Interdependencies between the EU and the Russian Federation in the current and future gas relationship

Contents

Abstract

Contents

List of figures

List of abbreviations

1 Introduction and problem statement

2 Assessment of sources

3 Theoretical framework: Theory of Interdependence by Keohane and Nye

4 Examination of the mutual interdependence in EU-Russian gas relations
4.1 Supply sensitivity of the European Union
4.2 The dependence of Russian gas exports on the EU Market

5 Diversification opportunities

6 Challenges of a common EU approach to gas-relations with Russia

7 Conclusion

References

Additional reading

Sources of figures

List of figures

Figure 1: Top 10 countries based on largest natural gas reserves in 2014

Figure 2: EU natural gas imports by country of origin 2012

Figure 3: Forecast of the European Union’s dependency on gas imports until 2030 (in percent)

Figure 4: Dominance of gas and oil in Russian Exports 2013

Figure 5: Gazproms gas production and exports in bcm

Figure 6: TANAP and Turkish stream

Figure 7: Pillars of an Energy Union

Figure 8: EU member states’ dependency on Russian gas imports

Figure 9: Gas prices and Russian dependence in 17 EU-countries

List of abbreviations

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Abstract

The following term paper aims to assess the current state of interdependencies as well as future developments in the gas relations between the European Union and Russia. The theoretical approach therefor is framed by Keohane and Nye’s Theory of Interdependence. It is used to analyze (a) the prevailing gas supply situation of the European Union, (b) the significance of the European gas demand for the Russian Federation, (c) diversification opportunities for both parties and (d) the progress and effects of a common EU approach in gas negotiations with Russia. It becomes evi- dent that the EU’s Energy security is very reliant on consistent gas supplies. Yet, Russia can only slightly exploit this sensitivity dependency as a source of geopolitical power vis-à-vis the EU, because its own economy depends on Europe’s investments and the revenue from gas exports to EU countries. The analysis of the diversification potentials reveals that the mutual dependence will remain strong in the near future. In the medium term the EU has to expand its range of suppliers by investing in LNG infrastructure and the Southern Corridor. In contrast, Russia tries to get hold of the Union’s diversification plans, as exemplified by the competition between the Turkish Stream and TANAP pipeline projects. A common European approach towards gas negotiations with Russia would mainly be beneficial for the bargaining position of the Union’s eastern members, which are highly sensitive to Russian gas deliveries. Rus- sia currently takes advantage of this by negotiating favorable long term contracts. However, contradictory positions between East and West complicate the realization of a joint European negotiation process. Viable and useful transitional measures would include regional trade associations and a revision of the current information exchange mechanism, providing greater competencies for the European Commission to gain insight in Member states’ bilateral negotiations with Russia.

1 Introduction and problem statement

Mainly “driven by events” (Buchan, 2015, p.358) like gas supply disruptions to the Eastern members of the Union in the more recent past, the issue of energy security has become a major point on the agenda of the European Union (European Commission, 2014a, p.2). Rela- tions with external suppliers gained even more relevance through declining gas resources within the EU. Those relations between organizations, institutions, countries and companies often connect commercial interests with geopolitical power opportunities, caused by a mutual dependence of supply and demand. The Russian Federation has frequently and recently been in the middle of regional as well as geopolitical tensions and owns the world’s second largest reserves of natural gas (see Figure 1). Along with the geographical proximity, this makes Russia one of the most important energy trade partners of the European Union.

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Figure 1: Top 10 countries based on largest natural gas reserves in 2014 (in trillion cubic metres)

Based on the theoretical framework by Keohane and Nye’s Interdependence Theory, the mutual interdependences and implications of the gas trade for Russia and the EU will be analyzed in the following. The paper concentrates on current events and moves on with an assessment of the respective diversification options. In the last chapter, the challenges and effects of a common EU approach towards gas negotiations will be discussed. The analysis’ findings finally lead to an examination of future developments and actor recommendations in the conclusion.

2 Assessment of sources

The following analysis was conducted with Keohane and Nye’s Theory of Interdependence, firstly introduced in “Power and Interdependence: World politics in transition” (1977) as a theory of International Relations (IR).

David Buchan’s contribution in “Policy-making in the European Union” (2015) gave a first overview of the current Energy security issues in the EU’s Foreign Energy Policy. Projections of the future EU gas demand and its import dependency, as shown in the first chapters, led to a concentration on gas relations. Other sources of energy as well as examinations of the internal Energy market would exceed the scope of the paper.

In order to compare the mutual dependencies between the actors, official documents and research papers from the EU and the Russian Federation has been integrated. The respec- tive Energy (security) strategies provided information, in which way the actors themselves regard their dependency situation and try to diversify their future gas program. Furthermore, with respect to the recent shale gas revolution in the U.S., Buchan’s analysis of the implica- tions for the European Market in “Can shale gas transform Europe’s energy landscape ?” (2013) has been examined.

As the focus of the paper is on current and future developments, several contributions in po- litical journals have been consulted and compared. On the EU side of the gas relationship, political and economic studies in “Energy Policy” proved to be very beneficial. Information about present Russian gas policies and Gazprom’s strategies has been drawn from articles in the German journal “Russland-Analysen”. Statistics from reliable sources like the U.S. En- ergy Information Administration, Statista and Eurostat supported and assured the argumen- tation process with recent data.

3 Theoretical framework: Theory of Interdependence by Keohane and Nye

The following analysis of the Russian-European gas relationship is framed by the neoliberal- ist (Götz, 2012, p.439) Theory of Interdependence by Robert Keohane and Joseph Nye (1977). Keohane and Nye (2001, p.8) therefore integrated the economic principle of oppor- tunity costs and define Interdependence not only as a sheer interaction between two coun- tries but as a relationship in which abolishment would generate costs for both parties. Such costs include financial and political costs associated with finding a new tradepartner (Hirsch- man, 1945; quoted in: Harsem & Claes, 2013, p. 785) and imply that actions of one party ultimately affect the other.

Thus, “interdependence in world politics refers to situations characterized by reciprocal ef- fects among countries or among actors in different countries” (Keohane & Nye, 1977, pp. 8- 11). Even when the cooperation generates benefits for both parties, this does not exclude competition and conflict between them. The reason therefor is a potential asymmetry in de- pendence, as the gains and opportunity costs may not be shared equally among the actors. The country which would lose less in case of non-cooperation can use asymmetry as a source of power and hence apply pressure on the more dependent actor in order to receive a better bargaining position.

In an effort to further explain the impact of asymmetry Keohane and Nye distinguished inter- dependence between the two categories of sensitivity and vulnerability: Sensitivity interde- pendence refers to the immediate costs of a country, which appear due to changes by the corresponding actor, before it can react appropriately (Götz, 2012, p. 440). Sensitivity in- volves the “degree of responsiveness within a policy framework - how quickly do changes in one country bring costly changes in another country, and how great are the costly effects?” (Keohane & Nye, 1977, p.12) Asymmetry in terms of sensitivity becomes a source of power for the stronger actor primarily, when it is not inhibited by regulations (Rana, 2015, p.294) or effective countermeasures of the weaker country imply legal difficulties and extreme costs (Keohane & Nye, 1977, p.18). Consequently, actors with a high degree of sensitivity seek to reduce their dependence and search for alternative collaborations.

Vulnerability includes the long-term costs which emerge through policy adjustments and re- main even after these countermeasures (Keohane & Nye, 2001, pp. 10-17). This means, that countries do not only distinguish in relative costs and gains, but also in the ability to escape from the established system. The more vulnerable country is not necessarily the more sensi- tive, but the one that would incur higher costs from altering the situation in the long run (Ra- na, 2015, pp. 294-295). Therefore, actors with relatively high vulnerability tend to intensify the interdependent relationship.

4 Examination of the mutual interdependence in EU-Russian gas relations

4.1 Supply sensitivity of the European Union

The following chapters will highlight the mutual interdependence of the EU gas relationship with Russia. As the European Union’s own gas resources only satisfy around one third of its demand, it is heavily dependent on external suppliers (EPRS, 2015, p.1). Russia covered 31,9 % of the import volume in 2012, making it the leading supplier of natural gas with Nor- way (Figure 2).

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Figure 2: EU natural gas imports by country of origin (2012)

Although the gas consumption tends to go down a little in the recent years (European Commission, 2014b, p.6), the import dependency of gas for the EU is expected to rise further over the following years (Figure 3; Fröhlich, 2010, p.243) due to declining resources within the Un- ion.

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Figure 3: Forecast of the European Union's depend- ency on gas imports until 2030 (in percent)

The recent developments in the Ukraine as well as several gas supply disruptions from Russia to the transit-country in the past (2006, 2009, 2014) made energy security a priority of the European Union (EPRS, 2015, p.2). The International Energy Agency (p.1) “defines en- ergy security as the uninterrupted availability of energy sources at an affordable price.” Ener- gy security attaches value to long-term aspects such as “timely investments to supply energy in line with economic developments and environmental needs” as well as short-term aspects including the ability to quickly respond to “sudden changes in the supply-demand balance” (IEA, p.1) .

In contrast to oil and coal shipping, Gas is mainly transported through pipelines, requiring large infrastructural investments and years of development. This creates strong connections with suppliers and prohibits an easy switch to another source in short time (Buchan, 2015, p. 355). Because gas is an indispensable good for European households and turning to other sources is difficult, suppliers may take advantage of this, request higher prices or even threaten with a supply disruption (Baran, 2007, pp. 131-132). In case of a total shutdown of the Russian gas-stream, the European Union would have to rely on its storage capabilities (Schiffer & Vrublevska, 2014, S.74). A model-based “stress test”¹ (European Commission, 2014c, p.1) proved the significant impact on EU countries’ energy security, especially among the newer members in the east.

Moscow has further increased its influence on the EU by investing in gas- infrastructure, pipelines and storages (Schiffer & Vrublevska, 2014, pp. 73-74). The export-monopolist Gazprom tries to get access to the European end customer and holds considerable shares of gas-trading and distributing companies in Eastern Europe, Germany² and other countries that open up opportunities to influence the demand side of the gas trade as well. Harsem & Claes claim that the gas and overall energy-import dependency hinders the EU’s political pressure on Russian policy issues, leading in some cases to a “gas-for silence strategy” (2013, p.786).

4.2 The dependence of Russian gas exports on the EU Market

Russia may possess some geopolitical power over the EU due to asymmetrical tendencies in sensitivity. However, the Russian economy itself is medium-term too reliant on Europe as a sales market to risk the gas-trade partnership (Schubert, Pollak & Brutschin, 2014, p.3; Götz, 2012, pp. 439-441). Threatening with supply cuts thus not only harm the destination country but also the image of Russia as a reliable energy supplier.

The impact of the European gas-consumer market becomes clear with regard to current figures (see Figures 4/5). Gas, oil and its products combined for two thirds of Russian exports in 2013. Around 200 bcm of Gazprom’s yearly production is exported to Turkey, regions of the old Sowjet Union and primarily EU countries. The revenues contribute to roughly ten percent of the Russian national budget, which illustrates the economic importance of the European gas consumer market (Holz et. al, 2014, p.12).

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Figure 4: Dominance of gas and oil in Russian Figure 5: Gazproms gas production and exports

Exports (2013) (in bcm)

In general, the growth of the Russian economy mainly depends on the “total revenue from energy exports, the global rise in commodity prices, as well as the foreign direct investments in the energy sector” (Simionov, 2014, p.325). Yet, Russia lacks a high-tech sector and sees its energy industry struggling currently with the oil-indexed price fluctuations (Kusznir, 2015, pp.5-7).

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¹ Before the Winter of 2014/15 “they simulated two energy supply disruption scenarios for a period of one or six months: a complete halt of Russian gas imports to the EU [and] a disruption of Russian gas imports through the Ukrainian transit route. The tests show that a prolonged supply disruption would have a substantial impact on the EU. Eastern EU countries and Energy Community coun- tries would be particularly affected. If all countries cooperate with each other however, protected consumers would remain supplied even in the event of a six month gas disruption.” (EC, 2014c, p.1)

² The subsidiary Gazprom Germany owns 10,52 % of “VNG”, the german gas distribution network, which links them directly with the customer (Schiffer & Vrublevska, 2014, p.73)