The Energy Union as currently proposed1 has a strong focus on natural gas and will impact the gas sector in a number of ways.
The EU has little indigenous natural gas remaining and is therefore increasingly dependent on imports, in the case of some Member States entirely from a single source.
The current geopolitical situation in regions close to the EU has called attention to the fragility of the European gas market. The EU needs a stable energy supply to grow and energy security remains at the top of the agenda.
In a scenario where oil and gas prices are low, the Commission wants to take the opportunity to reset the EU’s energy policy in the direction of an Energy Union.
“Projects, energy and natural resources – firm of the year”Legal 500 UK 2014
Diversity of supply
Some of the Member States on the eastern side of the EU, particularly Bulgaria, Finland and the three Baltic states Estonia, Latvia and Lithuania, are solely dependent on Russian gas supplies. For Finland and the Baltic states, for example, the severity of the single source dependency combined with lack of interconnection to Europe is such, that they do not form an integral part of the single energy market. As a consequence thereof, these Member States are exempt from some of the rules of the single market, in this context particularly unbundling under the Third Energy Package2. The Energy Union is intended to increase the diversity of supply and make the EU a stronger global player with the aim to reduce energy dependence, forcing the implementation of the Third Energy Package across all Member States.
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The European gas market is fragmented with a number of hubs and natural gas is purchased at a number of different points at different prices. Gas trading is inherently complex with multiple sources of production, imports and transit flows. Due to transport costs, different requirements and availability of infrastructure, there will always be different prices across the EU just as there are with other commodities. Gas prices differ not only between Europe and for example Henry Hub in the United States or Asia, but also across Europe. This is not necessarily a bad thing. Whilst the Commission is driving for a unified energy policy to be sure that no Member States are stranded, competitive international trade must still remain at the top of the agenda.
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Source: BP Statistical Review 2014
European LNG buyers are competing in a global market where LNG is delivered where the seller obtains the best net price back, considering its costs, including transportation. There has been much discussion about how ‘European’ cargoes have been diverted to East Asia, but it must be remembered that when such cargoes are diverted the European buyers take a share of the enhanced profits of the trade and will likely only agree to the diversion if they are comfortable that that they can replace the diverted LNG in their portfolio which cheaper pipeline gas.
The scope for higher priced Asian markets to draw LNG cargoes from European markets appears to be reduced at the moment: it is likely that the Japanese will start up their fleet of nuclear power plants soon, and there are questions over Chinese demand. When one considers that the price for long term LNG supplies to Asia has also dramatically fallen due to the decline in the price of oil (against which most existing LNG supply contracts are indexed) the net effect is to reduce the flow of LNG from the Atlantic basin to the Pacific. Potentially this makes the Commission’s initiative timely.
Noting how the political challenges in the recent months have evidenced the importance of diverse energy sources, the Commission plans to increase the diversity of supply and end single-source dependency to ensure secure and resilient energy supply to the EU.
To achieve this, the Commission has said that it will:
- focus on ensuring that work on the Southern Gas Corridor is intensified, allowing increased gas deliveries from Central Asian countries
- support the construction of the necessary infrastructure to bring the gas from point of entry to the user, and ensuring that users are capable of being supplied from a diversity of supplies, for instance by making sure that pipelines can flow in both directions
- establish LNG terminals in northern Europe to allow for multiple suppliers of liquefied natural gas3, which will be replicated in the Mediterranean area
- devise an LNG strategy. LNG is a key supply mode to the EU and in particular to the Member States furthest from the Russian and Central Asian pipeline gas supplies, eg the United Kingdom, the Iberian Peninsula and the Baltic states
It is obvious that the Commission is frustrated that parts of the EU are so heavily dependent on gas supplies from one source, not only for energy security reasons but also as this affects foreign policy. It is clear that the energy isolation must be discontinued and that the Commission does not want to be held hostage to politics. The complexity and cost of ensuring supply to the EU as well as interconnectivity within the EU4 will require that the EU’s funding resources and instruments are deployed together with private finance5.
A stronger global player
The Energy Union appears to rely on a spirit of solidarity for energy supply. The Commission’s desire is that Member States assist each other in case of supply shortfalls although how this will be achieved is not yet clear. We have in the past seen gas flow out of the UK market when UK gas prices were relatively low, but not flow back in when supply constraints drove up prices. In the past national self-interest seems to have prevailed when supplies are tight, and it is difficult to see how the Commission will change that.
The Commission has highlighted the close relationship between foreign policy and energy security, and there are numerous examples of this, from North Korea and Iran, to Ukraine and Central Asia. Accordingly, the EU has said that it will work with international partners to achieve an improved global governance system for energy. What form will this take in the world of Realpolitik energy diplomacy?
The Commission has said that it will seek to put supply security on the agenda in trade negotiations with third countries. In practice, this means that the EU will seek to negotiate specific provisions on security of supply and access to resources in trade agreements where relevant. Strategic energy partnerships will be important going forward and links to gas suppliers, such as Algeria, Egypt, Azerbaijan and Turkmenistan will be strengthened; the relationship with Norway, which is the second most important supplier of oil and gas to the EU, will be further developed, integrating Norway into the internal energy market; and the partnerships with Canada and the United States will be strengthened. Topically, the Commission wants to update the strategic partnership with Ukraine and, ‘when the conditions are right’, consider reframing the energy relationship with Russia.6
With these steps, the Commission aims to achieve a more secure and diverse palette of gas supplies.
Gas supply contracts
But it is not only in EU trade negotiations that the Commission wants to strengthen the position on energy security. The market cooperation should go beyond sovereigns and extend to Transmission System Operators, the energy industry and other stakeholders working together to achieve energy security. The Commission wants to achieve more transparency with respect to commercial gas supply contracts that could affect EU energy security.
It is unclear what the Commission is actually intending and it is difficult to understand how this would work in practice. Is it intended to have pre-approval processes in place similar to those for merger control?
Taking account of the EU’s need to attract investment, the Commission’s ambition for security and diversity of supply must not create import barriers, which would make it less desirable to export to the EU than elsewhere. Although the Commission says confidentiality will be safeguarded, it will be important to strike the right balance between transparency, regulation, security of supply and commercial reality.
Equally controversial is the approach to third country intergovernmental energy agreements (IGAs). Currently, the Commission can only review an IGA ex post which allows very limited possibilities to make changes as the agreement has already been entered into. Going forward, the Commission will want to be informed about IGAs early and review them ex ante, participating in negotiations and promoting standard clauses, so that the EU can speak with one voice in energy matters.
Again, it is unclear how this would work in practice.
A balance needs to be struck between enjoying the relatively cheap supplies of pipeline gas that Europe receives from Russia but not being in a position where the Member States are unable to formulate their foreign policy based on their core values out of a concern that doing so might threaten energy supplies. Diversity of supply into Europe is obviously a key element, and ensuring that barriers to gas moving within Europe, whether the barriers are economic, regulatory or physical is also clearly key. It is clear that this is not a project that is going to be achieved in a short time scale but it must be a positive indicator that these issues are being tackled by the Commission and the initiative will likely generate some interesting opportunities for those active in the European gas industry.