Is the EU getting serious about its energy future?

On November 13 2008, the European Commission proposed the Security and Solidarity Action Plan which included, among others, three key proposals:

1. An EU super-grid to accommodate higher percentage of renewables, especially wind power;
2. “The Community Gas Ring” which allows for pooling gas supplies of EU countries in the event of gas supply disruptions; and
3. Construction of two new gas pipelines connecting Caspian and African gas networks (connections to Nabucco).

Certainly these projects highlight that EU planners have realized the urgency to diversify energy supplies, and the fact that it is time for action- not just words.

Whether these projects materialize, and when, is a story in and of itself. Some of these are recycled ideas, but this does not make them any less important or urgent. Certainly, the last two are more immediately relevant, as we are reminded by renewed end-of-the-year threats between Russia and Ukraine regarding gas-related payments and contract negotiations, which may affect gas supplies to the EU. Considering recent geopolitical developments, I will focus on the options that the EU (and by extension the West, including the US) has to secure its energy future.

A number of Russian initiatives have made it more difficult for the EU to diversify its energy supplies, at least with regard to tapping Caspian energy sources. The South Stream pipeline promoted by Russia clearly competes with Nabucco, and as the demand for natural gas softens temporarily due to the financial crisis, it will be even more difficult to proceed with both projects. For Nabucco, the most serious obstacle is the lack of gas. As Putin said, “you can only build a pipeline if you have gas to fill it”. Russia has made it difficult for the EU to obtain Caspian gas by signing more gas supply agreements. In addition to shear political pressure being exerted on the Caspian countries, Russia has a competitive advantage over the EU when negotiating deals in the region, as it has no incentive to keep gas prices down. If it maintains the gas monopoly, the European countries will have to pay any price Russia negotiates with the gas suppliers.

Under these circumstances, the EU (and the West in general) needs to launch four parallel initiatives:

1. Re-orient the Nabucco pipeline to include more access to Iraqi gas: After all, the name of the pipeline is an inspiration from Verdi’s opera “Nabucco” (the tale of Nebuchadnezzar, King of Babylon) indicating that Iraq may provide some of the gas to the pipeline. Iraq’s natural gas reserves (3.2 tcm) are of the same order of magnitude with Turkmenistan (3 to 7 tcm). If the political situation in Iraq stabilizes, it should provide significant amount of gas. Also, it will provide access to more gas reserves in other countries of the gulf (Kuwait, UAE and Saudi Arabia). Of course, stabilization of the situation in Iraq is a significant uncertainty and stability in the Kurdish region needs to be considered, but the other energy supply options are not less problematic.
   
   
2. Improve relations with Iran: It must not be forgotten that Iran provides the easiest route for Caspian energy resources to western markets. Also, Iran itself has the second largest natural gas reserves (23 tcm) after Russia (47 tcm). While I do not underestimate the issues associated with the leadership of Iran and its plan to pursue the nuclear option, geopolitical interests of the West and Iran are aligned and provide a basis for some arrangement of mutual interest. If the West does not improve its relationship with Iran, others will- and are.
   
   
3. Improve relations with Russia: Over the last few years, the relationship between Russia and the West has been deteriorating steadily. Certainly, NATO’s continuous expansion eastward has not helped and, as many experts point out, the West has missed an opportunity to offer full membership to Russia and make it part of the Western alliance. A bold move to offer full NATO membership to Russia may need to be considered. Membership to Georgia and Ukraine may also need to be postponed or packaged together with Russia’s.
   
   
4. Develop strategic technological options, such as GTL, small-scale LNG and CNG technologies:

• Gas-To-Liquid (GTL) technologies produce liquid fuels (all grades, from diesel to kerosene) from natural gas; these products are much cleaner than similar products from crude oil. GTLs are ideally suited for the transport sector, which needs to reduce urban pollution. Also, GTLs do not need a new transport and distribution infrastructure as they can be transported and distributed with the existing oil infrastructure.
  Liquefied Natural Gas (LNG) is commercially available, but more suitable to large natural gas reserves and large consumers of gas who sign long-term LNG supply agreements. This leaves many smaller gas reserves (“stranded gas”) untapped. Also, smaller users can not afford LNG. The industry started developing smaller (even floating) LNG production facilities, but this needs to be accelerated.
  
  
• Compressed Natural Gas (CNG) technologies make it possible to transport gas in compressed form, suitable for short distances. Many such markets exist including: the Black Sea region; from north Africa to Southern Europe and Turkey; from Sakhalin Islands to Japan/Korea/China; from Colombia and Venezuela to Caribbean countries and Florida/Texas; from Indonesia to SouthEast Asia, etc.. So far, the main obstacle for the development of CNG has been economics. Steel, the material suitable for CNG containers, is too heavy and project economics are not favorable. However, synthetic lightweight materials (such as carbon fiber) can be used instead. Such materials have been used extensively in the U.S. Space Program and they are in an early commercialization stage. A number of companies have started developing CNG using carbon fiber, but without government support, CNG will not become commercial anytime soon.
  
  GTLs and CNG are particularly important because they increase the transport flexibility of natural gas. All these options need some government support to go through development-demonstration-early commercialization (the “valley of death” which is typical to the development of most technologies); these are strategic options and should not be evaluated only based on short-term economic considerations.

The first three initiatives fall in the sphere of geopolitics and are clearly politically challenging to pursue. What is needed is unity among the EU countries (something that has proven challenging for the EU so far) and collaboration with the US, which shares some common interests in the region. The development of GTL, CNG and small scale LNG technologies can be pursued unilaterally. Governments need to play a critical role, sometimes by taking the lead and at other points by supporting the private sector through Public-Private-Partnerships. The time to act is now.

Ukraine, Russia: Return of the Natural Gas Cutoff

SOURCE: Stratfor Today » December 31, 2008 1745 GMT

AUTHOR: SERGEI SUPINSKY/AFP


Summary
In an echo of events that took place in January 2006, a pricing dispute between Ukraine and Russia is once again threatening to cut natural gas supplies to Europe in the dead of winter. This time, however, Moscow’s focus is much tighter. Russia is not looking to smash the Ukrainian government, but it is looking for some specific changes in Kiev.

Europe is potentially hours away from a natural gas cutoff, thanks to a Ukrainian-Russian energy dispute. Russian and Ukrainian negotiators are in a last-minute scramble to resolve a pricing imbroglio — which, is in actuality a political fight in disguise.

The situation reminds Europeans of an unpleasant incident in January 2006. A pricing dispute resulted in Russia reducing natural gas deliveries to Ukraine, which receives about 70 percent of its natural gas from Russia. Europe, however, also gets about one-quarter of its natural gas from Russia, some 80 percent of which comes through pipelines that transit Ukraine. When the Russians cut Kiev off in 2006, Ukraine simply continued drawing natural gas from the pipelines, ultimately resulting in a reduction of supplies to Europe.

The present crisis has roots in similar circumstances. As in 2006, Russia is attempting to increase the price that Ukraine pays for natural gas. In 2005-2006, Moscow wanted an increase from US$50 to US$250 per 1,000 cubic meters; now, the Russians want to increase the price from US$179 to US$418. Also as in 2006, Ukraine is deeply in debt to Russia’s state energy provider, Gazprom. Once again Gazprom is threatening a shutoff, and the Ukrainian state energy firm, Naftogaz, is defiantly stating that it will simply confiscate natural gas transiting the country for delivery to Europe.

But there is a difference in Russian motivation this time around.
In the 2006 incident, Russia was sending a threat and a broad political message. The Ukrainian government had only recently shifted away from Russia’s orbit toward the West, in the 2004 Orange Revolution. The natural gas cutoff, therefore, was as much an effort to smash Kiev as it was a message to Europe: if we have problems with Kiev, you have problems with Kiev.

In the present circumstances, however, the Ukrainian government is unstable and ready to crack. This time around the Russians do not necessarily want to destroy the government — or even get Europe involved — they just want to make sure that Kiev crumbles in the right ways.
In particular, Moscow would like to be rid of Ukrainian President Victor Yushchenko, the leader of Ukraine’s staunchest pro-Western faction, and would like to replace him with Prime Minister Yulia Timoshenko. She has been an on-again, off-again ally of Yushchenko — the two walked in lockstep during the Orange Revolution — but in the shifting, Byzantine world of Ukrainian politics, Timoshenko is now marching to the Kremlin’s drum. She is hoping to use Russia’s influence to replace the president with someone more amenable to her own goals: namely, herself.

At the time of this writing, Timoshenko was supposed to be traveling to Moscow to work out an 11th-hour deal. Using a bit of state cash and her network of allies, she had managed to come up with US$1.5 billion to pay down Ukraine’s debt to Gazprom — something that would please Moscow mightily and could serve as an excellent starting point for negotiations on the 2009 natural gas pricing structure. Timoshenko could then bring a deal back to Ukraine and use it to torpedo Yushchenko’s credibility even among his staunchest supporters.

But the trip appears to have been canceled. Sources told Stratfor that Timoshenko found her state cash blocked at the last minute by Yushchenko’s forces within the Treasury, in collaboration with the pro-Russian Party of Regions (the group that previously served as Russia’s primary tool in Ukrainian politics). Yushchenko’s motives are obvious. Meanwhile, for its part, the Party of Regions apparently is none too happy about the Kremlin’s seeming infatuation with Timoshenko, and for reasons personal and professional pulled the plug on the planned transfer.

Thus, with five hours to go, Ukraine, Russia, Yushchenko and Timoshenko are all back to playing the game — and Europe is waiting to see how it all works out.

The one bright spot in all of this for Europe is that, unlike in 2005-2006, winter has not yet been particularly harsh. Most European natural gas storage facilities are full to the brim. Europe can easily, if unhappily, weather a cutoff for up to a month. Ukraine’s political instability, of course, will last far longer.