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Energy Dependency and Russia

Two sides to the same old story…

Taking sides in political debate is difficult enough but in the context of Geopolitics it is virtually impossible. When we are treated to the caricatures of political leaders of the world’s largest nations and whilst it is easy to generalise and apportion blame, the reality of the situation is inevitably far more complex than most commentators would have you believe.

Ukraine and Russia has again been grabbing headlines in 2014, we wrote recently about the parallels with 2009 and 2006, but with the ‘maturing’ of these disputes comes further insight and information of just what has been going on behind the scenes in the cabinet and boardrooms of the respective nations and what it means for world energy security.

Gazprom, the former Russian Energy Ministry, now turned international energy company is at the centre of most commentary. The general perception is one of Gazprom being the plaything of Vladimir Putin and carrying out punitive sanctions for political and not commercial reasons.

The reality however is somewhat different. Deals have indeed been withdrawn from Ukraine with two price discounts having been cancelled this year alone. The first to go was a reduction from c$400 TCM (thousand cubic metres) to c$270 TCM and the second, a reduction of c$100 TCM in return for the strategic placement of the Black Sea Fleet on Ukrainian territory.

But the Ukrainian gas utility, Naftogaz, has a deserved reputation as an inveterate late or non-payer of its bills, driven by years of government corruption and mismanagement. It is therefore against this backdrop that Russia, and Gazprom in particular, are justifying their actions. Indeed they claim that regardless of the Ukraine/Russia conflict, Naftogaz had done enough harm to their relationship already to justify losing its privileged discounts.

Both sides agree on one thing however, the fact that Naftogaz has racked up a total $2.2bn in unpaid bills for the gas received. The reason for this shortfall is the alleged tactics of Naftogaz in selling on the gas to consumers at below market costs. A strategy that is rarely going to end well, especially when you’re buying the commodity from an external, commercial and political source.

Ukraine is demanding that Gazprom should revert to its discounting policy, whilst Gazprom is demanding payment from Naftogaz. An unlikely peacemaker in all this is allegedly Putin himself, who it is claimed prevented Gazprom from insisting Ukraine pre-pays for all its energy needs back in 2009. As we said, nothing is clear-cut in geo-politics.

Why then could the biggest ‘enemy’ also prove to be the one time saviour?

As the former energy ministry, the Russian state still owns 51% of Gazprom and amazingly relies on Gazprom’s sales for half of its state revenues. This ‘dependence’ of the Russian state on Gazprom is even more acute than the much-maligned dependence on Russian Energy in the EU.

Any impact on Gazprom’s reputation therefore from taking outwardly aggressive action against a politically sensitive customer (disregarding the payment issues for now) could have significant impacts on the Russian government’s coffers as other customers shy away and look elsewhere for a more secure, reliable and cost effective supply.

Mr Putin doesn’t need telling how strategically important Russian energy’s influence in the world market is to his seat at the top table and indeed the health of the nation.

For all that however there is strong justification for accusing Russia of being overzealous, whether it be demanding ‘back-pay’ refunding the claimed $11.4bn discounts Ukraine has received since 2009 or the removing the discount earned from the placing of the Black Sea Fleet on (disputed) Ukrainian territory.

However, in a rare piece of positive news, the prospect of Ukrainian settlement of the immediate, and undisputed $2.2bn debt has been boosted by combined support from the IMF and EU.

Crucially in return for this cash injection Ukraine and Naftogaz have been obliged to commit to reforming the energy market, and though that may lead to a thawing of relations and improving of commercial terms between Ukraine and Gazprom it is unlikely to settle the nerves of other European nations who continue to be dependent, at least in part, on Russian sourced gas supplies.

Indeed our own Secretary of State for Energy and Climate Change, Ed Davey, has led the call for an end to Russian influence on world energy markets saying:

“It cannot be right for Russia to hold individual countries to ransom. This is an issue we cannot allow to go off the table”

But the UK’s energy security issues are not a new phenomenon; the oil crises of 1973 and 1979 first raised its spectre, but the now terminal decline of the once abundant sources from the North Sea, and the abject failure of successive administrations to head off this shortfall with investment in new energy sources means that as a nation we have, and will continue to become increasingly dependent on energy imports to meet our needs.

We have talked about it numerous times before but the current government will need to tackle the issues of both demand and supply to have any chance of reducing our dependency on other nations. Whilst we may currently have little reliance on Russian gas, we have significant dependency on coal imports, with 82% of all coal used in the UK being imported, and coal itself being the single largest volume of fuel used in UK energy generation. A new wave of new nuclear power stations, a stay of execution for fossil fuels, the longed for emergence of shale gas exploitation and a re-invigoration of the potential and commercial validity of UK coal combined with more wind, solar, and other renewable sources are required with real urgency.

We have spoken elsewhere as to the fraught nature of the fracking debate, but energy self-sufficiency in the UK would require fracking on an enormous scale to tap the undoubted reserves available across the Bowland and Weald basins. But the potential of shale gas being the answer to our energy security affairs must be questioned with both the social and much debated environmental impact as well as doubts as to the long term viability of extraction and the disruption and expense of the activity. Even in the US where the shale revolution has really taken off (and been the driver for the cheap unwanted imported coal that have flooded the UK in recent times) OPEC estimates that the marginal cost of producing shale in the US is $90 per barrel compared to $10 in Saudi Arabia.

Whether we in the UK directly depend on Russian energy sources or not, the fact is that we are not as a nation in a situation where we can take care of our own energy needs and our much vaunted solutions to these problems are either unproven, expensive, overdue, politically catastrophic or all of the above combined.

Furthermore the indirect dependency on Russia as a major worldwide energy player is just as significant for the UK economy, with our major energy companies deeply betrothed to Russia, with BP and Shell enthusiastic and willing investors and partners to Russian energy.

This is one relationship dynamic that cannot be simply wished away, regardless how much our politicians would like to.

Writing in the FT recently, Donald Tusk, the prime minister of Poland since 2007 outlined his strategy for overcoming Russian dominance of the energy markets, a situation that he believes leads to a weak Europe and an unhealthy energy market.

Tusk called for “a single European body charged with buying its gas” stating the precedent of Euratom, the European Atomic Energy Community, established in 1960 for the purchasing of uranium in the EU.

Tusk said:

“Whether in coal, steel, uranium, credit or gas, the principal idea of the EU has always been to bring Europe together, deepening our security and establishing fair rules where the free market is lacking. An energy union, too, would be based on solidarity and common economic interests”

Tusk’s ideal would see the European Commission taking a lead role in all gas contract negotiations, solidarity of supply (where member states would share the exposure from any supply cut off) until such point that gas supply is assured, significant financial support for infrastructure investment from Brussels (up to 75%), a continued, long term role for fossil fuels, using sustainable methods, and supply agreements outside the EU with the US and other energy exporting nations.

The irony of replacing dependency of one kind with a dependency of another seemed to be lost on Mr Tusk. Taking a subjective view of a good dependency (the EU) and a bad dependency (Russia) is not the way forward, however palatable an option for Euro enthusiasts of integration at any cost.

The only true way for security of supply is a mature, open minded, mix of energy sources from fossil fuel, through nuclear to the newest renewable ideas. This can only be achieved with foresight, investment and real action. The continued hand wringing and hyperbole which dogs geo-political issues the world over is not helping us tackle the very real issues the energy market continues to face.

Invest now to save in the future, it is the only way to keep long-term costs down and supply secure. That’s how Russia got into its current position of dominance, and that’s how the UK can look after itself, investment and ambition on a world stage.

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