The idea that Europe is becoming more dependent on Russian gas is as widespread as it is untrue. Europe's fears about dependency spring from several misapprehensions about the Russo-European natural gas relationship. The most important mistaken beliefs are that Europe relies increasingly on Russian gas, that such reliance poses a threat and that Europe should respond to the threat by dealing with Russia as one. In the end, a strong internal market is Europe's best defense. Markets are no panacea, surely, and they need certainty and regulation to function. But political meddling in energy markets is counterproductive.

For the past decade, Russia has supplied a sizeable share of European gas: roughly a quarter, depending on how one defines Europe. But Russia's market share is flat despite Gazprom's two new pipelines into Europe, and despite its tight grip on Central Asian gas. Europe now receives natural gas from an array of countries, including Norway, Algeria, Libya, Egypt, Trinidad, Nigeria and others. The continent's wide profile becomes more diverse with every year that passes.

Going forward, Russian supplies to Europe will remain at constant levels at best. Over 70 percent of Gazprom's gas comes from four fields, three of which are in decline. The company's new reserves are in the Yamal Peninsula and the Barents Sea, both of which will be difficult and expensive to develop. Even if Gazprom raises supplies to Europe significantly-which is unlikely given the expense involved and rising gas demand within Russia-it will at best top a 30 percent market share, which is not much above current levels.

Meanwhile, Europe's quest for diversification proceeds. While the political world is fixated on Nabucco, a pipeline to link the Caspian, and possibly the Middle East, to Central Europe, Europe's diversification efforts transcend that project. New pipelines from Algeria are being built, exploration activity is strong in Libya, and new liquefied natural gas supplies are coming online in Asia and in the Middle East, adding significant volumes to a tight market. While they haven't drilled a gusher, Europe's diversification program is yielding results.

Even so, isn't a quarter of Europe's gas coming from Russia already a problem? Economically, no. The price of Russian gas is similar to other supplies in Europe: as expensive as Norwegian gas, cheaper than Dutch gas and more expensive than Algerian gas. Much as consumers and politicians fret about Gazprom, the price of natural gas is linked to oil, and it is high oil prices, rather than Gazprom's tactics, which lead to higher natural-gas prices in Europe. Even in countries where politicians want to diversify from Russia, companies have often preferred Russian gas because it is cheaper.

Despite all these realities, many are still worried about the political implications of Europe's supposed energy dependence on Russia. Gas is a hard weapon to wield for political gain. Even Russophobes cannot show major gains that Russia has extracted from energy pressure in its near abroad-not even in the former Soviet republics. Countries bound by gas pipelines are like brothers growing up: they may dislike and argue with one another, but they are bound to live together, and the incentive to cooperate usually exceeds the gain from confrontation.

How, then, should Europe respond to Russia? The most common suggestion is for Europe to deal with Russia in a unified way-eliminating bilateral deals with Gazprom. This is alluring but unrealistic. Europe's energy profile is too diverse to make a common policy toward Russia possible. How can a county that imports no Russian gas (like Spain) and one that depends exclusively on Russian gas (like Hungary) agree on a common agenda, especially when their historical experiences with Russia are so different? Nor does Europe have a mechanism to allow for such policy: there is no "European" company to import gas nor is there a "European" market in which gas will be consumed. This is no reason to despair, however, as a common policy toward Russia is undesirable anyway.

A unified policy would stop bilateral deals with Gazprom by subjecting commercial decisions to a political veto-hardly the optimal strategy at a time when the market needs to move swiftly to access new supplies. Europe needs a stronger market more than a unified policy. The case for a common policy, moreover, contradicts another objective: boosting competition in the European gas market. A free market requires the depoliticization of energy-if companies cannot cut their own deals, there is no market.

Europe's internal gas market has failed it more often than Russia (even during the Ukraine crisis there were few serious physical disruptions to the gas supply). In 2006, the UK and Italy experienced gas shortages while their neighbors were well stocked, evidence of a malfunctioning and poorly connected market. Even in electricity, low rainfall or accidents have plunged countries into darkness more often than external shocks. Energy insecurity is often homegrown.

Such a view contradicts the idea that energy is "too strategic" to be left to markets. But give markets their due. In 1998, Spain imported 60 percent of its gas from Algeria; after liberalization of its energy market, it decreased to 37 percent by 2007. Italy is building half a dozen new import projects, most of them led by companies which a decade ago would have had no option but to buy their gas from Eni, the state-run energy company with a monopoly on the market. The UK, the first EU country to liberalize its gas market, has enjoyed lower residential prices than most and has multiple import projects to cope with the decline in its production. Politicians might talk about diversification but markets actually deliver it.

Europeans who complain about Russian interference in energy markets should look in the mirror from time to time-with most governments sharing in the shame. The hope that Russia will "open up" when confronted with a unified European policy is difficult to accept, since Europe is asking Russia to adopt a policy which it will not accept for itself. And despite the rhetoric, Russia is still open for business-albeit on Russian terms-as Gazprom's partnerships for the Yuzhno Russkoye and Shtokman fields prove.

Countries like Poland, Ukraine and Hungary will be more secure with a market in Europe to help them cope with disruptions. Such a market requires stronger regulation of network assets, more cross-border linkages and greater certainty about carbon supplies. Fundamentally, it requires a political commitment to markets-rather than trying to craft a common strategy toward Russia.

In truth, the underlying strategic problem is not Europe's dependence on Russian gas but the windfall available to the Russian state as a result of oil and gas exports. In ten years, Russia has gone from begging the international financial community for a bail-out to running huge surpluses. In 1999, Russia earned $31 billion in export revenues from oil and gas; by 2007, it earned $218 billion, a number that will grow in 2008 (in the first quarter of 2008, Russian oil and gas export earnings were already $74 billion). A country that earns over $800 million a day from oil and gas will act differently than its poorer self.

So long as the world consumes energy in the way that it has in the past half century, there is little that can happen to reverse these trends-European dollars and Euros will continue to accumulate in Russian hands. Despite the fear that Russia will use energy as a apolitical weapon, it turns out that other weapons-be it cyber attacks on Estonia or military action against Georgia-are more potent, made possible by Russia's increasing wealth. In the short run, Europe is on track to diversify its supply sources but it needs a stronger internal market to enhance its ability to cope with disruptions. And in the long run, Europe's relationship with Russia will hardly rebalance until Europe's and the world's appetite for Russian oil and gas diminishes.

 

 

Nikos Tsafos in an analyst with PFC Energy where he specializes on the European gas market and its link to suppliers such as Russia, the Caspian region, North Africa and the Middle East.