Russia and the European Union: An Outlook for Collaboration and Competition in European Natural Gas Markets
Cohen, Michael D., Demokratizatsiya
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. This is partly a result of stagnating production growth from indigenous natural gas fields, but it can also be attributed to the gradual deregulation and privatization of Europe's electricity industry. Natural gas-fired plants are in higher demand now with independent power producers (IPPs) because they are cheaper and easier for them to site and build than other types of generation. Also, IPPs prefer flexible contracts, which are better suited for natural gas than for other fuel sources. The growth in natural gas use for power generation will constitute the largest portion of total incremental gas use over the next several decades.4 Natural gas-fired generation is also less carbon intensive than coal- and oil-fired generation and is more economical than renewable energy. …