A growing "crisis of confidence" threatens the Russian-European
natural gas relationship, which has been integral to the economies of
both Europe and Russia over several decades, according to a new study
by Cambridge Energy Research Associates (CERA).
While there is much focus on specific issues, the reason for this
crisis is the combination of fundamental changes in Russia, Europe,
and in the gas business itself that are unsettling the relationship,
according to the study "Securing the Future: Making Gas
Interdependence Work." The CERA study is a comprehensive examination
of the changes taking place that alter the basic assumptions that have
underpinned the European-Russian gas relationship for many years. It
focuses on the current stresses and threats, and on ways to reduce the
tensions and keep the relationship on a solid footing. Its timeliness
is underscored by the new legislation on gas liberalization expected
from the European Commission on September 19.
"The crisis of confidence need not translate into a crisis of
supply in the future," says the report. "It is important that the
issues of gas interdependence between Russia and Europe be seen
simultaneously through the critical lenses of competition, security
and environmental sustainability. While attention may focus at any
given time on one source of tension or friction or another, a larger
perspective shows why a strong spotlight is now on this relationship
today."
"The broad conclusion is that the sustainability, efficiency, and
security of European energy supply will best be achieved not by
hastily deciding to reduce dependence on Russian gas, but through the
creation of a carefully and cooperatively managed 'interdependence'
between Europe and Russia," said Simon Blakey, CERA Senior Director,
European Research.
The study demonstrates the importance of the relationship both to
Europe and Russia. Although Europe accounts for almost one-fifth of
the world's annual consumption of gas, its own reserves represent less
than two percent of known global gas reserves. Russia is the world's
biggest holder of natural gas reserves. Russia provides 26 percent of
Europe's total gas, and the largest share of imports, while natural
gas is Russia's second largest export earner. In addition, the
increased penetration of natural gas into the primary energy mix for
Europe - critically supported by Russian supply - has been the key
factor in lowering CO2 emissions in Europe since 1990.
The study examines issues that go to the core of the gas
relationship between Europe and Russia:
-- Is there enough gas available in Russia to supply Europe's
future needs?
-- Can the next generation of Russian associated gas and the
transportation infrastructure in both Russia and Europe be
financed in a timely way?
-- How much dependence on Russian gas is consistent with European
security?
-- What alternatives exist to diversify Europe's sources of
energy?
-- Where are Russian policies on energy and energy diplomacy
headed?
-- How will the gas trade be affected by the European Union's
evolving policies on energy security, sustainability, and
competitiveness?
Three Fundamental Changes
Gas exports from Russia to Europe have benefited both seller and
buyers, and the scale of the business has been a significant
achievement considering the complexity of the relationship and the
political changes that have taken place. The gas continued to flow
even during the frostiest years of the Cold War. Central to the
current rising anxieties are changes taking place in Russia, Europe,
and the gas industry.
-- Russia is changing: Russia for the first time since the Soviet
era needs large-scale investment in the next generation of gas
fields and pipelines. There is also increasing competition
from the domestic market, as Russia's economic recovery
continues. In addition, the economy has bolstered a strong
central state, which views energy as a key element of foreign
relations.
-- Europe is changing: The European Union has evolved from a
customs union of 15 members, to a supranational entity with 27
members that sets the economic and regulatory agenda of member
states. This agenda includes a strong push towards
liberalization in the gas and power sectors. Environmental
sustainability is also a major policy objective, with the
recent commitment to more renewables, more energy conservation
and lower emissions of greenhouse gases.
-- The gas industry is changing: the industry is becoming global,
rather than regional, as a result of advanced trading and
balancing systems, the growing global liquefied natural gas
(LNG) market, and the evolution of pipeline financing models.
In addition to the changes that have already occurred, more lie
ahead, including new legislation in Europe to further alter gas
markets, and the coming change in Russian leadership.
"A constructive way forward will recognize both the significance
of the changes and the far-reaching stakes in the relationship," said
CERA Senior Director Thane Gustafson, Russian and Caspian Energy.
"This will provide the basis for managing the stresses and forging a
framework that assures that gas interdependence will continue to
deliver the economic and environmental benefits for both Europe and
Russia in the decades ahead."
What are the risks?
"It is not interruptions or cutoffs," says the study, "or even the
threat of them, that poses the greatest danger." Rather, "the more
significant risk" is the "degradation" and "corrosive undermining of a
relationship that is a fundamental pillar of both Europe's and
Russia's economies...and that has contributed to a lower carbon
intensity."
-- "European concerns" include transit risks, perceived "over
dependencies," worries about the future supply of gas from
Russia and Central Asia, and concerns about export monopoly.
-- "Russian concerns" focus on "the regulatory risks from
liberalization policies evolving in Europe, perceived
discrimination against Russian interests in Europe, and the
extension of EU policies and rules outside the present
territory of the European Union."
As the Russian-European gas relationship has become more complex
and uncertain, some have looked to alternatives to alleviate the
pressure. On the European side, where domestic gas production has
entered a sharp decline, with a drop of almost 30 billion cubic meters
over two years since 2004, liquid natural gas (LNG) is the most
attractive and immediately-realistic alternative. For Russia, it has
been suggested that gas exports can be diverted to East Asia, turned
into "embodied gas," consumed domestically, or just left in the
ground. However, for Europe, CERA has concluded that, while LNG will
provide diversification, natural gas by pipeline will remain the "fuel
of default," and that for Russia the only viable alternative is the
Russian domestic market, which may be a competitor to the European
market as a source of value for Russian gas producers.
A way forward
CERA's study concludes that exporting Russian gas to Europe is
still cost-effective, reliable, and beneficial for all parties. It is
important, however, that steps are taken to protect and sustain the
relationship in order to achieve realistic and sustainable
"interdependence" between Europe and Russia through:
-- Careful management of the European Union's liberalization
agenda, with the European Parliament and Council of Ministers
paying particular attention to the implications for security
of supply and environmental sustainability of the European
Commission's September 2007 proposals
-- The likelihood of a review by the incoming government of
Russia after the 2008 election of the objectives and structure
of the Russian gas industry
-- Maintaining a respect for national sovereignty in order to
support favorable conditions for cross-border investment and
to manage third-country transit issues
-- Cooperation to manage and diversify transit risk, including
reviving the idea of a multilateral consortium with Ukraine,
to manage the Ukrainian pipeline and storage system
-- Allowing markets to do their work. There is strong evidence
that the new market structures and market opening practices
that are already in place will evolve quickly to the benefit
of the gas industry's customers.
For more information about the study contact Bethany Genier at
bgenier@cera.com.
About CERA
Cambridge Energy Research Associates (CERA), an IHS company (NYSE:
IHS), is a leading advisor to energy companies, consumers, financial
institutions, technology providers, and governments. CERA
(www.cera.com) delivers strategic knowledge and independent analysis
on energy markets, geopolitics, industry trends, and strategy. CERA is
based in Cambridge, Massachusetts, and has offices in Bangkok;
Beijing; Calgary; Dubai; Johannesburg; Mexico City; Moscow; Mumbai;
Oslo; Paris; Rio de Janeiro; San Francisco; Tokyo; and Washington, DC.
(C) 2007, Cambridge Energy Research Associates, Inc. All rights
reserved. CERA and the CERA logo are registered trademarks of
Cambridge Energy Research Associates, Inc.
