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March 28, 2011

APPG Event: External Policies in Europe: The Energy Dimension


By kind invitation of Damian Collins MP, The All Party Parliamentary Group on Transatlantic and International Security was pleased to host a discussion with Philip Lowe, Director-General for Energy, European Commission.  Mr Lowe set out an overview of the external policies of the EU as related to energy, explored the inherent issues and challenges and offered his views on the policies the EU is pursuing to ensure a secure and sustainable supply of energy in the 21st Century.

There is virtually no country in the world where energy is not now front page news.  Energy is front page news for a number of reasons: is it likely to be cut off?  Is it likely to be more expensive?  Is it sustainable?  Is it really contributing to containing climate change?  And, to what extent is industry dependent on energy?   The reality is that supply and demand for energy in the world is pretty tight.  And it is going to get tighter and tighter.

People talk about liberalising markets, as they used to do in the 80s and 90s.  You can liberalise the aviation sector and get cheaper air tickets because people were prepared, very foolishly you might say, to invest in aviation.  In mobile telecommunications too, costs have been driven down by technology; competition.  So, there was a sense in which everyone was arguing in the 80s and 90s that if you only had more competition in the energy sector, you would also have lower prices.  Yet, the reality of things is that the energy market, as I said, is very tight.  The most you could do to bring competition into the market would be to actually contain what would be an underlying rise in the pressures on price throughout the world.

In the 2009 gas crisis, the situation was slightly better than the previous crisis of 2006.  But in the middle of Europe, particularly the Balkans, there was a severe restriction of supply.  Memories of households in the Baltic area, the Balkans and Central and Eastern Europe are pretty clear about how unpleasant it was to be at home, or work, without gas.  That is one illustration of how serious security of supply is for Europe.  Of course, you can imagine what that means for Europe as a whole given that this continent including the UK and Ireland is increasingly energy dependent in terms of oil, in terms of gas and in terms of coal.  Days when you could actually look at the energy balance of Europe and conclude that there was sufficient indigenous production are long gone.  We are, in fossil fuel terms, very heavily dependent on outside suppliers.  Oil is a global market and is victim, to a certain extent, to the volatility of oil prices.  Some people say that the oil price has permanently gone up due to the Libyan situation; I do not think that is the case, I think the price has gone up because of the market sentiment in relation to the Libyan situation, but the actual amounts concerned are not significant enough, even in Italy to merit a serious concern about security of supply.

The US, two weeks ago, proposed releasing strategic stocks in order to lower the price to which the European reaction, together with a number of other countries, was to point out that we should only release strategic stocks when we have a genuine interruption of supply, not just to lower the price because when we go into lowering the price, we will be there forever.

Japan, too, is another instance of fragility in the market because at least in the medium term, you will see a diversion of supplies of gas into Japan as a result of the closure of nuclear capacity.  It is reckoned that about 50 percent of the shortfall in Japan’s energy balance will have to be met by gas.  On the other hand, the Japanese economy is not capable of absorbing that amount of gas yet and it is interesting to note that even in Japan which is supposed to be one country, there are two transmission networks which are completely separate from each other.  The problems of security of supply may look rather fragmented Europe compared to the rest of the world, but in Japan, if you look at the energy pipelines and networks in the US, you will find a similar degree of fragmentation between different states and networks.

I have mentioned the gas crisis in 2009, the Libyan situation and the longer term situation in Japan, but what is the basis for energy security, looking forward?  Well, in Europe, I refer to the three major aims of policy.  Firstly, we must make sure that our supplies of energy are based upon sustainable sources, which means moving towards a low-carbon economy.  Secondly, we must ensure that there is security of supply with close attention to solidarity, interconnection, storage capacity, and diversification which is not very popular as a term in Moscow!  In Russia, they prefer to talk about diversification in the sense of diversification of routes.  They highlight the transit countries of Belarus and Ukraine as the source of friction in energy trade between Russia and Europe and therefore strain to underline their own reliability.  Hence, when they talk of diversification, they talk about building new routes, such as the North Stream and South Stream, whereas when we talk about diversification in Europe, we talk about diversification of suppliers.  There have been big moves to exploit the relationship, already existing in oil, but that could exist in gas with Azerbaijan, and potentially could exist across the Caspian with Turkmenistan.  You could add to that, the possibility of bringing, at some stage, Iraqi gas into the Turkish system and through the Nabucco Southern Corridor into Europe.

There are various nuances, or at least variations on the theme of the Southern Corridor and diversification of routes and supplies.  For example, the Greeks and the Italians would like to see pipelines not just going to the gas hub of Baumgarten, but also down through Greece and across through Italy.  That is an interesting concept.  Whatever happens, from an EU perspective, we will need the pipelines through the Ukraine for the next 7 to 8 years.  That is equally true from a Russian perspective.  We both need the Ukraine to do the necessary to make sure that the infrastructure is solid enough to take the volumes which it has been taking in the past.  But the infrastructure is in desperate need of renovation.

From the Ukrainian point of view, it is obvious that they would want to prove that their infrastructure is sufficiently reliable and that their regime is sufficiently reliable in terms of regulatory framework and commercial framework so as to negate the need for Gazprom to build South Stream that big and the need for the EU to build Nabucco that big.  I think one has to be pretty cautious about it, because for the moment, the Ukrainian partners are not sufficiently aware of the challenge and the danger of losing that business in the longer term.  Mr Miller of Gazprom has proposed the “ideal” solution which is that he and Gazprom take over the Ukrainian gas company; an idea that we are not very keen on!  I do not think the Ukrainian government is either.  In any case there is one thing which is common to all three partners and that is the next 7 to 8 years before Nabucco or South Stream come live.

The other very interesting aspect to look at, in terms of gas, is that when you find that a market develops globally, security of supply becomes less of a problem because you are no longer reliant on one source of gas.  In 2006 and 2009, the dominant source of gas was pipeline gas from Russia.  Today, the dominant source of gas worldwide is LNG.

The traditional indexation in Europe for gas pricing has been linked to oil.  China insists that gas is indexed to coal which explains a great source of tension with the Russians who are unsurprisingly unwilling to accept the lower price that would come as a result of linking prices to coal.  Since the discovery of shale gas and the abundant investment in LNG in the Middle East, the spot price for gas has diverged hugely; sometimes up to 4 to 6 times less than the long term contract price for pipeline gas from Russia.  That has lead to considerable amounts of pressure on Gazprom.  I think Gazprom officials would say that this is only a short term phenomenon and that the spot price will come back, but I do not think that that is the middle of the road view in the gas industry.  Gas experts would say that there has been a structural change in the market and that there is much more gas to gas competition and therefore, even for long term contracts, where you would expect to see some premium, in order to get security of supply, you will probably find that the indexation will be partly linked to oil because there is fundamentally a commonality between them, but also to an index of one of the major gas hubs, either in the US or in Europe.  That will also lead to some conversion between long term prices and spot prices and that is combined with the need for those who are supplying gas long term, to look again at the precise conditions inside long term contracts in terms of take or pay.  The conditions have been pretty punitive up until recently, but due to the pressure of the market and LNG in particular, there has been some welcome movement in those conditions.  There will always be some argument for oil being included in the index, but it will not be the only argument.  Also, both from the supply point of view, as well as the buyer, there is a good argument for more flexible conditions on take or pay.

Unconventional gas may also widen the potential source base.  Attempting to replicate the success across the Atlantic in the US, plenty of US companies are now exploring parts of Poland and Lithuania for shale gas.  There are quite a lot of reserves in the Ukraine and Kazakhstan too.  I am not sure that from a security of supply point of view, or from a low carbon economy point of view, we are that enthused about this, but why not investigate shale gas in Lithuania and Poland?  It is connected to longer term story about gas.  Gas is probably the most attractive commercial option for the moment for the next 15 to 20 years.  Maybe some shale gas could be exploited over that period.  After that period, we need carbon capture and storage (CCS) for gas if we are going to meet low carbon economy targets.  For Poland, it has a very high dependency on coal, indigenous coal and imported coal, so Poland in any case needs to develop CCS for coal.  But, of course, Poland is not a desert and there are populations above the kind of geological structures which hold shale.  So there will be quite a lot of environmental concern about developing shale in Europe because the conditions are quite different to the open spaces of some of the US deposits.

A lot of people say that despite LNG and unconventional, that there is still a big security problem for Europe because all the gas which is there now will be needed by China and India.  Well, that could be true, except that Qatar for example has got a capacity now operational in LNG which is equivalent to the entire annual needs of India and China for the next 10 to 15 years.  So there may be a problem coming up, but not necessarily for Europe straight away.  The Russians would dearly love to sell more gas to China and India, but China does not like the price of Russian gas and so the gas to Europe via pipeline is still, for the Russians, the best option, even though it is competing against LNG elsewhere.  Security of supply certainly means reserve stocks.  We have now, in Europe, a regulation that makes sure that member states keep strategic stocks of gas and also share them in the event of an emergency, but in the end, do we have an open capacity of market which allows everyone to amend those supplies in a way which will benefit?

Now, that brings us on to the third aspect: competitiveness.  The issue of creating a competitive market in Europe is also connected with security of supply.  There is one clear and growing consensus: it is better to run energy markets on a larger scale than on a smaller scale.  It is better, for example, if you want to integrate a lot of renewable energy into your network, to be able to balance it across that network with renewable energy from other areas, whether it is wind or solar.  The wind does not blow every day, nor does the sun shine.  So if you have a bigger network, with wider meteorological conditions, you are more likely to have better security of supply but you are also likely to attract new entrants as the price goes up.  If you look at the price differentials in Europe today in gas and electricity, it is absolutely striking how prices are significantly different; 25 to 30 percent sometimes.  It is only in recent years that electricity prices in northern Europe have equalised across the network.  For the first time, we have actually found something in Europe which is cheaper.  Not political Europe, but economic Europe.  The continent of Europe, if it manages its energy and invests in its energy networks and pipeline, will have lower costs and better security of supply.

If you look at the pipelines across Europe in oil and gas, they all run east to west.  We managed to get through a lot of legislation to buy and sell gas with reverse flow so that the gas does not have to move backwards, but you can sell it backwards if you need to.  You are managing, like you do oil tankers in the middle of the Atlantic, to buy and sell gas like that now.  But, in order to really make the networks effective, we need some north-south connections in gas to remove the energy islands which exist in the Baltic and in the centre of Europe and to create that space for more competition and more open markets.

I would now like to emphasise what the major priorities are for us in Europe in the light of these challenges that I have discussed; energy security, competitiveness and sustainability.  First of all, the obvious thing, in terms of energy security, is to make sure you actually use energy efficiently.  I think it is unfortunately one of the subjects which gets paid lip service to but less done about it.  But it is the cheapest way and the most competitive way to achieve energy security.  If you think about even buildings like this one, the House of Commons, and the EU Commission buildings, they are not always the most efficient.  40 percent of energy is consumed in buildings.  If we could just double the rate of renovation of major buildings and turn them into nearly emission buildings, we save a huge amount of energy.  Also, if we go into products and look into the ones that are energy efficient and also the ones that are inefficient and raise the standards, we can do an awful lot of things for energy security.  That may seem to be far away from Japan or Libya or even the global energy markets, but I assure you that energy efficiency is the top priority everywhere in the world, whether it is from President Obama’s office, or anywhere else, this is the area that is the easiest to tackle because it is in our control to do it ourselves.

The second thing is to build an incubated market where it is possible to buy and sell gas and electricity across the networks and to balance the networks easily.  We need to make sure that consumers can use energy most effectively, that means building in things like smart grids and smart meters so that people can understand what they are paying for.  It also requires companies that are selling energy to behave as if they are trying to satisfy their customers, rather than just satisfy their shareholders.  We get plenty of complaints about regulations and the hits to their own profits from energy CEOs, but I would like to have a queue of energy CEOs coming to me to say that they are really interested in competing against each other, which is not always so clear.  Supporting technology and innovation is absolutely essential for this, particularly for renewable technologies.  But on the external side, I have mentioned first of all that political Europe, the EU, is not necessarily the right profile for the economic Europe of the most efficient energy market.  The more we are able to integrate in some of our neighbours, the better.  This includes North Africa, in the longer term, where there is a huge potential for solar power, not only for indigenous purposes, but for export to the EU.  This makes more sense than Germany and Austria putting so much investment into solar panels on barn roofs all over Germany, where it is not always that sunny.  At the same time as massive potential in North Africa, there is massive poverty which is not being tackled.  Hence, there is a big theme for us there in market integration with neighbours.

Clearly, we have to go having a very stable relationship with our major suppliers, in particular, the Russian Federation.  Russia has been a reliable supplier to Europe.  It has problems with its transit countries and has had problems in adapting to the market economy which had governed the internal market in the EU and will continue to do so.  But they are getting used to it and they are getting better at it.  They are actually quite competitive.  We also have to make sure that we move all the European nations in committing to carbon economy.

Finally, a word on nuclear power.  The EU started off with the European coal and steel community with the aim of combined use of coal and steel, a single market, and also with the Euratom treaty.  The Euratom treaty does not actually give the EU any specific powers exclusively on nuclear safety.  What it does give us exclusive powers on is actually ensuring that nuclear material used in the EU is totally accounted for and is totally safe and that there is no danger of proliferation.  To reflect the importance of this issue, I have 550 people working for me; 330 are nuclear inspectors.  They happen to be safety experts as well, but they are mostly concerned with finding out what happened to every single piece of nuclear fuel through the whole process from start to end.  But, at the same time, we have in the Euratom treaty, the power to translate standards which are established internationally for safety into binding legislation at the European level.  Here, we come to the implications of nuclear safety problems in Japan.  It proposes that we now go through stress tests on the 143 nuclear reactors in the EU.  The heads of state agreed to that last Friday and the commission and the nuclear regulators in each of the member states will now establish some common methodology for those stress tests to take place.

What will they be about?  Well, we need to explore what happens if there is flooding.  We must consider what happens if there is a cut off in electricity supply.  What happens if there is a failed solution for cooling?  These are the sorts of things that need to be looked at and by the end of the year we are to produce a report and a recommendation on these issues.  There are two aims of that.  Firstly, we must have the highest safety standards in Europe as an aim in itself.  But also, the fact is in Europe that public opinion is totally divided.  There are at least 10 countries in Europe which are totally and utterly committed to nuclear as part of their energy mix and even the latest events will not change that.  This is partly because of energy security reasons, not just in France but also in the Central and Eastern European countries.  Secondly, 40 percent of nuclear plants in Europe are actually on the coast and another 10-15 percent very close to their neighbours.  Belarus, Russia and Turkey are planning new nuclear plants very close to populations in the EU.  This is why there is an element of trying to get stress tests transparent, shared by everyone, restoring confidence between member states and restoring confidence for public opinion as a whole.  So it is not for or anti nuclear.  It is about providing the best environment.

Linked to the stress test concept is the safeguarding of our energy infrastructure more generally.  The EU is currently not doing enough on infrastructure.  We have underinvested in networks significantly over the last 20 years.  There has been a lot of emphasis on lower electricity prices, but the cost of that has been not to look at investments over the cycle.  Combine that with the need to invest in infrastructure to integrate renewable energies and combine it too with the reality that if you want to have smart consumers, businesses, and households, you have got to give them smart information.  So, we need to modernise the grids and there is a big bill for it – we have estimated around 1 trillion over the next 10 to 15 years.  Of course, there is, like there is with designing a nuclear plant, a risk assessment to be made of what are the chances of a solar storm or other types of disasters.  The design of that plant needs to take that into account.

I would also like to mention the issue of joint management of upstream projects like gas exploration and the concept of public financing for these projects.  Whether or not there is public money in these projects, there could be a competition problem.  If, for example, the two major competitors in one particular country get together to exploit new reserves upstream somewhere and then jointly sell the same gas downstream, they are actually going to create a situation where they remove effective competition from that downstream market.  There is no need for that to happen, because if you have a riskier investment upstream, normally speaking you have to share that risk among a number of people who could be competitors.  What is important is that they do not sell the gas on the wholesale market, downstream jointly.  Unless of course they have a very small market share on the market concerned anyway, in which case, it may be a good thing that they bring in new reserves and challenge the incumbent.  If you put public money, whether it is national or European in to one of these projects, you can say that it creates a distortion in principle.  But it may be a positive distortion.  We have to believe that without this money, the project would not go ahead, or would not go ahead as quickly.  At the moment, Europe has actually put money into Nabucco and also into one of the Italian/Greek projects.  They are both competitive in principal and it would be ideal if they were both in the same project.  But I do not think that that is a major problem of competition; that one project or the other is financed.  There must, after all, be a justification from a public policy point of view.

In regard to the 20-20 goals, two of those objectives were binding; renewables and the reduction of emissions by 20 percent compared with 1998 and by 80-95 percent by 2050.  These two goals are going to be achieved and in regard to the second, the UK looks set to hit 25 percent or more.  This is mainly because economic gross has gone down, but also because of all the measures being put into place.  The objective on renewables at a European level is also going to be achieved.  Denmark, Spain and Germany have invested massively in renewables and Sweden and Finland have a very high percentage of biomass which is also renewable in their mix and they are expanding it.  Overall, that objective is going to be met.  The UK is, in that sense, lower down in the league, but it has always argued that it is on a different trajectory.  There are, of course, some eminent academics in the UK who argue that the renewable target of 15 percent for the UK by 2020 is a distraction because the pathway to 2050 will be lower getting in higher by 2030.  The big thing which everyone is terrible at is energy efficiency where even on the basis of present national and European policies, we will only get 10 percent saving compared with projections in 2020.

This is why we have proposed a European energy action plan where we acknowledge that member states do not like binding targets for energy efficiency, but try to propose what we do if we add up all these figures and we find we have to reach 10 percent more generation capacity.  This is a huge amount of investment, so would it not be a good thing for us all to reach that 20 percent and even further?  So what we have actually proposed in our energy efficiency action plan is to have much higher requirements on public procurement on buildings in particular and products for energy efficiency.  As far as the targets at national level are concerned, if in 2013 it does not look as though we are going to meet the 2020 targets, we will propose binding targets.  Now, what does a binding target mean?  It really just means that there is a lot more public pressure as well as some legal pressure on the member state to do something about it.  I think, for energy efficiency, the irony is that most member state governments realise that this is the cheapest way to deal with their energy problem.  So why don’t they get on with it?  Then we can stop the arguments about whether these are binding or not at a European level.