Tag Archives: South Stream

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.]

The Day Hungary Cleaved from Europe: The true cost of Russian gas

The visit of Russian President Vladimir Putin to Budapest on February 17th, 2015 marks the day the Hungarian government voluntarily returned to the Russian sphere.

The outcome is three-fold: First, Hungary’s Prime Minister Viktor Orban openly rejected the EU path of energy market transparency and integration. Second, Hungary accepted ‘cheap’ Russian gas in exchange for a Ukraine-like gas arrangements which depend on Orban’s political fortunes at home. Third, Hungary operates its gas network for the benefit Russian geopolitical aims.  This arrangement threatens both Europe’s  and Hungary’s drive for energy independence, system stability, and European energy security underpinned by interconnection between countries.

A great friendship

The Cost of Cheap Gas

The Hungarian movement into Russia’s embrace was done in the name of ‘cheap’ gas. Reportedly, the price dropped from the oil-indexed price of $440 per thousand cubic meters (tcm) to $260 tcm, against a European gas-on-gas average price of $270 tcm. Bingo! Nonetheless, the drop is significant when you consider this post listing previous 2013 prices in the EU (before our recent oil and gas price decline). Importantly, the deal renegotiated Hungary’s previous long-term contract with Gazprom enabling it to utilize its previous unused gas on the take-or-pay scheme. Although, this supply extension (from a trusted source I’m told) was already agreed to back in 2008 when E.ON owned the import rights. Thus in short, Hungary received very little from Russia for all the political and economic favoritism listed below.

But first let’s put these numbers into a regional perspective. The new price is based on non-oil based pricing, thus hub price. Bulgaria, for example in 2012, renegotiated its long-term contract between Bulgargaz and Gazprom increasing the gas hub based pricing to 20% from 10% previously.  While OMV in January of this year, shifted to hub based pricing with Gazprom. Thus Hungary simply follows on this regional shift that began in 2008 and gets a somewhat lower price for being a good customer.

This temporary arrangement, rather than going with a new long-term contract, was done under the reasoning that current volatile gas and oil prices means Hungary may see further price drops in the future (er, or Russia might increase the price?). It is also enough time for Hungary and Russia lay plans for a gas link to Turkey. Importantly, for this article, election years in Hungary may occur in 2018 and 2022. Any change in government after 2018 will need to deal with the Russians at that point. Cooperation on gas and nuclear will need to continue.

Nonetheless, let’s not think in terms of only open market pricing – which Gazprom is not noted for. Particularly, when Putin shows up on your door. Rather let’s consider that Hungary’s European Union membership was openly sold for gas necessary to prop up artificial utility price cuts and for a trip wire gas deal – any shift in the governing party will result in more expensive gas. Cheap gas and political trip wires are key reasons for the past political instability in Ukraine, in other measures Orban is also shifting Hungary to the Ukrainian gas model.

The overall actions of the Hungarian government during Putin’s visit demonstrate Hungarian historical values are neither respected nor honored. Rather, shameful Hungarian historical political tendencies bared themselves by Putin and Orban’s negation of the living memories of Hungarians break from the Soviet sphere in 1956 and 1989.  But Hungarian society, the one that I know, is waking up. The Hungarian people reacted to Orban’s governing style, and no doubt Putin’s visit, by taking away his two-thirds majority in Parliament in a local by-election this week, February 23rd.  There is no social return to Russia’s barracks.

The Hungarian populace is firmly in the EU. In contrast Orban openly embraces Russia in the pursuit of cheap energy sources, in the form of gas shipments and new nuclear power plant agreement. This pursuit belies a more efficient scenario where Hungary’s EU membership serves as a basis for a more secure  and interconnected system that provides sustainable priced electricity and gas. EU presence in negotiations can also boost Hungarian gas deals. Following the EU path both honors Hungary’s European membership and advances national and EU energy independence.

Political reasons are behind Orban’s friendship with Putin. Hungary has cut electricity and gas prices more than 25% since 2012. During the 2014 local elections advertisements existed across the country proclaiming the energy price cuts; in 2013 there was an open government funded PR war against foreign owned utilities – even a petition drive! The price cuts, while good for households in the short term, have significant impacts on the energy system.

These prices are resulting in private gas and electricity companies hemorrhaging cash for residential customers. Eni, the Italian gas and oil company Hungarian gas subsidiary, TIGAZ, is accumulating financial debts nearing its capitalization.  The Hungarian government is racing to set up its own for profit service provider in 2015 (although they say it is non-profit, it is registered as for-profit). This is necessary to take over the universal consumer obligation. The private distribution companies, owned by ENI, RWE, E.ON do not need to file again to be universal service providers to supply electricity and gas at a loss on the regulated market to households. Nonetheless, to be fair to the Hungarian government, these and other companies did have years to foster a competitive market for households and they never did. The question though is how to foster a  fair market price without bankrupting companies.

The losses on the regulated market can be taken over by the Hungarian state, which has conveniently placed the ‘non-profit’ entity in the Hungarian Development Bank. However, the placement of many energy entities – such as a gas trading entity, into the bank raises red flags.  The potential exists for capital injections into the bank, by the government  to result in cross-subsidized losses. The bank incurs losses, through its ownership of the service provider, but the government makes up for these losses by capital infusions into the bank. However, under the gas agreement the current 25% cut likely be maintained without losses, thus Putin delivered Orban a golden egg – with Putin keeping the goose.

(In the past few months I have submitted questions on this topic to the Hungarian government and state owned companies but my requests for interviews were all declined. The Hungarian energy regulator did speak to me about the technical reasons for cutting gas off to Ukraine in September 2014 – a contract from Naftogaz was never returned).

The Hungarian energy system now operates under the same politically driven concerns as the bankrupt Bulgarian energy system. As a starter, under Orban and the Fidesz super majority in Parliament, the operating profits of the Hungarian utility sector as a whole flipped from a profit of HUF 224 billion in 2009 to HUF 119 billion loss in 2012.   Bulgaria is at least attempting to dig itself out of these past practices, which has placed the Bulgarian state owned energy company, NEK in debt of €767 million in the past four years. (well, it now recognizes these losses, so maybe it will act). Hungary is just lowering the ladder to go down this hole.^ Orban is right, he does need Russian gas to have cheap energy for consumers. The significant losses by utilities and the re-organization of the Hungarian energy market demonstrates this.[For more on information on the similarities of Hungarian and Bulgarian energy systems see this (draft) co-authored article].

Putin’s Pipelines

Driving further dependence on Russia is Hungary’s reduction of interconnector capacity between Hungary – Austria (HAG), and Hungary – Slovakia. The HAG has 3 bcm, but Hungarian state owned MVM holds a monopoly on the capacity granted by the Hungarian Parliament in 2011 citing energy supply security as justification. Capacity is extremely limited and widespread media coverage given to a partially Russian owned firm, MET, holding a special arrangement with MVM on importing and reselling gas into Hungary through HAG. The other owners are reported in the Hungarian media as being politically connected in Hungary.

The story of the Hungarian-Slovak interconnector is short. Meant to open in January 2015, ‘technical reasons’ keep this 5 BCM pipe closed. In addition,  operating rules are delayed while they are being modified. The importance of the SK-HU pipeline is viewed by the fact that German Chancellor Merkel in her February visit with Orban, brought up the use of this interconnector by RWE. As is clear, Putin has Orban’s ear, not Merkel. It remains unknown when this pipe will open.

Constraining Hungarian import and export capacity also constrains volume and price liquidity on the Hungarian market. This would erode MVM’s and Gazprom’s lock on the Hungarian gas market and even allow export to Ukraine. Evidence of this can already be seen in the relatively huge profits booked by MET through its deal with MVM shipping gas from Austria. In 2010, MET had HUF 44 billion revenue in 2010, by 2012, the company had  HUF 280 billion in revenue and “paid 60 billion in dividends to its owners, 2.5 times more than the overall dividends paid by the whole group of foreign incumbents in the same year.”* Or as mentioned above, the utility sector as a whole experienced a  HUF 119 billion loss in 2012. Other market players receive no such treatment, instead they are burdened by both special sectoral taxes and regulated utility rates. The losses in Hungary may only be comparable to Bulgaria – not a model energy system, plagued by riots and constant court battles between utilities and governments.

In terms of the SK-HU interconnector, RWE would benefit by both exporting to Ukraine and servicing Hungary’s industrial sector, which are stuck with Russian gas. In addition, Orban promised Putin not to re-export Russian gas to Ukraine, further restricting gas that could flow to Ukraine.

Market liquidity enables Hungarian industry to build managed gas portfolios enabling them to leverage a variety of gas trading mechanisms to hedge and play with market pricing. These should be done on a liquid Hungarian gas exchange which is operated by MVM’s CEEGEX. Instead, western European gas is limited in Hungary.

Under current rules, Hungary operates a ‘free trade zone’ for gas in its state owned gas storage facilities. Gas traded between entities is confidentially reported to the Hungarian energy regulator.  No tax is paid until withdrawal happens. Thus, Gazprom is able to ship gas to Hungary, the gas can be traded multiple times, and only once it is withdrawn from storage does the price become known. Non-transparency is a friend of Gazprom. Just as huge profits are booked from imports from Austria by the selected MET, who buys and trades with MVM, the stored gas remains opaque. Bi-lateral contracts while legal, should be pushed towards the exchange. Hungary already has CEEGEX  where all free-trade zone gas should be openly traded and would serve Hungary and the region well. Orban has a vision to develop Hungary as a gas trading hub. Restricting imports and exports reduces Hungary’s regional potential.

The necessity to increase Russia’s gas storage in Hungary was prevalent last fall when Hungary needed Gazprom to store gas in Hungary  because it did not purchase enough over the summer months. After Hungary purchased the storage company from E.ON in 2013, the new owners in their first year were waiting for market participants to fill up the storage. With the Hungarian energy system already running a huge deficit, and the Hungarian government slapping taxes on everything from coffee beans to maintaining its 27% VAT,  the country is hard pressed to pay for gas.

One of the key outcomes of the recent Putin-Orban deal was Hungary now only pays for stored Russian gas once it is used. This means Hungary does not need to pay for gas sitting unused in its storage facilities. Security of its gas supply is now handled by the Russians. This is important, as was the case this past year, where Hungary had expensive Russian gas sitting in its storage while the hub price next door in Austria was significantly lower. This may be one reason, the HAG interconnector has a stuffy nose.

This agreement for storage between Putin and Orban also validates my previous argument explaining why Hungary stopped gas shipments to Ukraine and was not able to fill-up its storage during summer. By September 2014, it was clear the Hungarian government needed Moscow’s help. Thus the gas storage deal was struck in September and shipments to Ukraine blocked to make way for the deluge of Russian gas into the Hungarian gas system – or so the official explanation goes. (Coincidentally shipments stopped after Orban met with Gazprom CEU Alexei Miller in September 2014, previously I gave Orban the benefit of the doubt, no longer).

The agreement over flexible storage amounts and timing of payments is also reminiscent of Ukrainian dependency on Russian gas. In the past, Ukraine’s inability to pay for gas placed it under the thumb of Moscow. When Ukrainian political leadership changed, it also meant a significant price increase  for the European friendly government. The new flexible agreement with Putin and Orban further opens the way for any post-Orban political era – which the Hungarian people are beginning to contemplate. Future gas negotiations will need to occur in 2019-2020, time enough to check in on Hungary to see how well Paks is progressing (the start of construction), gas price shifts, Hungary’s stance on EU energy integration, and after the 2018 elections.

The impact that Orban’s embrace of Russia is already apparent. Neighboring Slovakia is planning EuStream which seeks to build an interconnector with Romania and routing the gas via Bulgaria to the Southeast market. This avoidance of Hungary goes against Hungary’s historical attempts to unify both the CEE and SEE region into a tightly integrated gas market. In 2007, Hungary’s MOL took the initiative in its New European Transmission System (NETS) to lead the way. I personally sat in one of the first meetings and it was clear while MOL was taking the lead, it was political resistance in the other countries that held back the concept.  Now we see Hungary attempting to maintain its political control and influence over the region, with neighboring states planning to avoid Hungary.

The pipelines leading into Hungary from Austria, Slovakia and Ukraine, under current operations, should be viewed as strongly influenced from the strong friendship that exists between Orban and Putin. It is apparent from many of Orban’s public statements that he views Hungary being under the tutelage of Russia. Despite calls that Hungary’s energy sovereignty must be protected at all costs. The cost is a battle with the EU over Hungary’s low energy prices, not with Russian energy dependency.

Quixotically, the result is reliance on Russian gas and nuclear technology. The definition of ‘sovereignty’ in recent history holds its place in the last great international relations era when the Soviet Union existed. Thus for this argument of energy sovereignty to even make sense, it must be defined as energy dependence with political and economic sovereignty at home. Unfortunately, if we look at Ukraine, not only have they lost territorial sovereignty, political sovereignty was violated when Russia increased their gas price as retribution for being EU leaning.

When Orban speaks of sovereignty he speaks of his own political sovereignty – retribution will come for new political leadership not aligned to Russia. Putin’s pipeline’s are no longer just transit pipelines.  Hungary maintains energy security restrictions on the HAG, flips on and off the tap to Ukraine, and has technical difficulties with getting its interconnector up and running with Slovakia. All these align with Russia’s aim of restricting regional gas flows. In the past I have usually given Hungarian authorities the benefit of the doubt on these technical matters. Sometimes, it is good to question authority.

The Message: Orban left Europe

The stern and cold messages sent by both Chancellor Merkel (before Putin’s visit), who didn’t know what to make of Orban’s admiration of ‘illiberal democracy’, Polish Prime Minister Ewa Kopacz who held, “honest and difficult talks” with Orban (after Putin’s visit), Slovakia routing neighboring pipelines around Hungary, Romania’s intelligence chief considers Hungary untrustworthy, and Ukraine invites the regional heads of state for a commemoration, but not Hungarian, these all send a clear message: Orban cleaved Hungary from Europe.

The European project founded on energy security and dependency is firmly rejected by the current Hungarian government. All European energy systems are nationally focused, but only those systems most open to corruption and voter manipulation, like the case of Bulgaria or Ukraine, firmly reject integration, transparency, and cooperation with neighboring countries. The European energy system pushes market transparency and integration in the pursuit of prices that sustain and develop the energy system.

In contrast, secret middle of the night nuclear deals, opaque financing of energy utilities, state controlled pricing, coincidental limitations on imported gas,  all underpinned by a hotline friendship – with a leader of a country that formerly occupied your own country, and  just invaded your neighbor, but who gave you some ‘cheap’ gas, to help your politically controlled energy system, reads like a Russian novel, with things never ending well for the main characters.

On top of our Russian novel,  none of Orban’s actions can be labelled as energy sovereignty. Rather, as we can see from Ukraine, energy dependency creates political instability, under investment in the energy system, corruption and the maintenance of a political distance from Europe. Stepping out of Russia’s line results in swift reprisals.

February 17th, 2015, Orban was the lone man out in Europe for opening Hungary to Putin.  The pursuit of cheap gas, the rejection of Europe’s new Energy Union and embrace of a former occupier signals Hungary’s political, economic and energy dependence on Russia. This new relation is dependent on Hungary’s nuclear power deal withstanding EU scrutiny, sustained ‘cheap’ Russian gas and Hungary threatening to block EU diversification efforts  through the Energy Union.  Hungary stands with the opaque political governance model of Russia, not the transparent governance model of the EU.

Nonetheless, as Hungary’s long history shows, the Hungarian people do kick the Russians out. The price Orban got for gas is already too much for most Hungarians.

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References:

^LaBelle, Michael, and Atanas Georgiev. “The Socio-Political Capture of Utilities: The Expense of Low Energy Prices in Bulgaria and Hungary.” University of Eastern Finland, Joensuu, Finland, 2015.
 *Felsmann, Balazs. “Winners and Losers on the Liberalized Energy Sector in Hungary: A Co-Evolutionary Approach.” Budapest, 2014.

A strong Hungary is Independent from Russia, not from EU

We have a date. January 1, 2015 when the gas can start to flow from Hungary to Ukraine. This according to reports from a meeting held between Hungary’s Prime Minister Viktor Orban and Germany’s Chancellor Angela Merkel. Hungary needs until then to keep pumping gas from Russia, through Ukraine into Hungary – thus it can’t do any reverse flow to help the Ukrainian’s out.

I think I was too charitable on a piece I published a few weeks ago about Hungary suspending gas to Ukraine. I said this would only take a few weeks – this assumption was from earlier reports stating this was the time needed to ship gas to Hungary.  Magically, that’s not the case. I always try to take the conservative view and be generous to the Hungarian position, but I see this may result in under emphasizing Hungary’s dependency on Russia.

The gas that will be shipped to Ukraine in January 2015 will come via the new pipeline with Slovakia – which Orban emphasized will need to be non-Russian gas. Although, it remains a question of why the current (artificial) arrangement of gas coming from Austria being shipped to Ukraine does not work. Mind you, it is hard to separate gas molecules, so it becomes a technical (or even a slight-of-hand) question of who’s gas ends up in Ukraine. If Hungary is stopping reverse flows to Ukraine for this long of a duration, to accept Russian gas, then the capacity used should be reduced in order to facilitate west-east reverse flows. But apparently, this was not part of the deal between the Russians and Hungarians.  This longer duration amplifies my earlier comments of Hungary being constrained by the Russians.

The question remaining unresolved is whether Hungary is punishing Ukraine on purpose, or the Russians  forced Hungary to stop  assistance to Ukraine. Since my last article I’ve had conversations with people that brings up this dilemma, but my original analysis still stands. In either case, significant explanations must be given – beyond putting Hungary first, as claimed by Orban, as to why Hungary does not assist Ukraine.

If my assumption in my first article on Hungary still stands, a financially weak Hungary is dependent on Russian good will, then the EU must shape its internal policies to account for Hungary being in the Russian camp.

I recently was asked by a Hungarian official why everyone thought Hungary was doing what Russia wanted in the EU. He simply refused to accept this and viewed Russia as a threat to Hungary. I have no doubt his comments and belief were genuine. However, there are two levels of cooperation with the Russians. The first is ‘positive’ in building an energy system. This includes South Stream and expanding Paks – both highly promoted by the Orban government. The second level is ‘negative’ and actively works against EU positions. This means punishing an enemy of Russia (Ukraine), in both of its support against sanctions on Russia and cutting gas off to Ukraine. Since this is the case, it is fair to ask how Hungary is meeting its EU commitments. Because at the end of the day – the Hungarian people still view the EU as a more positive partner than Russia. Thus it is the Hungarian government that pursues, for its own agenda, alignment with Russia.

But even if we consider there is a grey area in Hungary cutting off gas to Ukraine, the main question is whether Hungary was forced into this position, so Russia could advance its position in an EU member state, or does Hungary have another agenda in using its gas and its interconnector pipelines for political and economic ends? In either case, the position Hungary has taken projects weakness and not strength which Orban constantly promotes. A weak Hungary is a danger for both the EU and its neighbors. Its now time for Hungary to get back in line with the EU energy security policy and not be the outlier. And here is why:

If Hungary is forced/willing to use its geographic position in east-west gas transit for political and economic means what other components of CEE/SEE energy security apparatus will Hungary use to project its power? At CEU we recently had Radu Dudau from Bucharest University give a lecture of energy in the Black Sea region. He pointed out that the Hungarian government with its large holding in MOL, and its ownership stake in Croatia INA provides a leverage point the Russians can play.  Thus, if Russia can pressure and/or Hungary willingly blocks gas to Ukraine, how will other energy projects be treated by Budapest.

I think this Moscow-Budapest-MOL-INA connection was a great point. Because as Professor Dudau stated, if Russia has influence through Hungary and MOL, then any LNG terminal in Croatia, whether INA or MOL owned, becomes operationally dependent on Moscow and Budapest deals.  Thus Russia indirectly controls the gas market in the Southeast and in Eastern Europe. Any efforts to build gas independency from Russia is thwarted because Moscow has leverage in Budapest which is willing/forced to accept how the network and the Croatian LNG terminal operate. Russia has been actively seeking to secure control in Croatia’s energy sector for years, and now it may have a willing partner.

It may be more profitable for the Hungarians to  be reimbursed by Russia for any LNG losses (or preventing it being built). The huge debt Hungary is taking on to expand Paks nuclear plant with the Russian loan, already places Hungary into a weaker position.  Russia can leverage this over Croatian LNG. In addition, the constant drive for lower electricity and gas prices in Hungary only feeds the country’s vulnerability to Russian influence. Hungary is dependent on cheaper and cheaper gas to keep consumer rates low. To get lower rates, it becomes more servile towards Russia to get it. Not the strong and proud Hungary Orban claims is being built. The emerging energy and economic weakness of Hungary undermines attempts to increase energy security and independence from Russian gas.  All of the southeast and eastern Europe are exposed to Russian influence through Hungary – if Hungary chooses to support Russian policies in the region. The gas wars can spread beyond the Russian/Ukraine border and enter the EU. I believe this has already happened. Hungary needs to resume gas exports to Ukraine, and stop supporting Russia’s position.

20141012_093247_lesvos2

As a concluding note (because this is very cool), I’ve written this in Lesvos, Greece while at the University of the Aegean. I’m looking right now across the Aegean Sea to Turkey. I can see it on the horizon. A revised Nabucco is essential for breaking the Russian grip. The EU needs to be very clear in sinking South Stream and building alternatives to Russian gas. Both Turkey and Greece are essential in making this happen. But more importantly, a strong and independent Hungary is the most important. It should be made very clear to the Hungarian government, just as my Hungarian acquaintance told me, that Hungary does not serve Russia. It is up to the Hungarian government leadership to ensure its independence and alignment with EU policies. Being a good neighbor would be a good first step to rectify poor policy choices. Let the gas flow to Ukraine!

 

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.

 

 

Hungary is a Russian Gas Fuelled Grasshopper Biting Ukraine

This post is also available on Natural Gas Europe. But with a more professional title.

Just as surely winter comes every year, so does the heating season. However, if the justification from Hungary’s TSO, FGSZ is to be believed, they need to stop gas shipments to Ukraine to prepare for this winter. The Hungarian Prime Minister, Viktor Orban appears to be the grasshopper in Aesop’s fable. The Grasshopper and Ant story is about a grasshopper that plays all summer while the ants work – in preparation for winter. Well, in the cartoon version, it only takes the fall leaves to be blowing for the grasshopper to get cold and regret that he didn’t work harder. In our version today, it is the Hungarian government who didn’t work hard enough in the summer. Although on a state radio news broadcast last Friday night, Orban was credited with ensuring the country has enough gas for the winter – the announcer just didn’t mention this was at the expense of Ukraine.

If we can piece together events, on September 25th it was Naftogaz of Ukraine that suddenly found out, through an email from Hungarian TSO FGSZ, the counterpart was halting deliveries to Ukraine. Media reports imply this was after pressure from Gazprom’s head Alexei Miller met with Orban. However, I do not agree. Hungary is on too good of terms to be threatened by Russia – unlike Poland which disrupted flow for a few days after Russian pressure in September.

The reason Russia refrains from threatening Hungary is the Hungarian Prime Minister is at the forefront in Europe arguing against sanctions over Russia’s involvement in Ukraine. In addition, Orban spearheaded and flew in secret to Russia to sign a deal with Putin to expand the existing nuclear power plant. A big win for Russia to get an EU member to sign up to Russian nuclear technology. Hungary has secured a Russian loan to build the plant, despite having no discussions with the Hungarian public or any feasibility studies. Orban is in charge of Hungary’s energy policy – and representing Russia in the EU. He also pushes to restrain Ukrainian western leanings. Pushing for great autonomy for ethnic Hungarians in Ukraine matches Orban’s nationalistic zeal and his regional agenda; autonomy for ethnic Russians also matches Putin’s agenda in Ukraine. Hungary turning off the taps to Ukraine benefits both Russia and Hungary, by keeping Kiev under pressure.

Technically speaking, Hungary halted deliveries to Ukraine to receive significant quantities of western bound Gazprom gas to be stored in Hungary. The history here is on September 16th Hungary’s Development Minister Miklós Seszták received Russian deputy Energy Minister Anatoly Yanovsky. They discussed the ability for Hungary to store gas for Russia, around 500 million cubic meters. This would take 15 – 20 days to transfer into Hungary’s underground storage. In a scenario that gas flows from Russia, traversing Ukraine, are cut off then Gazprom’s gas would be available to European consumers – and to Hungary. Importantly, it helps Hungary because as of September 27th, the storage capacity was at 62%. It is, however, no accident that Hungary’s capacity is this low at the onset of autumn.

In May 2014, at an event hosted by Central European University the issue of Hungary’s ill preparedness was discussed. A now former manager at Hungary’s state owned Hungarian Gas Storage company, stated that the biggest issue facing Hungary was the low reserves and the financing of gas purchases. The reserves then were at 25% capacity. In short, money to buy gas was inhibiting Hungary’s ability to prepare for the coming winter. Therefore, the current low gas levels of 60% should not be seen in isolation. The lack of gas is a result of the lack of stable state finances for the energy sector and Orban’s energy ‘war’ waged against foreign owned energy utilities. The energy sector is now showing the stresses of heavy state ownership. The flooding of gas into the Hungarian system is at best a result of poorly managed state energy assets, at its worst, it is a calculated move against Ukraine.

Since 2010 Orban has put energy assets under state ownership and driven utility prices lower. Now, the utility sector, and particular retail gas companies, are deeply in debt, they are incurring huge losses to pay for the Fidesz government’s more than 25 percent reduction in electricity and gas bills instituted a year ago. The Orban government is now laying out a plan to have ‘non-profit’ utilities. This is hard to see how the sector can shift from horrific losses to a non-profit-chartable-status without increasing consumer costs. The cost reduction and continued nationalization of assets are set to continue.

Mike and HU energy billboard
A billboard proclaiming Hungary winning the energy war against the foreign owned utilities. This is me biking around Lake Balaton – my field research.

The story of Hungary cutting off gas supplies should not be seen as Hungary bending to Russian pressure, rather Russia is helping out Hungary. Central to Orban’s grip on elections is ensuring Hungarian’s feel benefits. Whether this is in the form of retroactively changing mortgage loans between banks and their clients – forcing the banks to payback money in cash, or buying E.ON’s gas storage unit – for energy security reasons – Hungary needs to project power and responsibility over its own fate – and at the same time, deliver cash into the pockets of Hungarians. Russia can help finance and make life more comfortable for Hungarians. Ensuring the Hungarian energy system functions is now dependent on Russian short and long term investments into the country (gas and nuclear).

Hungary needs more gas in its storage in case there is an interruption between Russia and Ukraine. Russia is more than happy to store gas in Hungary, this deal does the following four things to benefit Russia and Hungary: 1) Russia stores gas in Hungary and not in its normal location in Ukraine, giving it European market access and depriving Ukraine of the chance to siphon any off; 2) Previously stored gas was ensured by E.ON Foldgaz Storage, but storage is now owned by the Hungarian state- which lacks the funds to buy large quantities of gas; 3) Hungary boosts its gas reserves with no money down, it only buys from Gazprom if there is an emergency and needs to use it; and 4) Hungary gives the elbow to Ukraine (like it has throughout the entire Ukraine-Russia conflict) but doesn’t inflict significant pain, just cuts off gas for a few weeks proclaiming its own security as more important. Nowhere in this analysis is the assumption that Russia threatened Hungary with a gas cut-off for supplying Ukraine with gas.

Hungary could have – and should have, bought sufficient amounts of gas over the summer. Instead, the country’s leadership were playing with grasshoppers. Back in the spring or early summer the Hungarian government could have struck the same storage deal with the Russians. Instead both Russia and Hungary have waited until the last minute to unroll their ‘technical’ response to Hungary’s low storage capacity. By Russia flooding Hungary’s gas system, Ukraine is deprived of valuable and necessary capacity to help mitigate their looming winter gas shortage. In a generous reading, Hungary is an unprepared neighbor. In a bad reading, Hungary is colluding with Russia to short Ukraine of gas. Let’s hope Hungary is a grasshopper.

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.

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.

 

Hungarian Politics Torpedoes Nabucco Participation

The analysis of energy policy goes to the heart of a countries political and economic system. The statement by Hungarian Prime Minister, Viktor Orban that MOL, the Hungarian Nabucco gas pipelinepartner, was pulling out, can only be seen as a politicization of Nabucco and MOL decision making. It is no secret that Orban has a testy relationship with the European Union. But has he really removed a diversification option from the table? Despite increased regional options Hungary only perpetuates its present day dependence on Russian upstream supplies. Now Orban has thrown the country solely into supporting South Stream – diversifying to more Russian gas does not constitute noticeable diversification.

Continued on Natural Gas Europe…

Nabucco’s bubble bursts

Death is now amongst us. Stalking the Nabucco partners… watching as they each pull away. RWE is prefering to get away from the corpse. Death was not the result of a lack of gas, lack of finance or lack of political will: death came from reality. The broader social-political and economic reality that security of supply is not worth $10 billion.

Nabucco rose on the 2009 gas crisis between Russia and the Ukraine – the only viable long term option to for Southeast and Central Europe to diversity away from Russia. The timing was right for the plans and the consortium, the shutting off of gas and the impact it had on countries largely reliant on Russian gas spurred a great impetus to diversify.

Nabucco’s bubble grew with the momentum built on the concept of security of supply for Europe. For companies and governments who supported the project, their commitment and involvement meant that the momentum needed to be maintained. The competition against the Russian backed South Stream, meant there was a race occurring and neither Nabucco’s supporting companies or governments could be seen as folding to the demands – or in the face of Russia’s demands. The hot air continued to be pumped into the bubble as the company executives and politicians spoke.

But now it is done. The decision is made – now the companies and governments have to think of how to exit. I know the feeling. On this topic, I’ve had writer’s block for three months. I couldn’t figure out what was going on. In a previous post, I tried to make sense of it- tried exploring in my writing what was going on. But I just ended up with a feeble post. My friend at Natural Gas for Europe asked for something. I couldn’t deliver, was my explanation…. maybe if I had known my feelings more, I would have known I was watching my prized project – the one I invested so many hours analyzing, die. Like a football fan watching his winning team go down to an inferior team, the impossibility of it all means the mind can’t process the events. Nabucco is dead.

The popping of Nabucco’s bubble was not done in dramatic fashion. Death did not come from the lack of finance, lack of supply or lack of political support. Each of these factors other analysts have claimed would be the reason for Nabucco not to be built. I always argued otherwise; my reasoning was based on the trued concept of Earth, Wind and Fire. Man’s desire for the Earth’s mineral riches is too great, so geology (Earth), finance (Wind) or politics (Fire) could not stand in the way. My argument rested on the nonsensical argument that gas can be created, money spent with flimsy conditions and politicians can all get along. And this is all still true – Man (and I am being sexists in my use of the term) can make anything stupid happen.

The death of Nabucco was caused by a ‘holy shit moment.’ We all have these. Doubts stir, finally they emerge, not just in strong terms, but through clarity. The shift of US support in November 2011 to commercially viable projects that delivers gas to the CEE/SEE region marked an important point. While the other smaller pipeline projects were getting attention and it was ‘out there’ that these could become viable, it was all noise. (That’s all I could hear for the past few months – noise.) But now with the reduction of support from RWE, and the broader shift in the economic conditions in Europe and the world, air is seeping from Nabucco’s bubble. People and companies are ready to buckle down and see how the next few years go.  The importance of security of supply is now reduced. We are all back to comfort foods.

Death did not come about by alternative gas sourcing either. Shale gas did not kill Nabucco. Just as Nabucco went through a three year bubble of irrational discourse, so too is shale gas.  Pipelines did not kill Nabucco. There are two proposed smaller pipelines that would see the Turkish system beefed up, the Turkish and Azerbaijan TANAP project, and now the strong contender, South East Europe Pipeline project, each delivers less gas for lower cost to Europe – and from available reserves in the region. While these now appear to be commercially viable – it was never realistic that Nabucco could compete – or be built – with small capacity and a short term time horizon for payback. Nabucco was a large long-term project that was on the point of visionary –  smaller does not win in the long-term. And so Europe will not either from Nabucco’s demise. Political rationality helped kill Nabucco. The apparent rapprochement, or entrapment –  between the Ukraine, EU and Russia over the Ukrainian transit system, means that reality has also returned to the most financially viable method of transferring Russian and Central Asian gas to Europe. (Can the Ukraine afford to have South Stream built?) In an age of comfort food and ‘STOP – what’s rational?,’ then the continued use of the Ukraine for transit is also smart.

The public death of Nabucco will continue for sometime now. It won’t be fast. But for me, Nabucco is dead. South Stream, will be analyzed in a later post, but what killed Nabucco can also kill South Stream. They are the same creature. But just as one is at a loss after a death, I’ll have to search for a new way to perceive the EU- Russia gas relationship. Pipelines are so 2010’s; now we all have to understand and reconceptualize what the new energy relationship is between the EU and Russia – now the fun begins again.

 

Nabucco, and the distant love of Europe

Nine lives or no lives? That is the prospect for Nabucco.

Noise or game changing events: another round of alternative pipeline plans, the re-positioning of political actors, makes another act in the Nabucco opera either more intriguing or increases the restlessness of the audience.

Separate actions inflict little wounds on Nabucco but collective cuts may be eroding the ground underneath. Does the U.S. still fully support Nabucco? What’s the purpose and/or reality of  the new South East Europe Pipeline project?

Will there be any life for Nabucco?

All these questions lead to separate and diverse perspectives of what the future may hold for Nabucco. The doubts begin to settle in as the relationship between EU backers and the governments in the two distant regions move beyond the courting phase of their relationship and seek to build a solid gas link.

Reassessment of relations

There comes points in a long-term relationship where an assessment of what each partner wants…. is it true love, infatuation or is there a true coupling where each partner brings important elements to the relationship? Europe must decide whether it wants to develop the relationship further with the countries of the Caucases and Central Asia. The recent – warning shot – provided by the U.S. State Department Special Envoy for Eurasian Energy, Richard Morningstar should begin to focus attention in Brussels. The ‘misinterpreted’ comments that smaller pipeline projects that are more commercially viable may be better.  While the U.S. embassy rushed out a ‘clarification’ it still states that the sooner a commercially viable pipeline is built the better.

Reality or love

There are always reasons why a relationship will fail over the long term. Particularly when you put two ‘individuals’ together from two different cultures. Maybe now is the right time to review these. What are the worries that prevent countries from the EU to solidify their relation with potential supplier countries for Nabucco?

Financial:  “How are we going to pay for it?”

Distance: “But you are so far, can we really have a long distance relationship?”

Distractions: “What if you find someone else, while I’m away?”

Parental approval: “My mother wouldn’t approve” (i.e. Mother Russia)

“Your father has other plans for you.” (i.e. US wants EU to use shale gas)

Hometown girl: “Maybe you want a girl from home.” (i.e. shale gas)

Like most love story, it is the parents that get in the way. Those guardians that seek to steer their children in the right direction. Mother Russia certainly has a strong interest to insure that the EU is only supplied by Russia. The United States, is attempting to force a gas strategy on Europe – shale gas. The recent Baker Institute Study that projects a drop in European gas dependency from 27% to 13% because of the full utilization of European shale gas, has unfortunately – I believe, influenced US policy to push the EU to delay or stop the Nabucco Pipeline. Therefore comments emerge that discourage investment into Nabucco and encourage switching to a lower capacity pipeline that is commercially viable in the short term.  Pursing the most commercially viable pipeline option today does not provide the long term boost to security of supply nor provide the foundation the EU needs to have gas fill its power plants.

Multilateral and multicultural relations are at the heart of everything the EU does. Also central to the EU is the role of energy – the foundation of the EU rests on energy. Providing the will and reasoned justification for building a robust pipeline that will serve the long term interests and needs of Europe requires significant commitment today. Many of the issues that are meant to derail Nabucco are not strong enough to trump the security of supply implications that expanded gas supplies, that are not controlled by Russia, offer. Just as love can overcome obstacles, the large and abstract notion of security of supply serves as the impetus to take resolute steps to cement a relationship. It is time to stop worrying about what the future in-laws think.