Tag Archives: Bulgaria

Why Russia wins against the EU’s single energy market

A battle of ideologies is underway in the energy sector of the South and Central Eastern Europe. Just as the ushering in of democracy after 1989 was viewed as a done deal, infusing market mechanisms into energy system was also viewed as an obvious choice. In Hungary, preparing energy companies for privatization began in 1989. However, just as democracy is now eroding in the region, so are the neoliberal energy market mechanisms. State ownership in energy is maintained, while formerly privatized companies are bought back. A new era exists of state owned utilities, politicized energy regulators and retreat of private investors marks the EU’s eastern energy markets.

The cost is high for the energy systems of Bulgaria, Hungary and Poland. State ownership in Bulgaria results in failed strategic endeavors and huge debut (Belene NPP and NEK). In Hungary the repurchase of MOL shares, EON Foldgas transit and storage, gas distribution from RWE and now the take-over of electricity distribution obligations. These are all funded by taxpayer money, most of the endeavors in Hungary affecting end-user pricing are done by their development bank, with the potential to cover losses.

In Poland, large state ownership exists while the failure to launch a shale gas industry partially stems from the inability and the lack of experience to work with foreign investors [each of these three countries and these issues will be discussed in other blog posts, along with costs]. The financial cost of mismanagement and cancelled projects stymies efficient, secure and lower cost energy systems from developing. The once hoped flow of private capital in the region is in retreat.

My bias on the issue of state ownership is clear, I do not favor mismanaged state owned companies or overtly politically shaped utility rates. In the US government ownership exists, and there is political influence in rate setting and market structure. However, in our three countries examined, political influence prevents the system to function in both an environmentally and economically sustainable manner. Electricity and gas rates are cut across the board, benefit even those that heat their swimming pools in the summer, rather than those stuck in energy poverty. Investments into energy efficiency are neglected in favor of maintaining lower electricity and gas prices. Corruption and favoritism often floats around state ownership. From the favored gas trades with MET, in Hungary to selling yearly capacity in a no-bid sale to a private company in Bulgaria; the exclusion of transparency and competitive bidding for capacities stymies fundamental components for a market based energy system from developing.

Excluding the air of favoritism, the political view in all three countries is clear: State ownership (or deals with favored companies) protects the natural resources of the country and provides social benefits that private companies do not. This contradicts the neoliberal competitive market agenda and cross-border operation of energy companies instilled into EU institutions and treaties. The past Communist system held development of the energy infrastructure central to social acceptance. The panel house (with a lifespan of 30 year) may be badly insulated but at least the central heating is cheap. Centrally controlled pricing is still linked to income levels.

(Source: European Commission, 'Energy Prices and Costs in Europe', 2014)
(Source: European Commission, ‘Energy Prices and Costs in Europe’, 2014) Overall, the cost of electricity for households in Eastern Europe is low to average in comparison to other European Union countries.

Universal access to electricity was the last great global energy project. The goal was clear, provide access to electricity – almost at any cost. This agenda drove the development of energy systems in North America and Europe. Communism accepted the same mantra, thus we should not view some central tenets of political-economic systems as exact opposites. But there are fundamental differences in financing system expansion and operations. The Communist state, as compared to users, pays the overall bill. For example, wages, in the factories of Eastern Europe, may not have been high, but nor were daily living costs. The district heating facilities of Dunaujvaros (previously Stalin City) are connected to the town’s main employer, Dunaferr steal mill. Shutting down certain parts of the steal mill requires a new cogeneration facility – based on full market pricing. Just as universal access was an engineering and political project (hydroelectricity in America), integrated energy and socio-political systems are integrated.

The full commodification of the energy services, electricity and gas, in the household is a market mechanism. Private owners of generation and distribution facilities need to be reimbursed, and with a profit margin, to provide ‘efficiently’ managed services. The energy value chain in both Capitalist and Communist systems holds the fundamental flaw of incentivizing energy production and not demand reduction.

Despite great strides in Western Europe reducing energy intensity of economies, full commodification of energy efficiency does not exist. In Eastern Europe, energy efficiency programs are usually funded by EU funds without governments viewing efficiency as reducing gas imports or improving people’s living conditions. It is still more ‘efficient’ for politicians in Hungary and Bulgaria to sell discounts on people’s utility bills than to provide them with better living conditions in the form of insulation and new windows.

The incentives for supply side, while existing in both neoliberalism and Communism, plays out despite both sitting in contrast to each other. Neoliberalism is inherently an economic project. It was developed by the Chicago School of economists and is often linked to the privatization of energy companies in Latin America and Pinochet’s regime of oppression and rise of Neo-Marxist guerrella fighters. In general, the shift towards global capitalism took off in the 1980s and early 19990s. Neoliberalism, viewed as a project by academics focus on the inherent evil obliterating state support and jobs for three quarters of the world’s poor. Economic shock therapy, eloquently described in Naomi Klein’s ‘The Shock Doctrine’. Neoliberalism, privatization and the market economy rob the factory workers of their jobs, heat and wages.

In Eastern Europe, Communism and political suppression of free speech and religion were just a few ‘costs’ that were paid for living in a utopia – a non-market economy. Now the Communist days of low cost utilities and relatively low cost living standards are now fondly recalled in Hungary, Bulgaria and Poland. Marxist economists trained in Moscow guided the broken and inefficient economies of these countries. While the engineered infrastructure of these countries were designed with efficiency and rational engineering principles in mind, operating them created a different level of engineered and economic inefficiencies. Such as opening windows to regulate heat and an economy based on bartering.

Five year plans favored the academic discipline of engineering for developing the energy system of Eastern Europe. Markets worked according to the infrastructure, rather than the markets dictating what infrastructure would be built. The failure of the EU to integrate its energy system lies more with the market policies that must underwrite new infrastructure, with short pay back periods and avoidance of state aid rather than a lack of engineering skill to integrate the markets.

Even from a market perspective, infrastructure projects planned out over a five year time horizon (or longer) hold significant financial savings for companies supplying the energy and for consumers consuming. The failure of the Nabucco and South Stream pipelines are partially attributable to the conflicting demands of open market access and infrastructure ownership. Energy regulators are meant to create these efficiencies in a market based system. Their role is negated when decision making is politically influenced and returns on private investments are not realized. Thus Bulgaria, Hungary and Poland cannot secure long term advantages from a market based system.

Profits then losses in Hungary's utility sector. Source: Hungarian Central Statistical Office
Profits then losses in Hungary’s utility sector. Source: Hungarian Central Statistical Office, draft statistics compiled for a benchmarking report for the European Commission – not done by me.

The higher risk for investors and the inability of the state to secure long-term private financing for large infrastructure projects opens the door for Russia to have it’s way (this is less relevant for Poland). The ability for Russia to finance large pipeline projects (North Stream, South Stream, Turk Stream) and nuclear power projects (Bulgaria and Hungary) demonstrates the strength the Russian state has (paradoxically) in financing energy infrastructure in the EU. Thus while the EU’s energy market is based on economics it can’t compete on financial terms.

The market approach also can’t compete when political involvement overrides long term private investments. Political interference pushes these countries closer to Russia as the availability and interests of private companies shrinks. In an environment with politically influenced energy prices, realizing returns on investment becomes more and more challenging. In Hungary, the response has been clear. Private distribution companies, paid out high dividends thereby removing capital from the companies while slashing investments. With the rejection of a market based approach, a financing gap emerges. Russia is happy to fill this by offering its former satellites a one stop shop for finance, infrastructure, technology and the potential for politically favorable pricing.

 

The Collapse: Utility investments in Hungary
The Collapse: Utility investments in Hungary H1 = first half of year, H2 = second half of year, draft statistics compiled for a benchmarking report for the European Commission, not done by me.

It is no coincidence that the biggest supporter of Putin and Russia in the EU is Hungary’s Prime Minister, Viktor Orban. After securing a secret late night deal to expand Paks nuclear power plant with Putin, Orban now acts as Putin’s European cheerleader for building Turk Stream. The ultimate goal is political support for Orban and his 25% utility price cuts – that must be maintained.

The clash occurs in South and Central Eastern Europe between former Communist systems and the neoliberal regulatory approach to EU energy markets. The two overriding academic disciplines of engineering and economics only realize their potential with political permission. While these two approaches are reconcilable, politically, past and current adherance to one or the other approach dominants. Favoring a market orientated approach relies on trust in market forces that efficiency will be introduced to the energy market. Trust in engineering enables political involvement to set energy prices – rather than the market.

After the fall of Communism trust was placed in the neoliberal market approach, after 25 years of playing with economic markets, politicians are no longer willing to place significant trust in markets. Thus the crisis of the energy system in the region is set to escalate between the neoliberal market approach required by EU membership and a politically guided market price resting on centrally controlled and engineered large energy systems backed by Russia.

Energy Dependence: Politically cheaper than energy independence

The Soviet Union embedded into the landscape and economies of Central and Eastern Europe a system of technological and resource dependence. Political and social benefit derived from this energy system. Politicians still continue to benefit from this arrangement. This system fails to reflect current political arrangements and technological advances. Failure to build an energy system that is technologically and resource independent of Russia maintains the political and social ties established during Communism.

The centralized system created a continental oil and gas pipeline network to deliver the natural resources of the Russian heartland and Central Asia to the ‘satellite’ countries in Europe. Replication of this networked approach also extended to nuclear power through scientific knowledge and components. To create sufficient political independence a new energy system needs to be built. This includes a new gas networks and new electricity generation technology – all non-Russian sourced. Failure to build an alternative system maintains the historical status quo.

Picture of a young Communist worker building the foundation of Hungary's future energy system
Picture of a young Communist worker building the foundation of Hungary’s future energy system [Also, the Hungarian text on the side lauds the brotherly friendship of the Soviet Union and Hungary – I’m working on a translation]

The old- new energy system

The Soviet energy legacy was handed off to the Russian state which posses three key energy resources and technologies: 1) Oil, a global commodity that is easily shipped, and holds limited pricing differences. 2) Gas, relies on transit pipelines, industrial and household infrastructure and is susceptible to supply interruptions and monopolistic pricing, without sufficient storage or alternative supply routes. 3) Nuclear, rests on technological knowledge, spare parts, fuel processing and storage; technological lock-in occurs creating high switching costs.

Breaking the energy dependence network established by the Soviet Union requires Eastern Europe to establish a new regime of energy independence. This is done in two ways: First, alternative supplies of resource are required. This means building alternative delivery systems for resources currently delivered by Russia. New gas transit pipelines bringing non-Russian sourced gas will deleverage the region from energy dependency. Second, alternative technologies offer the ability to reduce long-term dependency. Nuclear power affects two generations of citizens, the high sunk costs prevent present and future political and social independence. Adding more energy alternatives rather than subtracting old infrastructure, over time, brings about greater energy independence.

The cost of energy (in)dependence

Resource independence holds two approaches. Poland pursues and energy independence strategy opposite Hungary and Bulgaria. Both are influenced by the cost of resources. For Poland, domestic and imported coal provide 90% of the countries electricity generation. Imported Russian gas is important for industry and cogeneration of electricity and heat. LNG now provides an alternative source of gas – but at a higher cost. The true cost of coal is not reflected in its market price. Environmental and health costs are not priced into the energy security argument for continuation of coal. Therefore, the cost of resource independence does come at a price.

Hungary and Bulgaria, in contrasts, seeks to maintain and increase their use of Russian gas. Alternative supply routes are sought through interconnectors to Slovakia and Romania. With the expansion of interconnectors, Western European gas can now reach the CEE region and act as a limited bargaining lever for lower prices. Nonetheless, both countries are slow to build and open up existing pipeline capacity to neighboring countries. The limited steps taken for infrastructure and market diversification prolong their resource dependence.

Resource dependence extends to upstream diversification. Both countries see Russian sourced gas, via Turkey as a ‘true’ route of energy diversification. Both countries are heavily dependent on Russian gas and use gas a political measure of their political devotion to Russia. Gas transit fees can help offset politically controlled gas pricing for consumers. The financial losses incurred by Bulgaria’s NEK are equal to the transit payments of Russian gas flowing to Greece. Hungary’s support for South Stream and Turk-Stream only excludes Ukraine, they do not break Russian resource dependency. Annual gas contract negotiations are always framed by the Prime Ministers of Hungary and Bulgaria as diplomatic successes and servility to Russia.

Technological dependence in Hungary and Bulgaria are present in the form of nuclear power. Poland rejected the Soviet offer for nuclear power in the 1980s.
The built facilities in each country provide ‘cheap’ electricity at a price consumers in both countries can afford. The centralized and state owned facilities enable the state to actively manage and influence the energy system in both countries. Low priced electricity can be supplied to households. Bulgaria was in talks with Russia to build another nuclear power plant at Belene (more on this elsewhere) but ultimately backed out of the deal during the financial crisis as demand plummeted. Hungary, after Prime Minister flew in secret to Russia, signed a (secret) deal to expand Paks nuclear power plant. Hungary is now technologically dependent on Russia for another 40 – 50 years.

Hungary’s dependence on Russia, while masked by the technological dependence is also financial. As an interviewee in Bulgaria pointed out, the Russians have the whole package that no other company or country can compete with. They provide the financing, the technology and the fuel – they are the Amazon.com of nuclear power. Competing on these terms is almost impossible for other countries. Thus, if a country is serious about nuclear power, the Russian offer – particularly if you are a cost conscious country – is very appealing. If a country is open to non-centralized generation sources and able to finance its own energy system, then they will probably not choose nuclear power (this is a general statement and needs more support elsewhere).

Concluding Energy Dependence

For our discussion, I discounted the full environmental cost of nuclear and coal (including waste storage and CO2 emissions). Avoiding the environmental discussion (for the moment) enables engagement with the political prioritization of energy security and energy prices. Energy independence is not provided when the energy system is based on the old political-economic order. The Communist system linked the energy resources of Russia and Central Asia to the Communist satellite countries of Central and Eastern Europe. This system is perpetuated in Hungary and Bulgaria.

The overriding cost consciousness of governments and consumers results in continuation of the energy system. Investment continuity, just as private investors demand it, is provided to Russia through political agreements. Continuation of resource and technology dependency ensures Russia stays politically and economically connected to new EU member states. There is an inherent contradiction between neoliberal market requirements of the EU and the secret and centrally controlled monopolistic structure of the Russian energy system. So far, Bulgaria and Hungary accept this contradiction, while Poland strives for self-sufficiency from both systems.

SCEE countries extend the Communist energy systems to the future

There is a delicate and blurred line between investments into the sustainable energy technologies and security of supply. Both are overreaching concepts that describe a multitude of approaches. At the core is the attempt to upgrade technologies with a low environmental impact while ensuring energy resources (primary and secondary) are secure. Creating a sustained momentum of investments through a clear trajectory is core to an efficiently managed system. The sustained trajectory towards a more secure and environmentally sustainable energy system is where countries in Central Europe fall short.

In Europe, there is a clash of how embedded energy systems contribute to energy security. There are two distinct approaches, one in older member states (UK, France, Germany) and one in newer eastern member states (e.g. Poland, Hungary, Bulgaria). Some countries transformed their energy systems in a rapid manner, like Germany and Spain, where solar and wind received a tremendous boost through feed-in tariffs. This transition is now self-sustaining due to the drop in the cost of technologies and a mature domestic service industry. While Spain cut off financing the industry became well established. In Germany, support remains and the renewable sector will continue to grow.

More broadly, the transformation boosted both countries’ energy security while moving them towards a sustainable energy system. Both environmental and commercial reasons (being leaders in energy technology) fueled this conversion. Spain reduced its oil imports while Germany reduced coal (temporarily) and nuclear power in their energy mixes. Social support existed in both countries for this transition.

Energy technologies in the SCEE region

Building a sustainable technological trajectory to transform energy systems is not occurring in South and Central Europe. Some countries, like Poland, Hungary and Bulgaria have not noticeably altered their energy systems. In fact, these countries are marked by a reassertion of their older technologies. Renewable energy technologies are kept to the minimum EU requirement which is below 20%, and little or no government financial incentives. Instead, these countries are clearly reliant on extending and expanding their current energy technologies. Poland will maintain a high mix of coal in electricity generation, currently this is near 90%. The overall 2050 energy mix is projected to have 60% from coal, 20% from gas and 20% from renewables. Thus a rough projection can see electricity generation from coal being around 70%, while boosting gas and renewables in electricity generation.

Hungary is set to increase nuclear power to over 70%, by expanding its nuclear plant. If life extensions are done for current reactors, then by 2050, this 70% ratio could remain in place. Electricity generation from coal and gas and some renewables will remain. Thus, Poland and Hungary pursue a 70% mark for their electricity systems based on previous technologies. This percentage, when combined with gas, effectively locks out renewable energy to any meaningful degree.

Poland’s Electricity Generation Mix

Source: European Commission Country Report 2014 - Poland
Source: European Commission Country Report 2014 – Poland

The energy mix of Bulgaria, from the outside, is diverse. It is a net exporter of electricity and has hydro, nuclear and renewable energy (wind and solar). However, as I will explore elsewhere on this blog, there are systemically high costs associated with Bulgaria’s solar feed-in tariffs, expensive long term contracts for coal-fired power plants, and the general overcapacity of nuclear power, which means even this ‘cheap’ source of energy either needs to be exported or (at times) taken off line due to the oversupply from solar and coal. The future of the Bulgarian energy system, while on the face of it, appears nuclear and centralized, consistent mismanagement may result in technologies with shorter payback periods dominating the energy mix, such as gas and renewable technologies.

Bulgarian Electricity Generation Mix

Source: European Commission Country Report 2014 - Bulgaria
Source: European Commission Country Report 2014 – Bulgaria

Technology and Resource Dependency

The choice of Poland and Hungary to maintain their future energy mix at 70% based on technologies from the previous energy era are directly connected to the perceived final price of electricity, gas and energy supply security. Bulgaria continues to debate and engage with reliance on Russian nuclear technology and gas pipelines – on the same level as Hungary. Bulgaria lacks the momentum to diversify away from Russian resources and technologies. All three countries are affected in their choice of energy systems by Russian control of resources and technologies. New investments fall into one or both of the categories of resource in/dependency and technology in/dependence.

The future energy systems in these countries are based on the previous Communist energy technologies and resources. This is not a trajectory that moves these energy systems towards being both sustainable and secure. Rather, ‘cheap coal’ and ‘cheap nuclear’ are perceived to provide the affordable energy that the citizens of these countries accept. The competitive advantage deriving from ‘cheap’ resources and technologies rests on the previous Communist energy complex. Today, these facilities are built under considerably different market conditions than what we have today or in the future.

It is the difference between the old political-economic regime and the one that exists in the EU that is a source of friction today. Financing of the expansion of Hungary’s Paks NPP is now provided by Russia. Russia attempts to influence the future energy choices of the region by extending the previous political-economic system of resource and technology dependency. This will be discussed in the  next blog post.

Launching of an Energy Expedition: #SCEEE

Today I’m launching the South & Central European Energy Expedition (#SCEEE). This project stems from my interests in the energy infrastructure in the Central Eastern European region. I also have a great interest in bike riding – particularly in Hungary. I established a goal this summer to bike from Budapest to the Black Sea. Combining the two interest seemed a natural fit that align with current research into efforts to keep energy prices low in Bulgaria, Hungary and Poland. These efforts are examined withing the broader context of the region’s market alignment to the European Union and its infrastructure alignment with Russia.

I am breaking the expedition into two legs. First from Budapest to Apatin, Serbia (where my great grandparents come from). This will only be about 4 days. In August, I’ll be biking then from Apatin to the Black Sea, passing through Bulgaria and Romania. Overall, I will be biking more than 1500 km and passing many of the regions nuclear power plants, hydroelectric facilities, thermal power plants and many, many farms.

The objective of this bike expedition is to observe firsthand and document both the centralized and decentralized energy infrastructure. The formal takes the shape in facilities like nuclear power plants, gas fields, district heating systems and damns. The informal are homeowners, farmers and communities using different energy sources like wood, coal, solar, wind, biomass for energy production. I also plan on interviewing and interacting with a range of stakeholders in these communities. Interviews are scheduled ahead of time and are also ad-hoc.

Picture from a bike trip around Lake Balaton in 2014. In front of a poster proclaiming the Hungarian governments slashing of utility prices.
Picture from a bike trip around Lake Balaton in 2014. In front of a poster proclaiming the Hungarian governments slashing of utility prices.

My aims are to establish from local officials, workers and ‘ordinary’ people how energy prices and energy technologies influence their everyday lives. In particular I want to contrast this everyday perspective with the those of policy makers, industry officials and representatives of organizations. The latter are often represented in a disproportionate way in my (and other academics) research on energy policy.

This back to basic approach is meant to infuse historical field practices often used in the discipline of Geography (I’m a Geographer by training). Much of this training I received as an undergraduate at the University of Minnesota Duluth under the influential Geographers of Professors Matti Kaups and Larry Knopp. In contrast, my MSc and PhD studies at the University of Bristol emphasized the theoretical approach – or at least the academic contribution stemmed more from the theoretical expression of the world, rather than expression of the world while using theory.

A final aim of the #SCEEE is to disseminate and educate to a wider audience what infrastructure exists and how local people interact with it. I will be blogging, tweeting (#SCEEE) and producing videos documenting these interactions. This real time data collection method and spot analysis will feed into more in depth research I am conducting with national level stakeholders and document analysis. Publications will be in the form of journal articles and a book on the pursuit of cheap energy prices and the social and geopolitical ramifications (and yes, I still need to find a book publisher – so offers are welcomed).

Finally, all expeditions are not launched solely in the interest of science. There is a personal interest that drives a person to explore and engage in a familiar or unfamiliar environment. This innate curiosity is what makes social science so much fun: The ability to break down larger social and environmental processes into categories that highlight systemic weaknesses or evolutionary trends (to name just a few themes). So I launch this expedition with the expectation of serendipity and chance to provide information to whet both my exploratory appetite and to inform the larger research project. My personal interest of energy and biking converge to propel both interests (literally) further down the road.

Nonetheless, looking out at the grey morning sky, I just hope my new tent repels the water that sinks many expeditions.

The Pull of the Communist Energy System

The role of the state in the energy system in Central Europe is fraught with historical ups and downs. Under Communism the energy system represented progress and equality with the Capitalist West. There is no doubt the energy system from gas transmission to electricity generation and transmission in all the former Soviet Union and its satellites was efficient. The energy system lends itself well to five year plans.

Last week I was in Bulgaria doing research on energy prices and the relaitons between Russia and Bulgaria (I’ll be having a lot more on this topic in future posts). I met with many renowned experts, including Bulgarian Atanas Professor Tassev, who has advised many governments and international organizations, including the World Bank. Atanas Georgiev and I sat in his office while he smoked away at his cigar. There are many old school habits that still persist the further east you go.

Professor Tassev is no doubt one of the leading experts on European energy, even if his spoken English is challenged. So I’m grateful to Professor Georgiev for translating for me. In the discussion over Russia Professor Tassev said, “When geopolitics talks, the politics shut up. And when the politics talks the economy suffers.” With this statement he gets to the heart of the energy debate between the EU and Russia.

The debate over energy is more than just everyday politics, it is about geopolitics which exist in a different realm. Our discussion was in the context of building a new nuclear power plant at Belene, Bulgaria. Russia was meant to build it, but Bulgaria backed out causing high tension between the two states.

Politicians act to influence economic development. The political strategy for the energy sector, whether in America (see my PhD thesis) or in Europe, is to provide electricity at the lowest price. Action will be taken over the choice of technology that fulfills the strongest social goals. In the case of Germany, ‘green’ goals are/were prioritized over upfront costs. In the CEE region, the price of electricity in the short term drives political decision making. Thus political interference in the regulatory pricing process.

Geopolitics is for the long-term. The long-term goals for energy technologies come in the form of nuclear reactors and gas transmission pipelines that span continents. Cheap and competitive electricity and gas today, must be preserved for those politicians that value the most energy costs. Open competitive and transparent markets, as those valued by the EU, provide no assurance on short-term or long-term price. Politicians involved in the economy fiddle with the elements necessary for economic growth. The energy sector is the backbone for any growing or declining economy, so there can be a convergence of domestic politics and international geopolitics in choosing energy technologies.

Russia posses both the technological know-how and natural resources to back up its geopolitical and political aims. These aims coincide with the domestic agenda of CEE politicians. Going forward economic growth in the CEE region is dependent on assurances and predictability in the price of energy. Price is seen by politicians in the CEE region as a competitive advantage against those EU countries with competitive and environmentally aware energy markets.

The Soviet Union modernized the energy infrastructure at a price each country could afford. Integration of these countries occurred through the energy infrastructure. A dependency built up over these years. For countries like Bulgaria and Hungary, turning away from Russia and this historical relationship becomes fraught with an inability of politicians to influence their economies. While a lack of engagement may be good for the economies, it is not good for the politicians. And this is where we have a stalemate between integrating into the EU’s interdependent energy system, and Russia’s dependent energy system.

Russia and Mackinder’s reach into CEE Gas Markets

The Magyar came next, and by incessant raiding from his steppe base in Hungary increased the significance of the Austrian outpost, so drawing the political focus of Germany eastward to the margin of the realm.

H.J.Mackinder 1904

Projecting Power from the Gas Heartland
What provides the best strategic advantage: Mobility upon the ocean or mobility across the stepped lands of Eurasia? The question was examined by Joseph MacKinder in 1904 before the calamities of the 20th century. Applying MacKinder’s treaties to Europe’s energy landscape of today provides important insights into sphere’s of influence. Today, we can draw on MacKinder and apply the sea vs. land argument for control and influence in Central and Southeast Europe.

In this post I will update a single key underpinnings of Mackinder’s consideration of spheres of influence, drawing from the concept of controlling the resources of the Euroasian landmass (Russia) compared to European counties with access (and control) of the seas. I do not address the historical role and influence of Mackinder’s writings. Reflecting on MacKinder is important because it serves as an important vehicle to understand current debates around Russia’s involvement in Central and Southeast Europe. By updating and re-positioning gas within Mackinder’s framework an assessment of the position of countries between Russia and Western European countries demonstrates important political and economic considerations in the price of gas. In this analysis I’m largely referring to EU member states Poland, Slovakia, Hungary, Romania, Bulgaria.

Historical Reflection

Thus marginal ocean-fed commerce… form[s] a zone of penetration round the continents, whose inner limit is roughly marked by the line along which the cost of four handlings, the oceanic freight, and the railway freight from the neighbouring coast, is equivalent to the cost of two handlings and the continental railway freight.

–H.J.Mackinder 1904

If we update this cost of handling – not freight – but natural resources, such as natural gas, oil and even nuclear fuelrods, we begin to see that the past price of freight is still relevant for our discussion. The zone of penetration of ocean freight benefits those countries in Western Europe. While the countries in Central Eastern Europe receive lower priced gas piped across the continent from Russia. While countries in Northern Europe benefit from the piped gas from the North Sea – acting as a ‘land’ source for their energy needs – however, bringing that same gas to much of Central Eastern Europe is constrained by continental infrastructure and increased cost competition for network access in mainland Europe.

Price Differences

The price differentials are first evident in the border prices for networked gas between markets. Hungary’s estimated Russian border price for gas imports for June – August 2014 are at 22.18 Euro/MWh, while the better interconnected network of Germany has a hub price of 18.33 Euro/MWh. While Bulgaria shells out 28.12 Euro/MWh for almost total reliance on Russian gas.

Source: Market Observatory for Energy DG Energy, https://ec.europa.eu/energy/sites/ener/files/documents/quarterly-gas_q3_2014_final_0.pdf, pg 26
Source: Market Observatory for Energy DG Energy, https://ec.europa.eu/energy/sites/ener/files/documents/quarterly-gas_q3_2014_final_0.pdf, pg 26

LNG is the seabased routing of natural resources. LNG cannot compete against European and Russian sourced gas for Central Eastern Europe. And here I’ll keep my analysis at a pan-European level to demonstrate even with liquid Western European markets, Russia hold significant competitive advantage. In a direct comparison against global gas prices, Russian gas prices historically come out competitive. In the chart below, the main lines to observe are the Europe Oil Indexed Contracts [after concessions (BAFA)] these include Russian contracted gas, NBP which is a basket of gas prices (including Norwegian gas). Even US exported gas, represented by the Henry Hub price, needs to be doubled for US LNG export.

Source: “Reducing European Depedence on Russian Gas: Distinguishing Natural Gas Security from Geopolitics.” The Oxford Institute for Energy Studies, October 2014. [http://www.oxfordenergy.org/wpcms/wp-content/uploads/2014/10/NG-92.pdf.] pg 31
Source: “Reducing European Depedence on Russian Gas: Distinguishing Natural Gas Security from Geopolitics.” The Oxford Institute for Energy Studies, October 2014. [http://www.oxfordenergy.org/wpcms/wp-content/uploads/2014/10/NG-92.pdf.] pg 31
The regional price for cooperative regimes, we see that deals can be struck. In February 2015, on a to Hungary Putin gave the cooperative Hungarian Prime Minister, Viktor Orban a discount for his friendly attitude towards Russia. In renegotiating a gas import contract Budapest achieved a price of $260 tcm (thousand cubic meters) as compared to a European average of $270 tcm. Similar price adjustments, reflecting changes in international gas and oil prices, were also achieved for Austria earlier in 2015 and Bulgaria in 2012. The takeaway is Russia is competitive and willing to adjust to international shifts in gas and oil prices.

Adjusting wholesale gas prices is essential for influencing the political landscape in Central Europe. Household gas prices are politically important in the region. I discussed above the competitive wholesale market prices in Europe, but divergence is strongly apparent at the household level. Politically, this is where results are achieved for politicians.

The map below shows the price difference for households. Ultimately, as discussed elsewhere on this blog and in other writings by myself, it is the consumer price that helps direct political control and strategy in the energy sector. In the pricing map we have a clear division between those countries reliant on Russian piped gas for consumer prices and those reliant on sea based sources – even underwater pipelines from the North Sea and from Russia (Nord Stream).

Source: Market Observatory for Energy DG Energy, https://ec.europa.eu/energy/sites/ener/files/documents/quarterly-gas_q3_2014_final_0.pdf, pg 30
Source: Market Observatory for Energy DG Energy, https://ec.europa.eu/energy/sites/ener/files/documents/quarterly-gas_q3_2014_final_0.pdf, pg 30

When we draw in this information, and the map (above) represents a clear division between how energy markets and geopolitical influence can be exerted. The household price of gas is significantly different in Central Eastern Europe and proportionally lower than the wholesale price difference. In this ‘flash’ analysis I won’t average out the household price difference between the two regions, but eyeballing it there is a clear difference – particularly if the information on the higher wholesale price, European averaged gas price are contrasted with the lower household price. In my opinion there is a significant story of why these price differences exist.

Nonetheless, for our discussion here this gets to the heart of our MacKinder hypothesis. That control of the heartland – the pivot region (Euroasia), the “vast area of Euro-Asia which is inaccessable to ships… and is to-today about to be covered with a network of railways….[with conditions of] mobility of military and economic power…” lends itself to a comparison of gas pipelines, LNG, market structures and geopolitical influence. Events in Ukraine underscore the military might, while differential in household gas pricing underscore the economic might of today’s Russia.

Objections

Objections to both a MacKinder view and regional pricing differential views, I believe would have two points. First, they would say that the underdeveloped interconnector network lends itself to isolated markets. A Gazprom position, is that Central European isolated markets consume less gas and therefore are more costly to service, price adjustments just represent market trends. Second, both the break-up of the Soviet Union and the loss of Ukraine of Russia actually weakens the application of MacKinder and the Pivot region. My response to both of these arguments is that if gas prices are non-political then household gas prices would reflect the wholesale market price. However, the dramatic difference between EU household prices indicates elements of political and manipulated economic interests.

Conclusion

Pricing differences between EU member states falls along an important geopolitical fault line. Control of the Eurasian continental heartland and the natural resources, delivered via pipeline, provides a competitive pricing advantage over LNG and even delivery from more volatile regions like North Africa or from politically contentious and higher priced technologies like hydraulic fracturing. Continued reliance and even promotion of options to increase Russian gas into the SEE and CEE regions underscore the political importance Russia holds in securing and dominating these gas markets. As long as household energy prices are a dominant political issue, Russia will continue to hold sway in the regions’ energy markets by projecting its power through political leverage.

Key Sources:
Mackinder, H. J. “The Geographical Pivot of History (1904).” Geographical Journal 170, no. 4 (December 2004): 298–321. doi:10.1111/j.0016-7398.2004.00132.x.

Market Observatory for Energy DG Energy. Quarterly Report on European Gas Markets. European Commission, Directorate-General for Energy, 2014. [https://ec.europa.eu/energy/sites/ener/files/documents/quarterly-gas_q3_2014_final_0.pdf.]

“Reducing European Depedence on Russian Gas: Distinguishing Natural Gas Security from Geopolitics.” The Oxford Institute for Energy Studies, October 2014. [http://www.oxfordenergy.org/wpcms/wp-content/uploads/2014/10/NG-92.pdf.]

Euro Energy Czar: Does West Europe finally get it?

The apparent creation of an energy czar for the European Union signals a harder line against Russia. A move from the days when Germany’s Chancellor, Gerhard Schroder moved from the chancellor’s chair to a Gazprom chair – represented the ‘tight’ relationship between Germany and Russia. Akin to marriages  between European monarchies. (I’ll leave it to you to develop the image of Schroder marrying into a Russian oligarch family.)

The revitalization of the eastern European countries is now represented by the appointment of Prime Minister Donald Tusk of Poland to lead the other European leaders in the EU Council of Europe. Tusk earlier this year championed a call for an EU gas union that was widely acceptable as a great idea – and has pushed forward the long simmering discussion of a closer EU energy union.  In 2010 former European Commission President Jacques Delors and Polish MEP Jerzy Buzek, floated the idea to build an EU energy community – drawing from the founding structure in the European Coal and Steel Community.

It is now the Polish contingent that is pushing for a ‘high official’ to coordinate all external energy policy.  The EU Parliament’s Foreign Affairs Committee overwhelming adopted the proposal to create an energy czar to represent a common EU energy position in the foreign policy realm. Adopting a common energy foreign energy strategy and representation – no matter how muddled by diplomatic niceties, is stepping in the right direction to address the tremendous energy security gulf between ‘old’ member states and the states joining since 2004.

As I’ve written before, there is a huge gap between the development of the energy systems in the west and east. Both financially the western EU members are able to invest and upgrade their energy systems, while the east are stuck attempting to keep prices extremely low, with limited upgrades throughout the system. This applies to rolling-out more energy efficiency measures and renewable energy. The east becomes stuck in this pipeline dependency. Unable  – and in some cases – unwilling to finance their way to a new energy system.

Independence from Russia is a nice dream, but energy is the way Russia projects its power. For some politicians, like Hungary’s Prime Minister Orban, staying within the Russian sphere of influence holds financial and political benefits. For the Poles, they gain politically moving away but are so wedded to the Russian gas system, and reject significant upgrading to their energy system, such as getting off the carbon road, that they remain tied.

An EU energy Czar able to counter the Czar of Russia (Putin) must be given legitimacy from EU members.This means both the Germans and the Hungarians – much line up with the Poles and seek greater independence from Russia. However, as the building of the South Stream pipelines shows, Hungary and Bulgaria are willing to move forward with Russia on the pipeline despite strong resistance from Brussels. Unilateral agreements and development projects – at the expense of the overall long term EU energy security – will fail to elevate the Czar to a meaningful position.  European countries must line up, and even lend some sovereignty to an EU high representative for energy. The foundation of the EU is based on coordination of energy and industry, let’s ensure this remains central to keeping Europe strong.

 

 

Inter-European Gas Wars: Europe’s pursuit of Energy-cide

Also published on Natural Gas Europe.

There is a gas race in Europe. This rivals the well reported US – Europe gas price difference, due to cheap US shale gas and high European imported gas prices. In an attempt to compete against the US European industry just got handed a price break in the form of lower support payments for the renewable energy sector. However, European countries also compete against each other over the price of electricity, a race to the bottom, or rather Energy-cide: the destruction of sovereignty in the pursuit of lower energy prices.

This price war also forces countries to develop strategies to keep electricity prices low. An example is Hungary’s deal with the Russians for a ‘low’ cost nuclear power plant. This inter-European energy price war holds significant long-term political and economic costs, which can hobble Europe’s competitiveness and political independence.

nuclear

The result of this inter-European price war is Russia captures the Crimean prize by understanding how the game is played. The limp EU financial sanctions to hold Russia in-check are framed as the EU punishing Russia. But this is Europe, the ‘unified’ EU action mask the inter-country price wars raging between member states. In each region this plays out differently, for those in the west of Europe (old member states) it is the result of the high initial cost of shifting towards renewable energy and the impact on industry; for those in the east (new member states), it is reliance on Russian gas and householders proportionally high utility bills.

The impact of this price war can be seen playing out in Berlin and Brussels in April, 2014. First the German government approved amendments to its renewable energy law, lowering the cost of German industry financing for renewable energy. Second, the European Commission voted to reduce payments energy intensive industry make to fund the renewable energy shift. The pressure is now intense in Western Europe to reign in energy prices and the real and potential threat of industry flight to the United States. The US, and its cheap shale gas, is held up as a magnet sucking European jobs. Europe feels the coming climate change apocalypse, just as much as a faltering economy, Russian tanks in the Crimea are simply less threatening. But this is a Brussels’ view of the world, in the east the people and politicians feel the heat from Russia.

The Hungarian government continuously lobbies against sanctions on Russia for the violation of Ukrainian sovereignty. With Hungary dependent on Russia for gas and nuclear power, its current charade of low energy prices can only be maintained by the wishes of Russia. The Hungarian government secretly inked an agreement with Russia to take a 10 billion euro loan to build two new reactors. Despite no social or political debate, the overriding excuse for such a deal by Hungary’s Prime Minister was lower energy prices – even if the numbers show a doubling of electricity prices. He envisions to have Europe’s most competitive electricity cost for industry and be more competitive than the Czech Republic or Germany. Hungary will be a manufacturing powerhouse fuelled by cheap Russian nuclear power. In return, the Russian’s hold over Hungary a huge mountain of debt which they’ll use to manipulate Hungary’s foreign and domestic policies.

Other countries in Eastern Europe are the same, Bulgaria has been plagued with violent riots over electricity and gas bills. The country’s seven member energy and water regulatory commission had 17 different members and six different chairman in 2013. Poland has lost an environmental minister due to bungling the country’s shale gas ‘revolution’ – it still awaits a commercially viable well. Each country in Eastern Europe has the stated aim of having the cheapest gas and electricity and literally being a regional powerhouse. Each country wants to compete and attract industry from Western Europe. Poland wants chemical manufactures from Germany. Hungary wants auto manufacturers to set up shop. It is a continental race to the bottom.

Russia benefits in spades from intra-European conflict over energy prices while the continent as a whole attempts, by any means, to close the price gap with the US. In 2012, the German border price for gas was four times higher than the US Henry Hub price (even if this is a flawed comparison, it is often made as an excuse for needing lower EU energy prices). To close the price gap, somehow the solution is more Russian gas. Russia’s South Stream pipeline project will avoid Ukraine and deliver the same gas to Europe, without Ukrainian interference. The pipe will traverses the Black Sea, landing in Bulgaria and connecting Serbia, Hungary and Austria. When the going got tough over a year ago for South Stream’s competitor, Nabucco, which would bring non-Russian gas to these same countries, both the United States and the EU failed to step up to ensure its success. The project offered to diversify Eastern Europe’s gas supply. Instead the EU accepted another gas pipeline to Italy – a long running ally of Russia and thus acceptable to both those in Brussels and in Moscow.

nabucco and gazprom v4

The evolving gas map keeps the east boxed in: South Stream and Nord Stream. There is almost zero western support for diversification, the result is high prices and Russian dependency with low security of supply.  But is this paranoia? Not when the German partner of South Stream remarks over EU blocked talks with Russia, “If anything, the approval procedures should be accelerated, not delayed,” said Rainer Seele the Chief Executive of Wintershall.

Should the only means of leverage Ukraine holds over Russia be sped up? Just so Ukraine can be eaten faster by Russia? Hungary’s Orban signs secret deals with Russians because he knows he needs to compete against the west on price, Berlin or Paris aren’t going to send cheaper electricity or gas to the east.

The true price masters are the Russians. They see this intra-EU country price competition. They see political leaders hanging by economic-popularity threads, industry bent over a Russian pipeline – sucking gas, Bulgarians protesting over prices and burning utilities’ cars, while Viktor Orban proclaims an energy price war against Brussels while furtively flying off to Moscow. Even the ‘green’ German consumer demands cheaper electricity. Industry perception of the energy system as a whole matters, even if Russian gas is marginal in Western Europe. The closure of German nuclear was perceived as a blow against German industry, another blow is unwelcomed.

The Russians hear from European industrial and political leaders, “take the Crimea, but just help us compete against our European neighbors and America.” Energy-cide, the destruction of sovereignty in the pursuit of lower energy prices. Russia is the cat and Europe is the mouse. Russia eats part of Ukraine, while Russia also politically binds the Bulgarians, Hungarians and Germans over gas prices. Unless Europe stops its Walmart-like energy price race to the bottom, and shores up energy diversification routes for Eastern Europe, Russia will continue to be the top consumer.

Two Approaches to Energy Price Drops: Bulgaria vs. Hungary

The energy price rebellion may have begun with the people of Bulgaria but it was Hungary’s government that first institutionalized the price cuts. Now, with new members on the regulatory board in Bulgaria, the State Energy and Water Regulatory Commission cut day time prices 10% effective January 1, 2014. Other price cuts and a warning shot for the private distribution companies means Bulgaria is headed down the same path as Hungary. Nonetheless, Bulgaria has flipped the title of Mafia State over to Hungary by demonstrating a professionally measured approach to the style of the price cuts (post-script: see the comment section for how wrong I got this post, the title should be split between the two. Also, please read this guest post to see how totally screwed up Bulgaria is, this was done to set the record straight on my mistake here. Fortunately, I’m building on this and looking to do more in comparing the two distinguished countries – it really appears they are merging in their chaotic approach to the energy sector).

Hungary - adding their energy numbers like Enron
Hungary – adding their energy numbers like Enron

Hungary took an anti-judicial and anti-technocratic approach to push through politically motivated price cuts. After forcing a 10% utility price cut on distribution companies, and then having courts overturn the initial effort, the Parliament shook up the regulator and removed an effective appeals processes for the utilities, paving the way for a 20% + utility price cuts. This was after the energy regulator had it authority removed resulting in politically mandated utility prices. And nothing represents ‘stability’ than Fidesz politicians (How many times has the ‘new’ constitution been amended?).

In the initial effort to stick to Hungary’s formula for utility prices, a friend of mine attending the meeting, described the itemization and justification of price reductions in the most inappropriate terms. It was so bad, I can’t even allude to it here. But I’ll just say my four year-old son could do better math – in English or Hungarian.

I’m not saying that the Bulgarian case is much better, as I don’t know at this stage what the effect will have on the system – but the Bulgarian case does demonstrate a respect for the rule of law, respect for state institutions and reliance on outside experts. A process of regulatory review was followed without infringing into the institutional competence of the Bulgarian regulator (OK, even if this independence is traditionally low in the country). I walk a fine line in comparing an sidelining a regulatory institution and politically influenced price cuts. Nonetheless, Bulgaria is left with a price cut that is institutionally justifiable, politically toned-down and not anti-foreigner. Too bad Hungary didn’t do this.

Why are state institutions important? The difference between the Bulgarian case and the Hungarian case, is some of my recent research shows that state institutions, and how they are handled by politicians, directly translates into the perception of people of the trust and respectability in state institutions. In Bulgaria, respect is very low, because historically the state’s scientific capacity was gutted (in relation to shale gas issues). This also influences investors cognitive investment perceptions.

The continual undermining and running foreign investors out of town, by the Hungarian government, translates into a perception of weak institutional capacity. Over the long term, the weakening of these institutions removes the best and brightest administrators contributing to economic growth. Once all the foreigners are run out of Hungary, institutions gutted of their human capital, Hungary will have limited capacity to grow. Once Fidesz is removed, and rebuilding of the country begins, there will be a lack of domestic expertise to re-attract financial capital. Human and financial capital go together. This is what happened in Bulgaria with the near bankruptcy of the country in the 1990s. They had to rely on foreigners to rebuild the country – Hungary has already done this once as well.

Max 1
Children grow up

 

I never state that energy regulators operate in a bubble separated from politics (certainly not in this region). Signals are sent back and forth between politicians and regulators, and an awareness of how far regulatory measures can go is fostered. Observing state institutional order preserves state continuity. In the case of Bulgarian energy prices, it is an orderly direction for the revolutionary zeal for price reforms. In Hungary, it is the revolutionary zeal destroying  state institutions, rule of law, and instilling populace pricing policies. Revolutions are not guided by rationality, but emotional power grabs. The price of energy is not getting cheaper – so there will be a dramatic price rise one day. Fidesz plans to control the country for at least a generation. This means Hungarian children will get the chance to rebuild their energy system, and no doubt their math will need to be correct.

 

 

The Russian Rock: Re-landscaping CEE energy (in)Dependence

The recent ‘war of independence’ against Western European owned utilities in Central Eastern Europe (CEE) and South East Europe (SEE) sets the stage for re-integration into Russia’s energy sphere – and dependence. A war against electricity, gas and water prices has been raging in Hungary since 2012 while SEE countries have a longer history. The firm rejection throughout the region of privately owned utilities managed by independent regulatory institutions limits capital inflow to upgrade and diversify the region’s energy infrastructure.

Omul de tinichea transfagarashan

Benefiting from the ‘war’ against Western capital is Russia. State owned Gazprom remains the dominant and stable supplier of gas to the region’s state owned firms and centralized energy systems. The CEE (including Poland) and SEE regions reject complex market structures with competition and diversified generation technologies pushed by the EU. Full independence from Russia is no longer sought, rather a ‘safety’ margin to weather a Russian gas storm provides a low cost diversification option. Three historical periods are discussed, with the third marking the re-integration into the Russian fold.

  • Stage one, fully dependent on Russian resources and technology;
  • Stage two, building an energy system semi-independent of Russia;
  • Stage three, ‘(in)Dependence’ on Russia’s energy wealth, the recognition of benefits gained from dependence coinciding with diversification of energy sources.

The CEE and the SEE regions see energy dependence as strategic while allowing for new infrastructure, such as gas interconnectors, shale gas and LNG terminals to rebalance the energy landscape and provide space for energy independence, rebalancing the historical Russian dependence. The term, ‘(in)Dependence’ provides a encapsulating expression of how Russia remains firmly positioned in the CEE/SEE regions’ energy landscape. It is the rock in the region that despite the best efforts of multiple countries, governments and international organizations, Russia remains firmly positioned in the CEE/SEE energy landscape.

Dependence

The Central Eastern European Region, including the Southeast of Europe, is heavily dependent on Russia’s energy resources. This includes gas, oil and nuclear technology. The ability to cement through physical infrastructure and human capital during Communist period established a robust connected system of resources and expertise between the region’s countries and Russia. The headlines hold that gas security is the most contentious issue. But finding a solution to this dependency requires a complex and stable energy investment climate. Since the fall of the Berlin Wall and 2004 and 2007 eastward expansion of the EU, diversification away from Russia for CEE countries was the overall most important headline issue. Despite concerted efforts the region has failed to find alternative sources for Russian gas and remained wedded to Russia. The era of Russian energy dependence can be seen to have evolved over decades under the technical capabilities of the Soviet Union.

We see the impact that this uncoordinated, but regional consistent energy strategy has on the CEE region: Complete reliance on Russian gas and oil imports. After the political winds shifted in 1998 and the region shifted towards Western Europe for political and economic integration these energy links were viewed as high risk entrapping the region into an almost single sided relationship where the terms are dictated from Moscow. The region may have gotten democracy and removed overt economic and political control but the energy infrastructure is a strong reminder that continues the previous political-economic relationship.

Independence

The launching of the energy independence period, away from Russia, began in the mid-1990s.  Privatization of energy assets and the establishment of energy regulators brought private capital into the energy system, transforming the role of the state. Market considerations would help guide and fund development of the national energy system. Technocratic independent regulatory institutions would oversee the region’s energy system.

Privatizations of energy companies, mainly electricity and distributions companies were never very popular, but the politicians making these decisions were aware the state was incapable of funding a renewed energy system able to operate efficiently. Bloated inefficient companies, were typical and unable – or unwilling due to political pressure, to collect from large and small consumers. In Macedonia at the time of privatization there were 500,000 individual court cases filed over fee collection. Large state owned factories paid little or nothing. Other countries mirrored this systemic inefficiency resulting in underfunded and crumbling energy systems. The entire CEE and SEE region made the hard decision to bring in mainly Western European energy companies to fund the renewal of power generation and electricity and gas distribution systems. These important energy assets were privatized, in some countries more than others, but each country, usually with strong encouragement from international organizations, did privatize. Enough to place the energy sector on a market footing.

By the mid-2000s sufficiently robust national and regional markets in electricity and gas were well under development in the CEE and SEE region. Strong market and regulatory elements were integrated into the system. Authority of the energy system typically, on a technical level, transferred from an energy minister to an ‘independent’ energy regulator, who set prices and technical standards. This technocratic system was established to ensure the long-term commitment and investments by private energy companies were secured and the system as a whole was managed to ensure its continual long-term development.

Since the onset of the 2008 financial crisis already strained relations between private energy companies and governments escalated. The underlining truth to the ‘Utility Rebellion’ of the CEE and SEE region is politicians had a hard time letting go.  From price setting, control or influence over cross-border electricity and gas interconnectors politicians have a hard time coming to terms with allowing the energy sector to operate like an open, but regulated, market. Repeated attempts to establish a transparent and unified electricity system in the Southeast of Europe has failed, despite consistent support (and pressure) from international organizations and institutions. In 2013, the tension has spilled over into outright social and political rebellion against private owners. This includes (but not limited to) some headline cases:

  • Albania: In January 2013 the energy regulator took away the license of Czech power company preventing it from operating in the country.
  • Macedonia: Disputes between Austria’s EVN and the Macedonia government over debts and investments are on-going since privatization in 2006.
  • Bulgaria: After years of building tensions, including court cases, between private investors (CEZ, EON, EVN), the spring of 2013 saw public street protests erupt over electricity and gas prices resulting in new elections, along with investigations and regulatory changes in Bulgaria’s energy sector. Although the fury is equally directed at state owned companies as well as privately owned ones.
  • Hungary: What was once a success story of privatization and equal risk levels to Western Europe, changed after the 2010 elections with the new Fidesz government.  Extra taxes on energy companies were introduced after which the energy regulator was sidelined and forced legislated price cuts above 20% in 2013, compounded by a proposed law to be passed before the 2014 elections of utilities becoming non-profit entities. Many privately owned utilities are making losses since 2011 and have slashed investments.

 

Markets and independence

The focus on market transformation contributed to two false assumptions: First, from a Western European perspective, overall EU gas supplies were not significantly exposed to Russian gas interruptions – if they were to occur at all. Russia was a stable supplier not willing to use gas as a political weapon and the governments of the CEE and SEE regions could diversify themselves; second, over time alternative sources could be secured from Europe’s ‘near abroad’. During this age of attempted energy independence, the pro-market perspective and activity created an assumption that the market would induce greater supply security, investments by Western European firms would contribute to greater energy security. However, these assumptions came to a head at the start of 2009.

Supply disruptions, between Russia and the Ukraine, were already regular seasonal events, but in 2009 the crisis cascaded into disruption to EU Member States. This disruption showed, what was already known in the region, diversification away from Russia was important for the energy security and security of supply for the region. It was not the overall EU level of dependence that matter, but the regional dependence. EU institutions woke up, but not until after they coordinated a technical response of sending gas to dried up systems in Bulgaria, Hungary and Serbia. Afterwards, the EU threw greater effort and coordination into helping the region diversify and open up alternative routes of supply for the region. These include interconnectors, expanding gas storage, ensuring reverse flow in pipelines and instituting new procedures and guidelines to ensure a timely coordinated action in case of emergencies. However, much of this diversification is funded by national governments. Key diversification projects include:

  • Polish LNG
  • Poland’s push into shale gas
  • Hungary’s oil and gas group MOL upgraded an oil pipeline to the Adriatic, tying the region into global oil supplies.
  • Bulgaria signed an agreement to import gas from Azerbaijan starting in 2019, completely avoiding Russia by transporting the gas through Turkey and Greece.
  • Bulgaria will build interconnectors with Turkey and Greece.
  • Upgrading gas interconnectors between Hungary and neighboring countries, particularly a new Hungary-Slovak interconnector that begins to establish a north-south gas corridor to Poland.
  • Gas storage investments in Hungary and Austria
  • Western interconnectors to Austria and Germany with reverse flow capability are being built or upgraded.

Missing from these ongoing or completed projects, is the most symbolic project of all, Nabucco. The failed bid to transport Azeri gas to the SEE and CEE regions may turn out to be more politically significant than functionally significant. Existing Soviet era transport pipelines to Russia remain the only large supply route of gas into the region. Regardless of boosted interconnectors, regional LNG access or gas storage, Russia will remain the dominate gas supplier to the entire region, all the additional projects provide a boosted level of energy security and improve security of supply in times of emergency. Nonetheless, if the goal is to ensure operations through a cold winter when the gas is cut off from Russia then the region can weather a Russian storm.

The failure of Nabucco to launch prevents the region from adding the significant alternative capacity, which combined with on-going diversification projects, could reduce further Russian reliance. Nabucco, backed by a consortium of CEE, SEE and Western European companies represented the most symbolic effort for energy independence. It was the battle between competing gas pipelines through Europe’s southern gas corridor: Russia supported South Stream vs. Nabucco. The EU backed Nabucco, had the political-economic edge to deliver more gas while increasing energy security. In the end, the pure commercial decision was taken by the upstream consortium to deliver gas into the Italian market through a competitor private pipeline to Nabucco. The downstream activities in the CEE and SEE region prove themselves just as important as the upstream transit routing decisions, which together influence large scale investments into the region.

Building the Nabucco pipeline through the CEE/SEE region would require decades of commitments from all upstream extraction parties tying them into downstream distribution partners. As outlined above, past relations between the region’s governments and foreign energy investors is turbulent. If Nabucco went ahead the upstream suppliers, extracting in Azerbaijan, would be tied to the political whims in the CEE and SEE region. If the original point is to play Nabucco against the Russians, then the tables could be turned to threaten the extra capacity from the older Russian pipelines to drive prices lower once Nabucco pipes are in the ground. Fixed assets and fixed prices are only as fixed as the political winds.

Current actions of governments throughout the CEE and SEE region demonstrate independent energy regulators are used for window dressing to meet EU requirements. Energy regulators were meant to ensure the long-term investments by energy companies were protected. This has turned out to be false. Under current conditions, the forced price reductions, revoking – or the threat of revoking – licenses and continued disputes over the prices of electricity and gas creates a significant challenge to maintain necessary investment levels, upgrade or prevent a company from financial losses. It is hard to imagine the political rhetoric and actions stopping for upstream suppliers physically locked into the region and with alternative sources of gas for governments to buy.

The original energy newcomers to the region, described above, are now withdrawing – or literally being squeezed out, like in Hungary. In short, the energy investment environment has turned negative, price pressures dominate, and political along with social demands result in an unpredictable market. Despite gas being a global commodity, politically mandated cuts in electricity and gas prices force losses onto distribution companies. Building a multi-billion Euro pipeline through the region begins to weaken under the current domestic and regional conditions energy providers are met with.

The loss of Nabucco should send a clear message, and the politicians of the CEE/SEE should hear it: Market fundamentals, are the basis for investments, not political considerations. Politicians can fight downstream electricity and gas companies for lower prices, argue with Russia over contracted prices, but unless governments are prepared to pay a market price for commodities – thus subsidizing their consumers, energy companies will go elsewhere. Private capital doesn’t finance displays of populism and energy independence that in the long-term undermine both security of supply and energy security.

 (in)Dependence

Today, 2013, we have a new era, of energy (in)Dependence. It represents the limits of infrastructure development, alternative import routes and politically induced market risks. Constant political warfare with private energy companies, in most of the CEE and SEE countries, has resulted in depressed incentives for infrastructure upgrades and price instability. Building a non-Russian transit pipeline into a region of significant market instability requires incentives outweighing these negatives. Each country in the region is proclaiming energy independence, which then (laughably) increases their reliance on Russian gas and increases security of supply risks. Resiliency within national systems is less than in regionally integrated systems. Faltering now on regional integration or preventing foreign capital from entering only underfunds alternative energy solutions which displace Russian gas.

The region’s largest gas projects moving ahead mainly rely on government efforts and financing. Gas storage in Hungary, network interconnectors, Polish LNG terminal and shale gas. While these efforts are able to move the ball down the court towards greater energy security, they do not provide substantial regional upstream diversification. The original intent of privatization of energy companies was to infuse capital into the regions’ energy systems to modernize the infrastructure, governments lacked the money to redevelop the basis of their economies. The question must be asked, does this trend continue, or has energy capital taken flight?

CEE and SEE governments cannot finance a new energy system that excludes market based elements and players. EU institutions are pushing for great market transparency, elimination of state aid, stronger energy regulators, stability in prices for private energy investors, and the interlinking of national and regional markets, thus reducing the room for political interference in energy markets.

There are now a number of attraction for CEE/SEE governments to deal with Russia and maintain its dominate position in the region, and in fact, moving away from Russia now appears more dangerous as the original – and justifiable reasons for energy independence fade. Russia remains a single supplier who is ‘simple’ to deal with. The terms of gas supply are clear, ‘You buy it we deliver it.’ Not the Brussels motto of, ‘If you buy it then here are the competitive conditions that have to be fulfilled, here is the transparency that is expected, and we expect the energy regulator to make well-reasoned opinions based on professional decision making process.’ Politically, that EU garbage only works in Western Europe.

Politically for CEE countries, Moscow can now act as a counterweight against Brussels. Whether this is just symbolic or not, the political elite in the CEE region is learning to balance energy relations between the old foe and the new foe. Finding a common cooperative topic with Russia is also beneficial for on-going relations, if not energy than what? Agriculture or software? There’s nothing that says a serious relationship than building long-term energy ties with Russia. Satisfying the strong neighbor, financially and commercially on energy issues distracts them from other issues.

A cooperative relation also demonstrates that CEE countries can stand by themselves with Russia. The rules of the energy sector may be dominated by Brussels and Western European companies, but the national governments of the CEE region still have an important role to play in their national gas markets and pricing. Bilateral relations are fostered and maintained with energy. While Russian gas, in the age of independence, was viewed as a necessity, in the age of (in)dependence, negotiations demonstrate politicians are in control of their country’s energy assets and a solid relationship exists between old foes/friends. This is contrasted against the assumed friendly relations with Brussels and the EU’s demands for an independent and transparent energy sector with complex rules and limited room for political grandstanding and influence. Russia and Gazprom are more than happy to lend to the showmanship, with the price of gas possibly linked to the temperature of relations between countries. Energy (in)Dependence provides security, simplicity, political capital and limits the need for a more complex energy market to replace Russian sourced gas.

The intertwined concepts of finance and market complexity, for alternatives to Russian gas, provide another reason for energy dependence on Russia. Despite alternative gas supplies, like LNG and shale gas, becoming more available, they will only make a small dent into the domestic or regional gas market. Any alternative to Russian gas requires considerable investments into developing a functioning gas market, including a nationwide network with gas power plants. Failure to incentivize private companies to invest in alternatives to Russian sourced gas (such as shale gas) ensures continued Russian dominance, for example in Poland’s gas market. Poland values energy independence, but not even concerted investments into LNG, shale gas and interconnectors can reduce its heavy reliance on Gazprom. The same applies to all the other countries in the CEE and SEE regions.

Conclusion

The political and economic hurdles for energy independence are too high for the CEE and SEE regions: Building a new energy system, funded by private capital, requires competition and complex market structures with limited political involvement.  Extending dependence on Russia energy resources provides the opportunity to maintain centralized energy systems and using Russia as a counter weight to Brussels non-political energy market schemes.

The collapse of Nabucco represented the failure of an energy independence strategy. A high priced, visionary project that was politically supported but without the political or economic stability required for its long term success. The debate over Nabucco overshadowed the on-the-ground work of building and expanding interconnector capacities, LNG terminals, domestic gas deposits and an overall beefing up of security of supply components. Enough so that supply disruptions, from Russia or transit countries, would have a limited impact. Energy independence can be gained by small hedges against Russian agitation and action. Therefore, (in)Dependence provides a lower cost, economically and politically hedged energy strategy that balances the local politics of the CEE/SEE region and the competing demands of Brussels and Moscow. A classic Central European strategy.