Eu-Russia gas blues.

• Author: Luciani, Giacomo
• Position: Europe

EU-Russia gas relations have come under the spotlight following the annexation of Crimea and the eruption of civil war, with direct Russian involvement, in Eastern Ukraine. Yet tensions in gas relations have been building up for the last two decades, and are primarily related to Europe's strategic decision to unify the gas markets of the member countries and enforce competitive and transparent trading conditions.

Gazprom, Russia's state-controlled natural gas company and the largest extractor of natural gas in the world, forcefully opposed this strategy in association with its traditional partners, incumbent gas importing companies. Following a long war of attrition that has evolved over the better part of the last twenty years, it now appears that Gazprom is on the verge of accepting the transformation of the European gas market, and is behaving competitively to preserve its market share. The Ukrainian conflict has been instrumental in precipitating this shift, facilitating the task of the European Commission in coalescing consensus on the need to rein in Gazprom's excessive market power.

Whether European dependence on Russian gas is bound to dimmish, however, is less clear. Russian gas remains an essential component of Europe's gas supply, and abundant Russian reserves guarantee that the European Union will be able to continue relying on Russia for the foreseeable future.

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Russian-European gas relations have always been politically sensitive. Russian gas exports started in the early 1970s (Germany in 1973, Italy in 1974), and were largely commercially motivated: Put simply, Russia discovered a lot of gas, much in excess of its own domestic needs; and the major European countries were motivated to diversify away from oil following the price increases of 1973 and subsequent years. (1) Europe was eager to avoid excessive dependence on Middle Eastern oil, especially from the Persian Gulf. Importing contract with Russia in 1960, it met strong criticism from NATO allies. (2) But gas imports were even more controversial, as the United States imposed a ban on sales of turbines and parts needed to pressurize the gas for long-distance transport; and the European allies developed their own technology to bypass the ban. Throughout the 1980s, the idea that dependency on Russian gas supplies might undermine the resolve of key European allies such as Germany, France or Italy was a recurrent theme in NATO debates.

Yet, dependence on oil supplies from the Middle East remained the primary European preoccupation. Thus, when the Soviet Union collapsed, the EU was quick to engage in energy diplomacy with the Russian Federation and the other former Soviet Union republics, with the aim of establishing a close partnership centered on energy trade and investment.

Europe's preoccupation with stability of gas supplies was the main motivation for launching the idea of a European Energy Charter. (3) Eventually, the United States, Canada and Japan became involved in the negotiations, and the European focus of the initiative was partially lost. But it was always clear that the Charter and the subsequent Energy Charter Treaty were expected to be the foundation of an innovative kind of energy partnership, which would be reserved to the countries of the former Soviet Union (and not extended to those of the Middle East and North Africa).

But, as it turned out, the Russian Federation maintained reservations on the Energy Charter Treaty's stipulations concerning investment and transit: Although the Russian government, under Boris Yeltsin, had signed the treaty, the Duma never ratified it. The EU insisted for years that Russia ratify the treaty, to no avail--until Vladimir Putin formally issued a decree terminating Russia's involvement with the Energy Charter in August 2009. (4)

Among other important provisions, the Treaty enshrined the principle of Third Party Access (TPA) to transport infrastructure, notably gas pipelines, and prohibited transit countries from interrupting the flow. Russia was in an ambivalent position concerning TPA; on the one hand, it would have benefitted with respect to its transit across Ukraine, but on the other hand, it might have been forced to concede transit to Caspian producers wishing to export to Western Europe. In the end, Moscow opted to seek alternative solutions for guaranteeing transit through Ukraine.

Delivery at Baumgarten

It should be underlined that political preoccupations were evidently always present in the minds of Soviet technicians and planners who designed the original system of pipelines to transport gas from the Western Urals to Western Europe. It is not by chance that all pipelines converged at an export point in Ukraine (Uzghorod--at the time, the possibility of Ukraine becoming an independent country separate from Russia was not a consideration) and crossed to Western Europe through what was then Czechoslovakia, a single country under Soviet military occupation since Prague's Spring in 1968. The main line ended at Baumgarten, in Austria, while a separate spur served East Germany. From Baumgarten, various pipelines served West Germany, Italy and other Western European countries.

The pipeline network was conceived for the political setup existing at the time and made little sense after the collapse of the Soviet Union. In several cases, pipelines entered and exited Ukrainian territory; the Ukrainian border had simply been considered unimportant. As such, it was clear from the immediate aftermath of the collapse of the Soviet Union that something would need to be done to guarantee correct functioning of the system.

Initially, concerns focused on the technical conditions of the main pipeline in Ukraine, which was feared to be seriously wanting. The EU launched several technical cooperation projects aimed at assessing the good health of the pipelines in Ukraine, and paid for the main Western European gas companies to survey the system. (5)

The implication--then and in subsequent years, up to the present--was that the EU should invest in the Ukrainian pipelines to ensure their integrity and functionality, and gain a measure of control. However, Brussels itself cannot directly invest in pipelines. There were attempts to encourage the Western European importing companies to do so, but these met with one major difficulty: The import contracts specified (and still do, to an extent) Baumgarten, Austria as the delivery point for Russian gas, i.e., the point at which the ownership of the molecules changes and ceases to be Gazprom's. This meant that there was no commercial justification for European importing companies to invest upstream of Baumgarten, as delivery to that point was (and continues to be) the responsibility of Gazprom. (6)

Gazprom never accepted a change in the delivery point, nor saw with favor any suggestion that the European importers should invest in the pipeline in Ukraine, because it has pursued the strategic goal of integrating downstream and reaching the final consumer in Germany, Austria, Italy, or elsewhere in Europe. (7) Gazprom could see very well that the value of the molecules increased significantly as they crossed borders and reached their final market. Thanks to their market power, European importers were able to get a much better price from the final consumer than they were paying to Gazprom, thus enjoying a significant "gas rent." (8) This was quite evident both to the European Commission and to Gazprom: The former moved to eliminate this rent by enforcing competition; in contrast, Gazprom aimed at increasing its share of the rent through a strategy of downstream integration, which, while falling well short of creating effective gas-to-gas competition, would nevertheless have enhanced the security of European supply.

But in fact, although concerns for security of supply became progressively more important in European Union discourse--especially since 2004 and 2007, when enlargements brought countries into the Union that are fully dependent on Russia for their gas--the main bone of contention between Europe and Gazprom was Europe's policy efforts to establish a single, competitive and transparent internal gas market.

The European Commission's strategic stance

Following the successful example of the United States and UK, the European Commission started pushing for the establishment of a single, competitive gas market in the mid-1990s. To scholars of the process of European integration, the determination with which successive Commissions pursued this goal is no surprise. In fact, in setting its agenda, the Commission must always be mindful of the legal basis for its action, which is found in the EU treaties. The Commission does not have a strong mandate on energy issues in general; it is only in the 2007 Treaty of Lisbon, amending the 1993 treaty establishing the European Union, that energy was listed for the first time as an area for shared competence between the Union and member states. Previously, it was exclusively reserved for member states, and even after Lisbon, the latter Commission maintained exclusive control on the most crucially important aspects, notably taxation and the structure of their respective energy balances. With respect to energy security, the Commission also has restricted legitimacy, as member states are primarily responsible for their security and defense policies.

In contrast, the Commission enjoys a very strong mandate for the creation of a single European market across all industries and services. It also enjoyed, from the...