EYE ON EUROPEAN ENERGY

Two events took places last week concerning energy policy in Europe that are worth returning to: Russian Prime Minister Vladimir Putin in his keynote speech at the World Economic Forum in Davos discussed (among other topics) energy policy, and officials representing Europe, the Caspian region, and the Middle East met in Hungary to discuss the construction of a pipeline running from Turkey to Austria that would bypass Russia. The former certainly received more press than the later.

Dissecting Putin’s speech adds some color on Russia’s energy outlook, yet his words are laced with rhetoric. He started by saying:

“Every one of us realizes that a sharp and unpredictable fluctuations of energy prices are a colossal destabilizing factor in the global economy…It is necessary to return to a balanced price based on an equilibrium between supply and demand, to strip pricing of a speculative element generated by many derivative financial instruments.”

RE: Russia has not shown signs of attempting to balance the price equilibrium between supply and demand. For one, Gazprom carves out natural gas contracts on a per country basis, on such factors as a country’s wealth and its allegiance to Russia. After all, there’s a reason why former Soviet states receive gas at half the price Western Europe pays for. It isn’t just a hand-out, there are political strings attached.

Putin then went on to reference the treaty establishing the European Coal and Steel Community as a beacon of international stability, saying:
“Consumers and producers would finally be bound into a real single energy partnership based on clear-cut legal foundations.”

RE: Russia has no interest in confining itself to a partnership or any relationship in which it must abide by the rules of the group. Russia has the largest natural gas reserves and at the moment is the majority supplier to Europe. Russia will exploit this leverage until Europe finds a substitute.

Finally Putin concluded by saying that his country is making efforts to expand the infrastructure of oil pipelines across Europe and Asia, suggesting that more pipelines would equate to “reduced transit risks” and prevent energy disturbances.

RE: This logic is plain backwards! In short, it doesn’t matter how many pipelines Putin and his countrymen build to service natural gas to Europe. At the end of the day, Russian leadership calls the shots on price and who receives supply. Europe is still very energy dependent on Russia so they’re left in a tenuous and reactionary position. This dynamic will not change until the EU finds a substitute to Russian gas.

The second event that took place was a conference in Hungary to discuss the construction of the Nabucco pipeline. Attended by officials from Europe, the Caspian region, and the Middle East, the conference proposed a 3,300 km pipeline that would stretch from Turkey to Austria (See Map Below) with supplies expect to come primarily from Azerbaijan, with Turkmenistan and Kazakhstan eventually joining.

RE: Nabucco is a very ambitious project packed with question marks. For one, the project would cost an estimated ~€10 Billion. Presently the European Commission is only willing to commit €250 Million to the project. So long as the EC (or another joint venture for that matter) does not put up real money to support this project, it appears unlikely that this project would get off the ground in this recessed and risk-averse environment. Secondly, the pipeline is estimated to deliver ~31 billion cubic meters of gas a year, which represents by consensus estimates less than 10% of Europe’s needs. Again, why would Europe back such a costly project for such little return?

While the conference ultimately failed to provide clarity on the proposal, the significance of the conference is noteworthy. It demonstrated that Europe is determined to find alternate sources of natural gas to remove the gas politics from its agenda. This is a very positive signal. Czech Prime Minister and acting President of the EU Mirek Topolanek said,

“Nabucco is a project of paramount importance for the freedom of the continent…the gas crisis lasted only three weeks. Nevertheless, it had a drastic impact on the economy of numerous European countries…with losses running into the billions and millions of people suffering from the cold. That is the very high price we pay for our energy dependency.”

Conferences are scheduled to address the Nabucco project once again in April and May of this year. Clearly, the EU has learned its lesson from the previous gas shut-offs. Already the European Commission has announced a pledge of €3.5Billion for off-shore wind farms to go along with talks of improving liquefied natural gas hubs around the continent. These European measures to reduce energy dependence on Russia are positive for Europe on the balance, yet funding, especially while Europe is deep in recession, may be hard to come by. In any case, Putin and Russia will have to respond to a Europe seeking alternative energy solutions.

Matthew Hedrick
Analyst