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. Last Updated: 07/27/2016

No Direct Lines to a Liberalized Market

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The EU's liberalization of its energy market "may disrupt the entire system of gas security in the region," Gazprom deputy chairman Alexander Medvedev told the World Gas Conference in Amsterdam last year. His warning echoed long-standing complaints from Moscow that the introduction of competition into Europe's gas markets is undermining long-term supply contracts and encouraging new players whose only goal is to make a fast buck.

Other -- potentially less self-interested -- voices also question the central thrust of the European Union's grand project to stimulate competition in the energy sector at a time when security of supply is becoming a strategic concern.

These supply concerns have been used by countries to justify energy deals with a distinctly anti-competitive feel. France, for example, claims the merger of its energy giants Gaz de France and Suez "will guarantee the safety of our energy supplies" by creating a company large enough to stand up to producers like Gazprom. Germany argues that the controversial Nord Stream pipeline, which will pipe Russian gas directly to Germany under the Baltic Sea, will help secure Europe's supplies.

Yet it is largely a myth that energy market liberalization is hurting security of supplies. Behind the scaremongering, you can detect naked economic nationalism at work and a desire to entrench the dominance of former monopolies at the expense of new competitors.

Awkwardly for the cheerleaders of liberalization, however, it is becoming increasingly apparent that Medvedev has a point when he argues that Europe's energy market reforms are hindering investment, which is desperately needed to keep energy supplies in line with rapidly rising demand. In 2000, there was a fundamental shift in world energy markets from a period of relatively low fossil fuel prices to a new era of high prices and excess demand. The United States, Australia and Japan have all reviewed their regulatory environments to reflect this change and support new investment to balance supply with demand.

The situation is particularly acute in Europe, which is projected to face a shortage of 70 billion cubic meters of gas per year by 2012. Europe therefore needs to redesign its regulatory framework to promote investment in new production, transport and storage infrastructure, as well as encourage competition. This should include a re-examination of the two basic concepts that currently underpin EU efforts to liberalize the region's energy markets, meaning phasing out long-term supply contracts and opening pipelines to all competitors.

Long-term contracts have traditionally been an integral part of the energy business as they provide "security of demand" to the builders of hugely expensive infrastructure projects. The consortium behind Nord Stream, for example, estimates the total cost could reach 7.5 billion euros ($9.8 billion). The European Commission needs to relax its position over long-term contracts, especially in relation to new investment, to allow investors to offset some of the risk inherent in such projects.

The issue of making pipelines equally open to all competitors also needs to be reviewed. "Third-party access" is regarded as essential for new competitors to prosper -- after all, you can't change suppliers if your new contractor can't pipe gas to you. Unfortunately, equal access also discourages investment in new infrastructure, as financiers and industry fear they won't recoup their costs.

Gazprom cites the example of the TAG pipeline, which carries Russian gas through Austria to Italy, as a prime example of the detrimental results of strict implementation of the EU's gas directive on access. When the pipeline was opened to third parties, some 149 companies from 10 countries won capacity. But only a handful of these companies had gas in worthwhile quantities and, Gazprom claims, some tried to sell their capacities back to Russia at a significant mark-up. Such a situation is unimaginable with a pipeline between Russia and China, which is now competing with Europe for Russian energy exports.

Supporters of liberalization say exemptions are available on the EU directive on third-party access. But haggling over exemptions tends to delay investment as national authorities compete with one another to offer the most attractive terms and suppliers endlessly debate the regulations.

This exemption to third-party access also needs to be extended to the new interconnector pipelines the EU must build if it is to really to create an internal market for gas. The commission has been somewhat guilty of putting the cart before the horse by forcing competition onto markets without actually putting the infrastructure in place that would allow this competition to thrive. As well as developing competition, interconnections between the various national markets improve security of supply enormously because they mean an area of scarcity can be fed by one with a surplus.

The lack of cross-border interconnections is having other negative effects on competition as former monopolies buy their way into each other's territories rather than competing head-on for customers. This is illustrated by the wave of consolidation among Europe's utilities. The commission has been complicit in this process, allowing mergers which will effectively rule out future competition even if new interconnecting infrastructure is constructed.

Even more controversial is the question of strategic gas storage to smooth over bumps in supply caused by seasonal variations in demand and volatile spot markets. Such stores are unlikely to be built spontaneously in a competitive market without some state help. Experience in Britain, which has the longest history of a deregulated gas market in the EU, shows that price signals are far too short term to encourage purely private investment in expensive storage facilities.

The EU also needs to improve relations with its most important supplier, Russia. U.S. public opinion may approve of Washington rebuking Moscow for bullying over energy exports, but Europe needs to take a more realpolitik approach. Russia is, after all, acting in an entirely rational way to insist that former Soviet states pay the market rate for gas so that it can invest in future production. President Vladimir Putin is also proving much more assertive than his predecessor, Boris Yeltsin.

Europe therefore needs to speak with one voice when negotiating with Russia, rather than pursue national self-interests. Nord Stream, for example, is a German solution to a German problem. Polish concerns about this pipeline -- likened by one minister to the 1939 Nazi-Soviet pact that divided Poland -- might receive a more sympathetic hearing if it were less problematic over other EU matters.

Forging a common energy policy with Russia may be difficult, but so is managing the transition to a world where investment in energy is paramount. The EU must meet these challenges to secure the energy needs of its member states. If the EU fails, then national governments will be tempted to act alone and that would cast doubt over the future of the whole EU liberalization process.

Nicholas Watson is managing editor of Business New Europe. This comment was published in Europe's World (