Towards an Energy Union – A Need for Common Policies
Common policies are needed for all European Union member states if the Energy Union is to be effective, contends Malcolm Keay, Senior Research Fellow at the Oxford Institute for Energy Studies (OIES).
Under the auspices of OIES, Mr. Keay has recently co-authored a paper entitled Europe’s Energy Union – a problem of governance. Of the publication, the Institute's website writes, “This Comment explores how far the EU can go towards the goal of an Energy Union. The European Commission announced ambitious plans for such a Union earlier this year and followed it up with a number of supporting proposals. However, the Comment identifies a fundamental underlying problem – of governance.”
He and his co-author, David Buchan, also deal with such themes in their recently published book, Europe's Long Energy Journey – Towards an Energy Union.
Of his interest in the Energy Union and EU energy policy, Mr. Keay notes that Europe has become more important in all sectors recently including energy. “The specific area I am interested in at the moment is electricity and climate change, and of course Europe operates collectively on climate change. However, the way it is operating is creating big problems for energy markets, particularly electricity markets. It is important to develop more coherent policy-making in this area, and earlier this year Europe decided it wanted to move toward a proper Energy Union, which has not existed in the past. Things are or should be happening.”
With that in mind, Malcolm Keay fielded the following questions from Natural Gas Europe.
Mr. Keay, the title of your paper points to the problem of governance in the Energy Union. Could you explain what you mean and why this is the case?
The Commission does not really have much power in relation to energy because the member states have the right to make most of the main decisions themselves. So while Europe has a set of objectives, when it tries to think about how to achieve these objectives, how to deliver, what to do in terms of setting up law structures and institutions etc., everything that governance involves, it does not really have the means. At the moment it is going for a very bureaucratic approach getting every member state to produce a comprehensive energy plan and then for the Commission to look at the plan and say if it is on track or not. I do not think that is either going to work or be popular. If the Commission says a member state is not on track, what happens? It has no power to enforce its decisions. So it is a slightly odd situation, with very ambitious targets but no means of delivering them.
In your paper you've pointed to the sentiment for member states to work together toward an Energy Union, yet at the same time there seems to be a lot of pushback to maintain autonomy regarding their chosen sources of energy, how they achieve their climate targets, etc.
I suppose it is a basic constitutional problem, in that the Lisbon Treaty gives the member states the right to decide their own energy mix. As long as they have that right, it is quite hard to have a harmonized approach. For instance, at the moment you have Germany moving out of nuclear and Britain apparently moving into nuclear.
All these different moves, because they are all the product of individual government decisions, are inconsistent with the idea of a single market in energy which Europe is in process of setting up. The whole package becomes a little incoherent, but given that Europe has a common objective–decarbonization– and that it's got common climate targets and common security problems - everybody depends on fuel, oil and gas from the same sources - it does make sense for European countries to work together.
At the moment this idea of working together and that every member state should decide what to do itself, has not really reconciled. It seems as if there is much more emphasis in Eastern Europe on energy security than on climate change mitigation, which is more of a priority in the West. How is it possible to rectify that?
There is a big gap between Eastern and Western Europe on this. Most Eastern Europeans are more concerned about energy security than climate change. Some countries, like Poland, are very dependent on coal so they see climate change as a direct challenge to their interests. The problem there is that Europe’s main policy instrument in this area is the Emissions Trading Scheme (ETS). But because Poland does not want any limits that are tight enough to undermine its coal industry, ETS prices are low and the ETS has not turned out to be a very good instrument for achieving a significant boost to low carbon investment.
You probably know the history of the ETS: not only are prices low, but they are also unpredictable. Europe keeps intervening to try and make it work better but it is a bit of a mess. In our paper, and our forthcoming book, we are calling for other policy instruments to be used which are more flexible and do not run up against these problems, instruments that can incorporate the concerns of the Eastern Europeans but at the same time deliver the reductions the Western Europeans want.
That, however, brings to mind the use of coal-burning generation plants in Germany, which seems odd considering that country's push towards renewables. Could you speak a bit on how renewables subsidies have affected backup generation?
Germany is relying more on coal, whereas Britain is moving out of coal –it has said it is going to close all its coal fire powered stations in the 2020s - so this is another example of the discrepancies between individual countries. From the British point of view what the Germans are doing just seems very odd, because to close nuclear stations and build coal stations is not good in terms of climate change.
But the reason people are worried about backup generation is because of the influx of renewables, which are given policy support across Europe.
This is one example that we quote in our paper about how you cannot make energy policy just by looking at one set of policies in isolation. You cannot just say “we will support a lot of renewable generation and everything else will remain the same.” It does not remain the same, because renewables are completely different from the existing generation.
They mean that balancing the system becomes a different sort of problem and that is why many of countries are introducing capacity payments. The UK is introducing a capacity payment system, or capacity mechanism, and Germany is thinking of something similar in terms of a strategic reserve. And other countries like France and Ireland, etc. have capacity mechanisms.
The original theory on which the Commission based its single market looks a bit shaky. The idea that you can do everything just by pricing in terms of kWh does not work with renewables, whose cost does not vary with output. The underlying point is that if you make a change in one part of the energy system, everything else changes. You cannot just say we will do this and forget about everything else, you have to have a coherent overall approach and that is what the Commission is failing to develop – but then it has the problem that it lacks the power to develop it.
How have national renewables support schemes contributed to this mix?
First, they are all different and they're all supporting different sources to different degrees, so you have not got a level playing field – this is not what a single market is supposed to be about. Secondly, when you get a lot of wind power, or solar power – we have seen this in Germany – it is zero marginal cost and all the cost is in the capital investment, so there are very low running costs. The way electricity markets work at present, that means electricity prices go down. In fact, we have seen electricity prices at wholesale level going down, for the past 5 or 6 years.
Meanwhile the prices to consumers go up, because someone has to pay for the renewables. So you have a very strange situation in which wholesale and retail prices are moving in different directions. Big companies like Eon and RWE are losing share value, losing money, cannot afford to invest. Their prices are going up but companies are facing enormous problems and cannot afford to invest without special support. So you end up with governments having to support investment in electricity and because there are different renewable schemes in different countries in different situations they are all doing it in a different way. So you have a lot of different renewable schemes, a lot of different capacity mechanisms, in what is supposed to be a single market.
Your paper mentions the Commission's matrix of trajectories and indicators that it's using to show progress on the five dimensions of the Energy Union. It sounds like it's pretty confusing.
Obviously, the Commission itself does not think that, but the structure is very complicated, very bureaucratic. You cannot really make the whole picture add up by looking at lots of different indicators in different ways in different countries. You have to have an overall strategy and that is what the Commission has not been prepared to develop.
The International Energy Agency (IEA) does country reviews already, against a set of goals the IEA has, but in a somewhat less bureaucratic way. I think the Commission is sort of copying this and doing country reviews in a slightly similar way, but against a much more rigid template.
The trouble is, most countries either do not have long term energy plans or if they do, they use a different template. So it is going to be a big bureaucratic problem for countries and, in the end, the Commission cannot do much about it, if it does not like the outcome.
Most of the outcomes in the plans are based on modelling, but most economic models get things wrong. So it is going to be difficult to say you are never going to get a particular outcome with a particular set of policies, because if one side says our model says we will get there while the Commission says our model says you will not, how do you prove it or disprove it? As we know from the Emissions Trading Scheme, just about all energy forecasts have been wrong for the past 10 – 15 years. Otherwise, the ETS price would not be as low as it is.
You contend that regional cooperation, like that seen for example in the Baltic states, could result in balkanization. How do you see the pro and con arguments for using regional cooperation as a model for greater Energy Union integration?
It is a little bit like the argument over whether trade agreements covering a few countries lead to wider trade liberalisation. There are advantages sometimes in those regional approaches but there are also big risks. You do get separate markets, separate cooperative arrangements. For instance, there is a scheme that has been led by Germany, but with the support of the Commission, for the countries in the main electricity markets to cooperate together in terms of electricity and non-intervention in the market etc.
But if one group does that and others do not, it is just going to complicate the overall workings of the market. It is not what I would call an Energy Union, and it can make it more difficult to progress toward an Energy Union. If you do not, in the first place, include the countries who may find the rules difficult, then it will be much more difficult to persuade them, once you have set up a scheme, to come in on that scheme.
There is a sort of analogy in the euro. If you do not engage and meet everyone’s needs when you first set an arrangement up, it will be very difficult to persuade anyone else to join later because they just do not like the rules that have been set up to suit the original members. And I suppose that an Energy Union means what it says – a single market, a single set of support mechanisms etc. across Europe; trying to get to that by doing it across parts of Europe only seems to me intrinsically difficult.
Given what you know, what are the prospects for the Energy Union working? And what would you suggest the most effective approach be towards making it happen?
In the book we've set out three scenarios in terms of possible levels of success. One is where we are just now. Another is about where the Commission might get to on its present proposals. Another is what we would think of as a true Energy Union. And you can only get a small way toward that true Union in the way the Commission is progressing.
What we think it needs to do is come up with some new common policies, rather than all these bureaucratic indicators and targets. Because there are some European policies – the ETS is one already – so this shows that you can introduce measures across Europe. Trying to harmonize and introduce new policy approaches across Europe, which do not require individual countries to make particular decisions about their energy mix – we think that is the way to go forward and we suggest in our book some ways in which they could do that by introducing new policies which would be common across Europe but which would not require countries to go for any particular energy source.
Could you provide an example of that?
One of the examples in the book is what we called carbon intensity targets instead of the ETS. Essentially you are setting targets, initially for electricity but later for other sectors, as to the carbon intensity. For Poland, say, if you were reducing carbon intensity by 10% a year, the ultimate target might be decarbonization. But you would recognize that Poland would need longer to get there than, say, France, which is already a lot further toward it in terms of its electricity production. So you could set targets for each country to make gradual progress, a bit like the original approach to renewables. The idea would be that each country would make the same sort of effort, but recognizing that some countries will continue to have higher than average carbon intensities for some time. And Poland obviously will.
The problem with the ETS is that because you have to have a single price across Europe, it's going to be a problem for countries like Poland if the price is high and therefore you are unlikely to get agreement on caps that will lead to a high price. If you have a flexible instrument that allows you to progress toward the same objective, but at different rates in different countries, that might make it much easier.
It is not too dissimilar from what the US is doing. The US system is pretty flexible, allowing different states to do different things as long as they are progressing toward the same outcome. The plan has not been introduced yet‑it is very controversial‑but it is the sort of approach you can adopt in a structure with a lot of internal diversity, where you have different parts of a country with different starting points and wanting to do things in a slightly different way.
How do you see the prospects for natural gas within a Europe that has an Energy Union?
This is another aspect on which the Commission, or Europe, needs to have an overall strategy because you have a difficult situation. In the short term, we probably need more gas, and UK policy is promoting this. But in the long term, we may need to move out of gas - at least that is the implication of the Commission’s de-carbonization target which would require that by 2050 there would be very little gas used.
We need to find a way of bridging the period between the short and long term. In particular, as many of the existing contracts run out there will have to be decisions on what will replace them and with gas, you are talking about quite long time scales. Particularly for the infrastructure, you are talking about a pipe that lasts 50 or 100 years, so you do need some sort of a long term strategy for how that is going to be used, and for future uses, for instance, are you going to use gas in transport?
There's already a growing interest in things like LNG for shipping for environmental reasons, but the Commission probably needs to come up with a more overall strategy. At the moment, although it is thinking about an LNG strategy, it really amounts to little more than saying, “this is what is going to happen – let it happen”. The way international markets are moving, spare LNG will tend to come to Europe and that is a simple fact, whatever the Commission does – so it might as well take credit for it. Europe has good deal of spare LNG import capacity and there is a lot of LNG being developed across the world over the next few years so there will inevitably be quantities of LNG coming to Europe.
And within the “constraints” of an Energy Union, how do you see possibilities for projects like Nord Stream II?
These things are always political and extremely problematic. There are probably too many pipeline projects around and they will not all happen. And that is why it might be sensible for Europe to have an overall strategy of what it wants to do.
At the moment, in the short term, the need is not very strong because there is so much spare LNG capacity while demand is static or declining. In the medium term, there is an issue in say the early 2020s, which Europe needs to think about. The difficulty is, it is tied up with geopolitics. For instance, the Russians basically want to avoid going through the Ukraine, while Europe does not want Ukraine to be left completely aside, which would undermine its economy. So the geopolitics gets pretty complicated.
-Drew Leifheit