The Curse of Russian Energy

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Despite U.S. and EU sanctions against Russia after President Vladimir Putin annexed Crimea in March, it is business as usual between European companies and Russia’s energy sector. Yet there is a growing consensus that this dependence must be broken.

On April 1, Hungary signed a $13.8 billion credit agreement with Russia for an upgrade of its Paks nuclear plant. The same day, Gazprom, Russia’s giant state-owned energy company, announced a 40 percent increase in the price of gas for Ukraine. Ukrainians will now have to pay $385.50 for 1,000 cubic meters of gas in the second quarter of 2014, a rise from the $268.50 agreed in December. That’s more than what Gazprom’s other European clients pay.

French energy company Total is holding talks with Russia’s Lukoil to develop shale gas in Russia. Saipem, Italy’s largest oil service provider, has signed a $2.8 billion contract to build Gazprom’s new South Stream pipeline. That pipeline, which had long been in the planning stages, is supposed to run under the Black Sea and deliver gas from Russia to Southeastern Europe. RWE, one of Germany’s biggest energy companies, has sold its oil and gas unit to a group of Russian oligarchs for $7.1 billion.

It’s not only energy contracts that these countries have in common. None of them is enthusiastic about imposing harsher sanctions on Russia. The close trade, energy, and economic ties these states have with Russia mean that any further punitive measures or diplomatic pressure on Putin will be limited.

Yet despite a number of lucrative energy deals, attitudes toward Europe’s dependence on Russia are changing, with the United States playing an increasingly important role.

In the case of Ukraine, the International Monetary Fund will cushion Gazprom’s price increase through a special loan package. That will relieve some of the political pressure from Russia. But it is only a short-term measure.

The United States and the EU are seeking fundamental reforms to Ukraine’s highly corrupt energy sector. During a meeting in Brussels on April 2, U.S. Secretary of State John Kerry and the EU’s foreign policy chief, Catherine Ashton, focused on how to build Ukraine’s energy security and rid the sector of corruption.

In particular, Kerry and Ashton called for “the long-overdue restructuring and reform of Naftogaz,” Ukraine’s state-owned gas company. The longer-term goal, they added, was the full integration of Ukraine into the European energy market.

That is a big change in policy by Washington and Brussels. It will require considerable pressure on the next Ukrainian government to implement such radical reforms in a way that can finally end Russia’s invidious hold over Ukraine’s energy sector.

Among EU member states, Poland is stepping up its efforts to establish a European energy union and will make this one of the key agenda items at next June’s summit of European leaders. “Europe needs to demonstrate more and more solidarity in the area of energy,” Polish Prime Minister Donald Tusk said on March 29 during a visit to Silesia, home to the country’s coal industry.

One of Tusk’s main ideas is to turn the European Commission into a power buyer. “We have worked on a number of ideas which could make the EU a sort of ‘power buyer,’ thanks to which countries that supply energy to Europe will not be able to slap tough conditions onto delivery contracts as they have done until now,” Tusk said.

It’s hard to see Germany and Italy signing up to this. But the fact that it is being talked about shows the need for the EU to break its energy dependence on Russia.

That will not happen unless the EU speeds up diversification of its energy sources. The United States will release some of its stocks and sell them to Europe. But that is a short-term measure that will have little impact.

Bruegel, a Brussels-based economics think tank, has published an article and interactive chart that analyzes the options European countries have for cutting their energy dependence on Russia. The switch would be costly, the authors argue, especially if long-term gas contracts between European companies and Gazprom were broken. “It is a question of political will and compensations,” according to the article. In other words, it might just be doable.

The big unanswered question is what role Iran might have in changing Europe’s energy mix. If the United States and the EU could reach an agreement with Iran over its nuclear program, that would give Europe what it has long sought: access to Iranian gas. Were that to happen, Russia’s ability to use energy as one of its main foreign policy weapons would surely be diminished.

But Russia’s ability to scupper those talks should not be underestimated either. The Kremlin knows what is at stake.



Comments (1)

  • Einar Wilhelmsen, ZERO foundation
    Interesting that the Author is not discussing possible impact of more renewables and more efficiency as a response. Northen Europe uses gas for heating of buildings and tap water, UK, Germany and Denmark use twice as much (or more) gas for heating compared to the amount used in gas fired power plants. Energy efficiency in buildings will directly reduce the amount of gas needed annually. This effect can already be seen, as gas consumptin for heating of homes is dropping in for instance Germany.

    Secondly, the greening of the electricity sector opens the door for heat pumps. This tecchnologi is widely used in Sweden and Norway where power is considered clean. A heat pump taking energy from ground/water will produce 2-4 KWh heat per kWh power used. A switch to more heat pumps in district heating systems and directly in buldings can rapidly decrease the need for imported gas. As this technology is much more efficient, it will also reduce emission of GHG gases. With the current german power mix 1 KWh heat via a heat pump will emit roughly 150 gCO2 per kWh, where a kWh heat from fossil gas is closer to 400 gCO2/kWh.

    Sweden have already done the switch, the heating sector is almost fossil free, based on renewable district heating, bioenergy and heatpumps. Denmarks energy plan "Vores Energi" describes how renewables an efficiency measures can deliver significant emission reductions for the heat-sector, and measures are now being taken to achive this goal. One major measure they will take: Build more windfarms and use the power in the heat marked (directly into district heating system, and through heat pumps).

    I am fascinated that this option is not even on the table in this analysis. Energy efficiency and switch to renewables is a more robust and secure policy than switcing imports from Russia to Iran og the US?
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