Russia and the European Union: An Outlook for Collaboration and Competition in European Natural Gas Markets

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Abstract: In the aftermath of recent natural gas and oil supply disruptions to European markets, Russia's long-term supply stability and Europe's natural gas market developments are of utmost concern to both the producer and the consumer. As Europe's indigenous supply declines, it will rely more on gas imports. Concurrently, Russia's domestic gas consumption is growing, its infrastructure continues to age, and Gazprom will continue to rely on both Central Asian imports and growth from independent gas producers to meet its long-term supply commitments. This article discusses a medium-term outlook for Russia and the European Union and outlines the barriers that are inhibiting competition and collaboration in the energy sphere.

Keywords: competition, energy markets, energy security, European Union, natural gas, oil, Russia

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In the past year, the security of natural gas supplies has emerged as one of the top issues of concern for countries in Europe, for the European Union (EU) and the North Atlantic Treaty Organization (NATO), and even for the United States. Concerns about natural gas security reflect uncertainty about available natural gas supplies, how supplies are delivered to the market (by pipeline or by liquefied natural gas tanker), and how much is paid for these supplies. In the aftermath of natural gas and oil supply shutoffs from Russia, Europe is trying to ensure its own security of supply through diversification and energy efficiency. Russia is trying to ensure energy security by diversifying its customer base, investing in the entire value chain (not only the upstream), and ensuring adequate investment levels both in its own energy supplies and those of its Central Asian neighbors.

The way in which the policies of regional and international organizations differ from the policies of individual states is hampering progress on energy market liberalization and energy efficiency programs, both of which are necessary to achieve stable market relationships between producers and consumers. To accurately frame the policy debate, one must understand the current and future role that natural gas plays for Europe's energy mix. Europe's demand for natural gas is increasing and Russia is the region's main supplier. However, Russia's ability to invest in upstream natural gas development over the next several years will directly contribute to Russia's natural gas production growth and Europe's security of supply. In the meantime, several alternative energy sources and hedging instruments are expected to mitigate Europe's dependency. For the region to best take advantage of these options, continued regional natural gas market liberalization is necessary.

Europe and Russia's Natural Gas Interdependence

In 2006, Europe depended on Russia for 34 percent of its natural gas imports, including European LNG imports (see figure 1). In contrast, Russia depended on Europe for 60 percent of its natural gas exports, sending the remainder via pipeline to the Commonwealth of Independent States (CIS), predominantly Ukraine and Belarus. (1) In evaluating Europe's true dependency on Russian natural gas imports, it is essential to understand the role that it plays in the total energy mix. In the decade after the mid-1990s, oil's share in Europe's primary energy consumption fell by around 3 percentage points while natural gas's share increased by twice this amount, to around 24 percent of final consumption.

On the one hand, Europe's natural gas consumption growth could slow in the future. Since the mid-1990s, EU demand for natural gas has been growing at a rate of around 4 percent per year. (2) The International Energy Agency (IEA) estimates that, over the next several years, the EU's demand for natural gas will grow at a slightly lower rate, by around 0.8 to 1 percent per year between 2004 and 2015. (3)

Even though the growth rate is expected to slow in the next several years, as figure 2 shows, Europe's natural gas import dependency is still more than 30 percent higher today than it was only a decade ago. …