NATO
Economic
Colloquium
1997

Cooperation in the Field of Energy

Friedemann Mller

Senior Research Associate, Stiftung Wissenschaft und Politik, Ebenhausen, Germany

Introduction

The day the Founding Act between NATO and Russia was signed, the International Herald Tribune ran a front page headline "NATO and Russia: The Gazprom Factor" and quoted in this article an executive from Gazprom:

    "Why are you guys so concerned about the enlargement of NATO to the East? I can assure you that the enlargement of NATO to the East will be more than compensated for by the enlargement of Gazprom to the West (1)."

Is this the new security guarantee for Russia? Will it provide stability for Europe? There is no doubt about the territorial "enlargement of Gazprom". However, the structure of the energy sector and the rules of the game have changed in Europe, both East and West during the 1990s. Competition is growing, cooperation and diversification have become more intensive, dependencies have changed fundamentally. The transformation of the energy sector in Europe reflects different movements during the millennium's last decade:

  • the transformation of the economies in the Former Socialist Countries (FSCs);

  • deregulatory measures providing more competition in the energy sector within the EU and beyond;

  • the linking of East and West after the end of the cold war.

Europe is still in the midst of these processes. The results are still unclear. It is, however, quite clear that future challenges such as the enlarged EU's need to be competitive in a globalised market and the necessity of dealing with global environmental issues, particularly the climate change problem, make a completely modernised and restructured energy sector as necessary as the agreement on common rules for the whole of Europe.


Transition of the Energy Sector in Former Socialist Countries : A Mixed Record

The energy sector received special treatment in all Central and East European FSCs during the transition process. The basics of the transformation to a market economy, which are price liberalisation, privatisation and demonopolisation, have not been applied without delays and exceptions, indeed, no continental European country has completely achieved these targets in the energy sector. First steps were taken in Western Europe in the 1950s. However, these processes only gained real momentum through the EU Single Market and globalisation effects which did not gain prominence until the beginning of the 1990s. In Western Europe, price liberalisation has been taken furthest, while privatisation has been given second priority. Demonopolisation in the field of electricity and natural gas has begun due to a major effort on the part of the EU Commission. However, the process is far from being completed (2). Those FSCs which have signed Europe Agreements (EA countries) and wish to negotiate EU membership after 1998 have no comparable timeframe to adapt their energy sectors to competitive market conditions. They therefore have to adjust to Single Market rules under immense time pressure. Those countries that are not preparing for EU membership, mainly in the CIS, will certainly need a longer transition period.

Price liberalisation is not being carried through consistently in any of the FSCs. Free prices, such as the price of coal in the Czech Republic, are the exception (3). An overwhelming majority of energy prices are regulated to prevent social unrest. The old reliance on subsidised energy prices as a substitute for an efficient social policy is still deeply rooted in all the transition countries (4). The effect is that energy consumption per GDP unit is several times higher than the EU average. This is particularly extreme in countries like Ukraine where economic recovery is substantially hampered by the high energy import bill. At the same time, low energy prices prevent the emergence of a profit-oriented energy saving industry (regulators, insulation, etc.) and serve to discourage foreign investment. There is, however, a growing awareness of this problem. In countries like Hungary serious efforts are being undertaken to adjust energy prices to a market level.

The progress made with privatisation by different countries varies greatly, with Hungary being by far the most advanced country. By 1995, privatisation was already well advanced. For example, the state's share of the country's vertically integrated oil and gas company, MOL, has been reduced to 55% (5). In Poland, plans to privatise power generators as well as the oil, natural gas and coal production sectors are partially combined with efforts at demonopolisation. However, progress is still insufficient. The Czech Republic has attracted some foreign investors, mainly in the field of oil refineries. All other EA countries are lagging behind. In Russia, the natural gas monopolist Gazprom is formally privatised with a state share of 40%; the remaining shares are divided among the company's management, the employees, and local distribution companies, with 9% of the shares reserved for sale to selected foreign investors. Russian oil production is divided into 12 companies producing between 0.16m (Onako) and 1.02m (Lukoil) barrels per day (b/d) in 1996 with a state share between 0% (Sidanco) and 100% (Rosneft). The state's stake in Lukoil is 11%6. Russia will continue to operate and negotiate joint ventures for shared production in huge oil and natural gas projects (7). The really big deals, however, were contracted by Kazakhstan and Azerbaijan with Western oil consortia. Even Turkmenistan, whose transformation lags behind, has recently signed a number of contracts with Western companies to develop its natural gas fields.

Demonopolisation is the least advanced aspect of the transition process. In Russia, to the extent that the oil companies compete at all, they do so in international markets (Kazakhstan) rather than domestically. The gas market (Gazprom) like the oil (Transneft) and electricity transportation (Unified Energy Systems) are formally organised in monopolistic structures. Even the big fight between Deputy Prime Minister Nemtsov and Gazprom over the company's adaptation to market rules ended (temporarily) with Nemtsov's declaration of success: "the largest company in Russia has finally come under state control" (8). Other FSCs have not made major efforts to introduce domestic competition. By virtue of its privatisation progress and its relatively high share of foreign capital, Hungary is better prepared than other countries to take this step in the foreseeable future (9).

Former Socialist Countries : From Dependency to International Competition

After the breakdown of the Soviet empire and the dissolution of the Council for Mutual Economic Assistance (COMECON) in June 1991, the East Central European countries were forced to completely reorganise their energy supply structures. In 1990 the Soviet Union had an almost complete monopoly in the natural gas trade with these countries and a very high share of the oil trade (10). While Russia tried to maintain the level of its energy deliveries to Western countries, it reduced its deliveries to the EA countries drastically due to the decline in production. Russian oil exports to East Central European countries were cut by more than half between 1990 (45.7 million tons {mt}) and 1994 (21.0mt) whilst deliveries to the Baltics were reduced to one-fourth of their previous level (11.5mt in 1991 to 3.7mt in 1994) (11).

The EA countries themselves had no reason to maintain the former monopolistic supply source of Soviet/Russian deliveries since the price advantage in comparison to world market prices had disappeared (12). Moreover, substantial declines in the size of their economies (of between 25-40%) in the early 1990s combined with energy efficiency improvements implemented since about 1994 have reduced import demand. There is a clear interest in modernising the energy sector in accordance with Western type structures and in diversifing supply.

Nevertheless, Poland signed a natural gas deal with Gazprom in 1996 which adds another 14 billion m3 to the already 8 to 10 billion m3 of natural gas it buys from Russia annually. This will cover virtually all Poland's demand for gas of 24 billion m3 after 2010. There is, however, a difference between this and former dependence structures. Firstly, the newly built Netra pipeline from Wilhelmshafen to Berlin which will probably be connected with the Polish network could substitute supply deficits. Secondly, the fact that this new deal with Gazprom is part of a major Russian-European deal delivering Yamal natural gas via Belarus and Poland to Western Europe means that the dependence between Russia as supplier and Poland as transit country will be a mutual one.

The Czech Republic has followed a different policy. In March 1997 it announced a long-term gas supply contract with Norway for at least 3 billion m3 annually to be supplied by three Norwegian companies. This would be in addition to the current 9 billion m3 provided by Gazprom. Trade Minister Dlouhy hailed it as a way to make his country "strategically independent from eventual possible Russian economic pressure" (13). He therefore declined an offer of supply by West European companies (Nederlandse Gasunie NV and Wingas) which are linked by joint ventures to Gazprom. The Czech Republic is already sufficiently connected with the West European natural gas network to avoid dependence on any single operator.

Bulgaria, traditionally the country most dependent on the Russian energy supply, announced recently that Russia is charging too much for its gas and that it is looking for alternative suppliers (14). Extending the Western pipeline system to East Central Europe will allow them to buy natural gas from West European sources in the foreseeable future.

Romania has made special efforts to establish a network of alternative options for the supply of energy to South East Europe. Romanian firm Romgaz signed a contract in 1996 with Hungarian and Norwegian companies to establish a pipeline link via the modernised Hungarian network to the EU (15).

Slovakia, however, relies completely on Russian natural gas and has extended this relationship by planning a fifth pipeline linking these two countries to be constructed by the year 2000. This pipeline will also increase Slovakia's huge transit capacity (85 billion m3 p.a.) for Russian gas to the West (16). It makes Russia's strategic dependence at least as high as that of Slovakia.

Ukraine's dependence on Russian gas is almost complete. While some natural gas is delivered by Turkmenistan, there has been to date no real alternative to the Russian transportation network. The high cost of energy imports which overall amounted to US$16.95bn in 1995 means that Ukraine's debt to Gazprom (as well as to Turkmenistan) has accumulated, thereby increasing its dependence on Russia despite efforts to diversify at least the oil supply (17).

The most dramatic change in terms of geopolitics and international economics is taking place in the Caspian Sea area where three Newly Independent States (NISs), Azerbaijan, Kazakhstan and Turkmenistan, are trying to gain wealth and independence through the exploitation and sale of their oil and natural gas reserves. The fact that all three NISs are landlocked forces them to cooperate with their difficult neighbours. But Russia is keen to preserve the status-quo which it considers to be the centrepiece of the CIS and tries to benefit from the natural and geographical conditions (18). The situation is complicated by the interest of other countries like Turkey, Iran and even Pakistan in profiting politically and economically from this emerging region. Even the United States is intervening as a major political player in the shaping of transport infrastructure by isolating Iran and supporting Turkey (19). The situation is further complicated by the fact that transit routes must cross regions of conflict. This holds true for the Nagorny Karabakh region, Chechnya, as well as Afghanistan. Nevertheless, from the dynamics of the oil rush there emerged a number of contracts and consortia involving different companies from Russia, the NIS and Western countries, an important training field for post cold war economic cooperation (20).

Oil, coal and electricity trade between Russia and the EA countries is no longer a matter for concern on the grounds of dependence. Coal trade was always negligible, whereas the oil trade has decreased sharply due to Russia's reduced capacity and a better supply system through alternative pipelines. The integrated electricity network of the COMECON countries has disintegrated to a large extent. Insofar as there is an interest in trading electricity, linking up with the European system is much more attractive.

Cooperation Between East and West : New Opportunities Under New Conditions

The diversification and partial reorientation of EA countries' energy supplies towards Western European countries (Norwegian natural gas, oil through pipelines from the West) has already been discussed. The most dynamic involvement, however, is taking place in the field of infrastructure and capital investment. Numerous pipelines linking East and West in Europe and the current planning of further construction are preconditions for more diversification, less dependence and more competition. Europe as a whole is moving towards an integrated network for the transportation of oil, natural gas and electricity. The capital for this is not only flowing from West to East, but also to some degree vice versa. The natural gas giant Gazprom is extending its transport routes and capital shares towards Western Europe. It has founded two joint ventures with the German company Wintershall (WIEH and Wingas), that have gained a 10% share of the gas delivery market in Germany and now own portions of the pipeline networks on German ground. The main capital transfer, however, is directed from West to East. Hungary has sold major shares of its natural gas and electricity distribution companies to Western companies. One source of Western firms' interest is the different price and quality structures of electricity within EA countries and between EA and Western countries. This might lead in the longer run to major trade in different qualities of electricity at different prices. Romania counts on significant Western capital inflows to regenerate its exploration and production of oil and natural gas both in on-shore and off-shore fields. Due to a lack of modernisation investments, production has been declining since the 1980s (21). The domestic pipeline system also needs renovation with Western technology and capital. In the Czech Republic local suppliers are cooperating with Western companies to build power stations, both nuclear and thermal (22).

The quantitatively biggest attractions for Western capital are Russia and the CIS countries to the south. Project planning for oil and natural gas production in the Russian Arctic, on the Sakhalin peninsula and around the Caspian Sea suggests an aggregate investment potential of more than US$100bn (23). The risk factor for investments made under still unstable legal conditions is, of course, high (24).

Interdependence in Europe : An Opportunity for Meeting Future Challenges

The energy scene in Europe has changed during the 1990s faster than in any previous decade. In 1990, two separate systems with totally different market and price structures were linked only through natural gas and oil deliveries from the Soviet Union to the West. Today, the Eastern systems are now adjusting to the Western system, which in turn is moving towards demonopolisation and more competition. Whereas the West's dependence on Soviet energy deliveries was a major concern and a cause of Atlantic dispute in the early 1980s, it is no longer an issue today. Like the West Europeans, most EA countries have made great progress in diversifying their supply structure. The end of the cold war provided an opportunity for closer cooperation and the taking of at least the first steps towards an all-European network with interdependent capital structures, pipelines and electricity networks. These are preconditions both for diversification and for the option to exploit market conditions which includes new product diversity, especially in the electricity sector.

To support this growing interdependence, the EU initiated as early as 1990 negotiations for a European Energy Charter as a regulatory regime defining common rules and market behaviour. The Charter was signed on 17 December 1991 by all OECD countries and all FSCs as a declaration of intention (25). According to the Charter, a legally binding "Treaty of the Charter" was to be negotiated over a period of three years and this was signed in December 1994 (26). It has not yet been ratified by all signatory states (27). Russia, for example, is presently in the midst of the ratification process. This Treaty of the Charter is an excellent example of how to deal with the deficiencies of the regulatory framework in international relations during a time of increasing exposure to globalisation (28). The very fact that it could be successfully negotiated between former adversaries is a good sign considering the need for further agreements on regulatory regimes. This is particularly relevant in the case of environmental problems linked to energy production, transportation and consumption. Transboundary pollution and climate change effects due to fossil energy consumption desperately need an effective regime that reduces the externalisation of costs. The necessity of such a regime is acknowledged in principle in the Charter as well as in the Treaty of the Charter.

There is still a long way to go to accomplish the goals of an integrated European energy market and an adequate regime on energy-related environmental issues, although the progress since 1990 does provide grounds for some optimism. There is no concrete force that wants to stop this process. It is no zero-sum game, there will be no loser and all players expect to benefit. To some extent, this growing interdependence is a sort of security guarantee. It drives Europe towards greater stability.

Footnotes

  1. International Herald Tribune, May 27, 1997, p.1.

  2. Adrian Brown, Towards a single European market for energy: recent European Union developments, Petroleum Economist, Vol.63, No.1 (1996), Supplement; Georg C. Goy, Chancen fr eine gemeinsame europische Energiepolitik, Deutsches Institut fr Wirtschaftsforschung, DIW Wochenbericht, Vol. 63, No. 41 (10 October 1996), pp.659-662.

  3. Josef Sejk, The Czech Republic: Combining Market Economy and Environmental Protection, in: Friedemann Mller, Susanne Ott (eds.) Energy and Environment in Central and Eastern Europe, SWP-S 414, Ebenhausen (November 1996), (pp.59-111), p.60.

  4. According to the Russian Ministry of Energy "10% of the richest Muscovites receive 50% of energy subsidies in the city", OMRI, Daily Digest No. 32, Part I (February 14, 1997).

  5. Eastern Europe. A Rocky Road to the Market Economy, Petroleum Economist, No 10 (October 1996), pp.52-53.

  6. Petroleum Economist No. 2 (February 1997), pp.6-8.

  7. In 1996 40 joint ventures with foreign participation produced 22 million tons or 7.7% of Russia's oil output, according to Finansovye Izvestiya, March 27, 1996.

  8. NTV, May 12, 1997 quoted in Monitor, Vol III, No.97 (May 16, 1997).

  9. Jeff Freeman, Energy - Hungarian Utility Privatization Moves Forward, OMRI Transition, Vol. 2, No. 9 (May 3, 1997).

  10. Friedemann Mller/Rudolf Botzian, Abhngigkeit der europischen Lnder von Rußland und der GUS im Energiesektor, in Wolfgang Heydrich et al. (eds.), Sicherheitspolitik Deutschlands: Neue Konstellationen, Risiken, Instrumente, Nomos Verlagsgesellschaft, Baden-Baden (1992), pp.475-499 (tables 1-5).

  11. Hermann Clement, Integrationspolitik und -entwicklung im ehemaligen RGW-Raum, Osteuropa-Institut Mnchen, Working papers No. 194 (December 1996), p.87.

  12. Russia still offers preferential prices to Ukraine, however also in this bilateral trade the price advantage is diminishing.

  13. International Herald Tribune, March 19, 1997, p.13.

  14. Monitor Vol. III, No. 93 (May 12, 1997).

  15. Striking the Balance Between East and West, Petroleum Economist No. 11 (November 1996), pp. 11-14.

  16. ibid., p.14.

  17. Volkhart Vincentz, Zur außenwirtschaftlichen Entwicklung Rußlands und der Ukraine, Osteuropa-Institut Mnchen, Working Papers No. 197 (December 1996).

  18. A. Vasilenko/V. Razuvaev, Neft i meshdunarodnye otnosheniya, Mirovaya Ekonomika i Meshdunarodnye Otnosheniya, No. 12 (December 1996), pp.56-64.

  19. Rosemarie Forsythe, The Politics of Oil in the Caucasus and Central Asia, Adelphi Paper 300, Oxford University Press. London (1996).

  20. The problem is broader discussed in Fond im. Fridrikh Eberta, Kaspiyskaya nefty i meshdurarodnaya bezopasnost', Moscow 1996, or in Heinz Kramer and Friedemann Mller, Relation with Turkey and the Caspian Basin Countries, in Robert Blackwill, Michael Strmer (eds.), Allies Divided: Transatlantic Policies for the Greater Middle East, MIT Press, Cambridge MA., 1997 (in print).

  21. Romania - Energy sector opens its arms to the West, Petroleum Economist, No. 3, (March 1996). p.47.

  22. Martin Czakainski, Deutsch-tschechische Kooperation auf dem Vormarsch, Energiewirtschaftliche Tagesfragen, Vol 46, No.10 (October 1996), pp.661-662.

  23. Petroleum Economist No. 12 (December 1996), pp.4-6; Supplement to Petroleum Economist , Gas in the CIS 1996 (October 1996), pp.41-43.

  24. Andrej A. Konoplyanik, Rußlands Energiesektor zwischen Krise und Transformation: Der Bedarf an auslndischen Investitionen, SWP-AP 2959, Ebenhausen (June 1996).

  25. Text of the Charter: Europe Documents, No. 1754, Brussels (December 21, 1991).

  26. The Energy Charter Treaty, Bundesrat Drucksache 963/96, (August 16, 1996).

  27. All FSCs and all European OECD countries signed the Treaty, also Japan and Australia, however not the United States and Canada.

  28. Thomas Waelde, International Investment under the 1994 Energy Charter Treaty, Journal of World Trade, Vol. 29, No.5 (October 1995) pp. 5-72.

Footnotes

  • Adrian Brown, Towards a single European market for energy: recent European Union developments, Petroleum Economist, Vol. 63 (1996), Supplement.

  • Hermann Clement, Integrationspolitik und -entwicklung im ehemaligen RGW-Raum, Osteuropa-Institut Mnchen, Working Papers No. 194 (December 1996), p.87.

  • Energy Charter, Europe Documents, No. 1754, Brussels (December 21, 1991).

  • Fond im. Fridrikh Eberta, Kaspiyskaya nefty i meshdunarodnaya bezopasnost', Moscow 1996.

  • Rosemarie Forsythe, the politics of oil in the Caucasus and Central Asia, Adelphi Paper 300, Oxford University Press, London (1996).

  • Georg C. Goy, Chancen fr eine gemeinsame europische Energiepolitik, Deutsches Institut fr Wirtschaftsforschung, DIW Wochenbericht, Vol. 63, No. 41 (October 10, 1996), pp. 659-662.

  • Andrey A. Konoplyanik, Rußlands Energiesektor zwischen Krise und Transformation: Der Bedarf an auslndischen Investitionen, SWP-AP 2959, Ebenhausen (June 1996).

  • Heinz Kramer, Friedemann Mller, Relations With Turkey and the Caspian Basin Countries, in Robert Blackwill, Michael Strmer (eds.), Allies Divided: Transatlantic Policies for the Greater Middle East, MIT Press, Cambridge MA. (1997), pp. 175-202.

  • F. Krawczynski, J. Michna, Effektivitt westlicher Hilfe im Energiesektor, Energiewirtschaftliche Tagesfragen, No. 1-2 (January 1997) pp.20-23.

  • Friedemann Mller, Rudolf Botzian, Abhngigkeit der europischen Lnder von Rußland und der GUS im Energiesektor, in Wolfgang Heydrich et al. (eds.), Sicherheitspolitik Deutschlands: Neue Konstellationen, Risiken, Instrumente, Nomos Verlagsgesellschaft, Baden-Baden (1992), pp. 475-499.

  • Friedemann Mller, Susanne Ott (eds.), Energy and Environment in Central and Eastern Europe, SWP-S 414, Ebenhausen (November 1996).

  • Peter Rutland et al., Energy, Transition, Vol.2, No.9 (May 3, 1996), pp. 6-29.

  • The Energy Charter Treaty, Bundesrat Drucksache 963/96 (August 16,1996).

  • A. Vasilenko, V. Razuvaev, Neft i meshdunarodnye otnosheniya, Mirovaya Ekonomika i Meshdurnarodnye Otnosheniya, No.12 (December 1996), pp. 56-64.

  • Volkhart Vincentz, Zur außenwirtschaftlichen Entwicklung Rußlands und der Ukraine, Osteuropa-Institut Mnchen, Working Papers No. 197 (December 1996).

  • Thomas Waelde, International investment under the 1994 Energy Charter Treaty, Journal of World Trade, Vol. 29, No.5 (October 1995), pp. 5-72.

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