The European Commission Unveils Its Energy Union Plan

Summary

Europe may be on its way to finding long-term relief from dependence on Russian energy. The European Commission on Feb. 25 released its Energy Union Package of proposals designed to continue developing the bloc’s energy market and energy security. The proposals, meant to establish a European Energy Union, are more a continuation of EU energy policies than a radical departure from them. The proposals will not substantially decrease the energy supplies flowing from Russia to Europe, but they will continue to erode Moscow’s ability to dictate prices in European markets — a tool Russia often uses to achieve political ends. Some of the broader initiatives, such as the greater harmonization of energy markets, will conflict with some member states’ core national interests, weaking progress on these fronts. 

Analysis

The Energy Union Package can be thought of as a successor to the Third Energy Package of energy legislation. However, at this stage, the Energy Union Package is simply a framework of policy objectives, not a piece of enforceable legislation. The Europeans will spend the next year or two exploring and drafting specific pieces of legislation before presenting them to the European Parliament. It will take time before the Europeans make any substantial progress on these initiatives, though the European Commission can undertake a few parts of the package by itself.

The package focuses on three main goals. The first — and most relevant to Russia — is the continuing diversification of Europe’s natural gas market. The second is the modernization of the electricity market. The third is the development of energy efficiency through the use of renewables and other alternative forms of energy.

Natural Gas Markets

The first part of Europe’s plan for its natural gas market involves internal development. Europeans will continue adding energy infrastructure projects — such as liquefied natural gas regasification terminals, interconnectors and pipelines — to the list of projects of common interest and make sure that they have financial support. However, with LNG terminals already being built in the Baltics (though one is searching for funding) and more interconnectors coming online, parts of Europe will see only marginal returns on these investments in terms of reducing Russian influence.

The one area where such projects can still be effective is Southeastern Europe. Connecting countries such as Hungary, Bulgaria and Romania to supply chains that can receive non-Russian natural gas will be a high priority. However, the distance between these countries and the liberalized European natural gas supplies, such as the Central European Gas Hub (which serves Austria, the Czech Republic and Slovakia), make it expensive to import non-Russian natural gas. In addition, states on the Black Sea are cut off because Turkey will not allow LNG tankers through the Bosporus to reach them. Low prices for LNG and energy in general have also led energy companies to shelve many of the plans for projects in the Balkan countries.

The European Commission will propose a resilience package for natural gas as well, putting emergency measures into place in the event of a supply cutoff or shortage. In such a cutoff or market, the commission will explore mechanisms to allow collective purchases of natural gas by groups of countries that depend on a single source, such as Russia.

The second part of the EU plan involves finding other external supplies. Some European regulations and increased infrastructure have diminished Russia’s ability to use energy dependence for political gains. Still, the European Commission will attempt to work with EU member states to further develop projects to establish strategic energy partnerships. Such options include the United States, the Caspian littoral states, the Middle East and North Africa, but each has limitations.

First, the Caspian states and the Southern Corridor are fettered by financial and political factors. The Trans-Adriatic Pipeline and Trans-Anatolian Pipeline are expensive projects that the European Union will not finance itself. They will require almost entirely private investment, but energy companies are scaling back operations considerably. Moreover, getting natural gas from Turkmenistan to the other side of the Caspian Sea is politically difficult because of unresolved maritime disputes. Russia, wanting to retain its influence in European energy markets, will make sure that no such pipeline gets built without Moscow’s involvement.

Shale gas exports from the United States are an option that EU leaders and U.S. leaders alike have mentioned as a potential option. The Lithuanian energy minister recently visited the United States to try to secure LNG exports. The problem is that U.S. LNG exporters are planning to send most of their natural gas to more lucrative markets in Asia. Washington might be able to give these companies political incentive to direct those exports to Europe, but it has little ability to influence where exports are sold. The Europeans would have to outbid China, Japan and South Korea for U.S. LNG supplies.

Algeria is a more likely external source for natural gas supplies; Sonatrach, a state-owned firm, is gaining direct influence over a greater percentage of Algeria’s natural gas production and would be involved in state-to-state negotiations. However, as Algeria considers building more LNG facilities to export natural gas, Europe would again end up having to outbid more lucrative markets, just as it would with the purchase of U.S. LNG.

The last part of the European Union’s natural gas market plan involves liberalizing natural gas prices and increasing the transparency of supply contracts. The European Union wants to review the laws regarding intergovernmental agreements for natural gas contracts — deals struck between individual EU member states and natural gas source countries — and give the European Commission a more active role in those negotiations. Brussels also wants to establish standard contract clauses and ensure that EU law is followed before such agreements are completed. Though the enforcement mechanism for this measure has not been decided upon, the transparency and auditing before deals are finalized would give the more politically powerful EU members like Germany and France the chance to pressure countries that sign intergovernmental agreements (mostly countries in Central and Eastern Europe). Brussels also wants to make commercial natural gas contracts more transparent, though it is not clear what this entails, and encourage the development of natural gas trading hubs.

All of these initiatives have a common goal besides transparency: to continue driving down Russia’s influence on natural gas pricing and its ability to give different EU members different prices. These measures would create a freer natural gas pricing market that Russia will have little choice but to accept because of its dependence on the European energy market.

Electricity Markets

With the Energy Union Package, the European Commission is also calling for a more integrated electricity network. This could be a decisive change in the way Europe operates. There is already some electricity trading within the European Union, but progress has been slow in reaching the European Commission’s goal of a 10 percent electricity interconnection rate. The commission wants an annual report on efforts to reach this goal. While 10 percent may seem like a small percentage, that much interconnection could drastically reduce the prices of electricity regionally by managing interday markets.

However, this will be a politically sensitive topic. Spain, for example, is completely isolated from the rest of the European grid and unable to enjoy the benefits of being integrated into a larger electricity network. This isolation makes it more difficult for Spain to develop a sophisticated, reliable and resilient power grid. France is the only way for Spain to connect to the European grid. However, Spain’s climate gives the country an abundance of renewable energy potential from wind and solar power, and French energy company Areva does not want the cheap renewable electricity coming from Spain to undermine it at home. Though not the only example, this situation illustrates how national interests will diminish any plan the European Commission proposes.

Part of this process will involve the European Union helping to develop new electricity grid technologies such as smart grids, distributed generation, energy storage and high voltage long distance connections to create what Brussels envisions as a European super grid. In doing so, the European Union will propose a complete redesign of the bloc’s electricity market, limiting state intervention in electricity markets to allow the electricity market to act more freely.

The electricity component of the Energy Union Package can dramatically increase the resilience and efficiency of the EU power sector, but it will not affect Russia. It will affect energy prices and, through higher efficiency and the use of advanced technologies, it could dampen demand for Russian natural gas as a feedstock for power plants.

Moving Away From Carbon-Based Fuels

Improving energy efficiency and encouraging wider use of renewable energy are a major part of the European Union. The bloc has been at the forefront of climate change advocacy — it now wants to reduce greenhouse gas emissions by 60 percent globally by 2050 — but it also suffers from a massive energy deficit, even taking into account Norwegian energy production. The European Union is extremely vulnerable to external forces in energy markets, with Russia being just one of those forces, albeit the most important. Energy efficiency and renewable energy will curb fossil fuel demand, decreasing Europe’s vulnerability.

The European Union still hopes that by 2030, 27 percent of its energy will come from renewables. The Energy Union Package will support this goal by proposing new legislation to achieve a 40 percent reduction in greenhouse gas emissions by 2030 (below 1990 levels). The commission will also propose a new Renewable Energy Package in 2016 or 2017 in order to support its 2030 goals. It will include legislation to make renewable energy more cost-effective, but the bigger question is what the private sector will do if LNG, coal and oil prices remain low. Brussels would have to offer extensive rebate programs, feed-in tariffs or other mechanisms to make renewable energy more appealing — more so than it would if oil prices were higher. Germany was able to implement similar measures, but Germany could afford it. With Europe’s demographic crisis worsening between now and 2030, the Europeans will have to manage the economy while shedding fossil fuel energy.

One of the measures will involve increasing investments to make European buildings more effective at cooling and heating. Buildings in Europe are inefficient in this area, and heating and cooling are the single largest energy-consuming sector in Europe, requiring a great deal of natural gas. The Energy Union Package will seek to modernize this sector. However, since the measure involves homes and commercial properties, a great deal of the investment will have to come from local or private sources. Economic limitations, particularly in poorer Central European countries, will hamper investment.

The European Commission also plans to develop a program called “Smart Financing for Smart Buildings” to make buildings more energy-efficient through smart grid systems. The smart grid is a more attainable goal, driving down electricity costs through the optimal use of power generation, transmission, distribution and storage infrastructure.

The European Union will also continue chasing one of the most elusive goals in the quest for independence from carbon-based fuels: getting the transport sector to move away from oil. To facilitate this change, the commission will present a road transport package to promote efficiency and intelligent transport solutions (such as the use of more trains) and take more actions to promote alternative energy sources for cars, such as fuel cells or electricity. As with all previous attempts, one limitation will be the high expense of building up the required infrastructure to make the transition. Getting people to buy cars that run on hydrogen, for example, would require hydrogen fueling stations to be available. To get people to build the fueling stations, there needs to be a demand. In the short term, and possibly the long term, low oil prices will discourage investment in alternative transport options.

What It Means for Russia

Unlike the infrastructure developments over the past five years, most of the new proposals are long-term projects that will not have an immediate impact on Russia. However, these measures will continue to reduce Russia’s negotiating position for natural gas, oil and other forms of energy. Eventually, they will force Gazprom to abandon long-term natural gas contracts tied to oil prices and move toward a more market-oriented pricing mechanism. Russia’s inflexible natural gas contracts have already resulted in significant declines in exports to Europe year-on-year in 2015. Russia has the ability to cut energy export prices in order to preserve its market share; prices have been so high during the past decade that a reduction would still give Gazprom a level of comfort.

What the Energy Union Package will not do is dethrone Russia as continental Europe’s main natural gas supplier. Russia will continue diversifying its exports to Asia and other consumers. However, as Europe moves away from coal and toward cleaner fuels to meet its emissions targets, Europe’s natural gas demand will continue to rise while oil and natural gas production in the North Sea continues to fall. Shale gas development in Europe has been almost nonexistent, with U.S. companies pulling out of Romania and Poland. Furthermore, shale gas production is largely opposed in the rest of continental Europe, meaning Europe will still need to import energy, and Russia will take part. Russia will retain the option to cut off natural gas supplies if it feels the political need, but with the Russian economy in shambles, it is an unlikely proposition.

While the Energy Union Package is really a continuation of existing policies, it will help take energy price setting out of Russia’s hands and put it into the hands of the international market. For a region that has been dependent on Russian energy — and Moscow’s political whims — for so long, it will provide much-needed relief, especially as Europe deals with broader issues such as its own economic and demographic crises.

Natural Gas Europe