The current crisis in Ukraine and the rounds of sanctions directed against Russia in the aftermath of the aggressions in Crimea and eastern Ukraine have once again led to the escalation of the debate about the energy independence of European countries. More specifically, the discussion focused on the options we have to create a comprehensive set of energy options that would leave us less vulnerable in the face of the power escalation with any potential adversary in control of a considerable energy resource. 

This issue became a crucial one mainly due to the fact that some of the Central and Eastern European countries have found themselves fully dependent on the imports of oil and gas from Russia, which have been threatened by the current escalation of conflicts in Ukraine and the rounds of sanctions that were passed on both sides of the conflict. The 2009 gas dispute between Russia and Ukraine was the first example of such an escalation and the impacts of this crisis were felt mainly in Slovakia and Bulgaria which had 100 % (Slovakia) and 96 % (Bulgaria) of their gas imports from Russia with no diversification ready at the time that could help them in the case of such crisis¹.

Thus, a plan of energy diversification became one of the hot issues in the face of this new conflict, which reached the level of a military aggression and the annexation of the Ukrainian territory. However, it is yet very unclear as to what the best options in context of this political and economic drama really are.

The list of energy options can vary from a simple diversification of imports to the countries of Central and Eastern Europe, through support of energy efficient transportation and production, to financial support for the renewable energy resources, and numerous others. However, due to the fact that the EU favours creating either financial disincentives against the production of CO2 – as illustrated by the proposals for the carbon tax – or direct subsidies for other energy resources – as in case of the renewable resources – it is necessary to ask a number of questions. Namely, it is crucial to investigate how do these policies affect the economic freedom of businesses and consumers within the EU, illustrate their impact and briefly discuss the alternative approaches that might have a smaller effect.

Due to the current military aggression in Ukraine, it is usually taken for granted that the EU must act as a protector of the energy independence and assure that the energy needs of the countries are met. However, it needs to be questioned how the EU should tackle this task and what this mandate should allow the EU to do. If we leave the issue of freedom aside for the sake of emergency situation we are now facing, we might find that this will lead to unintended consequences distorting the energy market and affecting the energy prices for the citizens and companies in Europe.

Energy strategy of the EU

So what have been the responses of the EU in the energy field so far? The current framework of the debate in the European Union about the establishment of a common energy policy has been properly kicked off in 2006 by the Green Paper entitled A European Strategy for Sustainable, Competitive and Secure Energy. This green paper included possible founding principles for the common energy policy going forward.

The first set of proposals, Energy for a Changing World, was published by the European Commission in March 2007. These proposals were supposed to lead to a post-industrial revolution and a low-carbon economy, which would be accompanied by an increased competition in the energy markets, more secure and diversified energy supply, smaller impact on the environment and also improved employment situation in the European countries. The key proposals that were included:

1. a decrease of at least 20 % in the emissions of the greenhouse gasses from the primary energy sources by 2020 in comparison to the 1990 levels together with continued support for Kyoto Protocol, which would aim for a 30 % cut by all developed nations;

2. a cut up to 95 % in CO2 emissions from primary energy sources by 2050;

3. a minimum target of 10 % for the use of biofuels by 2020 in the European Union;

4. improving energy relations with the main neighbours of the EU, including Russia and the bordering regions to the South and East, with the example of the Africa-Europe Partnership, to help Africa adopt low-carbon technologies and become a sustainable energy provider and supplier².

Moreover, besides the basic targets with regard to renewable energy and the emissions of greenhouse gasses, another key aspect of the EU’s energy strategy is the aspect of energy independence and the diversification of its energy resources. According to European Commission, in the year 2011 the EU countries imported more than 54 % of the energy they consumed. More importantly, however, the EU countries imported more than 80 % of its oil needs and 60 % of the gas they used. Over the last ten years this aspect was one of the driving factors behind the EU’s push for a greater self-reliance of the EU in terms of use of renewable energy resources, building of the new energy networks and the increase in the energy efficiency, which is also one of the key aspects driving the current initiatives of the EU.

There is a definitely positive tone to this aspect, particularly due to the fact that diversification of imports should bring more competition to the energy markets of the EU countries, and thus lower the prices for the consumers. However, with support for the domestic alternatives in the form of renewable energy policies through the policy of subsidies casts a doubt on the economic rationality even if the aspect of greenhouse gas emissions is included. This is mostly due to the fact that the unintended economic consequences create such negative effects that the potential positive effects can be more efficiently gained through other means. In addition, with the Ukraine crisis and the abovementioned rounds of sanctions that were exchanged between the EU and Russia, the political dimension of the energy debate is likely to take the upper hand as the focus will increasingly be directed towards serving the political interests that the EU currently prefers³.

These proposals clearly indicate that the main direction of the European energy policy was designed to be heavily focused on centrally creating targets that would have to be met by the countries through policies that would drive companies from the use of traditional sources of energy. This means two main things for the future success of these initiatives.

Firstly, the goals of the European Union were set in terms of a declarative tone of future levels, which are completely outside the power of the EU, which makes them unachievable and unrealistic given the competing interests of all the 28 member states of the European Union. Secondly, if the EU was to actively pursue these goals, it would have to encourage a set of subsidies and forms of regulation to ensure compliance with these plans, which (as it is shown later in the article) often leads to different results than those anticipated by the EU. Therefore, from the outset it is possible to say that the EU energy agenda is based on pursuing goals which will lead to series of limitations on economic freedom for the companies and the consumers themselves, and which will be mostly funded by the tax money. Therefore, it is necessary to investigate what the results of these policies have been in some countries up to this point.

Current policies and their impacts

So what did these strategies and goals amounted to in terms of actual policies and what were their outcomes as regards achieving their goals and impacting economic freedoms? As it was mentioned above, the 2007 targets led to an adoption of the set of goals which were approved by the European Council and became known as the “20-20-20” targets, which meant that every country was given a specific target for the proportion of energy to come from the renewable energy resources. These targets took into consideration the local climatic capacities and other circumstances specific for a given country. For example, Slovakia was given a target of 14 % and the Czech Republic 13 %. Moreover, each of the countries was required to ensure that by 2020 the proportion of energy from renewable energy sources in all forms of transportation will be at least 10 %.

CO2 emissions

To achieve this target the EU countries adopted numerous initiatives including the EU ETS (European Union Emission Trading Scheme) system, which set the limits for the CO2 emissions and enabled the trading with the allowances of the CO2 emissions. In theory, this should allow for the supply and demand with these allowances to result in a creation of a balanced price for the pollution and offer a good disincentive to factories and producers to scale down their emission levels. The problem with this approach is, however, that the level of the total number of allowances which was set up arbitrarily did not create a short supply of them, so the effect of the incentive was relatively low. The key to the success of this strand of energy policy is an optimal level of the allowances, which in practice is extremely hard to achieve, and which in past always proved unsuccessful⁴.

Renewable energy

Renewable resources are also on the priority list of the European Union and this was represented by the number of initiatives undertaken in this field in the member states of the EU. The main tool on this front in the EU member states was the Feed in Tariffs (FIT), which supports the renewable energy through guaranteed prices, and this approach is typically complemented by fiscal stimuli, numerous investment grants, Tradable Green Certificates (TGCs) and various support programmes based on the EU’s structural funds. So it can be seen that all of these programmes in support of the renewable energy were based on the interference in the market on numerous levels. This means that they were from their very outset prone to create imbalances in the energy market resulting in the unintended consequences to be borne by clients in the member states.

To begin with, the implementation of the renewable energy sources is expensive with respect to the initial investment costs as well as the energy demands at the time of installation. For example, the energy returns for the coal plants are approximately 3.2–3.6 months, for nuclear plants approximately 2.9–3.4 months and for gas 0.8 months. The renewable energy resources fare in this comparison is much worse, with energy returns for water plants being around 4.6–13.7 months and photovoltaics in the scope of 71–141 months⁵.

Another problem associated with the renewable energy sources is their irregular and unpredictable electricity production, since it is dependent on natural factors. In case of positive circumstances there is an overproduction of electricity and a considerable congestion of the transmission system. Conversely, in case of bad weather circumstances might cause insufficient energy supplies, which have to be compensated by the backup, which increases the costs. The problems of this system are aggravated by the increasing integration of the European energy network. This means that the member states will have to invest increasingly large sums of money to maintain and reconstruct their own networks.

One of the complementing arguments in favour of the renewable energy approach from the proponents was that it would help create new jobs and increase the competitiveness of the sector in comparison with the rest of the world. The total turnover of the energy sector in the EU was estimated to be 137 billion Euros. The number of new jobs was estimated to exceed 1.1 million. A bulk of them was associated with installation and the service of the new plants. However, despite the expectations, the European producers of renewable energy are gradually losing their competitiveness to the rest of the world. While Europe is still dominating the global market in the area of wind energy, in case of the solar energy, the top 10 producers of solar panels contain eight from China and none from Europe.

Moreover, even the argument about the jobs is based on a very limited perspective. The subsidies directed at the renewable energy are crowding out the investment and consequently jobs from the unsubsidised and cheaper energy sectors. Furthermore, the resources spent on subsidies could be directed to other purposes, and thus have a more positive effects on the employment, or alternatively, given back to the taxpayers for their own use⁶.

Finally, the most hotly debated aspect of the support for the renewable energy is the impact it has on the energy prices in the European countries. This impact is perhaps best illustrated by the example of the Czech Republic, which committed itself to 13 % share of renewable energy sources on the final energy consumption for 2020. It opted for a number of measures in support of the renewable energy producers, including income tax exemption for the first five years of production (later abolished), property tax exemption and investment support from subsidy programmes. The key element was the law no. 180/2005, which guaranteed returns on units of electricity for 15 years and capped maximum per-year decline in purchase price of renewable energy at 5 %. These measures collided with a decrease in the costs of the solar panels due to cheap exports from China, which caused a boom in the solar energy sector that then resulted in a boom in the energy prices. These were covered from two sources: the former from the subsidies provided from the national budget, and the latter from the increased energy prices for the households and companies. Just in the Czech Republic the subsidies reached 11.7 billion euros both in 2012 and 2013 and grew to 14.7 billion in 2014. However, these subsidies covered only some portion of the total amount of the increased costs associated with the renewable energy. The part that is passed on the consumer has reached 38.4 billion in 2012 and 44.4 billion euros in 2013. This proves that the politically motivated approach to decrease the dependency on the foreign sources of energy can cause negative outcomes if it is based on the policy of subsidies⁷.

Foreign imports

The last key aspect of the current energy policy of the European Union and its member states reflects the fact that the EU is a net importer of energy, as stated above, notably in the areas of oil and gas. Thus, it has been crucial for the EU to develop good energy relations with its neighbouring countries and regions, which could act as potential partners with respect to the energy exchange. The main regions that are in the interest of the European Union are the Eastern Europe (including Russia and Ukraine), South Eastern region (starting from Balkan countries, through Turkey up to the Caucasus region in the North) and Mediterranean region (including North Africa and the Middle Eastern countries in the East). These countries have been approached through various multilateral partnerships, such as the Union for the Mediterranean, Energy Charter Treaty, and Energy Community, which altogether cover all mentioned areas.

These partnerships focus mostly on energy market, efficiency, transit and investment, dispute settlement and increased use of renewable energy. The importance of the neighbouring regions for the EU was strengthened through offers for economic partnerships in form of the EU neighbourhood policy and later association agreements, which should act as a carrot that would encourage economic, social and political reforms. This explains how the EU has currently such a rich network of agreements, including the currently signed Association Agreements with Ukraine, Moldova and Georgia and the negotiations of the Agreements with Armenia and Azerbaijan. At the same time, the Free Trade Agreements reach even farther and to include countries such as Egypt, Tunisia, Algeria and Morocco.

When looking at the charts of the EU energy imports, it’s not hard to notice that many of the top fuels, oil and gas trading partners (including countries such as Colombia, Norway, South Africa, Indonesia, Canada, Ukraine, Saudi Arabia, Qatar, Azerbaijan, Algeria or Peru) either already have signed or are in the process of negotiating the Free-Trade Agreements with the European Union. This generally shows a good direction of the EU policy towards ensuring the security of its energy exports through expanding the options of the imports in case that there will be an escalation of the political crisis such as can be seen now. This approach even extended to the approach adopted by the Visegrad Group (Czech Republic, Hungary, Poland and Slovakia) to address the US House Speaker John Boehner to help fast-track the LNG (Liquefied Natural Gas) exports from the United States to the countries of the EU as a measure against their dependence on the imports from Russia. However, this is currently very difficult and costly mainly due to the regulatory processes that have to precede the exports to the countries, with which the United States have not signed the Free-Trade Agreement. Since this currently applies also to the countries of the European Union, these countries will have to either push towards a change of the approach in the USA or try to speed up the signing of the Transatlantic Trade and Investment Partnership, which would allow for a faster adoption of such measures. This proposal would be generally in lines with the principles of the free market⁸.

Common European gas purchasing vehicle

A different proposal, however, coming from the Polish Prime Minister Donald Tusk is directed towards the idea of an ‘energy union’. The idea behind this proposal is that the European Commission should negotiate gas contracts on behalf of the entire EU as a bloc, which would help unite its purchasing power, and thus ensure through its better bargaining position that the security of the imports would not be jeopardised.

According to Donald Tusk, this, together with the solidarity clause, would help weaken the position of Russia and help end its stranglehold on Europe. It may look good on paper. In reality, though, it would mean that Europe would bring the European Union back to the model of public utility of the 1970s or 1980s, where it would adopt the role of the end-to-end coverage of energy services and price setting, which would counter the entire set of reform packages currently aiming at the liberalisation of the energy markets.

Furthermore, the idea of solidarity that Tusk refers to, might be just a more eloquent name for something commonly known as free-riding, which presumes that while some member states would pay the bill, others would benefit, either in heightened energy security, lower prices or the cost of infrastructure. In this particular case, the Polish prime minister argued mostly for the European orchestration and the financing of a dense energy infrastructure, which would greatly benefit the Central and Eastern European countries, including Poland, but would be provided from the budgets of all the countries in the European Union.

Fortunately, it looks like this proposal will not be adopted at the European level as the liberal principles that are taking roots in the European energy market combined with the particular national interests of the individual countries seem to be too great a hurdle for such policy to be passed⁹.

Sanctions against Russia’s oil sector

Unfortunately, the outbreak of Ukraine crisis led to another unfortunate development that will undoubtedly affect the future of the European energy policy, namely in the form of the sanctions targeting Russian energy sector. The main rationale behind this policy is the effort to punish Russia for its military annexation of Crimean peninsula and discipline it into cooperative behaviour with respect to the ongoing fighting that the Eastern parts of the Ukraine are still facing.

The main reason why the energy sector was picked as a suitable one for the sanctions was the scope of the energy sector in Russia and the effects the sanctions could have on Russian budget and the economy. It was due to this aspect, that it was expected that such an approach would leave Russia without the option of turning the taps off for the European consumers. Whether or not we agree with the approach for political reasons and regardless of the actual efficiency, it is necessary to investigate a number of particularities of the energy market that could have a serious impact on the energy security and prices in Europe.

One thing that needs to be remembered about the global oil market is its size with roughly ninety million barrels of oil consumed each day. With such number in mind, it is almost impossible to place aside one of the largest oil producers out of the energy market without causing significant repercussions within the European Union. The primary consequences could be in terms of price shocks, inevitably hurting customers on both sides of the importing and exporting nations. The price vulnerability would be, however, felt mostly in the European economies. This cost is all the more questionable given the fact the outcome of the sanctions – the proponents of sanctions often refer to the sanctions that were placed on Iran due to its nuclear programme in 2012.

The problem with this analogy is that with respect to Russia we are dealing with a very different historical, political and economic background that preceded the application of sanctions in the country. As Iran has faced political and economic isolation by the Western countries for a period of decades prior to the oil sanctions in 2012, the investment in the country in form of capital and technology dropped to a minimum. This resulted in the productive capacities of Iran being much lower at the time of sanctions, and thus the impact on the global oil system was much smaller. This allowed for the tough financial sanctions to have much more influence on disciplining the Iranian regime. Given the prominent place of Russia in the global oil market it is less likely that such an approach can have similar effects on Russia, particularly, as it has already gone into military involvement in Ukraine and currently supports the actions of rebels in the eastern parts of the country. This shows that the stakes on the Russian side are much higher and it may not be easily deterred from taking this sacrifice¹⁰.

Evaluation

All these proposals coming from the European Union and its member states with the efforts to achieve energy security with regards to Russia and green development with respect to the renewable energy greatly simplify the global oil and energy markets and the resulting interdependencies stemming from the current power imbalances. It is therefore vital for the EU to revisit its basic goals in order to define the energy goals in a different way that would be more conducive to the free market principles and respecting the past developments as the key interest of the policy-makers should be to ensure the most economically beneficial outcomes for the citizens and businesses in their country. So far, this has not been achieved.

Furthermore, the EU and other global players – notably the United States and Russia – are currently facing more dynamic challenges in terms of the global energy governance. This includes a crucial element of growing importance of other energy actors, such as India or China, and also change in the main themes of the energy debates shifting more to soft issues of climate change and energy poverty. This means that the world is currently moving towards a more global governance system in the area of energy debate. As a result, the global energy governance is likely to become more multilateral and involving numerous non-state institutions and agents. If the current crisis will escalate into a full-scale energy conflict, this development might be severely threatened.

Conclusions

So all in all, it can be seen that there are some important lessons to be learned from the current approaches of the European Union towards the energy sector. First of all, over the past decades the EU has moved towards embracing the market principles in the area of energy and experiences positive effects of this approach. The main facet of this approach could be seen in the liberalisation of the energy markets and the overall diversification of its energy imports.

However, it wasn’t the crisis involving Russia and Ukraine that created the pressure for the EU to propose or directly enact measures conflicting the market principles. These have appeared firstly in the areas of CO2 emissions and also the support for the renewable energy, which was based on the political goals defined by the European Commission. The attempts to put these goals in practice had numerous unintended consequences that were mostly felt by the people and businesses in the respective countries.

These means of the politics-based approach to the basically economic issue of energy have been thus merely accelerated by the crisis involving Russia’s military involvement in Ukraine. It is up to the EU to revisit these policies based on the findings from their own policies and past examples from other countries to better tailor its steps with the interests of the EU businesses and citizens in mind.

The article was originally published in the second issue of “4liberty.eu Review” entitled “Energy: The Challenges Europe Must Face”. The magazine was published by Fundacja Industrial in cooperation with Friedrich Naumann Stiftung and with the support by Visegrad Fund.

Read the full issue online.