in 4 dimensions: it is responsible of 8% of Russia's GDP, 1/5 of its exports, 1/5 of its market capitalisation and is its single largest tax payer (notwithstanding the much lower tax rates paid by Gazprom in respect to the oil industry, arguably as a compensation for the subsidised prices in the domestic Russian market). Its traditional strategy feeds into two sources its past as the Soviet Ministry of Gas and its present as National Energy Company: both traditions are heavily influenced by State ownership. The problem of this is the vast economic
8 See Appendix A of the WB-CENEF report for an international comparison of global energy intensity for 6 major economic sectors (WBGr 2008: 122-4). Russia ranks among the top 25 energy intensive countries in seven major areas of economic activity [] Only Uzbekistan shares this distinction (ibidem: 29). Indeed Sharples (2010) stresses the strategic nature of gas both in Russia and in Europe and talks of a Social construction of Russia's [internal and] external energy policy.

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inefficiency in most of Gazprom's operations: its inefficiency prevents it from profiting from domestic sales and Gazprom has indeed strong incentives to keep energy inefficiency high in Russia. slund considers the likely reduction in gas demand very dangerous for the company's current business model: this helps to explain the resistance against improvements in EE within Russia. The situation at the infrastructural level is desperate. One of the most starting examples is that very few buildings in Russia have any means to control energy use, such as thermostatic regulators (Belyi 2011: 18). This leads to a situation where deployment of energy metering equipments and other relatively advanced measures are made useless. Korppoo et al. (2012: 214) provide an eloquent snapshot of the disastrous state of district heating infrastructure. However the true extent of the disastrous conditions of infrastructures in Russia can only be shown by giving the potentials for ES, which will be done in section 2.3. Turning to the social attitudes towards EE, the World Bank-CENEF report on EE in Russia (hereafter WB-CENEF report) notes that there is a diffused and persistent lack of awareness about the truly crucial importance of EE in Russia. This is true at all levels: businesses, households, banks, energy generators, regulators. The problem of the low political salience of EE is well known (EE efficiency improvements are invisible) thus people need political leadership to change their daily habits and cultural perspective. In additions such cultural perspective in Russia is heavily influenced by the Soviet legacy: the perception that utility services are public goods is widely held and is not by definition conducive to EE improvements. Part of the blame falls on the political lite which did not show a sufficiently strong political will to promote EE and engage the public on the topic; in addition it does not distribute enough data to raise awareness among the general public of the tremendous potential of EE improvements in Russia (WBGr 2008: 65, 68). It is worth looking at the situation in the residential heating sector (Korppoo et al. 2012), as it is the most relevant component of the communal services' bill (from 47% to 65% of the total). Notwithstanding the fact that in Russia the price for utilities is significantly lower even than in other countries with similar per capita GDP, the

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unwillingness to pay for EE measures was strongly expressed against attempts at setting an incentive structure based on tariffs to promote energy meter equipment installation. Two main problems can be identified: Although the utilities' bill is low in international comparison, the strong economic inequality implies that heating is indeed expensive for a significant part of the population (ibidem: 6); The quality of the heating service is so bad that the low willingness to pay is all but understandable and justified, from the point of view of the individual consumer. This example shows well the kind of difficulties encountered in the promotion of EE in Russia, particularly in sectors concerning the general population. It could thus be said that the behavioural barriers are much higher in Russia than in any Western country and are compounded by an objective problem of low quality of service.
2.2

Institutional aspects of energy intensity: (lack of) economic and legislative incentives

Institutional factors have a decisive influence on energy consumption dynamics in Russia, even more so than in European countries. This is mainly due to the fact that energy market in Russia is more tightly regulated in order to keep energy prices low for domestic householders. This however does not hold true for industrial consumers: indeed market liberalisation in this sector has made significant progresses therefore deeply changing the institutional setting of the whole internal energy market. The section is divided into 2 parts: the first is going to analyse the price dynamic of utility services and the practice of subsidies, the second analyses the EE legislation.
2.2.1

Energy tariffs and subsidies

The housing sector offers a good example of badly designed energy tariffs and perverse incentives. In the residential housing sector (i.e. households) some barriers to EE investments are intrinsic to the sector and are common all over the world, in particular the problem of split incentives (see note 8). However badly designed 17

subsidies are responsible for high energy consumption by households in particular: vast cross-subsidies from industrial and/or public budget to household consumers covers 1/3 of the real cost of utility services, but these subsidies are not targeted at the most vulnerable consumers (indeed the threshold for specific support schemes is households spending more than 22% of their income in utility expenses, which is expensive in international comparison). This results in a situation where the poorest consumers, which are not able to make EE investments, pay more than larger customers, which as a result of subsidies do not feel the need of investing into EE measures (Korppoo 2012). Another relevant issue is that tariffs paid by customers do not cover yet full costs, but are based on the cost-plus formula (calculated costs + regulated profits): this pricing formula does not give energy industris any incentive to enhance EE and provides huge opportunities for corruption and frauds. Lack of proper maintenance of energy infrastructures and the very high energy intensity of the economy are among the deleterious effects of cross-subsidies (ibidem).
2.2.2

Energy Efficiency Legislation and Policy

The WB-CENEF report laments that the single most important obstacle to an increase in EE in Russia is due to the lack of a coordinated, defined national [EE] strategy or policy, nor any authority responsible for improving [EE] (WBGr 2008: 65). Another important issue highlighted is the lack of proper statistical data. Not all these issues unfortunately have been tackled but the legislation is getting closer to the solutions advised in the report. In its Regular Review on Energy Efficiency Policies 2007 (ECT Secretariat 2007b) the ECT Secretariat considered the legislative framework on energy efficiency in Russia to have played a very marginal role in the improvement in energy intensity in the period from 2000 to 2006, with 75%-80% of the (better-than-forecasted) improvement resulting from structural changes in energy consumption [i.e.] relatively low intensity [industries] developing faster than more energy intensive [ones] (ibidem: 32). The report however commented positively on the

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implementation of market reforms in the energy sector, saying they were implemented with sufficient overall consistency in the main areas, namely pricing policies and the development of [] energy resources trading []; development of competition; institutional development in the area of resource and energy saving (ibidem: 34). According to the report the correct implementation of these reforms would provide energy users the incentives to invest in EE measures thus creating a market for such measures. The positiveness of these reform measures as assessed in 2007 was dependent on the future economic developments. Back in 2007 however no one could suspect that the greatest financial crisis since the Great Depression was looming large. The financial crisis strongly affected the Russian economy10 and this had a twofold effect: on the one hand it has pushed the government to act more decisively (for example by requiring recipients of government funds provided by the anti-crisis program to have an EE plan), on the other hand it has drastically cut corporate investments programs especially among the most energy intensive sectors, being these sectors the most exposed to the global economic downturn (Charap et al. 2010: 142). Therefore on the positive side the combination of the really weak performance of the Russian economy in 2009 together with the modernisation program of president Medvedev (Charap et al. 2010: 144) gave a real boost to the topic of energy efficiency and to related legislative activity, as can be seen by tracing the evolution of EE Russian legislation. Belyi et al. (2011) trace the history of EE legislation in the Russian Federation. Tapping the immense EE potential of the country was deemed the highest priority already in the 1995 Energy Strategy (a policy document), which also already recognised the need for strong market/economic incentives. At the same time however the main tool to increase EE was deemed to be an effective price policy (ibidem: 3) i.e. top-bottom State regulation. The Strategy did not set any EE
10 In 2009 Russia suffered the largest fall in GDP among G20 countries at 7,8%, although it did manage to contain the surge in unemployment levels and it avoided a dramatic depreciation of the rouble. The really dark side of the crisis however is that the price for containing the crisis was to avoid the restructuring of -energetically and economically- inefficient industries, on top of the depletion of international reserves (source: HSE 2012). For an account of the post-crisis recovery and a comparison with the 1998 crisis see WB (2012: 8-9, Box 1).

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quantitative target nor deadline, significantly weakening its relevance as a policy instrument. The same mistakes were repeated by the 2003 Energy Strategy (up to 2020), which did not set any EE target nor defined the concrete measures to be taken; instead it just set out hypothetical ES targets based on forecasts rather than technical evaluation. The 2009 Energy Strategy (up to 2030) finally set a target, i.e. reach energy intensity levels comparable to developed countries with similar climate (the closest peer being Canada): to do so it envisions to halve the energy intensity in 2030 compared to 2005 levels. Most importantly, the Strategy defined specific targets, procedures and instruments. The Strategy lists a very comprehensive set of measures, with the main areas being: Market liberalisation and improved business climate (especially important: complete transition to market prices); Increase cost of energy inefficiency through fines; Implementation of State statistical energy inspections and further analysis of it; State support to strategic initiatives (especially in the public sector). The Federal Law on energy conservation implemented most of the measures set out in the Strategy. Unfortunately (again) it does not set binding targets, nor it defines specific measures and instruments. The Law lists five core practises to improve EE (ibidem: 8): Effective and rational use of energy resources; Support and stimulation of [] EE improvement[s]: the best specified area is the support of investments into EE measures. In respect to private businesses, the government may compensate the part of the costs related to the redemption of loans or credits, taken in Russian credit organizations (ibidem: 9) to finance EE measures: government support is not guaranteed; in respect to the public (regional) sector, the government may devote funds from the federal budget to finance EE measures in the territorial subjects (ibidem) but only up to a certain limit defined by a particular election procedure, i.e. the amount of funds is defined each year in the federal budget; 20

 Consistency and complexity of activities in the field of [] EE improvement: in the fields of goods turnover, the building sector and energy metering devices. The most notable weaknesses of the Law in these sectors are the following: ineffective provisions related to the phasing out of incandescent lamp, too low requirements for EE in buildings to promote a fast enough renovation of the existing building stock, a complicated scheme to install energy metering equipment and (again) no informative campaign about EE opportunities; Planning of [] EE improvements: consisting of 3 actions: programming, monitoring and informing. The first action is implemented not only at the federal but also at the regional level, defining EE targets and instruments: among the targets, the requirement to reduce governmental expenditure for energy provision is very important, since public organisations themselves can not reap the financial benefits of reduced energy expenditures 11. The second action (monitoring) is implemented through mandatory energy inspections in State-financed and -controlled organisations, the FEC and energy-intensive industries: the data gathered from these inspections (once every at least 5 years starting from 2013) are then registered in the energy passport and are analysed on a regular basis by a dedicated organisation12. The third action (informing) should be carried on on the one hand through publicity in the mass media and on the other hand (and most important) on the prospective State Information System in the field of EE13. The use of energy resources with due consideration to resort, production and technical, ecological and social conditions. A common trend in the Law is the absence of economic sanctions and incentives, therefore it still relies on hard enforcement from the federal centre. This shows that it is possible to trace a recurrent contradiction in EE legislation of the Russian federation: a detachment between the stated objective of the creation of a market economy in the economy sector and the effective implementation measures mainly
11 The budgeting rules for public organisations and regional and municipal entities are tremendously ineffective in encouraging EE and are rather having the opposite effect. See WBGr (2008: 86). 12 For a blunt critique of the Energy Passport system and its potential for government interference into businesses' activities see Divovich (2012). 13 For an overview of the development of EE indicators in Russia see IEA 2011.

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relying on Command and Control measures. Another common trait is the scattered nature of legislation on Energy Efficiency among many different policy and legal documents, which weakens the normative potential. However the distance between words and (legal) deeds is becoming smaller and smaller and the latest Energy Strategy and Law on EE pose for the first time real foundations for the creation of an energy services market of immense proportions. In respect to the institutional structure (APERC 2010: 156-9), the responsibility for EE program definition and implementation has been of the Ministry of Energy since 2008. For the first time within the Ministry a dedicated Department of the State Energy Policy and Energy Efficiency was created. In addition, two intergovernmental groups linked to EE were set up: the Commission on the Fuel and Energy Complex located within the prime minister's office and the Expert Group on energy efficiency located within the Commission on Modernization and Technological Development of the Russian Economy, headed by the President himself. Another important actor is the Russian Energy Agency, an extended network dedicated to analysis and coordination of clean energy projects, i.e. not a regulator yet, but nevertheless a step forward towards implementation of best practises in the field of EE policies.
2.3

Energy Efficiency potential in Russia

Russia is often referred to as the Saudi Arabia of energy efficiency; its vast [EE] potential [] can be considered a significant energy reserve (IEA 2011). This quote already gives an idea of just how immense the potential for EE improvements is in Russia. The WB-CENEF report estimates the technical potential of ES at 45% of total energy consumption, i.e. roughly 300 million tons of oil per year [] equivalent to all energy produced and imported [] by countries like France or the [UK], or 2 percent of [the world energy production] in 2005 (WBGr 2008: 35). The report breaks down potential savings by sector. Savings potential is divided into technical, economical and financial potential: Technical potential (TP): established by comparison to technologies

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commercially available and actually used in the world; Economical potential: covers EE investments viable for Russia as a whole but not for the single consumer/industry, i.e. viable with government support14. More precisely, an EE investment is economically viable if the cost of saving a unit of energy [] is less than the cost of Russia [i.e. for the government] of building a new unit of production capacity [] or the opportunity cost of exporting a unit of gas, whichever the greater (ibidem: 39); Financial potential: covers EE investments which are financially viable, i.e. they save money to the individual consumer which invest in EE measures15. More precisely, an EE investment is financially viable if the cost [for the private investor] of saving a unit of energy [] is less than the cost of buying an additional unit of energy16 (ibidem). The report distinguishes 7 sectors, listed here in order of TP: Buildings (23% of total TP, i.e. 68,8 mtoe/year): the worst offender in buildings is water and (especially) space heating: Residential buildings: only high-rise buildings erected after 2000 meet modern thermal and heat efficiency standards, while buildings built before 1990 consume three times as much. However half of Russias multi-storey buildings were constructed before 1971, 43% in 19711995 and only 7% after 1995 (Aleksejev 2011 quoted in Korppoo et al. 2012:
14 Note that environmental externalities in the form of CO 2 emissions are internalised by assuming that ERUs (Emission Reduction Units) could be sold on the carbon market at 10 per ton of CO 2. The price of carbon however changes constantly so the economic potential in 2012 may be different. 15 The section will primarily focus on the economically viable share of TP because of the focus on the international cooperation between the EU and Russia and thus towards the potential for government action. In any case the share of financially viable savings is always going to be lower than the share of economically viable ones due to the differential in the opportunity cost of capital. 16 Such a cost is calculated with 2007 tariffs. It should be noted that the share of financially viable ES will no doubt increase given the long-term horizon of rising tariffs following the entry in the WTO and the objective of creation of a strong market environment posited in the latest Energy Strategy for the period up to 2030. The will to increase energy prices is clearly stated in the Strategy: establishment of a rational system for domestic energy prices through their gradual and controlled liberalization to promote careful use of energy in the economy and by the population (Ministry of Energy of the Russian Federation: 31). Domestic gas prices for industrial customers were supposed to reach netback pricing levels (i.e. EU level minus transportation cost) in 2011 (slund 2010: 167).

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214, footnote 2) . The renovation of space heating in buildings built before 1990 would suffice to save 17 mtoe/year. With 2007 prices 38% of the TP is financially viable and 78% is economically viable; Public buildings: the public sector is responsible for 9% of end-use energy consumption therefore is a fundamental actor. Space heating is by far the most relevant item, accounting for roughly 60% of total consumption in public buildings. TP for space heating and electricity is roughly 49% of consumption in 2005 (in electricity an additional advantage is the strong reduction in demand for peak load generation, which comes largely from the public buildings and is inherently less efficient than low- and middle-load generation). TP for educational institutions in particular is even higher at 60% average but with peaks of 80% of total consumption. Electricity generation (13,4% of total TP, i.e. 40,2 mtoe/year): Russian electricity sector overall is vastly inefficient: Condensing Power Plants (CPPs): TP is 22,5 mtoe/year, of which roughly 80% is economically viable. Average efficiency of Russian CPPs is 36%, while the value for OECD countries is 38% and 41% respectively for coal- and oil fired CPPs and for gas-fired CPPs; Combined Heat and Power Plants (CHPs): TP for gas-fired CHPs is 13,7 mtoe/year and it is 100% economically viable. Russian CHPs on average operate at 36% (liquid- and solid-fuel fired ones) and 39% (gas-fired ones) efficiency in contrast to average efficiency of respectively 51% and 46-48% in OECD countries; Diesel Power Plants (DPPs): Russian DPPs operate at average 25% efficiency, while modern equipment achieves up to 37% efficiency. TP however is a relatively modest 0,59 mtoe/year, with 80% being economically viable; Transmission and distribution: distribution losses in Russia averaged at 12,2% in 2005, versus an OECD figure of 6-7%. TP is 3,4 mtoe/year (i.e. roughly 35% of total losses in 2005). Manufacturing (13,8% of total TP, i.e. 41,5 mtoe/year): 97% of the TP is 24

economically viable and incisive action is facilitated even more by the concentration of potential (53% of sectoral TP) into the three most energy intensive industries: Ferrous metals: TP is 16,4 mtoe/year, i.e. 44% of the industry consumption in 2005. 99% of the TP is economically viable. The most effective improvements are switching from open heart to oxygen furnaces (5 Gj/t VS 0,28 Gj/t), change production mode of rolled steel (4,01 Gj/t VS 0,4 and 0,9-1,6 Gj/t respectively for cold and hot rolled steel) and change modalities of use of electric furnaces (halving energy intensity); Pulp and paper: TP is 3,7 mtoe/year, i.e. 53,6% of the industry consumption in 2005. Average intensity would thus be reduced from 18,1 Gj/tonne of pulp to the international average of 11-14,3Gj/t; Cement and clinker: TP is 2,5 mtoe/year, i.e. 43,8% of the industry consumption in 2005. The best improvement can be had by improving the EE of clinker production: energy intensity of Russian producers averages 8,8 Gj/t versus an international best practice of 3 Gj/t; Other (non energy intensive) industries: TP is 17 mtoe/year, i.e. 32% of consumption in 2005. The main causes of existing inefficiencies are outdated equipment (more than a quarter of companies use equipment for more than 25 years (ibidem: 51) and management practises (part of the problem described in section 2.3.1); Transportation (12,8% of total TP, i.e. 38,3 mtoe/year): 83,6% of the TP is financially viable. The most important sectors are road transport and gas pipelines: Road transport: responsible for 48% of total consumption in transportation. The average energy intensity (i.e. fuel consumption) of the Russian road fleet is generally higher than in European countries and this is particularly true in the case of light trucks (KAMAZ light trucks consume more than twice in respect to comparable modern Westernmanufactured models). In addition the trend is (strongly) towards increased personal car ownership and use; Gas pipelines: responsible for 37% of total consumption in transportation. 25

The pipeline network is old and inefficient and the surge in exports in the 2000s has put it under great strain. Losses in the gas network remain stable at 1 to 3% of all gas transported in Russia. More than 9% of domestic gas consumption is used by compressors to transport gas to final customers, a percentage which could be halved using modern technology. Of course the issue grows even more serious in international pipeline transportation17; Heating supply system (9,2% of total TP, i.e. 27,7 mtoe/year): Heat generation: TP is 10,4 mtoe/year (8,4% of total energy consumption), with 90% being economically viable. Russian industrial boilers, district heating boilers and small boilers operate respectively at 68,6%, 80,3% and 81,6%18 efficiency, against an international benchmark estimated at 95% and 85% efficiency respectively for gas- and liquidfired boilers and for coal-fired boilers; Heat distribution: TP is an astonishing 17,3 mtoe/year (9,3% of total heat production), 99% being economically viable. Although according to Korppoo et al. (2012) Russian district heating could potentially yield huge savings in respect to a decentralised solution, the WB-CENEF report notes that when distribution losses are above 10% district heating becomes relatively inefficient: such losses in the municipal heating system run as high as 20-25% even by official statistics (which are not considered reliable); Gas Flaring (6,9-10,5% of TP, i.e. 16,6-31,5 mtoe/year): gas flaring is a dramatic waste of gas, but as evident from the numbers provided in the report it is still a very uncertain issue: indeed there are no clear estimates of the share of investment being economically viable. The highest number provided, 38 bcm/year of gas flared, would be similar to the volumes of gas exported to Germany in 2006, or 5% of total gas production; Fuel production and transformation (1,9-2,4% of total TP, i.e. 5,6-7,2
17 See the article by Lechtenbhmer et al. (2007) for a quantitative assessment of the problem of losses in the long distance gas pipelines Russian network. 18 Energy audits conducted by CENEF show that this estimate is very likely overrated and real EE is much lower.

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mtoe/year): the most important improvements can be made in the oil production and refining sector. Gas production and processing also presents opportunities for enhanced EE but not as good as investments into the distribution network.

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3.

POLICY OPTIONS AT THE EU-RUSSIA RELATIONS LEVEL

3.1

Options at the multilateral level 3.1.1. The Energy Charter Treaty and the impact of Russia's WTO

accession As described in section 1.2.1 the outcome of the negotiations on the reform of the ECT is still very uncertain. Konoplyanik (2010) lists 5 well-founded Russian concerns over the unbalanced character of the ECT, mostly related to the lack of enforcement measures of Treaty provisions and of crisis prevention measures. From the point of view of cooperation on EE however the real added value of the ECT is the high level of investment protection it provides for. Investments in the energy sector are characterised by huge financial risks and a long payback time. It can be argued that EE investments as outlined in the WB-CENEF report are less risky than investments in the upstream sector because the ES resulting from EE measures can be more precisely predicted than for example energy consumption in the long term (a fundamental parameter in import/export contracts) and/or size of exploitable reserves (in the case of investments in exploration). Nonetheless EE investments have a long payback time and an healthy market environment in fundamental to raise the huge capitals required. The ECT investment protection regime is tailored on the energy sector and its specific investment characteristics and as such it would be desirable to have it fully in place in Russia in order to promote EE investments, especially given the latest developments in legislation outlined in section 1.2.1. While the investment protection is an important foundation for increased cooperation in EE, the other instruments provided by the ECT are not as important in this respect. In particular the PEEREA is a weak instrument in that it only provides a framework for the exploitation of opportunities in EE. The framework identified is of course a well-functioning market economy: the contracting parties to the PEEREA basically promise to stick to market principles and to use market instruments in the promotion of EE. It may be said that the PEEREA essentially represents a forum for discussion and sharing of best practises in the field of EE and encourages international exchange 28

both of technology/knowledge and goods related to EE. It completely lacks a political and financial dimension, both needed to carry out large-scale cooperation in the field of energy. The EU therefore has 2 options to utilise the ECT as an instrument enhancing bilateral cooperation with Russia on the topic of EE: Aim at a full ratification of the ECT by Russia by incorporating legitimate Russian concerns into the ECT; this would essentially involve a cost/utility analysis between the utility of a full ECT ratification by Russia and the cost of incorporating legitimate Russian concerns;. This road is not bound to be easy and fast, considering that the same issues have been on the negotiation table for almost a decade now and not much progress has been achieved; Concentrate the negotiations on the Investment chapter, where no major point of contention exists between the EU and Russia, and on the upgrade of the PEEREA to a significant tool with real political and financial capabilities. This of course does not imply that the other parts of the ECT should be discarded, rather the focus on these non-contentious areas would help on the one hand to step up cooperation on EE projects and ease the tension on the other, more contentious chapters of the ECT. The II option looks like the more practical and easily achievable by the EU. Two reasons in particular justify this choice: Russia has already applied the ECT treaty on a provisional basis for a long time, therefore advancements in the sole investment chapter is not a procedural impediment (although of course is a less optimal outcome in respect to full-on ratification). The upgrade of the PEEREA to a political tool could be negotiated so to tie even closer Russian modernisation and European technological know-how; Russia's accession to the WTO is posed to greatly improve business climate in Russia and will considerably lower political and economical risks. The accession to the WTO shows the will of the Russian government to integrate more closely with the world economy and play by the rule of the game. The 29

EU should definitely strongly exploit this window of opportunity and assist Russia in the first period of implementation of the WTO rules and at the same time put the onus on the investment regime of the ECT and the PEEREA, as the growing alignment of the Russian economy to market rules and practises increases the chances of success. 3.1.2. sides As described in section 1.2.2, the EU is a leader in the use of market mechanisms to reduce GHG emissions. However after the 2010 Cancun conference pessimism about the potential for a new, binding post-2012 (i.e. post-Kyoto) legal agreement on climate change is widespread among climate negotiations insiders (WB 2011: 1718). Given its expertise and its commitment under the Kyoto protocol, the EU has a strong interest for such an agreement in order to reduce the risk of carbon leakage 19 and reap the gains of its leadership in EE and renewable technologies. The Flexibility Mechanisms of the Kyoto protocol indeed can be a source of great savings for the EU in its quest to reduce GHG emissions20. However the EU is doing exactly the opposite, by strongly restricting the criteria for taking advantage of the Flexibility Mechanisms of the Kyoto Protocol: from 2013 each EU country won't be able to meet more than 50% of its own GHG emission reduction target through CDM and JI projects, i.e. it will have to achieve at least 50% of it within the EU (ibidem: 24). This limit was born out of concerns about the real quantity of emission reductions achieved in third countries (mostly as a result of unclear legal frameworks and shadowy policies in the latter countries, as in the case of Russia and the Danish Energy Agency see later in this section) and out of the goal of providing poorer EU member States with more emission allowances. The EU has therefore effectively decided to drastically limit the reliance on the Flexibility Mechanisms of the Kyoto
19 Carbon leakage is described as the risk of de-localisation of energy-intensive industries from the EU to other countries with lax or non-existent emission reduction policies. 20 Fichtner et al. (2001) assessed the economic efficiency of JI and CDM for Germany. They compare two extreme cases (i.e. GHG emission reduction on the one hand only through domestic measures and on the other with the full exploitation of CDM and JI potential). A simplifying assumption is that all JI projects are implemented in Russia and all the CDM projects in Indonesia. They find out that most likely a 25-50% share of GHG emission reductions would be carried out through JI and CDM projects, leading to huge financial savings.

Joint Implementation: a great potential hampered on both

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Protocol, compounding the lack of clarity on the prospects for a legally binding agreement on climate change and emission trading after 2012. It must be said that the history of JI in Russia is quite saddening and can not be held as a shiny success story. Back in 2004 Laroui et al. (2004) assessed the potential for JI cooperation between the EU and Russia in positive terms. What is interesting is that they gave such a positive assessment notwithstanding the issues that emerged in the AIJ (Activities Implemented Jointly) phase21 and the challenges presented by the state of the Russian economy in those years. In particular they cite as matter of concern the difficult business environment, the lack of institutional capacity on the Russian side, the lack of political backing to the AIJ phase and the inevitably steep learning curve associated with the implementation of a project so complex as the JI scheme. It can be confidently said that all these concerns, although still relevant, have significantly softened. In respect to the business environment, the situation in 2012 has improved in respect to 2004 (let alone the '90s). According to the World Bank Doing Business 2012 survey, the Russian Federation was 23 rd in closing the gap to best practises overall, wit a 10% improvement (although it must be said that large disparities among the various indicators remain) (WB 2012a: 10). Although its ranking remains far from the top, being 120th in 2012, the upward trend is encouraging. As already highlighted in the previous section the WTO membership is going to be decisive: indeed there is evidence that trade liberalisation not only enhances the business environment but also the quality of institutions of the country (WB 2012). The foreign business community is understandably excited about the prospects offered by the WTO membership (see e.g. Kredler et al. 2010). Thus the situation in respect to both the business environment and the institutional capacity has improved since 2004 and it appears to be set on such a path. In respect to the legislative action, in chapter two it was highlighted how EE has been made a central part of the Russian energy strategy only recently and following a
21 The AJI program served as the pilot phase for the JI and CDM schemes and ran from 1995 to 2000 (see Samaniego et al. 2002).

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strong input by Russia's president Medvedev in the framework of the modernisation of the Russian economy. The history of JI implementation in Russia is somehow similar. Russian authorities were very slow in realising the potential of JI (Taminiau 2011). The atmosphere of uncertainty about procedural aspects and the lack of political backing at the highest level of Russian politics resulted in practically no JIrelated activity up to February 2010, i.e. two full years after the start of the first Kyoto commitment period (2008-2012). JI proposals have been queuing up in the pipeline (ibidem: 8) already since 2006 but proper regulations were adopted only in October 2009. These regulations identified the Russian bank Sberbank as Carbon Unit Operator, i.e. the entity responsible for conduct the tenders for the selection of JI projects and ERU (Emission Reduction Unit) credits, and defined the eligibility criteria for JI projects: energy and environmental efficiency, technical and financial potential (i.e. the projects proposals must provide for its own financing) and economic and social effect (i.e. contribution to the modernisation of the economy). Although the greater clarity allowed to finally launch the first tender, many outstanding problems remain and the effectiveness of the Russian administrative machine is still low. The continuous uncertainty even prompted the Danish Energy Agency to withdraw from Russian JI projects in April 2011 (ibidem: 11). Political momentum at the highest level proves to be decisive for the successful implementation of the JI scheme. Indeed immediately after President Medvedev's urgent call to better exploit the opportunities offered by JI in June 2011, 17 million ERUs were issued in only two months (July-August 2011) (Shishlov 2011: 2), compared to 58,53 mln ERUs issued from 2008 to June 2011 (Taminiau 2011: 10, table 1) and an overall limit of 300 mln ERUs for the whole first Kyoto commitment period (2008-2012) (Shishlov 2011: 2). In addition in October 2011 new regulations were approved, the most important changes being: the stronger position of Sberbank (as mandatory third party in any foreign ERU trading contract), the obligation to invest revenues from ERU sales into EE and/or environmental projects and the indication of precise time limits for each stage of the registration and issuance procedures (ibidem). The combination of political visibility and improved regulation is expected to boost JI projects approval delivering at best 200mln ERUs by 2012, with a more likely outcome being 142 mln ERUs (ibidem: 3). Although this is a

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notable improvement it still falls way short of the 300mln ERUs limit set for the 2008-2012 period. The EU must keep the topic of JI implementation high on the agenda of the EU-Russia Energy Dialogue to help maintain the political momentum. This is especially important in light of the heavy blunt given to the Kyoto Protocol by the withdrawal from a II Commitment Period on the part of Canada, Russia and Japan on occasion of the G8 Meeting on April 2011 (EUbusiness 2011). However the Russian Socio-Ecological Union (RSEU 2011) affirms that while Russia is not sustaining a Second Commitment Period it is very interested in further developing the Flexibility Mechanisms. In light of this approach it may be more productive on part of the European Union to stress the business side of JI projects rather than tying the use of JI to advancements in international climate negotiations.
3.2

Options at the bilateral level (Energy Dialogue)

The strategical importance of the Joint Thematic Group on Energy Efficiency (JTGEE) was highlighted by the EU-Russia Energy Efficiency Initiative, launched in 2006, which confirmed the work of the Group and maintained its structure and competences amidst the reorganisation of the EU-Russia Energy Dialogue organisational structure (see section 1.2.3). The following are the objectives confirmed in 2008 (JTGEE 2011: 2): increasing [EE] while promoting economic growth; improving the standard of living of the population and expanding the range of level of services on offer harmonising the range and legal and regulatory base and making it more effective reducing the impact on environment by introducing new energy efficient and environmentally clean technologies and renewable energy sources. Looking at these objectives it can be seen that the social and economic component of EE is very important. The agenda for the JTGEE is thus very ample and not focused on the practical introduction of EE measures. The review of the work undertaken by the JTGEE in the period 2006-2010 shows that indeed the work of the group has been focusing mainly on the legislative area, partially overlapping with the agenda of 33

international forums such as the ECT under the PEEREA and the IPEEC (International Partnership for Energy Efficiency Cooperation), i.e. forums in which to share experiences and policy advices regarding EE. One can see however a very positive trajectory in the intensity of the activities of the group. Between 2006 and 2008 the JTGEE itself met 4 times, 4 conferences were organised and 3 joint projects were implemented, while another project was due to start in September 2007 and run for two years. All the projects focused on the legal and legislative frameworks for improving EE (JTGEE 2008). Between 2008 and 2010 the increase in intensity of the JTGEE's activity is noticeable. 8 conferences were organised, 4 projects were implemented and 1 started in February 2010. Again, the majority of projects focused on the legal and legislative framework, but also concrete EE measures were implemented under the Northern Dimension Environment Partnership (JTGEE 2011). The peculiarity of the JTGEE activity is the cooperation at the regional level. In 2006-2008, experts of the JTGEE elaborated in-depth guidelines and identified priority areas for EE improvement in the regions of Astrakhan, Arkhangelsk and Kaliningrad. In 2008-2010, a study identified the potential for EE investments projects in the Russian regions. Such a focus is not easily found in traditional international cooperation between International Organizations and States and could be an important card to play for the EU to strengthen its energy partnership with Russia. However it is clear that the EU-Russia Energy Dialogue, ad the JTGEE within it, are not tools studied to raise the huge investments needed to structurally improve the EE of the entire Russian economy. The need of raise investments is where the Partnership for Modernisation (PfM) comes in. As explained in section 1.2.3, the PfM is meant to provide investments for a wide variety of goals, covering every subject in the EU-Russia relations. This of course implies that it is way too dispersed to be really effective in promoting structural change in a single field. Indeed Longdi (2011) deems the Partnership as one of the many steps taken by the EU and Russia to de-politicize their relation and increase thrust. The fast implementation of the PfM after the decision taken at Rostov-na-Don hints at the fact that the goals of the partnership (i.e. to modernize the

34

Russian economy) are indeed shared by both parties and therefore the PfM should in theory be conducive to such better relations. However the crack appears when confronting how Russia and the EU define Modernisation. To the former, modernisation means top-down selection and support of strategic sectors with very high added value (such as nanotechnology, the biomedical sector, ), while to the latter it means an open economy where market forces define winners and losers. Barysch (2010) to underlines these different perceptions and the strong difficulties arising from them, in particular the non-existent chances of changing the Russian economy into a knowledge-driven one (ibidem: 32). These differences between Russia and the EU are nothing new and in this sense the PfM does not address them convincingly: the very lack of focus on specific topics encourages the emergence of friction points in different sectors. Bayrisch (ibidem) points to the example of the Russia-Germany PfM to show that focus on few, welldefined areas can more effectively de-politicise relations thus making them more productive.
3.3

Barriers and how to remove (or soften) them through cooperation on EE

The barriers to increased cooperation between the EU ans Russia are numerous: Different perceptions of energy security: each side has a different view of what Energy Security means, stemming from its nature as energy exporter and energy importer. According to Kirchner et al. (2010) the EU follows a security of supply paradigm, with energy security being defined as in the research design. On the other hand Russia seeks a security of demand, i.e. a quest for a market for their energy exports which correlates to increased (government) revenues (ibidem: 864); Politicisation/Securitization of energy relations: Such a difference however need not to be a problem, as Khrushcheva (2011) sustains, as long as producer and consuming countries are part of the same Energy Security Society.the above issue is in a sense structural, depending on each actor's endowment of natural resources. Such a difference however need not to be a 35

problem, as Khrushcheva (2011) sustains, as long as producer and consuming countries are part of the same Energy Security Society. Khrushcheva analyzes in depth the issue of securitization of energy relations between the EU and Russia and shows its damaging effects by pointing out the mutual failure of the competition between the South Stream and the Nabucco pipelines: securitization hinders rational cost/benefit analysis and encourages hard power rather than soft power approaches; Unequal dependence and historical memories as securitization factors: many authors have stressed that the EU Eastern Enlargement has made relations between the EU and Russia much more difficult than before, because it has brought in the EU States which rightfully or not have deeply ingrained russophobes feelings. For example Leonard et al. (2007) identifies 5 groups of EU member States depending on their attitude to Russia: Eastern European countries represent 50% of the two groups with the most negative attitudes towards Russia. Such feelings derive by the interplay between the recent past of Soviet control and/or occupation and the degree of dependence on Russian energy22; Uncertain business climate for Western companies into the upstream Russian energy sector: the at present very poor interconnections between national markets in Europe and the unequal dependence on Russian energy among member States make the issue of insufficient Russian production capacity an extremely serious problem for the whole of the EU. Appendix 5 devolves into the topic of investments into the Russian FEC. Many scholars doubt that Russia can maintain production levels high enough to cover both growing internal demand and growing demand for exports. Unfortunately the business climate has been uncertain to say the least in the upstream sector, as shown in particular by the history of the ECT. This of course fuels tensions between the EU and Russia. Different concepts of legal harmonisation: Romanova (2010) highlights the profound differences between the two parties when dealing wit the process of
22 See also Bozhilova et al. (2010) for an account of the rational behind different member States' attitudes to Russia. In addition see Nol (2008) for a specific outlook on unequal dependency on Russian gas among member States.

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legal harmonisation (a process which features prominently in the work of the JTGEE, for example). Quoting Mark Entin, she highlights that Russia interprets legal harmonization with EU rules as convergence, or mutual movement to a desired legal reality (since EU rules are perceived as external) while for the EU such a convergence process has already happened inside the EU and third countries are expected to simply accept the EU acquis, unchanged. The research question should now be reintroduced, in order to assess how EE could affect the barriers listed above. Research Question: Does the EU allocates enough importance to EE as an instrument of foreign policy in its relation with Russia? As specified in chapter 2, the WB-CENEF report assesses ES potential of Russia at an astonishing 300 mtoe per year. This quantity must be confronted with the longterm outlook of energy demand for the EU27. It must be first reminded that in chapter 1 it was said how leaders on both sides acknowledge the increasingly important role of gas on the European market, mainly because of its low CO 2 emissions and efficient use in Combined Heat and Power Plants, which makes it the most sensible choice for power generation in the long term. This is also confirmed by the long-term projections of the Directorate General-Energy (EC 2010a). In the 2009 baseline scenario, gas imports increase significantly to 364 mtoe in 2030 VS 293 mtoe in 2030. Clearly even in the baseline scenario the achievement of technical EE potential of the Russian economy would be able to completely cover Europe's gas imports up to 2030. In the Reference scenario to 2030, although the full implementation of the 20/20/20 strategy has a decisive impact on the total final consumption, the imports of gas are destined to grow anyway up to 318 mtoe in 2030 VS 288 mtoe in 2010. It is even more evident in this case that an increase in EE would guarantee natural gas supply to Europe in the long period. In this way cooperation on EE would touch upon 2 areas of friction outlined above: By limiting or delaying the need for new explorations and exploitation of

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fossil reserves it would limit Western companies involvement in the uncertain upstream sector; By cancelling the risk of supply shortages in the long period it will help to depoliticize relations between Eastern European states and Russia, promoting the rise of soft power politics and thus an increased role for the EU. Unfortunately the EU does not seem to recognise the importance of EE in guaranteeing its future energy supply security. As we have seen the focus of the latest External Energy Strategy in respect to Russia is more on the need to complete the new Partnership and Cooperation Agreement in order to proceed to market integration rather than put EE policies at centre stage. Romanova (2010) shows that this policy is wrong. She argues that the EU-Russia cooperation on EE has been characterised by the right kind of legal harmonisation, in the sense that both sides agreed on all three levels: Strategic goals and principles: they were mainly set at the international level (especially the Kyoto Protocol) where Russia and the EU are equal members, therefore gaining legitimacy in Russia's eyes; Specific policy goals: specifically, both sides converged into setting targets on EE and renewable energies, with similar time frames; although Russian targets are way less ambitious than the EU's ones, there was still convergence on the kind of policy goals; Implementation methods: a review of Russia and EU implementation measures show that in principle they're very similar, although again with an higher degree of sophistication and internal coherence in the case of the EU. This convergence on three levels helped Russia and the EU break down two barriers: the differences in concepts of legal harmonisation and again the uncertain business environment (because of the similar implementation methods). Two other advantages can be immediately seen in stepping up cooperation on EE with Russia: Enormous potential for CO2 emission reduction: 793 million tons per year (WBGr 2008: 25), i.e. roughly 160% of the reduction in CO2 emissions the 38

entire EU is planning to achieve in the reference (i.e. optimistic) scenario from 2010 to 2030 (499 mln tons, from 4021 to 3522 mln tons) (EC 2010a: 46). It is clear that exploiting this potential would allow the EU to reduce cost of compliance with its own emission reduction targets through the JI projects and maintain the absolute leadership in climate change talks; Enormous business opportunities for European companies: the WB-CENEF report estimates the investments needed to fully realize the technical potential of the Russian economy at $320 billion (WBGr: 15). Considering the difficulties in investing into upstream and transport sectors in the FEC, the EU should concentrate and encourage businesses to concentrate on EE investments economically viable and with the largest potential, that is residential buildings, Combined Heat and Power Plants, Condensed Power Plants and the Ferrous Metals industry. In conclusion, it is evident that while cooperation on EE can not solve all the major problems affecting the EU-Russia Energy relations it can pave the way to improved relations better than the other major cornerstone of the Energy Dialogue, i.e. the legal harmonisation on market rules. As demonstrated by Romanova (2010) and highlighted by Khrushcheva (2011) Russia can not be forced by the EU to accept values and principles which it does not agree on. The WTO membership shows that Russia wants to be part of the global markets but only if it can set the pace of the agenda. As we have seen the soft power of the EU is difficult to apply without the temptation of the full EU membership, but it's basically useless in respect to a country as powerful and as jealous of its independence such as Russia.

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4.

CONCLUSION

It is clear that the EU is not putting enough leverage on the cooperation on EE with Russia. As chapter 2 showed the possibilities are immense. An effective partnership on EE can cut through many of the issues currently hampering successful EU-Russia energy relations. In the first chapter it has been shown how the EU represents a global leader in terms of fight to climate change and in terms of complexity of its EE legislation. It has also been highlighted how the topic of EE has gained prominence at the internal level but was not made the cornerstone of the External Energy Strategy, which is still mainly focused on the practice of soft power to expand market rules worldwide in the energy sector. The failure of promoting such an approach have been visible in the history of the ECT process, where mutually excluding demands on part of the EU and Russia forced the collapse of the ECT negotiations. In the second chapter the staggering potential of ES in Russia was assessed sector by sector, after having inquired into the causes of the extremely high energy intensity of the Russian economy. Both structural and legislative causes are important, but from the prospect of EU-Russia relations the possibilities of intervention over the legislative aspect. Although the networking done through the Energy Dialogue is surely helpful, in the end substantial decisions lay in the hand of the Russian government. Therefore the structural potential was examined more closely to identify the areas of greater interest for European investment. The third chapter zoomed in on the actual energy relation and analysed the different instruments employed. It was argued that the EU should focus on the relatively less controversial investment chapter and upgrade the PEEREA to a political instrument able to spur real changes in the EE sector. On the other hand the decision to downplay the JI was criticised on the basis that it would lose the precious moment of political backing at the highest level. In addition the JI mechanism is at present the only one able to move a significant quantity of investments between the EU and Russia. In respect to the JTGEE the noticeable intensity of the activities during four years is a sign of the successful implementation. However it was also noted that the activities remained limited in scope and could just improve EU-Russia relations on a 40

small scale. A very significant and positive development, impacting on any kind of cooperation, is going to be Russia's WTO membership. The evaluation of the potential of the collaboration on EE shows that it could be exactly the kind of activity needed to build the necessary trust and confidence which is sorely lacking in EU-Russia energy relations. The EU should reorient its whole energy relation with Russia to the cooperation on EE because of its cross-cutting positive effects and tremendous potential, while assisting the transition to market economy by supporting at every step the correct implementation of WTO rules. The impact on Russia and on the world economy and climate would be of a scale not attainable through other bilateral relationships, due to the complementary character of the EU's and Russia's economy and to the structural conditions of international relations, which curse both parties to be permanently aware of each other.

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APPENDIX 1 ENERGY EFFICIENCY INDICATORS Patterson (1996) defines 4 classes of EE indicators: Thermodynamic indicators: this class of indicators gives precise measures of EE for a given process under specific conditions, but at the same time this specificity makes comparison over time and between different processes difficult (especially given the difficulty in accounting for different types/qualities of energy e.g. coal VS electricity); in addition even these indicators become subjective when used in social context (e.g. assessing the useful energy output of a process); Physical-thermodynamic indicators: this class of indicators is useful when assessing production of commodities (e.g. output in tonne/energy input) and is therefore widely used to assess technical efficiency of an industry. A problem to be taken into account is the joint-production problem, i.e. how to correctly allocate the energy used when there is more than one output per process; Economic-thermodynamic indicators: here the input is measured in thermodynamic units and the output in economic units. The main indicators of this group are the energy/GDP and energy/Y(/roubles/...) ratio (also known as energy intensity of respectively an economy/country and sector) and the GDP/energy ration (measuring the energy productivity of an economy/country). The main problem with these class of indicators is that per se they don't distinguish between improvements in technical EE and other factors which can influence energy consumption (e.g. changes in the sectoral composition of the economy towards less energy-intensive sectors); Economic indicators: these indicators are the same as the economicthermodynamic ones but the output is measured in terms of economic value. Although strictly speaking these indicators do not measure EE, they do have the advantage of linking EE improvements and monetary savings thus can be useful in awareness campaigns for the general public.

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APPENDIX 2 THE EU LIBERALISATION PROCESS Understanding the internal liberalisation of the EU is fundamental to understand the External Energy Policy of the EU too, since convergence to EU rules is a major part of such a policy. The liberalisation process has advanced through so-called Energy Packages, each comprising two directives, one for the Gas market and one for the Electricity market23. The oil sector has not been included in the liberalisation process because of the already elevated liquidity of international oil markets24. The most fundamental and contentious initiative of the EU liberalisation process has been the unbundling of vertically integrated companies, i.e. the separation of the production and supply activity from the transmission and distribution activity. The requirements of the EU directives got more and more stringent with each directive but at the same time they have been met with increasing resistance in particular in bigger member States willing to protect their so-called national champions25. We shall now review the most relevant content of each package: I Energy Package (1996 -electricity directive- and 1998 -gas directive) (Official Journal of the EU 1996, 1998): the package covered five areas: generation, retail market, transmission and distribution, unbundling, regulation. The most significant measures were: Obligation to open part of the retail market for large users and distributors (33% by 2003 for electricity and by 2018 for gas);
23 Separate legislation for each of these markets is needed because of the difference in physical characteristics of the two commodities. In terms of market configuration two differences in particular are relevant: storability (electricity can not be stored, unlike gas) and sourcing (electricity can be produced by a number of sources, while gas has to be sourced from a very limited number of countries). These characteristics of electricity are reflected in the use of merit ordering in electricity markets, whereas gas hubs and exchanges focus on the allocation of available gas, i.e. only shortfall and/or excess gas. See Altmann et al. (2010): 48. 24 Oil markets are markedly more liquid than both the electricity and gas markets primarily because oil can be distributed by a variety of means, i.e. it is not dependent on fixed infrastructures only for its distribution. While gas markets can be liquid too (such as in the case of the USA and the UK gas markets), this is not the case for the continental European market because of the high external dependency (Russia, Algeria an Norway being the most important suppliers), the prevalence of super-giant gas fields among the ones supplying the EU and the low market share of LNG (liquid natural gas). For an in-depth account of the differences between international oil and gas markets see Energy Charter Secretariat (2007a). 25 See McGowan (2008) for an account of the revival of the so-called economic nationalism both inside major European countries and in energy producing countries.

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 Introduction of Third Party Access (TPA) regulation, albeit leaving in place the possibility of negating TPA on grounds of insufficient network capacity; Accounting and management unbundling of integrated energy companies into network and generation/retail activities (i.e. creation of Transmission and Distribution System Operators (TSO and DSO, respectively)); Introduction of the principle of reciprocity, i.e. preventing the access to the European market to companies from Countries with closed retail markets. The response to the package was critical because the measures were seen as too weak, leaving many loopholes to be exploited by national monopolies. Indeed most countries adopted the more liberal options [] and opened their retail market further than required (Thomas 2005); II Energy Package (2003) (Official Journal of the EU 2003a, 2003b): encouraged by the positive response to the I package, the Commission introduced strong measures in the same 5 areas and also included the topic of security of supply. The most significant measures were: Introduction of authorisation as normal procedure to build new energy plants (i.e. the end of central planning), although tendering was allowed in specific cases (e.g. build additional capacity if needed or support infant technologies); Complete opening of the retail market for all consumers by 2007; Regulated TPA (i.e. at published tariffs, approved by the regulatory body) as the only option for transmission; Institution of a full-fledged sector regulator (National Regulatory Authority, NRA) and of a European Regulators Group to encourage cooperation; Promotion of the construction of interconnectors between national networks, to enhance international trade and energy security; Constant monitoring of the supply/demand balance to guarantee sufficient generation capacity (recognition of the inadequacy of market instruments in guaranteeing sufficient generation capacity). The response to this Energy Package was rather less enthusiastic. As of 2010 25 Member States had not transposed the II package properly (Altmann et al. 2010: 53). The most serious and diffused infringement was the lack of transparent 44

access to cross-border network infrastructure [for electricity] and the lack of information provided by TSOs [about] capacity allocation systems to optimise network use [for gas] (ibidem). Other diffused infringements were the continued existence of regulated prices not complying with the directives' restrictions and the disrespect of consumer protection rules. In addition a general and very serious problem was the poor enforcement action against the violation [by the NRAs, revealing the] absence of an effective system of penalties at national level (ibidem: 54). III Energy Package (2009) (Official Journal of the EU 2009): notwithstanding the slow implementation of the II package, the III package was passed in 2009 and entered into force on 3rd of March 2011. The most significant measures were: Introduction of ownership unbundling, or in alternative evolution of TSO into either ISO (Independent System Operator) or ITO (Independent Transmission Operator). In short, the ISO is still part of the integrated company but is fully responsible for operating, maintaining and developing (i.e. investment planning) the transmission system. The ITO performs similar functions but its independence is guaranteed through a cumbersome governance structure and heavy oversight by the NRA; Attribution to the DSOs of the duty to equip up to 80% of the consumers with smart meters by 2020 (if economically feasible); Third Country Clause, i.e. the requirement to negate access to TSOs from non-EU countries if it could put at risk the security of supply of the Member State and the Community (ibidem: 50) a requirement apparently very general, but in reality targeted at major companies from supplying countries such as Russia's Gazprom (indeed it has been called the Gazprom Clause (European Parliament 2009) and Russian officials have openly voiced their concerns about it (Commission 2011b: 66); Stronger powers to NRAs and setting up of the Agency for the Cooperation of European Regulators (ACER); Setting up of a pan-European network for European TSOs, which are also asked to make forecasts and 10 years development plans for expanding 45

interconnectors; Legal and operational unbundling of Storage System Operators (SSO), with strong regulatory powers in the hand of the NRA. Overall the strong liberalisation of the energy sector has been met with considerable resistance inside of the EU, which makes the task of promoting market reforms in the energy sector in neighbouring countries very difficult, as the history of the Energy Charter Treaty process shows.

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APPENDIX 3 THE EU'S ENERGY EFFICIENCY STRATEGY The EU's EE efficiency strategy is defined by two documents: the Energy Efficiency Plan 2011 (EC 2011a) and the White Paper on Transport 2011 (EC 2011d). The five major directions for improving EE as defined in the Energy Efficiency Plan 2011 are the following: Leading role by the Public Sector: 1) Put strong EE requirements in public spending and public construction; 2) Accelerate the rate of renovation of public buildings (from 1,5% of floor area to 3% annually); 3) Make energy performance contracting (e.g. use savings from EE projects to pay out the investment) mandatory; 4) Support municipalities willing to commit to ambitious CO2 emission reduction targets (Covenant of Mayors); Tapping the vast potential in buildings: 1) Improve heat consumption efficiency (even through central district heating where feasible); 2) Solve the so-called split incentive problem1 through legal and economic provisions; 3) extend technical training to bridge the (potential) future skill gap 4) creation of a list of accredited Energy Services Companies (ESCOs) 2 and model contracts to address consumer concerns; Improve EE in the industry sector: 1) Tackle inefficient use of energy at the source i.e. in the energy generation sector (particularly through greater use of cogeneration) and in the distribution sector; 2) Give a financial value to EE and energy savings to crate an EE business sector 3) Supply more information to and develop EE incentives appropriate to small and medium sized enterprises while continuing to use the ETS scheme for large industries and continuously upgrading the energy performance requirements; 4) Support
1 2 Such a problem arises when the incentive to invest in EE measures is split between two actors (the most common example being landlord and tenant). ESCOs essentially offer Energy Services, i.e. they provide technical assistance and sometimes financial support [] to lower the transaction costs of energy efficiency investments (WBGr 2008: 73, box 5.3). In practice ESCOs provide a guarantee that the energy savings will be achieved and can also lower the cost of financing the investment by procuring a loan and funding the projects themselves (as large and competent firm they can obtain better conditions than small businesses). The ESCO then either retains a share of the cost savings resulting from the investment or, if the savings do not materialize, compensates the customer. The contract signed between an ESCO and the customer is called Energy Performance Contract (EPC). See ibidem for more details.

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research on and adaptation of new EE technologies among the industry; Develop suitable financing products and make them easily available: in order to overcome market and regulatory barriers (especially weak price signals, which prevent the realisation of many actually profitable EE investments). Empowering and involving consumers: re-design energy labels to accommodate consumer interests and enhance dialogue with consumer organisations, support the implementation of new technologies helping consumers manage their own energy use (i.e. implementation of smart grids). The provisions specifically related to EE in the transport sector as found in the White Paper on Transport 2011 are the following: Developing new propulsion systems: in particular in urban spaces (phase out conventionally fuelled cars by 2050) and in the aviation industry (use of greener fuels); Multimodality: structural reorganisation of infrastructures to achieve extensive and efficient multimodal logistic chains (i.e. combine different modes of transport aiming at using the most EE modes for the largest part of the journey possible); Information systems and market instruments: in particular implementation of the European Satellite System Galileo on the one hand and of the user pays and polluter pays principles on the other.

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APPENDIX 4 ENERGY INTENSITY OF RUSSIA IN INTERNATIONAL COMPARISON It is important to remember that Russia is not an average country by any means. It has a large population of 143 million people, is the biggest Country in the world, has the II coldest average temperatures and the resource-intensive heavy industry represents a significant share of its economy (see next section for an in-depth analysis of this last feature). In order to shed light on the specific characteristics of Russia's energy consumption, Russia must be compared to its closest peers, i.e. those countries sharing similar income levels and/or industrial structure and/or geographical size and/or average temperature. The World Bank (WB), together with the Moscow-based Centre for Energy Efficiency (CENEF), carried out such a comparison (WBGr 2008: 27-34) assessing each of the factors listed above: Income and Energy Consumption: PPP-weighted GDP only explains part of the energy intensity: Russia is a clear outlier in a negative way, being the 10 th largest economy but the 3rd largest energy consumer; Industry structure and Energy Intensity: the heavy industry bias of the Russian economy accounts for part of the energy intensity, yet again Russia's performance is poorer than other countries with similar industry structure; only other post-Soviet Countries' performance is as poor; Geographical Size and Energy Intensity: the correlation is relatively strong and appears to explain part of the energy intensity; Average Temperatures and Energy Intensity: the correlation is not as strong as in the case of geographical size. This is particularly evident when comparing Russia and Canada, which have respectively the II coldest and the coldest average temperatures among all Countries: Canada's energy intensity is just over half of Russia's. It must be said however that Russia fares better when compared to the other Post-Soviet Countries with cold average temperatures. Overall the report concludes that 25% of the energy consumption is not explained by comparison with other similar contries.

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APPENDIX 5 - ENERGY PRICE DYNAMIC AND INVESTMENTS IN THE FUEL AND ENERGY COMPLEX THE GAS ISSUE As noted previously the FEC plays a decisive role in Russia's economy and thus it is worth assessing its evolution. In particular it is interesting to focus on the dynamic of energy prices and investments, to understand the propensity to long-term investments (such as exploration and EE improvements) of the dominant actors in the FEC sector. Indeed since EE has been conceptualised as a fully-fledged source of energy, it is possible to transfer concerns of under-investment into new explorations and increased extraction capacity to the field of EE, i.e. the political relevance for the EU of under-investment into EE measures in the Russian energy sector (and the Russian economy at large) is as strong as in the case of under-investment into exploration and production capacity. The section will concentrate on the gas industry1 because of its much greater relevance in EU-Russia energy relations (see Appendix 2, footnotes 1 and 2). The most important development in the Russian gas sector since the 1998 financial crisis has been the resurgence of economic nationalism, which consisted in the stark re-definition of Gazprom as a central tool of the State Energy Policy under Putin's rule (Finon et al. 2008). Such politicisation increased the perceived risk of Russian gas supplies in the eyes of the EU. However many scholars and agencies pointed out that the real threat to security of supply to Europe was the continued lack of investment into exploration and production, i.e. the lack of long-term investment strategy: many such scholars and agencies even raised doubts about the capacity of Gazprom to increase or even only maintain production levels (see among others Goldthau 2008, IEA 2006, Riley 2006). Fernandez (2009) says that changes in the gas pricing policy since 2006 (namely, higher internal energy prices, at first for industrial consumers only, in exchange for a commitment to expand production) bring a much more optimistic forecast for gas production, sufficient to cover domestic demand and exports even in the pessimistic scenario. An important issue of course is the trajectory of Russian internal
1 However see Kalyuzhnova et al. (2008) for an assessment of the evolution of the oil market in Russia and the behaviour of National Oil Companies.

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consumption and energy efficiency improvements are considered fundamental to achieve the optimistic scenario. There are still however many sceptics and such an optimistic argument is challenged, especially in light of post-Soviet Russia energy policy and its less-than-stellar achievements (for a review of Russia's energy policy up to 2005 see e.g. Milov et al. 2006). A particularly malicious critique to Gazprom is that it is intentionally curbing production prospects to raise gas prices (see e.g. Ahrend and Thompson 2004). However Finon et al. (2008) argue that Gazprom can not afford a long-term strategy of high prices because barriers to entry in the European gas market are not high enough: therefore in the long run high gas prices would encourage other producing countries (first of all Norway) and large companies to boost their market share. It is possible to affirm that the characteristics of the European gas market push Gazprom and the Russian government to care about long-term prospects in order to increase the production and export potential of the gas industry. This highlights once more the fundamental relevance of an increased level of EE of the Russian economy.

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