Bridging the Energy Islands
Bridging the Energy Islands: Development of Gas Infrastructure in the Baltic States and the Internal Consistency of the EU Gas Market Model
Developments of gas infrastructures and the completion of the Internal Gas Market are EU top priorities, yet the internal coherence of the EU gas market model is under serious considerations. While the need of for infrastructure interconnection is unquestionable in political discourses of member states, implementation of the EU-designed gas market model in practice has faced certain challenges. The first-cut explanation of these difficulties lies in divergent domestic groups’ interests and advantages various projects might bring to member states. Another aspect to consider is practical inconsistencies in EU-designed schemes for the EU internal energy market, accompanied with (limited) steering capacities of the European institutions to promote projects. Forging regulatory reforms in case of limited economic prerequisites for them might invoke various inconsistencies, extremely difficult to be mitigated within the disposed EU instruments. In other words, flaws in the EU gas market model are argued to be also in the disparity between the level of rhetorical commitments of member states and the level of practical implementation of the EU provisions.
This is particularly a the case of for the Baltic States, which due to the Soviet legacy remain the so-called “energy islands” in the EU and thus seek infrastructure interconnection with the rest of the EU and alternative gas supplies. These countries have expressed a high level of solidarity at the EU level, and their governments’ positions and public opinions are highly pro-European. Moreover, taking into account a high level of threat perceptions towards Russia’s geopolitical dominance and gas export leverage in these states, the case of constructing an LNG terminal—aimed to overcome dependence upon gas supplies from Russia—would be the most-likely case of cooperation between these states within the EU-led agenda. However, a number of competing and mushrooming LNG projects, backed by the Baltic States, and an ambivalent position of the European Commission have demonstrated that this assumption is at least premature. Thus, the recent news confirms that Estonia and Finland still cannot decide who is to build an LNG terminal and the Commission resists the option of two terminals being built both in Estonia and Finland, underlining that no EU subsidies are to be offered in this case.
This ongoing competition also requires a serious assessment of the EU initiatives, pro-active and sometimes even bullish, yet often unaccompanied with a well-elaborated methodological framework of implementation and with serious evaluation of economic conditions of national gas markets. This is also the case of the re-assessment of investment provisions into gas infrastructure after the Third Energy Package when serious obstacles have highlighted the inconsistencies in the model of gas infrastructures as a separate business.
EU Internal Gas Market and Energy Infrastructures
Since the early 2000s, the creation of the EU Internal Gas Market has become crucial part of the EU energy policy. Developments in EU gas markets were also fuelled by the interruptions of gas supplies towards the EU via Ukraine due to the infamous gas disputes between Russia and Ukraine in 2006 and 2009. This was a period marked by ever growing political entrepreneurship by the Commission aimed to enhance ever deeper liberalization and unification of member states’ gas markets and to boost a more coherent EU common energy policy. The completion of the EU Internal Gas Market has also been viewed as a key element in improving security of supply. A developed gas infrastructure network would allow redistribution of gas flows across the EU, having made the gas shortages of 2006 and 2009 less likely, if not impossible. Geopolitical concerns were also brought back to the EU agenda, having articulated the need to diversify gas supplies via the development of trans-European energy networks.
The changes in gas market regulations, finalized in the Third Energy Package (TEP) of 2009, resulted in reconfiguration of the gas business organization in the EU, requiring a sharp division between production, transmission and distribution. Even if the initial Commission’s proposal was softened in the final draft, allowing three options of unbundling (full ownership unbundling, the independent system operator (ISO) and the independent transmission operator (ITO)), the market model designed to provide incentives for gas infrastructure as a separate business has been corrected with deeper involvement of EU planning. The energy infrastructure package, proposed in 2011, admitted that changes introduced by the TEP, including unbundling, obligatory Third Party Access (TPA) and allocation of transmission networks into a separate business, required certain mitigation.
By far, the Commission has admitted that some projects, being commercially unattractive for private investments but essential for the completion of the EU Internal Gas Market, need EU support, especially in case of the small gas market of the Baltic States. EU funding has been recognized as a need to boost the development of infrastructures—to attract private investments and to secure project risks. The development of infrastructures has been deliberated via the Projects of Common Interest (PCI), which require that at least two member states benefit from the outcomes of the proposed project, thus making cooperation between member states essential. EU funding has been expanded as well—the PCIs could be financed under the “Connecting Europe Facility” (CEF) in the period 2014–2020, while previously EU funds were mostly aimed to financing feasibility studies. Thus, in order to be eligible to EU funding (up to 50% of the costs for studies and works, “in exceptional circumstances” up to 80% “for projects that are crucial for regional or EU-wide security of supply or solidarity, require innovative solutions or have cross-sector synergies”), the projects have to prove that they are commercially not viable. In October 2013 the list of 248 PCIs was approved by the Commission, allowing these projects to get faster through permit granting procedures and apply for financial support from the CEF under which a €5.85 billion budget has been allocated to trans-European energy infrastructure for the period 2014-20".
Post hoc alleviation of the flaws inherited in the EU gas market model sheds light on two major aspects. First, as has already been said, forging the EU regulatory framework should also coincide with the ability to mitigate divergent interests of various actors, both member states and their domestic economic groups. The Commission underlines that PCIs are to facilitate regional cooperation and to mitigate differences in interests of various stakeholders, as well as to optimize costs for infrastructure construction. However, this “top-down” promotion of regional cooperation appears to be slightly premature.
Second, practical implementations need to be elaborated more thoroughly as well. It is necessary to note that a clearer and more standardized methodology of the project evaluation (including Cost Benefit Analysis) has been introduced, aimed to improve the selection process as “a one stop shop” with the whole permit granting procedure not to exceed three years.
Baltic States: Competing for Projects
Infrastructure interconnections are especially needed in the Eastern European member states, due to the historical division of gas infrastructures between Western and Eastern Europe. Especially, this is a case of the Baltic States, which due to historical reasons represent the so-called “energy island”, having no connections of their gas infrastructures with the rest of the EU and receiving their gas supplies from a single supplier, Russia, via pipelines from Belarus, Kaliningrad and central Russia. Therefore, the construction of infrastructures would allow reversing supplies from other member states and reducing the countries’ over-dependence on Russian supplies. Moreover, diversification of gas supplies is viewed as an opportunity to negotiate allegedly politically motivated gas pricing of Gazprom. Long term contracts with Gazprom expire in 2015 for Estonia and Lithuania, in 2030 for Latvia, and the need of feasible alternatives is urged. The Commission has also underlined that since the Baltic States and Finland gas market accounts for modest 10 bcm/year, and “the market alone does not offer a good return on investment”, it is essential to link these countries to the EU energy market partially at costs of the EU in order to guarantee diverse supplies.
At the level of rhetorical commitments, the Baltic States have explicitly supported the EU-led initiatives of speaking with a single voice, strengthening external dimension of EU energy policy, and completion of EU Internal Gas Market. For example, Lithuania has started implementation of the most radical type of unbundling, the ownership unbundling, not obligatory but much welcomed by the Commission. In addition, geopolitical considerations have played an important part of the countries’ past and present—all three countries share their perceptions of Russia’s gas supplies as a threat to national and energy securities and see diversification as a national priority.
Since the gas market in the Baltic Region is rather small (around 10 bcm/year) and gas demand is expected to be flat if not to fall, only one LNG terminal seems to be feasible for the whole region and the states have to agree where to build it, taking into account both economic considerations and logistics, beneficial for the whole region. The Commission strongly supports the Baltic Energy Market Interconnection Plan (BEMIP) aimed to coordinate states’ efforts in promoting further integration of the EU Internal Gas Market and identify “the most economical, minimum infrastructure necessary to diversify gas supplies in Finland and the three Baltic States and to end isolation”.
Unfortunately, mushrooming LNG projects appeared in each Baltic State and Finland, and the parties failed to reach an agreement, each claiming to offer the most attractive options. Among all of them, the last BEMIP Progress Report has identified the three most important infrastructure projects in the Region—the BalticConnector between Finland and Estonia (2.0 bcm/year), the Polish-Lithuanian Gas Interconnection, and a regional LNG terminal.
In Estonia, three options have been proposed—LNG terminals in Sillamae (3.1 bcm/year), in Muuga (3 bcm/year), and in Paldiski (2.5-3.0 bcm/year), the last one is considered the most feasible option. Finland promotes the LNG terminal Inkoo (2 bcm/year) on the opposite shore to the Paldiski LNG. Latvia lobbied an LNG terminal in Riga (2.0 bcm/year), claiming its lower costs due to closer location to Incukalns gas storage facility, and offered to build also a pipeline connection to Estonia and Finland. Lithuania has got the permission to build a floating LNG terminal in Klaipeda (2-4 bcm/year) which is expected to be completed by the end of 2014. Moreover, Gas interconnector Poland-Luthiania (GIPL, 4,2 bcm/year final capacity) is also identified as a PCI.
There have been continuous debates within and among these countries and the Commission had to urge them to reach an agreement and even to order the feasibility study of LNG projects in the Baltic Region, which finally defined Estonia and Finland as the most attractive sites for an LNG terminal. Early this year Finland and Estonia decided to build two terminals on both coasts and to apply for the CEP to cover up to 50% of funds. Both claim to offer the most optimal option and latest news reports that both sides continue to promote their projects (Inkoo and Paldiski). The Commission seems to stay aside, claiming that Finland and Estonia should decide on the site themselves. This reluctance might be a result of accusations in impartiality the Commission faced, when it announced to choose the winner between Muuga and Paldiski in Estonia, and Inkoo in Finland by the summer 2013 (Finland was rumored to win). However, the Commission has rejected the option of two LNG terminals both in Estonia and Finland, claiming no EU subsidies are to be offered in this case. The parties are asked to find a solution by August 19, 2014 in order to be eligible for this round of financing, yet the agreement is likely to be stalled since Gasum (Finland) has announced no intension to speed up the decision.
Solidarity vs. Domestic Considerations
The case of construction of an LNG terminal in the Baltic Region is an example when a high level of solidarity for the EU common goals has not been reflected in the implementation of EU regulations. This case shows a gap between rhetorical commitments and practical implementation of projects in the EU and questions the model of the EU Internal Gas Market. There is a rhetorical support among these states of EU common energy policy, diversification strategies, and interconnection of their gas markets. Yet, they remain reluctant to implement these commitments in practice. Moreover, sticking to their own projects, the states do not cooperate to work out the most feasible and most attractive commercial solution for the whole region. The Commission’s calls for solidarity and, the results of the independent assessment have not prevented these states to startfrom beginning building construction of their own terminals or to lobby their projects in the EU. Thus, Lithuania is constructing its own LNG terminal in Klaipeda, and Estonia and Finland are struggling to agree on the location of their LNG terminal while the Commission is still calling for a common solution.
This case also confirms that the division between the so-called “Old” and “New” member states is often exaggerated in the academic and policy-oriented discourse—it is often argued that the bilateral cooperation of “Old” member states with Russia inhibits a common approach in EU energy policy. These member states are argued to have special relations with Russia in the energy area, thus preferring bilateral deals and causing difficulties in formulating EU common energy policy. This argument presupposes that the Baltic States should find a common solution as fast as possible in order to overcome Russia’s dependencetheir dependence on Russia. Taking also into account the argument that “small” member states use the EU in order to be “heard”, cooperation between them should be even more occurrent.
A solid explanation lies in the fact that domestic considerations (economic and social advantages, perceived to be gained from a project) prevail over EU solidarity at the level of practical implementation of a project, while the states rhetorically commit to more general EU guidelines and express their adherence to EU values. In this regards, domestic considerations of projects are used by each country as a justification of a project as a right choice. Overall, commercial feasibility and economic interests of the whole region are increasingly disregarded.
This is also the case of limited steering capacities of the Commission and unclear selection procedures of PCIs. The extent to which EU membership influences decisions of member states is a wide topic for academic inquiries, but reality shows that prescriptions on paper do not always lead to coherence in implementation. Even shared understanding of what is needed and good for the EU as a whole does not bring per se cooperation at the practical level. Imposition of one or another model—forged at the regulatory level without coherent implementation—often leads to inconsistent actions and the question remains to what extent the Commission manages to guide and facilitate decision-making process on infrastructure projects.
Irina Kustova is a PhD candidate in International Studies at the School of International Studies, University of Trento, Trento, Italy