The War of Energy Independence: Central and South East Europe warms to Russian dependency

Introduction

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 overseen by independent regulatory institutions limits capital inflow to upgrade and diversify the region’s energy infrastructure.

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. 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.

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 1989 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. But the energy links remain. 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. 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.

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. 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, with 2013 seeing forced legislated price cuts building to be above 20%, 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.

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. 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:

• 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.
• Hungary’s oil and gas group MOL upgraded an oil pipeline to the Adriatic, tying the region into global oil supplies.
• Gas storage investments in Hungary
• Western interconnectors to Austria and Germany with reverse flow capability are being built or upgraded.
• Polish LNG
• Poland’s push into shale gas

Missing from these ongoing or completed projects, is the most symbolic project of all, Nabucco. 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. If Nabucco went ahead the upstream suppliers, extracting in Azerbaijan, would be tied to the political whims in the CEE and SEE region.

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. 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. 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. Politically for CEE countries, Moscow can now act as a counterweight against Brussels and its effort at professionally managed energy markets. 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. Energy (in)Dependence provides security, simplicity, political capital and limits the need for a more complex energy market to replace Russian sourced gas.

Conclusion

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.  

Michael LaBelle is an Assistant Professor at the Central European University Business School and in the CEU Department of Environmental Sciences and Policy. He teaches courses on sustainability in business and on energy technologies and policies. He conducts research on how institutions and organizations foster change to contribute to a low carbon future. Dr. LaBelle is a member of the Atlantic Council’s Emerging Leaders in Environmental and Energy Policy Network. His blog is energyscee.com.