The EU energy market is undergoing transformation. Governments across the EU are seeking to enhance security of supply by diversifying their sources of gas and increasing the share of renewables in primary energy consumption. Equally, major gas importers are seeking to reduce the stranglehold of oil linkages in long-term gas contracts amid unprecedented declines in EU gas production.
The recently published BP Statistical Review of World Energy 2012 puts numbers to the trend: gas output in the EU in 2011 fell by 11%, while gas consumption declined by 10% – the largest falls on record. The underpinning factors are well understood: recession, a warm winter, low demand and high oil prices. In addition to gas demand reduction, a consequence of these circumstances has been the substitution of relatively less expensive coal and subsidised renewables for gas.
Many gas producers have responded by renegotiating the price formula to link the price to gas hubs, thereby better reflecting the market fundamentals of gas. Moreover, since mid-2009, a growing number of utilities have been buying gas at the hubs, meeting their contractual obligations in oil-indexed contracts only at the take-or-pay level. By 2011, over 40% of European gas supplies were market priced, but the remainder continued to be oil-linked. Despite witnessing erosion in its market share, Gazprom has allowed only limited concessions in its long-term contracts and remains adamant on the need to preserve oil indexation as a measure guaranteeing ‘security of demand.’
In Europe’s political circles, the perceived need to reduce reliance on Russian gas imports has produced a two-pronged policy of diversification. The first emphasises diversification by source and route. The EU Security and Solidarity Action Plan denotes the Southern Corridor aiming to bring Caspian gas to the market as ‘one of the EU’s highest energy security priorities.’ The second is diversification by energy type. Renewables are subsidised for being ‘the EU’s greatest potential source of indigenous energy’.
There are, however, aspects to both prongs of this policy, which expose the fact that the EU’s ‘dependence problem’ is far from being resolved even if both forms of diversification take place.
Caspian gas is no panacea
While Azerbaijani oil is flowing to international markets at the rate of around 1mn barrels per day, the politics of Caspian gas are significantly different. The aspirations – as well as the bargaining position – of the key supplier-state, Azerbaijan, and its state oil company, SOCAR, have evolved. Merely selling gas to the Nabucco consortium at the border with Turkey is no longer seen as adequate or even fair, and so new terms are being articulated that would see SOCAR playing a more active role across the value chain, with the eventual direct access to EU consumers.
Bringing Caspian gas online would reduce reliance on Russia but it would come at a cost – most notably political, as the EU may be forced to accept that control of the Turkish stretch of the pipeline would be in the hands of non-EU states.
Renewables: what is wrong with self-sufficiency?
Renewables are hailed as an indigenous source of supply for the EU. Yet rare earth elements (REEs) used in the manufacture of permanent magnets for large wind turbines and PV thin-film semi-conductors are mined almost exclusively in China. All three REEs – europium, terbium and yttrium – that are essential components in phosphors for energy-efficient light bulbs, as well as dysprosium, which is required for electric vehicle batteries, are sourced from China.
Today, China mines 97% of world supply of REEs. Beijing’s slashing of the export quota by 72% in July 2010 has led many clean energy producers to experience supply instability and price spikes. If the excessive politicisation of energy is what the EU is trying to reduce by moving away from Gazprom, then relying on REEs from China will not solve the problem of dependence on outside suppliers. It will merely shift dependence to a different supplier – and one that is unlikely to prove less political or assertive of its national interests in energy decision-making.
In September 2011, the EU Industry Commission admitted that stockpiling of REEs had begun in the EU to ‘improve sourcing’ and ‘reduce dependence on China.’ In March 2012, the US, EU and Japan jointly filed a complaint with the World Trade Organisation against what the US Trade Representative called China’s ‘massive distortions and harmful disruptions’ in REEs supply chains throughout the global marketplace.
While the EU’s policy emphasis on clean energy is necessary to cut greenhouse gas emissions and move to a low-carbon economy, the argument of greater self-sufficiency is predicated on the assumption of uninterrupted access to REEs. Yet this cannot – and should not – be taken for granted.
In December 2011, the US Department of Energy assessed five REEs, including neodymium (used in large wind turbines), to be critical in the short and medium term in two dimensions: importance to clean energy and to supply risk. With little or no substitutes, sourcing REEs is likely to become increasingly difficult and expensive. This situation will last at least until the coming online of new mines in the US and Australia around 2015.
The recent trend of coal replacing gas as a cheaper fuel undermines the EU’s political stance in negotiations with the developing world over CO2 emissions targets. Subsidised renewables, on the other hand, undermine the EU’s position in negotiations with Gazprom.
The move away from the traditional price formation mechanism in long-term contracts is inexorable; yet the speed with which it takes place will depend not only on economic negotiations of large European utilities but also on the rhetoric and political action of the EU and its individual member-states. Vilifying Russia as an unreliable supplier will encourage Moscow to develop new outlets for its hydrocarbons. Indeed, this trend is already underway, with the scheduled opening of the Eastern Siberia-Pacific Ocean oil pipeline to China in late 2012. In the longer run, the emphasis on the Asia-Pacific would come at the expense of upstream investment in the fields that could feed the European market.
The EU’s two-pronged policy of diversification has numerous merits, including introducing non-Russian gas sources and reducing carbon dioxide emissions. Unfortunately, the argument of lesser politicisation and greater self-sufficiency is not one of them.
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