More than half of the EU’s natural gas and 30% of its crude oil imports originate from the Russian Federation. Dependence on Russian energy imports and the occasional disruptions of gas flow through pipelines to European customers in the past few years have raised concerns regarding the security of gas imports from Russia.

Some EU member states have called for a unified stance in dealing with Russian energy policy. However, variations in the size of each individual country’s gas consumption and the degree of their dependence on Russian oil and gas remain an obstacle. For instance, out of 218 bcm of Russian gas exported to Europe in 2010, 70% went to EU member states, of which half was imported by Germany, Italy and France.

Yet the share of Russian gas in the energy basket of these customers varied between 5-10%. These countries are among the most important sources of revenue for Russian firms and therefore enjoy favorable terms and friendly conditions. They in turn hesitate to give their full support to the formation of a unified European front in dealing with Russian energy firms.

Tables included Table 1: Russian Gas Exports To Europe, Contract Years 2007-10 (Bcm)

Country 2007-08 2008-09 2009-10
Germany 39.72 27.02 36.82
Italy 23.57 19.04 12.43
Turkey 24.43 20.75 16.85
France 11.26 9.64 11.16
UK 6.1 7.47 6.68
Total “Western Europe” 124.08 99.76 101.12
Total “Central Europe” 44.53 33.4 40.98
TOTAL EUROPE (Gazprom definition) 168.61 133.16 142.1
Total including Baltic Countries 173.21 136.5 146.28
Source: Market-based prices and anticipated supply and demand trends in the 2010s (www.oxfordenergy.org)

Germany, France, and Italy take a favorable view of Russia as a future guarantor of energy supply to Europe. While Gazprom hopes to gain access to Europe’s downstream sector and petroleum market, firms from these three European nations are in return seeking permission to invest in Russia’s upstream sector. The Nord Stream pipeline in 2010 and the continued campaign to build the South Stream pipeline are cases in point.

In comparison, east and central European countries depend for more than 50% of their natural gas on Russian imports, while Slovakia, Bulgaria, and six Baltic Sea region countries depend on Russia for 100% of their energy needs. However, it is important to note that volume of eastern and central European countries’ energy consumption is much smaller than that of west European countries. For instance Estonian and Latvian annual imports total approximately 2 bcm; whereas Germany’s annual gas imports alone are around 35 bcm.

Tables included Table 2: Russian Gas Dependency In 2010

Country Gas Imports (Bcm) Gas Consumption (Bcm) Russian Gas Imports (Bcm) Import Dependency (%) Russia in Imports (%) Russia in Consumption (%)
Czech Rep 8.51 9.28 7.46 91.7 87.66 80.39
Hungary 9.64 12.05 6.77 79.96 70.26 56.18
Poland 10.9 17.2 9.76 63.35 89.55 56.73
Slovakia 5.97 6.26 5.97 95.27 100 95.27
Estonia 0.7 0.7 0.7 100 100 100
Latvia 1.12 1.82 1.12 61.69 100 61.69
Lithuania 3.11 3.12 3.11 99.78 100 99.78
Source: Russia-EU Gas Relations: The Russian Perspective (www.academia.edu).

Since east and central European countries’ imports are small in percentage terms and Russia enjoys a monopoly over their energy sectors, they have little bargaining power other than their value as a transit route for energy exports. The Nord Stream pipeline connects Russia directly to Germany bypassing other European nations and thus weakening their last bargaining chip. That is probably one of the reasons why the central and eastern European countries are trying to establish a single European gas market and adopt a unified European energy policy.

The success of the EU’s gas policy is dependent upon establishing a unified European gas market in which Europe would be treated as a single market for Gazprom. In the event gas flows to one member are disrupted, they could easily be restored by transferring gas from other locations. Gas supplies from sources other than Russia will also find a chance to compete in this market, thus strengthening the EU’s bargaining power.

OIL-LINK PRICING

Russia’s insistence on oil-index pricing is another problem for EU energy policy. Gazprom maintains that an oil link is necessary to cover investment in exploration and production. However, oil prices have soared while gas prices have registered only a small increase, and this continued divergence between oil and gas prices has coincided with lower gas demand.

With the continued Eurozone debt crisis damaging economic recovery, oil-indexed pricing is coming under increasing pressure. In 2009 Statoil reduced oil indexation to 75% in its contracts, compared with Gazprom’s 85% in 2011. If Statoil again reduces the oil indexation in its continental Europe contracts, Gazprom will also have to be more flexible, especially for buyers able to access spot, hub gas.

EUROPEAN SHALE GAS?

France and Poland are estimated to hold 10% of the world shale gas reserves, but it is not clear if the North American experience can be repeated in Europe. North American markets are already well established and enjoy a high level of infrastructure compared to Europe. A new EU case study shows that European shale gas development will not replace declining conventional output in the region.

European efforts to reduce dependence on Russian gas have also raised concerns about security of demand on the Russian side. These concerns include, but are not limited to:

•The politicization of gas exports to the EU.

•Increased supply-side competition in the EU gas market.

•Export destination diversification options.

•The development of EU legislation.

•Russia’s perceived exclusion from the EU gas market.

Addressing European concerns about the security of supply while acknowledging the Russian perspective on security of demand might appear to be a paradox, but both sides ultimately depend on each other. With 60% dependence on imports, Eastern Europe in all likelihood will continue to rely heavily on Russian energy imports, while Russia’s projected increase in gas exports to the Asia-Pacific region, intended to reduce dependence on exports to the EU, may take time to materialize.

CONCLUSION

Lack of basic infrastructure such as pipelines interconnecting various EU member countries and the absence of an established energy market similar to the one in the US, as well as limited east and central European access to non-Russian gas, are a few of the reasons why occasional disruptions in Russian gas flows to Europe are hard to replace. Security of supply, oil-indexed pricing, lack of bargaining power on the part of east and central European countries on their natural gas imports from Russia and disunity among EU members on energy policy matters are among the issues raised.

On the other hand, the Russians are concerned about the security of demand. They watch EU efforts to diversify gas imports, develop an EU gas market and establish a common EU external energy policy with increasing alarm. The ongoing recession in Europe, the US shale-gas ripple effect putting downward pressure on global gas prices, the Trans-Caspian pipeline planned by Azerbaijan and Turkmenistan and increased competition from Statoil and other rivals, are among issues that may threaten Russian gas exports to Europe and potential revenues earned by them.

A decline in demand caused by the ongoing European recession and cheap carbon prices motivating consumers to switch to coal may result in minor concessions by Russian firms in the form of an oil indexation reduced to below the current 85%. But the fact remains that the proposed EU reforms will not materialize any time soon, and a major infusion of natural gas from non-Russian sources is unlikely. Europe needs Russian gas and Russia needs the revenues; will honest, transparent dialogue without the distractions caused by politics help? ¶

*Mr Ghaffari is a Senior Energy Policies Expert in the Energy Policies Department of the Iranian Ministry of Petroleum. These are his personal views and they do not represent the views of the ministry.