Challenges and Prospects for Energy Integration in the Greater Eurasian Space

_ Yuri Kofner, head, Eurasian sector, CCEIS, Higher School of Economics, research assistant, IIASA. Moscow, 29 January 2018.

What “fuel” will the Greater Eurasian space “burn”?

Since it’s first mentioning by Nursultan Nazarbayev and Vladimir Putin in 2016, the concept of a Greater Eurasian Partnership has been able to attract more and more attention. Both from businessmen and political analysts. Some Western schoolars even talk about the dawn of a new Eurasian age.

The “Greater Eurasia” concept envisages the creation of a common economic space from Lisbon to Shanghai based on a nexus of free trade agreements and on integration between regional trading blocs and larger economies, such as the EU, EAU, ASEAN, China, Iran, Turkey and India.

This article is based on the insights of an internatinal high-level workshop that was held in May 2015 at the International Institute of Applied Systems Analysis (IIASA) in Laxenburg, Austria. I will try to give some analysis and recommendations on the pre-conditions, obstacles and potentials for enhanced energy cooperation between the main players of the Greater Eurasian space, mainly the Eurasian Economic Union, the European Union and China.

Before moving on, it should be noted, that from a purely economic standpoint (!) the interests of the EU and the EAEU in a common energy market coincide. The European Union needs guarantees of energy security (supply security). The EAEU wants stability of demand for energy in the EU (demand security). It is to my opinion, that rather non-economic, political reasons have in the past 25 years hindered any further integration of the energy markets from East and West. Washington’s aim to use the Ukranian crisis as a means to make European countries buy more

EU energy monopsony versus future EAEU energy “competition”

First of all, during the last 25 years we have been able to notice the centralization of the EU energy policy.

The European Commission’s “Strategy to a resilient Energy Union” (25 February 2015) outlines distinct policy aims, which lead to energy market centralization in Europe and had to be taken into consideration by energy suppliers, including: improvement of energy efficiency to moderate demand; de-carbonization through EU Climate policy and becoming the leader in renewables; technological leadership via research, innovation and competitiveness.

Thus, it is likely, that, as time goes on, the EU will speak more and more with one voice in energy matters due to this centralization process; energy related trade regulations are already exclusive to Brussels. Thus the EU is working towards an energy monopsony.

On the contrary to this European “monopsonization”, within the next10 years we are likely to see the liberalization of the energy market within the Eurasian Economic Union.

A complete harmonization and liberalization of the EAEU energy market is planned: according to decrees passed by the Eurasian Economic Commission, a common electricity market will be established within the EAEU by 2019, and a common oil and gas market by 2025. This means the liberalization of energy supply within the single Eurasian economy. Substitutability of energy goods between the EAEU member states is expected to take place a decade or so by 2030.

Russia is ready to supply gas according to the rules of Third Energy Package. Most Russian exeperts agree with the need to impose effective anti-trust laws against energy monopolies. However, a oil and gas monopsony is harmful as much as a Eurasian monopoly. Liberalization and trust should come from both sides – demand and supply.

A joint thinktank or discussion platform where it would be possible to discuss energy matters between the EU and Russia/EAEU as equals could prove crucial to solve this policy divergence.

Perspectives of the new energy deals between China and Russia

The European Union in an extremly important trade partner for the Eurasian Union: in 2016 it accounted for about 50% of the total exports from, and for about 41% of the total imports to the EAEU.

However, due to Western sanctions, put into effect after the Ukrainian crisis (more on that below), Russia was forced to look for alternative buyers of her imense gas and oil produce. Russia’s “Turn to the East” is slowly gaining momentum. The APEC countries are beginning to overtake the EU as a source of imports: in 2016, the Eurasian Economic Union imported relatively more goods from APEC countries (42% of total imports – mostly from China, Korea, and ASEAN countries) than from the EU (41%).

At the same time, China’s domestic gas demand is expected to rise from 200 bcm in 2015 to 471 bcm gas in 2030. The potential of gas imports from Russia is as high as 130–140 bcm.

It was Western unilateral sanctions that pushed Russia into China’s arms. In May 2014 Russia’s Gazprom and China’s CNPC have signed a historic gas deal which will provide the world’s fastest growing economy with the natural gas it needs to keep pace for the next 30 years. The total value of the contract is $400 billion.

Russia is now constructing the Altai gas pipeline to China. Upon the completion of this project, Russia will become a swing supplier between the European market and the Asian market, namely, Russia will be able to choose to whom to supply gas. However, the impact of this project on the European gas market could be limited.

Yet, the Altai gas pipeline is not a key priority for China, which is currently most interested in the establishment of the Silk Belt corridor. More inland pipeline gas supply to China from Russia, as opposed to supplies in the form of LNG shipped by sea, will put pressure on the LNG price in the Asian-Pacific market. However, Western sanctions on Russia are likely to delay the construction of the Vladivostok LNG terminal.

These new Russian gas deals will help in the expansion of the gas use in China and the decline of coal’s share below 50% in China’s energy mix by 2030. It will be one of the most important contributions for the global climate change initiative.

A gigantic Russian-Chinese project of coal-fired electricity generation plants and transmission lines to China is  also being constructed in Siberia, which may ultimately export as much as 60 billion kWh annually to China.

The Ukrainian crisis

The Ukrainians crisis causedd fundamental implications, both local and larger regional, for the energy relations and policies in the Greater Eurasian space, escpecially between Russia and the EU.

Due to the conflict with Russia, Ukraine also tried to find alternative gas suppliers even going as far as reverse gas flows via Slovakia, coal imports from South Africa and Poland. Ukraine decreased its gas consumption by 16% in 2014 and increased the share of gas imports from Europe.

As a part of taking the Third Energy Package transparency pledge, in 2014 Ukraine decided to publish all data about the cross-border gas flows and one can now see how much gas is flowing through Ukrainian pipelines, and from where to where.

The international expert community is plit about the risks of changing the nuclear fuel supplier to Ukrainian nuclear plants from Rosatom (Russia) to Westinghouse (USA). While one side argues to be very cautious about safety and possible hazards, as well as about an estimated 30-50% increase in costs, arguments on the other side speak for the market-based competition and Ukraine’s effort in attaining energy independence from Russia.

One of the biggest problems of the Ukrainian energy market are the high subsidies to consumers, amounting to 2.9 bln Euros in 2011, which will have to decrease, also due to the commitments taken by Ukraine towards the IFIs and the EU. The full transition to market rates is expected to be achieved by 2019. Yet, a large downside of this is the big burden on household incomes. For this reason, Ukrainian economists appeal to EU policy-makers to increase financial support to the Ukraine’s ongoing energy market reforms and Kiev’s “European choice”.

As part of this, Ukraine intends to integrate its energy system into the European Network of Transmission System Operators for Electricity (ENTSO-E). However, transition to EU standards in the electricity grid is costly and difficult.

European experts and policymakers underline that the Russo-Ukrainian gas disputes in the past years, especially in 2014, showed Russia to be an unreliable gas supplier. Russia’s decision to cease gas transit via Ukraine after 2019 is referred to as an example of Gazprom’s contract breach of long-term contracts with Slovakia and Hungary.

According to Russian experts however, Russia should be seen as a reliable gas supplier and the focus should be on long-term contracts. Russian delivery disruptions to the EU, especially during the Russian-Ukrainian conflict in 2014-2015 were due to the fact that gas was taken from the pipeline without payment, i.e. it was simply stolen by the Ukrainian interim government, thus the responsibility is not on the Russian side. Except for transit problems via Ukraine, Russia has been a reliable partner, in particular, for example, there has been no problem ever with the gas supply from Russia to Europe through the North Stream pipeline(s).

In order to build a healty energy market in Greater Eurasia, capable of potential interregional economic integration, the Ukrainian crisis needs to be resolved. The repeated gas supply crises between Russia and the EU via Ukraine makes the efforts on maintaining cooperation and dialogue between the two even more important. 

Despite the fact that Ukraine intends to integrate its energy system into the European Network of Transmission System Operators for Electricity (ENTSO-E), maintaining interconnections with the Russian and Belarusian electricity grid can help decrease electricity price inflation during the transition period.

Energy efficiency in the Ukrainian household sector should also be a topic of joint interests and needs. Cooperation between the Eurasian Economic Commission and respective Ukrainian research institutions for comparing approaches being adopted both in Ukraine and by the member states of the Eurasian Economic Union would be useful.

EU – Ukraine – Russia gas scenarios

The total EU gas demand in 2015 was 435 bcm, of which 287 bcm was imported. 135 bcm came from Russia. Russia’s gas export capacity to the EU was 290 bcm with transit via Ukraine and would have been 175 bcm without transit possibilities via Ukraine. The EU has become increasingly dependent on gas imports over the last several decades: the share of imported gas increased from 40% in 1960 to 70% in 2006. Yet, Russia’s share in the EU’s imported gas declined from 55% in 1990 to 40% in 2006. The US unconventional gas production is estimated to rise from 1 to 10 mboe/d (2010-2035).

It is estimated, that if Russia does not transit gas via Ukraine, does not build the Blue Stream 2 gas pipeline and prices for liquidated natural gas (LNG) are low, then the total EU gas demand in 2025 will be 489 bcm, of which 387 bcm will have to be imported. Only 75 bcm of this amount will be from Russia (with a maximum capacity of 120 bcm from Russia). In this scenario Russian gas exports to Europe would be less than the half of Norway’s.

Some experts harbor concerns about the conditions and restrictions applied by Russia related to its exports to the EU, and to various EU MS. The serious suspicions of anti-competitive behavior led the European Commission to opening a competition case against Gazprom, which is still ongoing.

In an opposit scenario of continued gas transit from Russia to the EU via Ukraine after 2019, the total EU gas demand in 2025 is estimated to be 526 bcm; 435 bcm of this amount will have to be covered by imported gas, 190 bcm of which would be supplied by Russia. The total Russian gas export capacity to the EU would be 290 bcm. If gas imports from Norway and North Africa increase, there will be no need to import LNG from ex-regional players, e.g., North America.

And in the scenario, in which there is no Russian gas transit to Europe via the Ukraine after 2019, yet LNG prices stay high and the Russian Blue Stream 2 pipeline to Turkey is not built, then the total EU gas demand is estimated to be 480 bcm in 2025, 383 bcm of which will have to be imported. 135 bcm would come from Russia, with a total capacity to be exported to the EU being 175 bcm. Other estimates suggest that Russian gas imports in this scenario would be at 125 bcm with an estimated total supply capacity up to 180-200 bcm after 2019.

Thus, regarding the possibilites for future EU – EAEU/Russia cooperation in the natural gas sector one can give the following recommendations.

Firstly, a continuation of the work of the EU-Russia Gas Advisory Council would be useful for preventing ambiguities in Russian gas supplies to the EU.

Secondly, an international gas research cooperation program could be set up to enhance cooperation between the European Commission and research institutes of different regional players (not only Russia!), which might help gaining objectivity and transparency that are desperatly needed when conducting forecasts in the gas market.

Potentials of EU – EAEU energy market integration

Let’s assume that the political problems have been resolved to some degree. What would be the technical conditions and potential outcomes for the creation of a common electricity market between the EU, the EAEU and beyond?

The creation of a common EU – EAEU electricity market could be useful, since it could stimulate large-scale construction of various types of generation assets in the Kaliningrad Region and in Belarus (nuclear, hydro and thermal power stations), that could provide power to Poland, Lithuania and other neighboring countries.

The planned EAEU energy market reforms (by 2019 and 2025) draw on the experiences of the EU regulations and are in line with the WTO rules. This already increases the compatibility between the European and the Eurasian Economic energy unions.

Cooperation could be enhanced on the basis of the Energy Charter Treaty (1998) mechanism. Most EU-EAEU member states are participants of this treaty (except for Russia and Serbia). The Energy Charter mechanism could provide effective tools for the promotion of political dialogue and cooperation on regulatory issues and further regional/cross-border electricity projects, such as between Armenia and Iran.

By 2020, the decline in oil and gas production in the traditional Russian regions would need to be offset by an increase in production in Eastern Siberia and the development of some difficult-to-extract reserves. By 2021 – 2035 the main contribution to the stabilization of production levels might come from the development of the Arctic shelf.

More and more experts argue in favor of lifting sanctions that restrain the access of Russian oil companies both to innovative technologies and equipment from Europe and to international financial markets resources needed for key investment projects. A joint development of the Arctic shelf might become a promising and prestigious longterm project of economic and investment cooperation between the EU and Russia. Again, however, economic, ecological and political factors need to be thoroughly analyzed beforehand.

Long-term investment in infrastructure projects (e.g. pipelines and joint Arctic energy exploration) between the EU, the EAEU and China would in any case mean more stability for both supply and demand than dependence on spot prices and demand fluctuations for gas and oil in Asia.

Literature

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