Pázmány Péter Katolikus Egyetem
Bölcsészet-és Társadalomtudományi Kar
Nemzetközi és Politikatudományi Intézet
The Third Energy Package and its Effect on the Energy Relations of Russia
and the Baltic States
Rácz András Árok Norbert László egyetemi adjunktus Nemzetközi tanulmányok MA
Budapest, 2014.
3
I. INTRODUCTION 4
II. THE EUROPENISATION OF THE ENERGY POLICY OF THE EUROPEAN
UNION 6
II.1 The starting point - the consequences of 2006 and 2009 Ukrainian-Russian gas
crises 6
II.2 The disintegration of bilateral relations 8
II.3 The antitrust case against Gazprom 11
II.4 The liberalisation of the energy market 14 II.4.1 The content of internal energy market 14 II.4.2 The Third Energy Package 17 II.4.3 Debated points and controversial issues 19 II.4.4 Creating infrastructure: the BEMIP 21
III. THE BALTIC STATE’S VISION 25
III.1 Setting the scene – current status of the gas energy market of the Baltic States 25
III.2 BEMIP: a feasible solution? 34 III.2.1 Gas storage facility 34 III.2.2 GIPL, LNG market 35
III.3 Price setting 39 III.3.1 Gazprom’s new contractual portfolio 40
III.4 The Baltic State’s strategy in practice 45
IV. CONCLUSION 50
V. SOURCES 52
4
I. INTRODUCTION
The contemporary EU energy policy has been under a formative period in the previous
decade. The most determining changes emerged in the gas sector of Europe. As a result of this
process an increased Europeanization emerged where the emphasis in the agent – principle
relationship moved towards the European Commission (COM) as the principle. Consecutively
the Baltic States has been undertaking a more active and proactive stance towards their energy
policy. The most basic assumption of this very thesis is that the Baltic States might enhance
their position in these new coordinates of the European energy policy. As a natural
consequence of the unique conditions characterising the energy attributes of the Baltic States
we will situate the behaviour of Russia and Gazprom in these coordinates.
In this thesis we undertake a unique approach to the Europeanization through the lenses of the
Baltic States. In the corresponding literature various aspects of the Europeanization has been
elaborated. One broad field brings under the scope of investigation the Europeanization as the
process of norm internalisation. By definition represented by the other set of scholarly
literature the Europeanization is being assessed as the Member State’s (Ms) proactive agenda
setting behaviour so that the EU norms serve the objective of their national energy policy.
This approach involves such concepts as ‘solidarity building’. The approach that is of our
pledged interest is the agent-principle relationship where the Commission undertakes a
proactive stance. By further elaborating this broad concept we aim at a new assessment: How
a state can use indirectly the means of Europeanization in order to fulfil short-and medium
term objectives other than the most profound aim of these legislations. The end-time of our
investigation was the end of February, 2014.
Our hypothesis being tested in this very thesis is that in a disadvantageous position can
advocate in an enhanced way certain policy objectives. In line with these, disadvantageous
position is being conceptualised as a high dependency rate on a foreign supplier at the same
time being isolated from other markets. In order to reach the testing of this hypothesis a broad
set of questions needs answer to:
1) The broadest question is what are the elements of the modified agent-principle
relationship? What kind of policy changes and dynamics prevail in the landscape?
2) How does it affect the position of Gazprom and in an interrelated way Russia?
3) How can we assess the position of the Baltic States in this regard?
4) Based on the assessment which options are available from the broad set of tools of
Europeanization?
5) As a vector of the previous questions which objectives might be fulfilled?
5
6) What kind of strategy the Baltic States have undertaken in this process? Did they
engage in unified actions or choose different path on the contrary?
The scholarly literature of our analysis is of profound importance. To the greatest extent the
periodicals of the leading energy policy research institutions are elaborated in the thesis.
These include the Oxford Institute for Energy Studies or the Oil, Gas and Energy Law
Intelligence (OGEL). While periodicals are used to the greatest extent for certain economic
concepts we assess the findings of the profound energy economics and energy law textbooks.
In line with these we aim at comparing and contrasting assumptions of opposing experts on
certain issues. In order to reconstruct certain chain of actions we elaborate the corresponding
news from EU and national, English and Russian language portals with critical stance. The
basis of our investigation are the primary sources. These include EU legislative sources,
strategies and assessment reports. Parallel, where available we assess agreements and
proposals. The other set of primary sources are the various data on investment and energy
flows. This said it has to be highlighted that certain limitations are imposed on the availability
of the datasets and legislative sources respectively. While data on energy flows constitute a
fairly public set of information, investment sums, contractual obligations and draft proposals
are not made available for the public. In spite of these difficulties we aim at providing the
assessment to the possibly most accurate extent.
The thesis elaborates the gas energy market developments; as a result no reference is made to
the electricity market of the EU and related developments. We take as precondition the
concept of mutual dependency concerning the EU-Russia energy relations. In line with these
we do not intend to provide with an EU28 elaboration of the topic alongside with broad
assessment of EU-Russia energy dialogue and the partnership in general. This said
methodological limitations are posed upon the analysis of EU energy policy respectively.
Such policy developments as Renewable Energy Resources promotion, proposed Emission
Trading Scheme or the Energy 2020 impact on the national energy mix are beyond the scope
of our investigation. The geographical scope is limited to the Baltic States that are composed
of Estonia, Latvia and Lithuania. However, where it is required we make brief reference to the
broader Baltic Sea Region. From a methodological point of view we do not conceptualize the
issue of energy security as a separate entity but rather elaborate it as the starting point for
certain assumptions.
6
II. THE EUROPENISATION OF THE ENERGY POLICY OF THE EUROPEAN
UNION
II.1 The starting point - the consequences of 2006 and 2009 Ukrainian-Russian gas
crises
In this section of the paper we evolve the first part of our basic argumentation for
understanding the environment of action for the Baltic States. We support the view that the
2006 and later the 2009 gas crises triggered the increased securitization and parallel
politicization of energy relations between Russia and EU. Consecutively we encountered a
gradual disintegration of existing framework for institutionalised cooperation. Considering
this as a basis point we will come to the conclusion that the EU COM has undertaken a new
path with regard to the relations with Russia and consecutively the Gazprom. We describe this
new path as extending the internal dimension of energy market to external relations. The
concept involves on the one hand the means of the competition policy on the other hand the
means of liberalisation of the energy market.
From the dissolution of the Soviet Union the Russian Federation pursued a foreign policy that
assessed the rest of Europe as being a partner sharing the similar values. While the inherited,
historically developed energy relations and settings were recognised the two parties
scrutinized a cooperative approach.1 The developments of 2006 and 2009 marked a turning
point in the EU-Russia energy relations. The Russian issue became the most complex and
important factor of the EU’s external energy policy.2 The two crises triggered several
considerations to be revised in the EU. First and foremost the very obvious consequence
gained fundament; the Russian state is willing to exercise leverage upon the Gazprom to
comply with foreign policy goals. By the means of the Gazprom Russia has not avoided
cutting supplies to Europe. Consecutively Russia has ceased to exist as a reliable partner. In
line with these the vulnerability of Europe was highlighted. Gazprom is the leading supplier
of Europe. In this regard the interruption of gas supplies was threatening. From a technical
point of view the lost capacity did not pose immediate threat the size matters. Due to
alternative supply in Western Europe and the available storage capacity the interruption did
not have immediate consequences. However the perception of it multiplied the effect. From
this point of view the new era marked by 2006 and later reinforced by 2009 paved the way for
1 Belyi, 2009:121 2 Belyi, 2009:122
7
increased securitization, and as complementary phenomena, and politicisation of energy
relations. This was marked outstandingly by the formalization of the issue into the CFSP.3
In 2006 was issued the strategic document of the EU by the COM. The Green Paper entitled
“A European Strategy for Sustainable, Competitive and Secure Energy” marked the new
energy policy of the EU. Sustainable, competitive and secure energy was highlighted as the
overall priority of energy policy for the upcoming decades. Clearly the COM advocated a
broader perception of energy security. It is not limited exclusively to supply security but it
involves as well higher prices. The “outside threat” that brings naturally Russia into focus has
gained much reinforced ground. In line with these the Green Paper explicitly refers to
interruption in energy supply owed to politically motivated actions. It is clearly outlined by
the document that the COM dedicates more emphasised role to the means of the internal
energy market and competition rules.4 The two policy areas where the COM exercises strong
control and has considerable power. Earlier the marked year the incumbent president of the
COM José Manuel Barros highlighted as a sign of determining change in the stresses of
principle-agent process: “If I have one message for you today, it is that the external aspects of
energy policy must be seen together with the internal aspects...To have a successful external
policy, we must have a strong internal policy,”. 5
The new external policy concept was issued by the COM in 2011 and later approved by the
Council and the Parliament.6 In principle the document aims at a stronger coordination of the
energy policies of the MSs. In line with these we observe the modified agent-principle
relationship where the COM takes more initiating power in political moves. It is best reflected
in the centric concept of the paper that entails an information exchange between the MSs and
the COM. The Communication issued by the COM serves as a basis for the Proposal and later
approved legislation.7 The document lists four policy priorities. The first point “building up
the external dimension of the EU internal energy market” proposes an information exchange
mechanism upon bilateral agreements with third countries that is by definition notification of
the COM. In line with these the COM is vested in the right to ex-ante and post-ante asses
these agreements while as well might be involved into the negotiation process of the very
agreement. There is a wide range of bilateral agreements that might be subject to assessment
on the top of which are those that provide (long-term) political and regulatory backing to the
3 Belyi, 2009: 9 4 European Commission-Green paper, 2006 5 The Parliament, 2006 6 European Commission, 2011 7 European Commission, 2011a
8
commercial relationship of the energy companies (national champions) involved.8 These
contractual structures are predominant attribute of the Russian-Gazprom related agreements.
Notably, the finally Decision enacted jointly by the Council and the Parliament enlightened
this option by stating that “...Member States should have the option of informing the
Commission of negotiations with regard to new intergovernmental agreements or
amendments to existing intergovernmental agreements.”9 Moreover the Paragraph (9) of the
final decision as well underpins that “this Decision does not create obligations as regards
agreements between commercial entities”. Of course in principle it might undermine and
liquidate the profound aim of the regime.10 At the same time the logic one might elaborate
with it is more illuminating. The Decision on the first place does not specify the scope of the
rights of the COM in the process of the negotiation; these are open ended conditions. This
might result in an active participation of the COM in the negotiations. The assessment (ex-
ante and post-ante) has a wide scope as well: the process is subject to assessment from the
prospective of the competition law. We will see that these assumptions are of profound
importance of the Baltic States: it is a forceful tool in the hands of the MSs in longer term.
Beside these, the string of documents stipulate the broader security concept as well the
strengthening of the external dimension With reference to the external relations the concept of
the ‘exporting the energy acquis’ prevails. The profound idea of the concept ‘exporting
energy acquis’ is to establish a single regulatory space where based on these the directives and
the rules of internal energy market the security of supply is guaranteed. This new approach
has three profound implications. The first to create a single regulatory space by the means of
regime building. The most profound one is the Energy Community launched in 2005. Further
one, we will see in the upcoming section is the Energy Charter Treaty as a multilateral forum
being in strong relation with the EU-Russia Energy Dialogue. The third tool is the internal
application of the Energy Directives where the reciprocity principle applies alongside with
other questions related to our basic concept. The last three assumption will be further
elaborated in the upcoming sections.
II.2 The disintegration of bilateral relations
The most profound manifestation of bilateral energy relations with the EU has been the EU-
Russia Energy Dialogue. From the first half of the 1990’s promising developments prevailed
8 Van Vooren, 2012: 63 9 European Council, 2012 10 Van Vooren, 2012: 71.
9
in the EU-Russia bilateral relations resulting in the 1994 Partnership and Cooperation
Agreement (PCA). By ratifying the treaty the legal basis had been established for the Energy
Dialogue to be launched. In 2001 four working groups were set up with the prime objective to
provide the analytical basis for the further enhancement of the dialogue. Later in the same
year the EU-Russia Summit in Brussels paved the way for the main guidelines for cooperation
in the field of promotion of investment, increased energy security and boosting commercial
relations in the energy sector. The end of the first stage was marked by the adoption of the
four Common Economic Spaces on the Moscow summit to further increase the cooperation in
the field of energy as well.
The second stage lasting from 2004 until 2007 envisaged cooperative stance towards the
cooperation. In 2005 the first meeting of the high level Energy Permanent Partnership Council
was held. However the previously mentioned 2006 Green Paper has marked the new security
perception and possible change in the EU external energy policy it still vested in the
determining role into the Dialogue in general and the Partnership Council in particular.11 In
the dialogue Russia adopted a more active standpoint; President Putin stressed in his opening
speech at the G8 Summit in St.Petersburg that international cooperation is of special
importance to facilitate energy security.12 During this period the Thematic Groups were re-
organised. One group was dedicated to the short-term issues, such as forecast and strategic
planning, the second one on the market developments and the third on the energy efficiency.
The third period encountered a gradual degradation of the Energy Dialogue. One of the
primary and obvious cause underlying was the end of the PCA agreement. However the
negotiations have started upon a new PCA the end of the process is far from being in sight-
distance. Moreover the PCA itself was a determining obstacle as since the institutional setting
did not allow for the adoption of legally binding documents. The output of the Thematic
Groups and the high level meetings were solely of political content.13 For the EU it was
definitely not satisfactory. The Dialogue, as we saw previously, evolved into three specific
areas. In case of the energy efficiency considerable progress was observed mainly because the
aims on this field had complementarity in the EU and Russian domestic priorities. However
the market making section was hindered by the profoundly divergating perceptions.14 In line
11 Belyi, 2009: 122. 12 g8russia.ru, 2006 13 Van Elsuweg, 2012: 7. 14Romanova, 2012: 5.
10
with these we shall not forget that the 2006 and 2009 crises resulted in negative perceptions
difficult to repair – it had as well direct influence on the relations.15
The Energy Charter Treaty (ECT) was a subsequent milestone that hindered the further
development of bilateral relations. We saw in the previous section that the EU advocated a
cooperative and multilateral approach in until the early 2000’s. The ECT acquired a pivotal
role in energy governance being a unique example for multilateral regime building. It
stemmed from the fact that it provided legally binding provisions accompanied by Dispute
Settlement Mechanism. The ECT was signed in 1994 and entered into force in 1998. The
founding document established three legally binding pillars. The first and the second pillar
cover the field of trade where the GATT norms and provisions, like MFN, are applied to the
signatories. The strategic value of the two pillars is the regulations upon the transit. The ECT
signatories are obliged as a negative provision not to interrupt the transit flow and at the same
time to take the necceserary measures to facilitate the former. The investment pillar just as in
the case of the first two is based on the GATT norms. Investments made are covered basically
through the entire supply chain where the transparency, non-discriminatory practice and the
investment protection against non-commercial risks (i.e.: illegitimate appropriation) is
detailed. The other profound strategic value of the ECT system is the Dispute Settlement
Mechanism (DSM) that is applied to the transit (state-to-state) and the investment (state-to-
investor) respectively.
The EU and the Russian standpoint differed to a great extent regarding the international
governance structure embodied in the ECT. It is clear that the Russian government was highly
critical about the ECT for a long time. The prime consideration was that on the one hand the
ECT and the Transit Protocol can only ratified simultaneously in spite of the EU official’s
pressure. On the other hand the Transit Protocol doesn’t take into account the Kremlin’s
considerations and priorities. However few of these assumptions are incorrect – or rather
perceived wrongly.16 At the same time it is clear as well that the EU expressed it’s modified
external energy policy in the negotiation process. The acquis has been extended as a result of
the increased and changed Europeanization.
This was represented vividly by the Transit Protocol (TP) where for Russia it was the mean to
ensure long-term supply chain and in relation with it avoiding unnecessary competitiveness.
While for the EU to introduce flexibility in the supply chain, one of the prime aims of the
15 Talseth, 2012: 37. 16 Konoplyanik, 2009: 277.
11
liberalisation process.17 As we will see later, the 2003 gas directives made the ‘transit of
energy’ de jure inapplicable, for this reason the EU represents itself within the ECT as a
Regional Economic Integration Organisation.18 From the definition it clearly concludes to the
modified Europeanization logic of the EU: the acquis is applicable, therefore the transit
provisions are not applicable within the EU. In line with these the EU representatives included
the so called ‘REIO-clause’ into the draft Transit Protocol.19 With the wording of the Article
20 (the ‘REIO-clause’) of the draft TP the EU claimed that the transit rules shall not apply to
the flows in the market of the EU. However the Russian representatives claimed that the term
‘transit’ has been limited only to the export flows into the EU from a third country. As since
the export entry points of Russia with the 2004 enlargement had been re-situated within the
borders of the EU these are as well exempted from the binding provisions of the TP.20
However not comprehensively explaining but partly providing a reasoning the EU new energy
governance approach has pushed Russia towards to terminate the provisional application of
the ECT in 2009. At the same time Russia has lost an overly valuable tool for investment
protection.
II.3 The antitrust case against Gazprom
In September, 2012 the European Commission “has opened formal proceedings to investigate
whether Gazprom, the Russian producer and supplier of natural gas, might be hindering
competition in Central and Eastern European gas markets, in breach of EU antitrust rules.”21
This proceeding might be profound in the logic of the COM. On the one hand it fits into the
internal energy market creation of the COM having been pursued since the 1990’s. The most
profound cases were the prosecution against the alleged activity of European majors like
EDF, GDF, E.ON and RWE. This said the Gazprom case represents a further opportunity to
be embraced by the COM to foster the steps towards the energy market liberalisation.22 On
the other hand, notably this question is of our profound concern, the COM might advocate the
main logic: To bring the “game into European (legal) field”. The logic underlying is that the
acquis communautaire is might be proved by the COM superior to those international 17 Belyi, 2012: 16 18 The Regional Economic Integration Organisation (REIO) means according to the Part I, Article 1, paragraph 3 of the ECT “an organization constituted by states to which they have transferred competence over certain matters a number of which are governed by this Treaty, including the authority to take decisions binding on them in respect of those matters.” 19 Notably in the draft of the TP the EU and the Member States (based on the harmonised standpoint) declared several concepts already detailed in either the acquis or related documents, such as ’abuse of dominant position’, the existence of ’internal energy market’ 20 Konoplyanik, 2009: 282. 21 European Commission, 2012 22 Riley, 2012: 6.
12
commitments. This standpoint is a broadly advocated one especially by representatives of
Gazprom.23 The reasoning behind can be captured as the following.
The communication states that “first, Gazprom may have divided gas markets by hindering
the free flow of gas across Member States. Second, Gazprom may have prevented the
diversification of supply of gas. Finally, Gazprom may have imposed unfair prices on its
customers by linking the price of gas to oil prices.” The market partitioning claims concern
the ‘destination clauses’ of the Long Term Supply Contracts. This is not a new phenomenon.
In 2003 the COM has already came to agreement with Gazprom and the Italian ENI on the
destination clauses, the same cancellation was reached with OMV in 2005.24 In theory these
are non-existing ones. However provisions of such nature might be in the scope of
investigation of the COM. The second bunch of claims regard a suspected prevention of
diversification of supply through the Third Party Access.25 The claim makes reference to the
1st, 2nd and 3rd Energy Package as being the source of this regime. The past investigations
against RWE, ENI, GDF and E.ON has represented a precedent in this regard.26The third
claim of unfair pricing includes the LTC with take-or-pay (ToP) clauses that in nature
imposed higher cost upon the customers of the EU. Interesting enough, until recently only the
German Federal Court of Justice was the only authority to investigate such implications of
contractual settings.27
The decision of the COM, being a legal act, can be appealed to the European Court of Justice
in annulment proceedings. Notably neither the RWE, nor the E.ON reached this point of
debate. Moreover they agreed upon a Commitment Decision meaning that allegations against
these firms did not enter the public domain. However as part of the deal was that the firms
were obliged to proceed with the unbundling respectively.28 Given the intense response from
the Russian Federation the Gazprom is not expected to set this deal. It stems from the fact that
the company might attempt to provide a reasoning based on obligations derived from
international law. One of the prime examples would be legal arbitration based on the BITs
providing some degree of investment protection. Under the obligations of the bilateral
agreements the contracting party might imply that because of the TPA the value of its
23 Konoplyanik, 2013:10 24 Sartori, 2013: 5. 25 In September 2011 the COM had opened an inquiry into the alleged practices of the Gazprom in the CEE . This inquiry serves as the basis for the investigation of the Gazprom’s practices in the 2012 formal proceeding. By definition “the prevention the diversification of supply of gas” was expressed as breach of TPA in the 2011 inquiry. (http://europa.eu/rapid/press-release_MEMO-11-641_en.htm?locale=fr) 26 Sartori, 2013: 6. 27 Sartori, 2013: 7. 28 Riley, 2012: 7.
13
investment has been decreasing.29 Appeal might be made based on the WTO rules applicable.
However due to the high level of fragmentation of sectoral classification system it is of high
risk at the same time probable.30 However the verdicts of the ECJ, by main principle, does not
necceserary have to be in compliance with the MS’s commitments derived from international
agreements. Moreover, as a profound criteria, the MS have by all possible means have to
avoid discrepancy between the EU law and their commitments that might result in the
termination of that certain agreement.31 Provided this we have come to the ending implication
of the previously launched claim: If the Gazprom turns to the ECJ for appeal the former might
found itself in a sticky situation. As since the ECJ is not obliged to decide based upon
international obligations it might consecutively embrace the opportunity to enhanche the aims
of the COM. In practical terms the ECJ might disapprove the Gazprom claims explicitly
referring to the superior nature of the acquis. This fear has vocalised by Gazprom officials as
well.32 Moreover the pricing will have implications respectively. Having a prohibition
decision in place and a probable ECJ decision the other European energy companies might
use it as a basis for legal claim before arbitration panels.33
With this step the COM had obviously manoeuvred itself into a position where it can have a
considerable leverage upon the Gazprom. Of course it was an unavoidable step to call into the
game the Russian state – it symbolises as well the perception of considering the step
determining. The Russian Federation, seemingly, tried to put a grip upon the developments by
issuing the Presidential Decree No. 1285. The first point of the Decree pointed out three
explicit limitations on the companies operating outside the territory of the Russian Federation.
Without the consent of the appointed appointed executive offices cannot take action upon
request of either foreign states or international organisations. Three main actions are
providing information upon activities, perform changes in agreements and perform business
activity in assets.34 On the very same day Sergei Kuiyanov, the spokesperson for Gazprom,
answering on questions informed that the company have to apply for consent of the federal
bodies in case of information request, amendments are entailed in the contract or request upon
the sale of assets. Denial might be incurred if it contradicts with the economic interest of the
Russian Federation.35
29 Fratini, 2009: 11. 30 Cottier et.al., 2010: 11. 31 Blutman, 2010: 215. 32 Konoplyanik, 2013: 10. 33 Riley, 2012:9. 34 Kremlin.ru, 2012 35 Gazprom, 2012
14
This said one notable remark has to be given to further underline our argumentation. No
explicit explanation was given to the term ‘economic interest’. By definition it does not
specify the range of it and the extent to which these federal bodies might intervene. Provided
this the Federation might undertake three options. The one is confrontation that might result
in a lose-lose situation. Triggering political clash might enhance and increase tensions and
would further disintegrate the political relations in the field of energy. This would be
accompanied by a harsher response on behalf of the COM.36 This is the least probable
outcome. Another trajectory would be to increase pressure within the COM. Based on the
collegiality decision making of the Russian Federation might leak the decision through
pressure imposed by the MSs on the corresponding Commissioner. The election of the new
COM is still ahead but given that the current Commissioner for energy has been delegated by
Germany the logical answer would have been that the course of the development of the
COM’s energy policy could have been changed course. Neither it is true for Commissioners
originating from other strategic partners of Russia and the Gazprom (such as Italy). On the
contrary it did not happen.37 In order to provide an even broader approach, political pressure
might not apply as it did not happen with such famous cases such as Microsoft when the US
was at its highest political and economic power.38 Тhe most probable outcome would be the
cooperative approach with the Commission. It can undergo in the existing framework of the
Dialogue. At the same time all the outcomes and responses are pursued within the established
framework favoured by the COM.
II.4 The liberalisation of the energy market
II.4.1 The content of internal energy market
The Founding Treaties do not establish explicitly this legal entity but rather a complex set of
primary and secondary legal resources establish the system of what we might entitle as
internal energy market. In fact the European Commission regularly refers to terms like
’energy market’, ’energy acquis’, ’internal market’ etc. however, the TEU and the TFEU do
not refer explicitly to it as the internal energy market.
From the point of view of our scope of research the second, third and sixth column is of
special importance. In particular the Directive 2009/73/EC on the common rules for the
36 Sartori, 2013: 14. 37 The author is well aware of the fact that in principle the Commissioner is not supposed to represent interest of the sending state. 38 Riley, 2012: 7.
15
internal market in natural gas, the Regulation (EC) No 715/2009 on conditions for access to
the natural gas transmission networks and the Regulation (EC) No 713/2009 on establishing
an Agency for the Cooperation of Energy Regulators secondary resources are of highlighted
relevance accompanied by the TEN-E provision with special emphasis on the PCI.
1. Figure: Overview of the energy policies of EU
The natural gas has completely different market attributes compared to the natural gas.
Storing natural gas faces many difficulties moreover it is heavily dependent on the
infrastructure. The rationale underlying the latter in terms of energy market is that it becomes
tradable ones it exits the pipeline. For this reason controlling the entire supply chain is of
special importance. In practice it results, on the one hand, in a single supplier, moreover in a
vertically integrated energy company that covers the import, the transmission and the
Basic of the EU energy
policy
Internal market External policies
Strategy for competitive, sustainable and secure energy
• COM(2010) 639 (
infrastructure and technologies – TEN-E • TFEU article 170-172 • TFEU Article 194 o Decision No 1364/2006/EC o Decision 96/391/EC
Energy Community • Decision
2006/500/EC
Functioning of energy market: Electricity and gas directives (‘Third Energy Directive) • TFEU Article 47, 55, 95 o Directive 2009/72/EC o Directive 2009/73/EC o Regulation (EC) No
714/2009 o Regulation (EC) No
715/2009 o Regulation (EC) No
713/2009
CFSP
Security of Supply (SoS) • TFEU Article 194 • 2004/67/EC
EEAS
Promotion of Renewable Energy Resources and energy efficiency • TFEU Article 191, 194 o Directive 2009/28/EC o COM(2011) 109 ( Energy
Efficiency Plan 2011)
Oil stocks • Directive 2006/67/EC
GTM
16
distribution (wholesale market) as well. On the other hand these conditions point towards the
need for long term contractual settings, rather than capacity market structures.39 The
contractual relations include long term supply (LTSC) contracts and long term capacity
contracts (LTCC).
The liberalisation aims are in strong correlation with the EU’s overall energy policy aims,
namely security of supply, sustainability and competitiveness. The 4 February 2011
conclusion of the European Council highlights and summarizes with great effectiveness the
milestones and rationale behind energy market liberalisation.40 The liberalisation efforts
should include market opening, market coupling (rules, norms, network codes) and company
restructuring in order to facilitate increased cross-border movement of natural gas, increase
competitiveness, stimulate investment. These actions should be based on solidarity of the
member states. The set of directives aim at fulfilling the above scrutinised objectives.
At this point we are advised to make some legal notifications on the directives. As we have
noted above neither the TEU nor the TFEU makes direct reference to the internal energy
market as a result not establishing such. The primary source for any secondary legislation can
be derived back to the TFEU Title XXI, Article 194. However it still not refers to the internal
energy market, the listed measures should be implemented “In the context of the
establishment and functioning of the internal market...”. Article 194 (2) states that “the
European Parliament and the Council, acting in accordance with the ordinary legislative
procedure, shall establish the measures necessary to achieve the objectives in paragraph 1.”
Notably, with important exemptions detailed in Article 194 (2), namely “Such measures shall
not affect a Member State's right to determine the conditions for exploiting its energy
resources, its choice between different energy sources and the general structure of its energy
supply...” Prior to that in Article 4 (2) of the TFEU refers to the energy as shared competence
of Member States (MS) and the European Union. These provisions together have several
implications. On the one hand there is a clear basis for legally binding secondary legislation,
on the other hand provides a basis for the application of other internal market provisions. In
line with these, however it is beyond the scope of this study, competition law procedures may
apply to certain energy-related issues (i.e: LTSCs, LTCCs) being an exclusive competence of
the EU (Commission). This is underlined by various decisions of the European Court of
39 Talus, 2011: 261 40 European Council, 2011
17
Justice (ECJ) such as Costa v. Enel 6/64, Campus Oil 72/83, C-393/92 Municipality of
Almelo, C-158/94 Commission vs. Italy, referring to the energy as a good.41
II.4.2 The Third Energy Package
The Directive 2009/73/EC is a result of a more than a decade development. The Directive had
been preceded by two other directives on the natural gas. The first one was enacted in 1998,
the second in 2003. There are considerable improvement between Directive 1998/30/EC and
2003/55/EC. The first gas directive in Article 18 (5) indicates a 30% market opening for
eligible customers42, however no reciprocity is included. The second gas directive on the one
hand includes all customers, including residential consumers, in Article 23 (1) on the other
hand indicates full market opening for the eligible customers. For this reason not only the
wholesale but also the distribution market is to be opened. Moreover, with reference to the
previous paragraphs, the 1998 gas directive established the internal energy market. By 2009,
the COM found, based on Sector inquiry (2007), Green Paper and Benchmarking report, in
summary, the following aspects hindering the effective functioning of energy internal market
has been found:
• Vertical integration • Lack of market integration • Lack of TSO cooperation • Regulatory gap • High degree of market concentration • Lack of transparency • Different powers and competences of national regulators energy regulators43
In response to these, the 2009 directive has three pillars around which the provision emerge;
the unbundling, the access to infrastructure and the retail market. On the contrary of the
COM’s intent, a much more liquidated unbundling regime was involved into the 2009
directive. Ownership unbundling was codified to be optional, not a mandatory provision. The
basic idea behind unbundling is that the transmission and the supply/production are separated
in the vertically integrated company.44 In line with these, liberalised access to infrastructure
is not possible without unbundling. Without the regime a conflict of interest would occur
between the supply/production and the transmission. In economic terms a competition would
emerge within the company resulting in a negative impact on the overall return of the
41 Banet, 2010 42 Defined in Article 18 (1), in general words it aims at the liberalisation of wholesale market. 43 Braz, 2007 44 Vertically integrated energy company is the structure where the supply/production and the transmission/distribution is integrated within the company, under the same managerial and ownership structures.
18
company.45 Ownership unbundling envisages, according to Article 9, that the vertically
integrated company is deprived from its owned assets. The unbundling is legally executed by
the designated regulatory authority by certifiying the transmission system operator (TSO)
based on Article 10. The Directive allows for two other option in the unbundling regime. On
the one hand it facilitates, provided the COM’s consent, the so called independent system
operator (ISO). In case of ISO, no deprivation of the assets occurs however, as expressed by
Article 14 (4), is managing the TPA, access and congestion charges and maintenance of the
transmission system. The independent transmission system operator (ITO) model envisages as
well no deprivation of the physical assets. However, in comparison with the ISO model where
the TSO legally doesn’t have to be outside the structure of the company, the ITO aims at
establishing a legally separate company operating outside the vertically integrated company.
The legal independence of TSO is further ensured by such measures as supervisory body or
compliance officer. With reference to the distribution (retail market) Article 26 of the
Directive indicates unbundling as well, similar to the ITO model. It does not require deprival
of the assets by the vertically integrated company, solely managerial separation.
The other prevailing cornerstone of the Directive is the third-party access (TPA regime). The
Directive provides only the most profound rules with reference to the TPA, the more detailed
provisions are submitted in the 715/2009 and other market plans based on the latter legal
source. According to the Article 32 requires access by third parties to the transmission and
distribution system. It is a regulated TPA as since the tariffs and access methodologies are
provided based on the Article 41 by the national regulators in advance. Concerning TPA for
the storages, regulated and/or negotiated TPA access shall be selected by the MS. The latter
indicates that the national regulatory authority shall establish the requirements and procedures
for managing access to the infrastructure. This right is delegated to the national regulatory
authorities, the capacity allocation and the congestion management (the procedure to get
access to the allocated capacity), by Article 41 (c).
The exemption of new infrastructure from TPA regime is a profound provision. According to
the Article 36 (1) details of the exemption. There are 5 requirements on the top of which is
that the new infrastructure must enhance competition in gas supply and enhance security of
supply. Moreover, the precondition must be standing that without the exemption the
investment wouldn’t be realised. It is important to note that the owner of the infrastructure has
to be, at least legally, independent from the TSO operating in the given area.
45 Talus, 2011: 265
19
The Directive 715/2009/EC provides more detailed provisions on most of all TPA with
referring conditions, such as capacity allocation and congestion management, tariffs for entry
and exit capacity, network codes. Beside these, the registration of TSO and DSO are made
reference to alongside with the establishment of the ENTSOG, the cooperation forum of gas
TSOs. According to the Article 14 of the Directive, the TSO are obliged to provide TPA on
long – and short term and non-discriminatory basis; the similar rules apply to the LNG
facilities. It is important to note that the Directive implies a strong determination to move
towards a market-based environment on the top of which is the emergence of spot markets
and hub trading (i.e. Article 16 of the respective Directive). The COM in a regulatory
commitology procedure accepted on the 24 august 2012 a set of amendment on the congestion
management procedures (CMP). This document provides a comprehensive insight into the
capacity allocation and CMP rules aimed at by the EU. The capacity allocation is a clear
procedure, it basically provides capacity booking on non-discriminatory and transparent basis.
The rule underlying the congestion management is that the TSO might monitor the capacity
booked by market stakeholders and in case of finding unused capacity, it might utilize two
basic CMP: buy-back scheme and use-it-or-lose-it mechanism (UIOLI). In both cases the
capacity may be re-allocated on the same rules as initial capacity allocation.
The Third Energy Package makes strong reference to the third country investors in the energy
infrastructure. The Directive details the regarding provision in section 22 as “Persons from
third countries should therefore only be allowed to control a transmission system or a
transmission system operator if they comply with the requirements of effective separation that
apply inside the Community.” In Article 11 the EU obliges the countries to certify those legal
persons intending to acquire assets in the infrastructure that are from third countries. The
assessment is exercised by the EU COM that bases it on the requirements of Article 9 of the
Directive.
II.4.3 Debated points and controversial issues
It is beyond any debate that from the trinity of EU energy policies the security of supply has
gained more importance.46 These assumptions are clearly depicted in the liberalisation
process. Beside the direct gains from liberalisation (competitive prices for customers,
investment attraction etc.) the liberalisation indicates security considerations that fits into the
wider perception of SoS. Through the unbundling options and TPA provisions the EU aims at
46 In the Energy2020 the three prevailing priorities of the EU energy policy are: Competitive, sustainable and secure energy.
20
challenging the pillars of the Gazprom’s business model on the market. In a historical
perspective the EU has gradually made the provisions stricter. The ownership unbundling is
now a feasible option. The TPA has been made obligatory alongside with the relations to third
countries controlled by the Directives. The correlation, detailed below, will shed light on the
justified bases for this assumption.
With reference to the process of liberalisation three profound concerns arise. First, the
question of TPA, the quality of unbundling and the so called Gazprom clause. The TPA
combined with capacity management establishes a peculiar situation. Under the current
setting, as we have learnt in the precedings, the TSO is obliged to grant access to the
transmission pipelines for third parties (supply companies). The capacity allocation is realised
through congestion management. The Gazprom, rightfully, raised the concern of supply-
capacity mismatch. The gas is different from oil to a great extent. On the one natural gas is
highly dependent on the infrastructure. Currently the Russian export is entirely tied to the
cross-border pipeline infrastructure. However these are historically developed, they are capital
intensive with a long, generally 15-25 years, payback period. On the other hand the capital
intensive exploitation needs long term security of shipments. It not only speaks for long –term
supply but as well capacity contracts.47 We can admit that the short term capacity allocation
aims at the increase of competition and market building. At the same time, besides it is
important for the security-of-supply, the long term supply contracts are still predominant on
the European Union’s energy market.48 The profound explanation underlying the concept of
supply-capacity mismatch is that the shipper cannot fulfil the contracted volume. It stems
from the fact that it either cannot at all compete for capacity because of the scarcity or does
not win the auction for the capacity allocated. However in theory all the suppliers may face
the challenge of not gaining access to the existing, to the greatest extent Gazprom faces this
challenge.49 Moreover the fact that the Nord Stream 1 and 2 is operational now, it still not
reduce the risk for the mismatch.50 Gazprom’s fears are not beyond reasonable assumptions:
last year capacity allocation was unsuccessful to the OPAL pipeline essential for deliveries
from the North Stream.51 Moreover of course the evolved capacity management is under
process the EU COM has already enforced the TPA through the tools of the competition
policy. In the past few years two predominant cases were processed by the EU COM. On the
47 Talus, 2011: 261 48 Talus 2011: 269 49 Yafimava, 2013: 29 50 Yafimava, 2013: 35 51 Reuters, 2013
21
one hand the Gaz De France case on the cross-border capacity and gas market foreclosure.
The other prevailing case was the E.ON case referring to the access to pipelines.
The aforementioned provisions for the third countries are widely considered as the “Gazprom
clause”. In the past few years, on the one hand, it has been evident that the Gazprom aims at
gaining footholds in EU infrastructure assests.52 The Gazprom has already leaned towards
this strategic pattern from the 1980’s and by 2010 it had direct stakes accounting for 10% of
British and French market – mostly through joint ventures.53 The traditional strategy of
Gazprom has been M&A’s. The Commission has explicitly addressed to have tight control
over these actions.54The perception that the EU assesses the third party clause is telling and
can be evaluated as a strong response to the overall concept of persuasive EU actions.
Returning to the section 22, the certification of investors is derived from security of supply
concerns. As we have learnt before, the correlation between the unbundling and the third
country provision are correlated and points towards the securitization of energy relations with
Gazprom. The EU has clearly incorporated the third country clause so that the unbundling
provisions can apply on companies operating extra-EU.55 Especially by the deployment of
ownership unbundling the monopolies are deprived of their infrastructure assets. As a result
the investment is subject to the third party clause by which investment is regulated under EU
acquis.56 This obviously affects to the greatest extent the Gazprom.
II.4.4 Creating infrastructure: the BEMIP
Infrastructure projects are considered to be of high priority. At the same time represents a
prime example for the Europeanization of EU energy policy. The BEMIP identifies the
infrastructure priorities for the region to terminate the “energy island” of the East-Baltic
states. Тhe BEMIP is based upon the document “An Energy Security and Solidarity Action
Plan”, that addresses 6 priority infrastructure plan. It aim at the identification of “the key
missing infrastructures necessary for the effective interconnection of the Baltic region with
the rest of the EU, establishing a secure and diverse energy supply for the region, and listing
necessary actions, including financing, to ensure its realisation.”57 Notably, two separated
section discusses the corresponding infrastructural topic on the East and West-Baltic. The
final report of the BEMIP, presented by the High Level Group, provides the most profound
52 Locatelli, 2013: 8 53 Locatelli, 2013: 12 54 EU Energy Law and Policy Yearbook 2012, 2012: 45 55 Fratini, 2009: 2 56 Belyi, 2009: 125 57 European Commission, 2008: 4
22
objectives in the region in terms of market integration and the closely related interconnection
facilities. The final report suggests that “gas infrastructure development projects in the region
are necessary to allow the creation and strengthening of the internal market...”.58 There are
four objectives set on the top of which is the termination of the isolation of the East-Baltic
States from the EU energy market and the assessment of the LNG infrastructure. 59 In line
with these, the BEMIP as well lists the infrastructure priorities essential for the objectives.
2. Figure: Project indicated by BEMIP
Project Short description of the project Dependency on
other project
Responsible body
GIPL pipeline connecting Lithuania to Poland via the Yamal-Europe pipeline or national Polish system. (Capacity: at least 3 bcm/year)
(Reverse flow on Yamal-Europe)
GazSystem, Lietuvos Dujos
BalticConnector Off-shore gas pipeline connecting Finland and Estonia (Capacity: at least 2 bcm/year)
Gasum Oy
Estonia-Latvia; Latvia – Lithuania upgrade of cross border capacity and internal systems
An increase in the capacity of existing systems by establishing new meter stations and upgrade of pipeline capacity
Lietuvos Dujos, Latvijas Gaze, Eesti Gaze
Finngulf LNG, new LNG terminal in Estonia, Latvia or Lithuania
capacity-3 bcm/year Gasum Oy, Eesti Gaas
Access options for gas storage in Latvia or Lithuania
One of the following options: a) Expansion of Inčukalns storage (from 2,3bcm to 3,2 bcm) b) New strategic storage in Lithuania – Syderiai (0.5 bcm) c) New storage in Latvia – Dobele UGS (6 bcm active gas) (feasibility study 2009-2010)
a) Latvijas Gaze b) Ministry of Energy of Lithuania c) Ministry of Economy of Latvia
Source: BEMIP
3. Figure: Projects indicated by BEMIP
58 High Level Group, 2009: 17 59 High Level Group, 2009: 17
23
Source: BEMIP
The founding of the projects involved under the aegis of the BEMIP are entitled to
community founding from TEN-E and EEPR. The decision 1364/2006/EC, amending the
1229/2003/EC, establishes the guidelines for TEN-E networks including natural gas and
electricity interconnection infrastructure. With reference to natural gas, the scope of
highlighted infrastructure is limited to, as stated by Article 2, high-pressure gas pipelines,
excluding those of distribution networks, UGS, reception, storage and re-gasification facilities
for LNG and complementary installations needed for the formerly mentioned infrastructures.
The TEN-Es are divided into three different groups and are ranked accordingly. Projects of
common interest (Article 6.) are those projects that fall within the categories listed preceding;
accompanied by the objectives listed in Article 3. It indicates that the PCI encourages the
effective operation and development of the internal market, facilitates the development and
reduces the isolation of the less-favoured and island regions of the European Union, as well
reinforces the security of energy supplies. Of course, these requirements are further detailed in
Annex II of the Decision. The PCI shall be granted limited Community founding based on the
provisions of (EC) No 2236/95. Member States shall take any measures they consider
necessary to facilitate and speed up the PCI alongside the respect of Community legal
provisions. Priority projects are those that shall have priority in Community founding. These
projects are selected from the PCI. Priority project that are of cross-border nature or which
have significant impact on cross-border transmission capacity are declared to be of European
interest accompanied by overall priority for EU founding. Currently the following project fall
under the provisions of TEN-E from the point of view of our paper:
24
4. Figure: TEN-E project in the East-Baltic region
PCI Gas pipeline from Russia to Germany, via Latvia, Lithuania and Poland, including developing underground gas storage facilities in Latvia (Amber project) Gas pipeline Finland — Estonia
Priority projects Projects of European interest
LNG terminal Świnoujście (Poland) capacity increase of USG in the Baltic Sea Region
Source: European Commission
Besides TEN-E and as part of the TEN-E the European Energy Programme for Recovery
(EEPR) has been established by the Regulation (EC) No 663/2009 and later amended by the
Regulation (EC) No 1233/2010. The EEPR is a financial instrument gas and electricity
infrastructures, offshore wind energy and carbon capture and storage. The budget is,
according to Article 3 of 2009 Regulation is EUR 3,98 billion out of which gas and electricity
infrastructure projects account for EUR 2,365 billion. With reference to the East-Baltic states,
a number of projects are involved in the EEPR (that are of special importance from the point
of view of our investigation), namely:
5. Figure: Project founded by EEPR
Baltic-Poland interconnection leads to the Świnoujście LNG station and connects to the Polish transmission system
Swinoujscie LNG terminal Latvia - Lithuania - reverse flow (RF LV-LT)
This project aims at improving the infrastructure and equipment for bi-directional gas flow between Lithuania and Latvia. The project will eliminate bottlenecks and will safeguard required capacities in both directions. It consists of the reconstruction of 15 wells in the Incukalns gas storage complex, the reconstruction of the Daugava river underwater pass in Latvia, and the modernisation of the Panevezys gas compressor station in Lithuania.
Source: European Commission
However these are ambitious projects, the community founding accounts for only a fraction of
the investment cost. According to the legislation of the TEN-E the founding might be devoted
up to 10%. The EEPR in general provides the founding 1/3rd of the total costs.
25
III. THE BALTIC STATE’S VISION
III.1 Setting the scene – current status of the gas energy market of the Baltic States
The three Baltic States and Finland share numerous attributes of their natural gas market at
the same time differ to a great extent.60 All four states face 100% dependency from one single
supplier, Russia and in particular the Gazprom. In line with these, each of the countries face a
historically developed complete isolation in terms of connection to the rest of the EU’s energy
market. The ownership structure of their TSOs, dominated by Gazprom and E.ON, is as well
a shared attribute accompanied by the same outnumbering presence of the former two
companies. In terms of the quantity of the shipped natural gas the 4 countries are small
players for Gazprom as the sole supplier. On the contrary the Baltic States and Finland have a
different TPEC setting alongside with different total energy consumption pattern.
6. Figure: TPEC of the East-Baltic States (as % of total energy consumption in Mtoe)
Source: Eurostat
The Total primary energy consumption of the East-Baltic states differ to a considerable
extent. Nuclear energy, since the closure of the two blocks of the Ignalina power plant in
60 We use the data on Finland solely a point for visual comparison. From a methodological point of view Finland is not subject to investigation.
36%
11%13%
20%
10%
10%
Finland
Oil
Natural Gas
Coal
Nuclear Energy
Hydro electric
Renew- ables
43%
50%
3%
0%
2%
2% Lithuania
Oil
Natural Gas
Coal
Nuclear Energy
Hydro electric
Renew- ables
52%
12%5%0%
0%
31%
Estonia
Oil
Natural Gas
Coal
Nuclear Energy
Hydro electric
Renew- ables
53%
14%2%
0%
0%
31%
Latvia
Oil
Natural Gas
Coal
Nuclear Energy
Hydro electric
Renew- ables
26
Lithuania is totally absent, and the similar pattern applies for the other two Baltic States. 61
On the contrary in Finland nuclear energy plays a determining role accounting for 20% of the
consumption. Energy produced from renewable energy resources (RES) has a minor share in
Lithuania in comparison with the other three, where RES, including hydro energy production
and biomass, have a pivotal role.62 Provided the increased road – and sea transportation,
stemming from the underdeveloped railway infrastructure and geographical attributes, the oil
consumption is visibly great. The oil shale exploitation in Estonia boosts to a great extent the
share of oil within the TPEC.
Source: European Commission
The direct usage of natural gas accounts for 11% to 14% in Finland, Latvia and Estonia as
such being a relatively low figure in comparison with Lithuania’s 52%. However, taking the
61 Lithuania undertook the obligation as part of the accession agreement with the European Union to phase out and close down the two blocks of the Ignalina Nuclear Power Plants by 2010. As a result Lithuania has become increasingly dependent on electricity import. Currently the country is considering the construction of a new Nuclear Power Plant in Visaginas. 62 For Latvia, biomass export to the West-Baltic states, especially to Sweden, is of special importance.
7. Figure: Electricity generation of the East-Baltic states (as % of TWh)
Estonia Latvia
Lithuania Finland
27
electricity production into the scope of the investigation, the picture becomes more
modulated. In Finland the proportion of natural gas approximately equals to the share within
consumption. Accounting for almost 15%, the natural gas has an underlying position in
electricity generation.63 It is clearly visible, that for Lithuania and Latvia natural gas is
inevitable and essential in this regard; increase case of the former the data indicates 52% in
case of the latter 45%. However Estonia enjoys the advantage of domestic supply in oil shale
located in the North-Eastern part of the country. The data suggesting a considerable position
of natural gas in Finland and for Latvia and Lithuania is clearly visible.
8. Figure: Heat generation in the Baltic States and Finland
Source: EU COM -Energy DG
Heat generation has a pivotal effect on the energy policy considerations and actions of the
states, these considerations have a crucial place within these structures due to the Nordic
climate. The former attribute is accompanied by the low energy efficiency of the residual
buildings. In case of all the countries the natural gas is in a determining position, with special
emphasis on the three Baltic States where natural gas usage in heat production is well beyond
50%. In line with these, the sustainable, secure and competitive natural gas supply is in the
centre of the energy policy settings of the Baltic States and Finland.
63 In my point of view, this position can be considered as solid – especially with reference to coal. Coal is an advantageous source of energy because of the competitive (low) price, established world market and geographic distribution. On the other hand it is not a complementary product to the natural gas stemming from the obligations on 202020 objectives.
28
9. Figure: Natural gas import of the East-Baltic States
Year / Billion cubic
metres
2008 2009 2010 2011 2012
Estonia 0,92 0,62 0,67 0,6 0,65 Latvia 1,3 1,7 1,1 1,7 1,5 Lithuania 3,2 2,7 3,1 3,4 3,3 Finland 4,0 3,6 3,9 3,4 3,1 TOTAL 9,476046 8,598224 8,814459 9,133529 8,554342
Source: BP, Eurostat
The quantity of the East Baltic States accounts for roughly 10 bcm.64 It is clearly noticeable
that Finland has the greatest import qualities and natural gas market – we will later on make
the necessarily statements on it with reference to internal market considerations. However it is
clear that without including Finnish market into the system we cannot reach the proper market
size to attract infrastructural investment and diversified supply with alternative shippers. The
three Baltic States account for 1% of the entire export quantity of the Gazprom, together with
Finland the data doubles65 – they are far from being “big fish” on quantitative terms.
However, as we will highlight in the upcoming chapters, they can be in a negotiation-position
in unbundling, TPA issues, and most probably capacity market and price arbitrage. In Estonia,
gas is imported only from Gazprom accompanied by the sole wholesaler (importer) Eesti
Gaas. The import price of gas is calculated by a price formula that considers nine months
heavy and light fuel oil average prices in USD/ton preceding to the accounting month, taking
into account the USD/EUR exchange rate.66 Latvijas Gaze acts as the importer of natural gas
in Latvia from the Gazprom, accompanied by the licenses for the storage (Inčukalns UGS),
transmission, distribution and trade of natural gas.67 The Inčukalns is the only UGS facility in
the Baltic States with roughly 50% of winter withdrawals allocated for Latvia, 25% for
Estonia, and 25% for northwest Russia (Lithuania now only rarely draws on the UGS).
Gazprom enjoys operational control over Inčukalns through Latvias Gaze, which it has the
right to manage through 2017.68 In Lithuania the participants of the natural gas import market
are Lietuvos Dujos AB (39,6%), Dujotekana UAB (14,9%), Achema AB (38,0%), Kaunas
Combined Heat and Power Plant (Kaunas CHP), Haupas UAB (7,0%). Market shares of all
other market players decreased accordingly: the share of Lietuvos Dujos, AB decreased by
10.8 percent from 50.4 percent to 39.6 percent, the share of Dujotekana, UAB – by 2.3
percent from 17.2 percent to 14.9 percent, market share of Kauno Termofikacijos Elektrinė 64 The data is complicated to access. In this regard i was obliged to use diverse resources. The professional literature, facing the same problem usually quotes 10 bcm/year. 65 Gazprom, 2011 66 Konkurentsiamet, 2012, 12 67 Sabiedrisko pakalpojumu regulçðanas komisija, 2011 68 Bryza, 2012
29
decreased from 8.8 percent to 7.0. Market share of Haupas, UAB changed very little - down
from 0.5 percent to 0.4 percent. Notably, the Lietuvos Dujos rules the retail market
accounting for 70%.69
As it was highlighted by the European Council and the European Commission, the East-Baltic
states are considered to be ‘energy islands’. The term ‘energy islands’ means that these
countries are solely connected to Russia as an external partner while they are completely
isolated from the rest of the European Union’s energy market. The two institutions
highlighted that eliminating the ‘energy islands’ is essential to the completion of the internal
energy market. 70 As we can see from the Figure 12., the interconnection is historically
developed, between Estonia and Latvia, in case of Latvia and Lithuania interconnectivity is
established respectively. In case of the former the Karski in case of the latter the Kiemenaj
pipeline provides interconnectivity with bi-directional flow capability. In addition to, the three
Baltic States are solely connected to Russia and Belarus. TSO’s of these capacities on the
Russian entry point section is the Gazprom, on the other way around companies with
Gazprom shareholder domination. E-ON Ruhrgas and Gazprom posses the absolute majority
in the TSO’s of the three Baltic state’s company. In fact, E.ON Ruhrgas possesses in Latvijas
Gaze and Lietuvos Dujos more shares in comparison with Gazprom. However the companies
are explicit strategic partners, leading to no doubts about joint and harmonized action in the
decision making procedure.71 The decision-making prevalence of Gazprom in Vörguteenus
TSO is assured by different system in comparison. The company capital is made up of A-type
shares and B –type shares. A – shares nominal value is 10 Euro, B-shares represent 0,10 Euro.
In line with these the A-type shares represent more vote in the general meeting of the
shareholders. Possessing more than 50% of the A-type shares72, Gazprom exercises bigger
leverage in comparison with the other shareholders.73 The constellation is more moderated in
the Finnish Gasum Oy, as since Fortum Heat and Gas Oy might out-rule if the corresponding
two companies act on their own.
Currently the pipeline network, interconnections and import transmission pipelines, do not
constitute a physical hub, such as the one in Baumgarten, Austria. In addition to this arise the
quality and the need for investment in reconstruction considerations. However the technical
69 Valstybinė kainų ir energetikos kontrolės komisija, 2011 70European Council 2011; European Commission, 2011 71 At 03.07.2012 in the renewed Long term supply contract (LTC), stated, that, „…Gazprom and E.ON have shown once more that, as long-term strategic partners, they are able to arrive jointly at viable solutions. By signing today's agreements we are strengthening our long-standing, success-full partnership…” 72 There are 721843 A-type shares, Gazprom possesses 367268 of them in comparison with E.ON’s 254,598. 73 Eesti gas, 2012
30
capacity is capable of transmitting the required quantity for the three Baltic States, the
reliability stemming from the outdated technical features of the system.
10. Figure: Shareholders of the energy companies in the East-Baltic States
Estonia: Vörguteenus
Latvia: Latvijas Gaze
Lithuania: Lietuvos Dujos
Finland: Gasum Oy
Gazprom 37.03% 34,00% 37,1% 25% E.ON Ruhrgas 33.66% 47,23% 38,9% 20% Itera Latvija 9.99% 16,00% Fortum Heat and Gas OY
17.72% 31%
Respective Ministry/state
17,7% 24%
other shareholders/small shareholders
1,60% 2,77% 6,3%
Source: Vörguteenus, Latvijas Gaze, Lietuvos Dujos, Gasum Oy
The degree of liberalization of the supply and retail market of East-Baltic states can be best
captured by the employment of HHI.74 In case of the supply market of Estonia, Latvia and
Finland, we can talk about very high market concentration as since there is solely a single
supplier and a single import company (HHI=1 / 10 000). The retail market is equally highly
concentrated in Estonia and Latvia, stemming from the fact that however there are more
distributing companies available, in practice these two represent a 90% (Eesti Energia AS)
and a 100% (Latvijas Gaze) share. We can talk about in Finland as well about a high
concentrated market. Notably, the vast majority (around 95%) is sold directly to big users
(enterprises, district heating producing plants), the retail market only accounts for 5%.75 and
In case of Lithuania, the normalized HHI equals to 0,1025 (1025) that represents a moderate
market concentrations. The retail market is very high concentrated, as since the HHI equals to
0,5902 (5902). However, while making these highlights we have to keep in mind a crucial
factor; it is clear that there is still a single supplier still.
74 The Herfindahl–Hirschman-index is widely used to measure market concentration as a result, the degree of
liberalisation. The . where . The normalised HHI can be expressed with a value between 0 and 1 or in percentage, where the outcome can be placed between 0 and 10 000. The latter is a more picturesque solution as since three categories can be established. Between 750 and 1800 we can talk about moderate concentration, high concentration is indicated between 1800 and 5000. Above 5000 there is a very high market concentration. 75 Energiamarkkinavirasto, 2013
11. Figure: Natural gas retail prices in the East
Source: Eurostat
One of the prime concerns of the three Baltic States is the price
graph indicates, the end-customer price has
second half of 2012; in Estonia, Latvia and Lithuania respectively. It is clearly recognisable
that for Lithuania the natural gas is available on the highest
single supplier it has vast influence on the end
. Figure: Natural gas retail prices in the East-Baltic States
One of the prime concerns of the three Baltic States is the price level. As the above detailed
customer price has been rocketing between first half of 2010 and
second half of 2012; in Estonia, Latvia and Lithuania respectively. It is clearly recognisable
that for Lithuania the natural gas is available on the highest price. As since Gazprom is the
as vast influence on the end-customer prices.
31
. As the above detailed
been rocketing between first half of 2010 and
second half of 2012; in Estonia, Latvia and Lithuania respectively. It is clearly recognisable
. As since Gazprom is the
32
12. Figure: Cross-border capacity in the Baltic Sea Region
Locati
on System Operator 1
C
C
B
Z System
Operator 2
C
C
B
Z
Technic
al
physical
capacity
GWh/d
Techni
cal
physic
al
capacit
y bcm
Available
flow
directions
Rema
rks
TS
O1
TS
O2
Karksi Vörguteenus EE >
Latvijas Gaze
LV
-
7 N B
Karksi Latvijas Gaze LV >
Vörguteenus
EE
70,0
7 B N
Kiemenai Latvijas Gaze
LV >
Lietuvos Dujos
LT
55,0
5,2 B
Kiemenai Lietuvos Dujos
LT >
Latvijas Gaze
LV
55,0
5,2 B
Imatra Gazprom RU > Gasum Oy FI
249,0
6 - N
Korneti Gazprom
RU >
Latvijas Gaze
LV
200,0
6 - B
Kotlovka
Gazprom Transgaz Belarus
BY >
Lietuvos Dujos
LT
323,0
27-31 N
Värska Gazprom RU >
Vörguteenus
EE
41,0
4 - N
Narva Gazprom RU >
Vörguteenus
EE
31,2
0,5-4 - N
Source: , ENTSOG, EEGA,Pakalkaite, 2012: 7.
Тhe first question that needs a reply is why the Europeanization is the best tool in the hands of
the Baltic States. By contrasting this question we might get a more illuminating answer.
Notably we have to highlight the fact that the effects are to be considered in medium-and
short term – the current EU policies aim at embracing this distance in time. Long term
decision characterise the infrastructure decisions in the field of energy policy. At the same
time short-and medium term changes are to be met in this regard.
In the previous section we elaborated numerous characteristics of the Baltic States that we
will use a basis for the further assessment.
• From the point of view of gas deliveries we can underpin the elaborated concept of
“energy island” with reference to Estonia, Latvia and Lithuania. There is no
connecting infrastructure available to rest of Europe.
• The rate of exposure to the Russian deliveries are the highest in Europe, accounting
for 100%. In relative terms the Baltic markets are smaller.
• The three Baltic States are highly dependent on natural gas in their domestic and
industrial consumption. The structure of energy majors are dominated by Gazprom.
33
• It is clear that the transition to hub based pricing is not feasible in the near future. For
this reason changes in the incumbent contractual structure is possible.
As a consequence we can assess the position of the Baltic States relatively weak in
comparison with the Central-European and especially with Western MSs. The three profound
reason underlying are the small market size, the complete isolation from the rest of Europe,
dependency on a single supplier. In line with these we argue that in the absence of a strong
position in national capabilities it is a natural consequence to embrace the opportunities
represented by the means of the Europeanised energy policy.
13. Figure Overview of the elements of the Europeanised energy policy
Objectives ‘secure’ - Security of Supply • diversification (energy mix,
alternative routes, transport security)
• interconnectivity
‘secure’-price • transparency • competitiveness (liberalisation)
Tools – legal framework
internal market – BEMIP (Gas Security of Supply Directive 2004, Regulation 2010) external dimension – EU-Russia; Energy Charter Treaty; Energy Community Treaty; information exchange mechanism
• 3rd Energy Package – unbundling, ‘Gazprom-clause’
• competition rules
role of the COM
EUROPENISATION – (subsidiarity) • ‘exporting energy acquis’ (EU-Russia) • antitrust-investigation • information exchange • 3rd Energy Package • BEMIP
In line with the above mentioned starting points we have to assess the possible means being
utilized by the Baltic States. On general terms we can state that to the liberalised energy
market and the supply diversification might the COM contribute with added value; according
to the Baltic States.76 Consecutively we elaborate the possible gains and losses of a
combination of policy tools. Notably not all the objectives might be realised in short-and
medium term. In general we can state that the most important policy objectives are the supply
diversification as being considered the main element of achieving the reasonable price.
76 Molis, 2011: 79.
34
III.2 BEMIP: a feasible solution?
The most comprehensive program aiming at the termination of ‘energy island’ status is the
Baltic Energy Market Interconnection Plan (BEMIP). However it is a promising program it
only provide with a long-term solution. The BEMIP envisages three broad projects that might
foster the feasibility of program: the UGS terminal, the GIPL and the LNG terminal.
III.2.1 Gas storage facility
The BEMIP indicates three different underground storage facility that shall be implemented
within the complex system of infrastructure. The UGS is of special interest because
traditionally it plays a pivotal role in providing during increased winter time gas consumption
additional capacity in peak load. In a hub-based system, it fosters counterbalancing of supply
shortage and price volatility.
In line with these, the question arises: which of the three project might be implemented. To
start with the analysis, the Net Present Value shall be evaluated in a comparative manner.77
Project Inčukalns UGS Syderiai USG Dobele UGS Responsible body Latvijas Gaze Lietuvos Dujos N/A (Latvijas Gaze) Cash flow (million EUR)
59 77 59
Cost (million EUR 140 347 230 Discount rate (%) 4,35 4,59 4,35 Time interval (year, basis year 2011)
5 (expected) 5 10
NPV 0,036 0,002 ~0 Source: ENTSOG - GIPL, NASDAQ, LAtvijas Gaze, Lietuvos Dujos, EU COM
Based on these accountings, the Inčukalns UGS capacity-extension project has the highest
probability to be realised. However, other factors foster the higher possibility to realisation of
the project. At the end of June this year, a capacity increase has been completed within the
framework of the BEMIP internal and cross border capacity increase by the reconstruction of
17 wells of the UGS78. This aimed at to secure the capacity withdrawal capability of the
Inčukalns USG, which is currently 2.3 bcm.79 Moreover, the EU has already allocated 7,5
million EUR on the proposed capacity extension project. This brings the Inčukalns UGS
77 The Net Present Value (NPV) provides a comprehensive measure of net benefits and is widely used for project
ranking and decision-making. Mathematically can be described as the following: �����(����)
(���) . If NPV = 0,
then the investment would neither gain nor lose value for the firm. If NPV<0 than the investment would generate loss, if NPV>0 then the investment would generate additional value for the firm. (Bhattacharyya, 2011: 176) 78 Baltic Course, 2013 79 Latvijas Gaze, 2012: 18
35
closer to realisation and displays stronger commitment on behalf of the EU. Notably, the
extension is of special importance, as since the entire capacity is withdrawn by Latvia,
Estonia and Russia. Provided that transition to hub-based market pricing is envisaged in long-
term by the EU, the extension is prevailing.80
However the leverage of Gazprom over the Inčukalns UGS is determining. Currently the JSC
Latvijas Gase is the operator of the UGS in which, as we have learnt before, Gazprom has
controlling share, while the facility itself is owned by the Gazprom in 100%.81 Latvijas Gaze
posses the operational rights until 2017.82 Provided that the East-Baltic states have
derogation from the transposition of the unbundling provisions, the Inčukalns UGS might not
contribute to the establishment of market based environment, mainly hub-based pricing. On
the contrary, there is no such derogation provided with reference to TPA. It has been
explicitly vocalised by the Latvian government that no ownership retention is going to take
place. However, re-nationalisation is not, the Latvian government will insist upon granting
TPA access to the Inčukalns UGS.83 In line with these, it is clear as well that the UGS is not
going to be a market-establishing factor. Much more additional investment would be needed
to effectively connect it to Lithuania and Latvia – such infrastructure is not in its place.84
III.2.2 GIPL, LNG market
The Gas Interconnector Poland-Lithuania is the cornerstone of the entire matrix envisaged by
the BEMIP as since it would connect the East-Baltic states to the rest of the European energy
market. According to the plans of the Lietuvos Dujos and Gaz-System, the GIPL would have
a 2,3 bcm/year capacity in Stage with the future possibility of extension up to 4,5 bcm/year in
Stage II. The expected cost account for 471 million EUR.85
Currently there are many open questions concerning the GIPL stemming from the fact that the
final investment decision is to be taken later in 2013.86 One of the most prevailing questions
is the source of supply to the pipeline. The two stakeholders in the project in their
presentation given on the BEMIP conference in Vilnius listed a number of projects as
80 Bryza, 2012: 7 81 Gazprom, 2011: 13 82 BNN, 2011 83 Ābele, 2013 84 Belyi, 2013: 3 85 Gaz-System, 2012 86 In May 2013, the feasibility study of the GIPL has been conducted, yet not made open for the public.
36
prospective sources.87 Notably, all of these resources, technically speaking would provide in
long term secure supply, however different level of diversification.
14. Figure: Potential resource base for the GIPL
Project Russain (RUS)/Non-Russian (nRUS)
resource
Yamal I RUS LNG PL nRUS Brotherhood RUS Baltic Pipe nRUS Shale Gas nRUS Source: LSTA
The table indicates that there are various sources available not of Russian origin. It includes
Świnoujście LNG terminal, the Baltic Pipe and the indigenous Polish shale gas production.
The LNG terminal can host various sources, traditional LNG suppliers such as Algeria or new
ones like the US. However, the impact of the US LNG export is beyond the scope of this
study. The Baltic Pipe subsea gas pipeline connects the natural gas transmission systems of
Denmark and Poland delivers natural gas from Norway. Being a bi-directional flow pipeline it
might provide an entry-point for the Świnoujście LNG terminal.88
On the other hand, it is clear, and has been vocalised by the companies at the same
conference, the pipeline depends to future infrastructure and investment to a great extent.
However, the 5 bcm/year capacity of the Świnoujście LNG is going to be in service of the
GIPL, the proportion is still unclear. The objective is in place, explicitly assessed by the Gas
System, being the owner of the facility.89 The actual contracted volumes, either in long term
contract or hub-based mechanism, will be up to the Polskie LNG, the system operator of the
facility. According to the original plans, the facility was expected to be completed by the
second half of 2014, and deliveries are beginning in 2015 according to the contractual
commitments with Qatar.90 In may previous year, with the additional aid granted by the EU,
the status of completion indicated a 60% level. 91 However, in September at least 6 month
delay was announced as a result of an investigation on progress.92 The BEMIP, as we have
seen, identifies LNG terminal projects in each of the East-Baltic states. The Booz&Co.
prepared an analysis for the EU COM on the different scenarios and prospective of feasibility
of each of the LNG terminals. It highlighted that the most preferred terminal would be the
87Gas System, 2012 88 Gas System 89 lngworldnews, 2012 90 naturalgaseurope.com, 2013 91 .lngworldnews.com, 2013 92 Warsaw Business Journal, 2013
37
FinGulf LNG project, provided that it could enhance the SoS and supply diversification aims
at the same time would be located to the biggest market among the East-Baltic states.
However the Estonian project in Paldiski or in Muuga would indicate the same advantages.93
The EU Com recognised the findings of the analysis and as a result established strong
commitment towards the funding of the LNG projects. It was made explicit that either of the
project will be realised with the political and financial support of the COM.94 Up to date
Lithuania is taking the lead on the construction of the LNG terminal in Klaipeda. According
to the press releases of the operating company, the terminal itself should be ready by the end
of 2014. Consecutively, first agreements on delivery are being negotiated.95 Notably, it wont
have considerable effect on the current energy scene of the country. The first deliveries are
still the question of the upcoming years and the effective amount largely depends on the
prospective of US deliveries. On the contrary of the possible disadvantage of the Russian
resource, connection to the already existing Yamal pipeline might be a feasible solution.
Provided this, the granting of TPA of special interest, however the last intent on it by the
polish TSO was published in 2010.96
Poland in particular nourished great expectations towards the shale gas exploration and
extraction in the near future. Based on a comparative approach the maximum production is
going to be reached in 5 years time, in 2020, accounting for 28,3 bcm/year. The asset life,
with the given marginal cost curve, would be 40 years.97 However, many uncertainties
surround the outlook of exploration of the Polish shale gas reserves. The EIA estimated the
polish technically recoverable shale gas reserves of Poland 4,43 tcm. That result is lower than
the widely referred to 2011 report that indicated 5.6 tcm of technically recoverable sale gas
for the Baltic Basin, the Lublin, the Podlasie and the Fore Sudetic basin.98 On the contrary
the Polish Geological Institute’s estimations, based on exploration drillings, are considerably
lower, accounting for only 768 bcm.99 Until the first half of 2013 concessions for shale and
tight gas prospection and exploration have been granted out of 256, while 0 concessions for
exploitation or production has been issued.100 It has been widely considered to be alarming
that the ExxonMobile abandoned its exploration wells in the Lublin and Podlasie basins in
June 2012 accompanied by two other companies. Some established connection with low flow
93Booz&Co., 2012: 102 94 thebaltictimes.com, 2012 95 euinfrastructure.com, 2014. 96 Energy Regulatory Office, 2010 97 Geny,2010:82 98 eia, 2013: 1-9 99 Bloomberg, 2012 100 Ministry of Environment, 2013
38
rates, however in inadequate tax –and royalty regime has been anticipated the reason
underlying the abandonment.101 As the ExxonMobile case might depict, both reasoning can
be established. Early indications assume that the exploitation costs might account for 10-15
million USD accompanied by the fact that the wells need additional infrastructure such as
connecting pipelines, storages or roads.102 Moreover, the services attached to the drilling
activities need to be discussed. Services, on the top of which is the rig service is of special
importance. In the US, as the primary player in shale gas development, the inexpensive rig
capacity was essential for a feasible exploitation and production.103 According to the various
interviews with service companies, the rig rate would be around 20% higher in comparison
with the US rig rates. It stems from the fact that the market for rig services is oligolopistic.104
Inexpensive and competitive rig services the marginal cost curve might be more steep in
comparison. As for the national regulatory environment the Polish Exploration and
Production Industry Organisation (OPPPW), the industry's main lobby group assessed the
current and the proposed legislation on shale gas exploitation highly disadvantageous. The
OPPPW argued that the concessions for exploitation is inadequate as since the time frame is
too short for viable production in economic terms. Moreover, the obligation to provide share
in each project for the state-owned company, NOKE, is beyond the interest of the
industry.105 Generally speaking, the most profound question is the economic viability of the
shale gas exploitation. Provided this, with the projected 28,3 bcm/year it might be a potential
source for the GIPL.
It is clear that there is a supply base for the GIPL, however with various level of completion
deadline and prospective. On the hand, provided that it is the primary facility to terminate the
”energy island” status of the East-Baltic states, the EU COM shall foster the completion of the
infrastructure. On the other hand, considerations arise in the current framework of the internal
energy market to the GIPL. As we have seen with reference to the secondary legislation of the
energy market, exemption for TPA might be provided for new infrastructures. The TPA in
practice separated the supply and capacity contracts accompanied by the aim to move towards
shorter durations in capacity allocation. On the one hand it shall foster the competition on the
capacity markets. On the other hand the operational nature of the natural gas industry
shouldn’t be left beyond the scope of considerations. The industry is based on long-term
strategic thinking, where the mismatch between long-term supply obligations and short term
101naturalgaseurope.com, 2012 102 Grodzki, 2012: 10 103Asche, 2012: 119 104Geny,2010:82 105 Economist, 2013
39
capacity allocation facilities might decrees participation in the market and might mitigate
investment.106 It is beyond any doubts that the East-Baltic market is small in comparison. In
live with the former suppliers barely would compete for shipment rights under TPA regime.
The international experiences indicate that the shippers and pipeline investors prefer
comprehensive agreements (supply and capacity contracts jointly) as a result of the TPA
exemption.107 However exemption wouldn’t foster capacity market, spot market
developments, it is the inevitable tool for the higher probability for the completion of the
project, provided the established market attributes.
As we see, however the political aim is in place, the BEMIP does not represent a short-and
medium solution. Behind it lies the following reason on general terms:
• Uncertainty in financial terms. Uncertainties surround the entire system envisaged by
the BEMIP from the point of view of Community and private financing respectively.
On behalf of the EU, the small proportion that the community undertakes as financial
contribution. The small market size and the high proportion of community support
hinders the process of infrastructure development on general terms.
• Uncertainty with reference to the sources of supply. It considers as well the most
advancing infrastructure project in Lithuania.
• Uncertainty regarding the relevant EU legislation, such as TPA exemption.
• Lack of unified actions and cooperative agenda setting on behalf of the political elite
of the Baltic States.
Stemming from these assumption, it results in that the only feasible aim the Baltic States
might fulfil is the most advantageous price level. Here the Baltic States have a broad set of
tools from the Europeanisation’s achievements.
III.3 Price setting
In short –and medium term the sole feasible objective that might be fulfilled is the price level.
The government officials and experts constantly argue that the Baltic States pay in relative
terms higher price in comparison with the neighbours and the EU respectively. The most
challenging reaction was presented by Lithuanian officials on the topic firmly adopting the
stance that the Baltic states in general but Lithuania in particular pays the highest price in the
106 Talus, 2011: 269 107 Belyi, 2013: 2
40
EU.108 To assess the relative level of price in terms of the EU28 level faces difficulties. The
LTC’s content and provisions are not open to the public. The indexation formula may differ
from country to country agreed with Gazprom resulting in a different price level. 109 What we
can firmly state is the end-customer price.
Notably the investigation from an absolute point of view brings us closer to a proper
assessment. As we have seen in the previous section there is a price difference among the
three Baltic States where Lithuania pays the highest price. Of course complete transition to
hub-based pricing does not imply any realistic prospect as it intended by the COM. For this
reason a more advantageous price level should be reached.
III.3.1 Gazprom’s new contractual portfolio
As we have observed in the previous section in short-and medium term considerable
infrastructural developments are not feasible. In line with these steps might be taken in order
to realise a more advantageous price setting. To assess these prospective of the Baltic States
we have to as initiating step asses the price setting policy of the Gazprom. The reason for that
is twofold: On the one hand we can determine if the energy giant is willing to take measures
aimed the reduction of the price level. On the other hand we might identify those points that
contributed to and underlined the aforementioned steps. In line with these we might as well
assess whether these steps might applied to the Baltic States or the tools of the
Europeanization might be deployed.
On the course of 2010-2012 the Gazprom faced numerous challenges on the European gas
market. To counterbalance these negative tendencies, it employed for the first sight
remarkably flexible changes to its export portfolio. Тhe Russian contractual portfolio was
characterised by numerous, seemingly uncontested, attributes. On the top of these attributes
was the so called Take-or-Pay clause (TOP) accounting for 80%-85% of obligatory purchase
of the total contracted volume. This minimum pay obligation aimed at ensuring a high
utilisation rate of high investment in the pipeline system.110 The other cornerstone of the Long
Term Supply Contracts (LTC) was the oil-indexed net back pricing where the price of the
commodity was tied to a previously agreed multiplication of crude oil and oil product. The
Gazprom had the preference for long term run up periods, in average 20-25 years of
108 http://www.euractiv.com/energy/lithuanian-minister-gazprom-know-news-529127 109 Grigas, 2012: 11 110 Kopolyanik, 2008: 157
41
contractual period. The last attribute ceased to exist in 2002; the destination clause is no more
part of the LTC’s of Gazprom.111
From 2008 onwards we see a considerable change on the gas market of the European Union.
In principle these are the decrease of natural gas consumption, the surplus of natural gas on
the market resulting in increased gas-to-gas competition, and in strong relation to it the
widening difference between the oil-linked and the hub-based pricing.
15. Figure: Consumption and import in the EU
Source: EU COM
The above figure clearly indicates a decrease in the total consumption within the European
Union. It is a direct result of the 2008 economic and the later transposing European crisis. The
overall consumption is one thing. The more determining development is the massive surplus
of natural gas on the European market. Furthermore, as it is depicted in the figure 16., the
share of LNG import has steadily increased, mostly from Algeria and Qatar.
16. Figure: Developments of EU27 imports and the relative position of LNG
Source: EU COM
111 The destination caluse was by definition the restriction imposed ont he re-export of natural gas delivered to a certain state. The economic rationell underlying the destination clause was that the importing state might gain profit by selling with a considerable profit margin the previously cheaper deliverd Russian natural gas.
42
in the past 10 years the European natural gas market has witnessed an increasing role of the
trading hubs. 112 These include the Title Transfer Facility (TTF), the Zeebruge Hub, The
NetConnect Germany, the Gaspool Balancing Service and the Points d’Echange de Gaz.
17. Figure Development of trade volumes on related European hubs
Source: data from ZEE, NGC, GPL, PEG, TTF
18. Figure: Price differentials between contracted and spot volumes
Source: BP
The volume traded on these hubs has increased to a considerable extent – as it is portrayed by
the above graph. Moreover, the average price of the on-hub-traded gas has decreased in
comparison with the oil-indexed one, mostly as a result of the aforementioned oversupply and
112Patric Heather, the leading expert on the development of European hubs employes the categorisation of 1) trading hubs 2) transit hubs 3) transition hubs. However this categorisation doesn’t have direct relevance from the point of view of our investigation.
43
the increase in the world oil price. Тhe price difference by 2012 accounted for approximately
14% in average. As a result of the increased share of hub-based trading and consecutively the
emergence of gas-to-gas competition the justification of oil-indexed pricing has been put into
question. The primary assumption underlying the assumption is that the spot market prices are
generally lower than those of oil indexed ones. During 2008 and 2010 it has become looming
that on the North-Western European hubs a hybrid pricing emerged, where the customers
found themselves in a situation where they had the obligation to buy at least 85% of their
contractual commitments. At the same time they were obliged to sell natural gas on the
provided spot prices; being in average lower.113 Moreover, the buyers failed to take the
contracted TOP volumes in year 2008/2009. The reason behind is that they excessively made
purchase of spot gas due to lower prices.114 In line with these, the decoupling of oil indexed
and hub-based prices raised wings.
As a result of the above scrutinised gas market developments the Gazprom faced two
profound challenges, namely the fulfilment of TOP clauses and the average wholesale price
developments. Notably these changes have to be observed through critical lenses. As for the
price, it is profound to express that the question of price level and price setting, however
being correlated are different in time scale. The price setting is a question in long term, not
imposing immediate effect on the policy of Gazprom. In stems from the fact that the future
relative price developments are unpredictable to a great extent. Currently, however almost all
of the hubs fulfil the requirement of anonymity and liquidity, the most determining criteria of
the at least 10 churn ratio rate is barely met by the continental hubs.115 This challenge their
position for benchmarking gas prices. It has to be highlighted that the question of price setting
formula is related to benchmarking, namely to include spot prices into the LTCs. In this
regard to opposing standpoints evolved over the course of the past few years. One pole of the
debate strongly supports the maintenance of the current oil-indexed setting. Sergey Komlev,
Head of Contract Structuring and Pricing Directorate at Gazprom Export expressed his
opinion in favour of the current system. He stresses the importance of the risk sharing nature
of the oil-indexation (accompanied by TOP clauses).116On the contrary Jonathan Stern argues
in favour of spot benchmarking as since he foresees a continuing decouple of oil-indexed
prices and spot prices. He supports the assumption that the world price of crude oil will be
constantly above 70 USD/bbl. In line with these, with the continuing surplus of natural gas
113 Stern, 2010: 21 114 Stern and Rogers, 2011: 22 115 Konoplyanik, 2011: 8 116 naturalgaseurope.com, 2013
44
supply the spot pricing shall result in lower relative price.117 Andrei Konoplyanik, advisor to
the CEO of Gazprom, argues in favour of a mixed system where different contractual
structures will coexist that will link both to the competing fuels (interfuel competition) and
gas-to-gas competition.118 All three of them agree upon the continued existence of indexation.
In the short term the price levels faced the necessity to be revised. The Gazprom reduced the
prices in two steps. First in 2010 when 15% of the contracted capacity was being indexed to
spot prices. During 2012 a further price reduction occurred however surrounded by certain
degree of uncertainty whether being owed to indexation to the spot pricing or modification in
the oil indexation formula.119
Between the economic-and euro crisis and 2012 we see a gradually evolving set of attributes
exposing pressure on the export practices of Gazprom. We are able to advocate the
assumption of András Deák’s by admitting that Gazprom pursues a more flexible export
startegy as a result of price pressure from European hubs and related developments. However
these are only general stipulations. The below table allows for further elaboration of the topic.
Here we are predominantly interested in, whether an East-West divine can be detected in the
modified export strategies of Gazprom. More precisely
Share in
Gazprom
export %
Dependency
rate on
Gazprom (%)
Dependency/correction Export
share/correction
Austria 2,86 61,9 + +
Belgium 4,45 28,0 - -
Bulgaria 1,52 100,0 + +
Czech
Republic
3,99 66,2 + +
Finland 1,91 100,0 - -
France 4,41 20,8 + +
Germany 18,19 34,6 + +
Greece 1,37 78,4 - -
Hungary 2,90 81,3 - -
Italy 8,27 22,9 + +
Netherlands 1,27 14,4 - -
Romania 1,38 72,8 - -
Poland 5,45 82,2 + +
Slovakia 2,30 92,7 + +
117 Stern, 2011 118 Konoplyianik, 2013 119Deák, 2013: 4-5
45
In the table we aimed at identifying two relevant variables. The correlation between
dependency and change in the price level (or TOP modification) and the other one is the share
in export in correlation with the price change. We listed western and eastern countries
respectively. Firstly we can state that our investigation is proven: in both cases if the country
was a major partner of Gazprom and/or had access to different sources and trading hubs a
price modification occurred. At the same time in countries where there is a relatively low
ranking with reference to export position and/or relative isolation from spot markets
accompanied by a high dependency on a single supplier price change emerged.
III.4 The Baltic State’s strategy in practice
This said, we can claim that other external factors might gain justified foothold. In this regard
we strongly adapt the position that the Baltic States aim at the price re-setting by the tools of
the Europeanization. Notably, we have to make a methodological bypass at this point. On the
one hand the three Baltic States use these tools in a different manner. To the pattern followed
by Estonia and Latvia we refer as passive which is on terms by definition a dispute avoiding
behaviour accompanied by a free-raider strategy where two states build upon the
achievements of another one. On the contrary to the strategy of Lithuania we refer to as active
that entails a gain maximising behaviour. On the other hand we support the idea that all three
states use the considerable part of the tools in an indirect way. By definition the indirect usage
means an act where a policy tool with a well defined objective is used as a bargaining tool to
fulfil other objectives.
We have seen through the lenses of our reasoning in the preceding part the prospective and
opportunities for a liberalised market setting for the Baltic States is not feasible in short-and
medium term. It stems from the small market size resulting in low attractiveness for investors
and the development of necceserary infrastructure on a slow pace. However we observed
respectively that the Gazprom is willing to ease the terms of the contractual portfolio under
certain circumstances. Тhese circumstances might be market-based leverage or other external
factors. This said our profound argumentation is that the three Baltic States use the provisions
of the Third Energy Directive in an indirect way. One of the profound aim of the Energy
Package to create an integrated energy market that will be an essential part in creating SoS.
The Directive aims at the liberalisation of the market in order to channel in investment and
increase competition. This said it is clear that the aims are reachable over a longer period of
time. For this reason the manoeuvring of the Baltic States reflect that the direct elaborative
46
aims are only of secondary nature. While operating along these lines the objective that is on
the forefront of the moves are to agree upon a more favourable price setting.
As we have referred to it is a complicated task to assess the actual import price differences of
the Baltic States. What we can firmly state is that from the dissolution of the Soviet Union
until 2004 the Baltic States enjoyed a discount import price. In the period lasting from 2005
until 2008 the accelerated increase resulted in price amounting for the Western European
level.120 Based on the content of the interview conducted with Deputy Chairman of Gasport
Valery Golubov in 2011 there is a considerable price difference between the Baltic States. As
he elaborated, due to “Vilnius’s inadequate behaviour while restructuring the gas sector”
Gazprom did not cut the prices by a level accounting for 15% for Lithuania as it happened for
Estonia and Latvia.121
From the point of view of the above scrutinized system and in the presence of price difference
in absolute terms we can assess the strategies undertaken by the Baltic States. It is widely
known that Estonia and Latvia opted for a delayed implementation of the Directive until 2014.
It is accompanied by the fact that both of them announced the implementation of the ITO
option where the owner of the infrastructure is not deprived from the assets in essential. For
this strategic behaviour we refer to as passive strategy. In comparison Lithuania took a more
proactive stance towards the price reduction. This first was being manifested in not applying
for an exemption under the provisions of the Directive and parallel announced the OU
formula for the unbundling requirement. By this pattern we mean active strategic
manoeuvring.
In the preceding chapters it was clearly shed light on that Lithuania is as well an isolated state
in terms of energy infrastructure as the other two Baltic States. However Lithuania has a
strategic asset in hands on which Vilnius might put a grip upon. Traditionally, basically until
the Package was enacted, Lithuania considered the pipeline supplying Kaliningrad oblast as
an important element in shaping the relations vis-á-vis Russia.122 The strategic drawback was
imminent; there was no direct control over the pipeline until 2013. As a first step Lithuania
choose the option to challenge the Gazprom by the means of the national legislation, more
precisely by strict legal means. In the legal process started in 2011 the Lithuania state brought
before court the claim of alleged discriminating in price setting and using it as a pressure on
the state of Lithuania. The Gazprom turned for arbitrage to the Stockholm’s Arbitration
120 Grigas, 2012: 10. 121 Moskovskye Novosty, 2011 122 Balmaceda, 2013: 222.
47
Institute to make the Lithuanian state to abandon the cases. At this point Lithuania aimed at
directly establish a connection between Gazprom’s practices and the higher price of natural
gas imported. From 2012 onwards we see a partial turn in the policy concept of the Lithuanian
state in this regard. The question of price setting was gradually attached to the legislation of
the unbundling format. In 2012 the Shareholders meeting decided upon the establishment of
the Amber Grid as the TSO of Lithuania. Notably, the decision upon the shareholder’s status
was postponed.123 On more specific terms Vilnius set a complex strategy: It pushed to the
possible furthest extent the unbundling manifesting in OU. Parallel the question of the
Kaliningrad pipeline was vested in with centric position. As a vector of these steps the price
reduction was set as the ultimate objective.
Russia’s strategic position vis-á-vis Lithuania is centred around the pipeline respectively.
Kaliningrad oblast is solely accessible through the pipeline running through Lithuania. From a
strategic point of view Russia cannot exercise leverage upon Vilnius by for example cutting
supplies or reducing the delivered quantity as since it would have immediate effect upon the
oblast respectively.124 In line with these however Moscow insist upon supply diversification
of Kaliningrad in the framework of an LNG terminal. Notably the earliest point for the
operational status is might be no sooner then the course of 2018-2019.125 This in turn allowed
Lithuania for a broader space for manoeuvring.
Having this broader space, Lithuania could maximise the gains. The OU was given green light
when already in 2013 the Russian PM considered the implementation of the Directive as
Lithuania’s internal authority.126 This was a landmark as since the Russian Federation allows
for a free negotiation between the Lithuanian state, the state energy company and Gazprom.
At the 2014 meeting between the Lithuanian PM and the CEO of Gazprom the issue of the
implementation of unbundling was considered to be settled and completed. 127 At the same
time Vilnius made congestions in this process to proceed towards the ultimate objective of
price reduction. The initial Russian position claimed a 10-year long term supply contract
guaranteeing uninterrupted supply and under the market price transit tariffs.128 The
momentum where Vilnius could embrace the Directive as a negotiating tool was that it did not
exclude Gazprom entirely from the system. While Gazprom sold the shares in the Amber Grid
TSO on the one hand it could stay as investor in the company. On the other hand it has still
123 thebalticcourse.com, 2013. 124 Grigas, 2012: 56. 125 Sharples, 2013: 7. 126 Lithuanian Tribune, 2013. 127 Lithuanian tribune, 2014. 128 naturalgaseurope.com, 2014.
48
determining share in the Lietuvos Dujos energy company. These two provide with
considerable weight for the company, notably, with limits set. Under the provisions of the
TPA the tariffs are determined by the national regulatory authority. However being
independent of the government, the prospective of effective lobbying is still in place for
Gazprom. The temporary frozen negotiations restarted in 2014. The positions have
approaching mutually in two determining senses. At the above mentioned Sochi meeting the
Lithuanian side did not keep aloof from a commercial agreement to be negotiated between
Amber Grid and Gazprom. In addition, however not being certified openly respectively, the
Gazprom’s proposal contained a reduced price accounting for 20% in the new LTC starting
from 2015.129 This seemingly marks a success for the Lithuanian strategy.
In comparison with Lithuania, Estonia and Latvia employed a passive strategy. It stems from
the fact that neither of the countries possess such strategic asset or were not capable of
exploiting the potentials vested in. Estonia should be considered to be characterised by the
first group of attributes. Notably in case of Estonia there might be a change in the strategy.
The legal basis has been already established as since Riigikogu has approved a legislation to
deprive the assets from Eesti Gaas with a deadline of 2015.130 At the same time this decision
at the same time clearly reflects the wait-and-see passive strategy. On theoretical terms the
Incukalns would be a basis for negotiation just as we encountered it in case of Lithuania. On
the contrary the Incukalns UGS does not share such strategic attributes. The prevailing
contractual structure means a considerable obstacle for effective TPA to the UGS. It is
accompanied by, as we referred to in the preceding section, the low capacity and need for
modernisation of pipelines.131 This effectively lacks behind because of the slow pace
advancement of BEMIP. For this reason Russia could exert leverage upon Riga. Moreover the
Latvian government had concluded an agreement with Latvia’s Gaze to possess the exclusive
rights of supply in the infrastructure until 2017.132 Latvia has explicitly referred to the price
dynamics on which the Gazprom has the ultimate impact. The author of the thesis on an
energy policy training was informed by high ranking government officials that they prefer the
moderate ITO option due to “strategic reasons” in relationship with the Gazprom. 133 In 2013
uncertified news have roamed in the Baltic media of a 20% reduction for the price of gas in
the new supply contract with Gazprom.134 While in time close to these alleged developments
129 bne.eu, 2014. 130 Bloomberg, 2012. 131 Lejins, 2010:75. 132 Grigas, 2012: 15. 133 Lecture given by Gatis Ābele, deputy state secretary of the Ministry of Econom of Latvia 134 eurotopics.net, 2013
49
the Saeima approved a delayed implementation of the Directive.135 We can assess, based on
the information available for the public, that both strategies are proven to be successful.
However we can firmly state that on in short- and medium term. The passive strategy does not
foster to reach the integration of the gas market of the Baltic States in long term.
The other tool from the toolset of Europeanization is the antitrust case filed against Gazprom.
Notably, this instrument is of complementary nature to the basic strategy scrutinised above.
At the same time it reflects partly the basic strategy of the three Baltic States. We can assess
the developments from the point of view activity and passivity alongside whether the
investigation implies any effects in short-and medium term. As we have revealed in the
preceding section upon the topic the COM proceeds with the investigation in three profound
respective in CEE states. It claims that Gazprom may have:
1) hindered the free flow of gas across Member States;
2) prevented the diversification of supply of gas;
3) may have imposed unfair prices on its customers by linking the price of gas to oil
prices.
The first alleged breach is not of profound interest for the Baltic States. It stems from the
already elaborated ‘energy island’ status of the countries. The second field of investigation is
only of particular interest in longer terms where the precondition is the successful level of
implementation of the infrastructure included in the BEMIP. In case the COM finds satisfying
amount and proving-powered evidence, might assess an alleged behaviour of hindering the
BEMIP projects, including pipelines and proposed LNG terminals.136 Direct and profound
effect is imposed by the third section of investigation. Notably, the effect in terms of time
considerations is dual. What might imply short-and medium term considerations is the proof
directed at the unfair nature of price. In case of underpinning such practice it might give
additional tool of leverage in the hand of the Baltic States. As we have seen the new LTCs are
under negotiation currently. To come to terms on a more favourable price level, however, this
tool has indirect effect providing additional leverage. We have to highlight that the COM’s
aim is different to the latter in comparison: the objective might be assessed to put pressure on
the Gazprom to alter its pricing model from oil-linked to hub-based pricing. However this is
in long term a feasible scenario and might rather result in a hybrid pricing.137 This assumption
135 The Baltic Times, 2013 136 Riley, 2012: 9. 137 Grigas, 2012: 13.
50
is even more underpinned if we contrast it with a transition to an exclusive hub-based pricing.
If the BEMIP as being implemented would result in diversification and thus increased
liquidity is it put into question, whether the Baltic States would enjoy lower prices in
comparison. The standpoint is even widely adopted that such a ‘Baltic Hub’ would provide
with, in relative terms, higher prices. It stems from the fact that such a hub established would
reflect a relative price to already established Western-European hub resulting in a, for
example, ‘NBP plus’ pricing.138 From the point of view of active or passive behaviour, the
Baltic States are not unified in this regard. Lithuania clearly adopted an active stance. Various
source confirmed that Vilnius has appealed to the COM already on the course of 2011-2012 to
initiate an antitrust investigation upon Gazprom.139 With reference to Estonia and Latvia no
such activity was reported, their strategy reflects the passive, ‘wait-and-see’ practice. The
investigation is did not reveal any proactive stance adopted by the latter two countries, they
rather aim react passively on the developments.
IV. CONCLUSION
Currently the energy policy of the EU is characterised by an increased Europeanization where
in the agent-principal relationship the balance has moved towards the agent, the European
Commission. In this dynamic process the COM has established a system where it acquired a
strong proactive role. Three broad fields were identified within this system. The ‘export of the
internal energy market’. This new concept was the direct result of the changes in the EU-
Russia relations. On the one hand stemming from the consequences of the Russo-Ukrainian
gas crises the COM acquired considerable rights through the means of the internal energy
market and was delegated competences by individual string of documents. On the other hand
the disintegration of the EU-Russia Energy Dialogue the Gazprom lost considerable defence.
The third element, the Antitrust Case exercises additional leverage upon the Gazprom. The
vector of these attributes the Gazprom and Russia in the backyard was increasingly forced to
undertake the ‘rule of the game’ set by the COM. The Third Energy Package is a prime tool
for establishing the common energy market. The Package well integrates into the increased
Europeanization. On the one hand it delegates considerable authority to the COM at the same
time challenges the positions of the Gazprom to a great extent. The BEMIP is considered to
be a landmark in fostering the establishment of the internal energy market. Here the COM
plays an underlying role in promoting the infrastructure development.
138 Belyi, 2013: 2. 139 Konoplyanik, 2013: 3.
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We elaborated in a comprehensive analysis the current status of the energy market of the
Baltic States. This said, we could underline the concept of ‘energy island’ that is by definition
the complete isolation from the rest of continental Europe. In line with these we described the
ownership structure of the energy companies in the Baltic States alongside with already
established infrastructure. Consecutively we underlined that based on the status of
development of BEMIP the only feasible objective is the reduction of price level in short and
medium term. As part of these assumptions it has been shed light on that provisions of the
Third Energy Package, with special emphasis on unbundling and TPA, and the antitrust case
was being deployed as means of arbitrage. Notably, solely these tools could have been
measured, other set of tools might be in service of the Baltic States but these were not
objectively assessable at the time of the research was being conducted.
Based on the publicly available information and dataset we could firmly state that the ultimate
objective of the Baltic States was fulfilled by the indirect use of tools of the Europeanised
energy policy. At the same time different strategies were deployed. Estonia and Latvia, as
constituting one set of rules, undertook the strategy of ‘passive’ approach while Lithuania was
in advocation of the ‘active’ strategy.
52
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