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Introduction

Stiftung Wissenschaft und Politik German Institute for International and Security Affairs Comment

Eurasian Integrates WP Energy Markets – EU Stands Aside S Maria Pastukhova and Kirsten Westphal

The process of establishing a common energy market in the (EAEU) is moving forward after and succeeded in resolving important differences. This reorganisation of the energy space will also affect the , because Russia and are major oil and gas suppliers, and important export pipelines originate there. At the same time regulatory and technical fault lines are becoming apparent between the EU/European Energy Community and the EAWU – also affecting transnational physical infrastructure. Furthermore, the integration blocs overlap in sensitive regions like the , the Black Sea region and the Baltic states.

The EU remains sceptical towards the Eura- sight body, the Council of the Eurasian sian Economic Union (EAEU), which was Economic Commission. Decisions in the founded in early 2015 by Russia, , Board of the Eurasian Economic Commis- Belarus, Kazakhstan and . The sion, are by consensus or two-thirds major- EAEU has ambitious goals: ity, with each member state supplying a common electricity market by 2019, a two representatives regardless of size and common oil market by 2024 and a gas economic strength. market by 2025. The EAEU’s integration process is driven by more than just Russia’s geostrategic inter- Energy Market: Progress since 2015 est in consolidating its own sphere of influ- Under the Treaty establishing the EAEU in ence. It also offers its members a survival 2015, cooperation and integration in the strategy for economic systems still heavily field of energy is one of its main objectives. shaped by their Soviet heritage and value Energy market concepts for the three prin- chains. One concrete indication that the cipal energy sectors– electricity, oil and gas EAEU is more than just a -driven – were drafted by the Board in 2015 project is the consensus principle for deci- (see SWP Comment 9/2016) and adopted by sions in the EAEU’s highest supranational the Supreme Economic Council in spring organ, the Supreme Eurasian Economic 2016. Based on these concepts, individual Council, and in its most important over- programmes for electricity, oil and gas will

Maria Pastukhova is Research Assistant in the Global Issues Division at SWP. SWP Comments 5 Dr. Kirsten Westphal is a Senior Associate in the Global Issues Division at SWP. January 2018 This SWP Comment has been written as part of a project funded by the German Federal Foreign Office.

1 define timeframes and lay out fundamental at EAEU level. This arrangement will on the principles for cooperation. Ultimately the one hand grant the oil-producing members programmes will serve as the basis for the (Kazakhstan and above all Russia) greater national development plans of the individ- leverage over Belarus, as will be losing ual EAEU member states. In recent months its ability to make unilateral decisions on the EAEU has made progress on formulating tariffs and transport for its (re-)exports of the programmes, even if implementation crude and petroleum products. On the other will require time for coordinating and im- hand, the EAEU’s position in will be plementing standards, norms and processes. strengthened, because new oil-related infra- The Council of the Eurasian Economic structure projects “of mutual interest” will Commission adopted the programme for no longer be realised unilaterally or bi- the development of a common electricity laterally but agreed and implemented market on 30 November 2016. It was able multilaterally at the level of the Economic to move fastest on electricity, where the dis- Union. This could for example force cussions are less politically sensitive and to develop the Eurasian infrastructure ele- existing trading platforms can be used to ments of its in co- create a common market. Although a con- operation with the EAEU, rather than bi- crete pricing mechanism has yet to be laterally with individual countries as it finalised, it is already clear that the pro- has to date. Especially for the Central Asian posed energy exchanges will function under countries, the EAEU clearly represents an common rules. Since the EAEU was estab- important component of a multivectoral- lished, cross-border electricity trading has ism designed to avoid becoming subsumed grown by 24 percent to 7.61 terawatt hours entirely into China’s . per annum. Overcapacity – with total in- The EAEU is also discussing harmoni- stalled capacity in the member states sation of energy statistics, a shared data- exceeding 282.8 gigawatts – and moderni- gathering system and common quality sation requirements generate extensive standards. Committees are already working potential for synergies. to list measures required to regulate inte- The Board of the Eurasian Economic grated oil and gas markets, such as inclu- Commission approved the programme sive auction processes, access to transport for a common oil market on 12 September systems, and trade mechanisms for oil and 2017. It passed the Council on 20 Decem- gas. Even if these programmes are tailored ber 2017 but has yet to be signed by the to the internal markets, the emergence of heads of state. The programme will abolish EAEU-wide energy markets could also im- state regulation of oil pricing within the pact external relations. However, all the EAEU and create a common market ex- programmes are as yet very vague, and change by 2021, as well as guaranteeing still need to be translated into technical non-discriminatory access to transport norms, regulatory standards and legal pro- pipelines. visions. The common oil market will be coordi- nated with the EAEU’s transport and infra- structure policy. Implications for infra- Integrated Gas Market: structure projects must be anticipated not Biggest Hurdle Already Cleared only within the EAEU member states, but The concept for the EAEU gas market was also for transport links to third countries. approved in spring 2016 at the same time Tariffs for transport of crude oil between as the oil concept. But the negotiations over EAEU states, for transit of crude and for this integrated market were subsequently resale of crude and petroleum products to stalemated for a considerable period, above third countries are to be harmonised, and all on account of Russian-Belarusian energy infrastructure projects will be coordinated dispute (see SWP Comment 15/2017).

SWP Comment 5 January 2018

2 In early 2016, at a point where gas prices such, Belarus has postponed its wish for a were falling in the EU, Minsk declared that netback pricing formula until the creation it was paying too much for Russian gas. In of a common gas market. Secondly, the 2016 Belarus unilaterally cut the price it EAEU standards agreed to date (in other paid Gazprom from the agreed $132 per words rules for access to the services of thousand cubic metres to just $73, and as a natural monopolies) are at least partially result accrued debts to Gazprom exceeding applied to the bilateral gas trade. $720 million. Russia responded by cutting oil exports to Belarus, dealing a grave blow to the latter’s oil-dependent economy. Further Progress in the Gas Market In April 2017 Presidents The deal between Moscow and Minsk put and Alexander Lukashenka reached a com- the integrated gas market back on the promise under which Belarus will receive agenda. The Eurasian Economic Commis- Russian gas for three years at prices lower sion’s advisory committee for oil and gas than that of 2016 ($130 per thousand cubic approved the programme for such a mar- metres for 2017, $129 for 2018 and $127 for ket on 24 April 2017, and the Board adopted 2019). The price formula will remain based it on 12 September 2017. Unlike the pro- on the price of gas in the Yamalo-Nenets gramme for the integrated oil market, Autonomous Okrug in northern Russia. On which provides for common tariffs and 13 April 2017 Belarus paid Gazprom $726.2 mechanisms for transit and export to third million owed for Russian gas supplies in countries, the programme for the integrated 2016/2017. The use of gas pipelines and market applies exclusively to other infrastructure will in future be gov- extraction, trading, transport, storage and erned by EAEU rules for access to the ser- processing within the EAEU. vices of natural monopolies and Russia will Another objective is to ensure non-dis- increase its duty-free oil exports to Belarus criminatory access to transport services of from 18 million to 24 million tonnes an- natural monopolies (meaning gas pipelines nually until 2024. While 18 million tonnes and related infrastructure) for the partici- ensure that Belarusian oil refineries can pants in the integrated gas market. Along- operate at full capacity, the other 6 million side harmonisation of norms and standards can be exported directly with the export in the integrated market, control mecha- duties accruing to the Belarusian state nisms are also to be developed to avoid the budget. One important condition attached EAEU’s internal tariffs applying to its ex- to the agreement is that the two sides agree ternal trade: these will include preventing a “sustainable programme for a common resale to third countries of gas purchased gas market in the EAEU” by the end of 2018. for domestic consumption within the This agreement demonstrates Russia’s EAEU. That will preserve Gazprom’s mo- enormous influence on its neighbour’s en- nopoly on pipeline exports. ergy policy, on account of the Belarusian The regulatory and institutional frame- economy’s dependency on refining and work for a liberalised gas market in the processing Russian oil and on supplies of EAEU has yet to be developed. The pro- Russian natural gas. But the agreement also gramme proposes a dual pricing mecha- removes the most important obstacle on nism for transnational gas trading in the the road to a common energy market. The EAEU. The price of gas traded under bi- April 2017 accord ensures, firstly, that – as lateral agreements will remain subject to long as the pricing mechanisms of a com- state regulation, while market pricing will mon EAEU gas market cannot be applied be facilitated for the rest (both long-term (probably until 2024) – gas prices for Bela- contracts and exchange trading). There is rus can be calculated using a formula that also a long-term objective of developing a is more or less acceptable to both sides. As pricing mechanism that ensures identical

SWP Comment 5 January 2018

3 margins across the EAEU, but this will prob- Both Beijing and the EAEU members are ably have to await the agreement of a treaty very interested in bringing the EAEU to- establishing a common gas market. gether with the Chinese Belt and Road ini- The volume of gas traded within the tiative. Both sides regard the two projects EAEU is comparatively small, with 33.5 bil- as complementary. Talks over an agreement lion cubic metres per annum as against on trade and economic cooperation between 177.4 billion cubic metres exported to third the EAEU and China began in June 2016. countries. But the volumes traded at the Since October 2017 the Eurasian Economic Russian platform Spimex (St Petersburg Commission has been preparing an agree- International Mercantile Exchange) are ment in cooperation with business repre- growing steadily: from 0.5 billion cubic sentatives. metres in 2014 to an estimated 21 billion Cooperation with China is sought not cubic metres in 2017. There is good reason only at the level of trade relations, but also to believe that the Russian exchange will in the development of a common transport slowly establish itself at least as a price and energy space. In March 2017 the Eura- marker if not as the central trading place. sian Economic Commission identified a list Of course, in the first place the pro- of infrastructure projects supporting the gramme reflects the interests of Russia as Belt and Road initiative to be conducted in the EAEU’s biggest gas exporter. The new the scope of the EAEU. Thirty-nine of them control mechanisms would grant Moscow fall within the category of transport (for another instrument to prevent, for example, example modernising existing routes or de- gas supplied to Belarus or Kazakhstan being veloping logistics and transport hubs). The sold on to or China. On the other proposed web of Eurasian infrastructure hand, the gas-importing member states also comprises energy projects, including retain the right to receive cheap supplies another gas pipeline to China: the Beineu- from Russia under bilateral agreements, Bozoi- Gas Pipeline, through so a balance of interests is obtained. which the first five billion cubic metres of Kazakh gas flowed in autumn 2016. Funded jointly by KazTransGas (Kazakhstan) and Expanding External Relations the Trans- Gas Pipeline Company Limited Both the energy market concepts and the (China), its capacity is to be expanded to existing agreements suggest that the har- 15 billion cubic metres annually. The pos- monisation of norms and rules, the stand- sibility of using it to transit Russian gas ardisation of pricing mechanisms and the to China has also been discussed. All this codification of standards and data all relate shows that Eurasian interconnectivity is initially only to energy trading within the being pushed by the EAEU and naturally – EAEU. But the EAEU is also working on its in the scope of the Belt and Road initiative external relations. In Asia it has encoun- – especially also by China. tered interest both among individual states – including , , and – and from international organisa- EU Stands Aside tions seeking economic cooperation with Beyond the EU, energy spaces are experi- the EAEU and participation (also financial) encing restructuring. As yet Brussels has in its integration processes. made no official contact with the EAEU, China naturally plays an outstanding despite the latter’s great interest in co- role, and the EAEU heads of state lost no operation. Political spokespersons of the time initiating talks with Beijing in 2015. EAEU, as well as representatives at working China is the second-largest trading partner level have consistently expressed the wish for the EAEU, which regards it as a strategic for exchange with the EU on “best practices” economic partner in the Asia Pacific region. in the areas of energy and transport. The

SWP Comment 5 January 2018

4 EAEU regards dialogue with Brussels as The EU’s activities to date have concen- logical and objectively overdue: it views the trated on the European Energy Community, “European vector” as an external economic which includes the states of the Western priority, and seeks closer cooperation with Balkans, , and . the EU in particular in the areas of tech- The Energy Community seeks to establish nology, energy efficiency and Industry 4.0. a stable regulatory framework and reliable Moreover, dialogue between EU and EAEU market mechanisms by gradually introduc- is seen as vital for economic cooperation ing key elements of the EU’s acquis commu- in Europe. nautaire in the area of energy. Alongside a The reasons why the EU remains on the fundamental overhaul of national laws and sidelines include scepticism about whether regulations, this presupposes deep struc- the EAEU project will really materialise. Here tural reforms. and Armenia already Brussels is ignoring both the most recent possess observer status in the Energy Com- developments within the EAEU, which is munity; Belarus has applied. While Brussels continuing to deepen despite political is working towards a common market en- differences between its members (see SWP compassing the EU and the Energy Com- Comment 9/2016), as well as the growing munity, at the boundaries divides are deep- economic confluence between the EAEU ening. But neither the geopolitical nor the and countries in the Asia-Pacific region. (geo-)economic repercussions of the emer- One reason for the EU’s reticence will cer- gence of increasingly distinct energy blocs tainly be the EAEU’s strategic importance can lie in the interests of the EU. A whole for Russia and its consequent geopolitical series of concrete and fundamental argu- relevance. For Moscow the EAEU is one ments thus mitigate in favour of dialogue element of the balance of power in a multi- with the EAEU. polar world, creating a counterweight to both China’s Belt and Road initiative and to the European Union. But in restricting its Ten Reasons for Strategic Dialogue vision to and security, the EU is 1) Avoiding regulatory barriers. It should be ignoring the EAEU’s potential to generate in European’s interest to avoid regulatory progress on market liberalisation and diver- barriers within its broader region. Ultimately sification. the region stretching from western The energy space joining Europe and and all the way west to Lisbon Asia is increasingly being shaped by actors is interconnected by pan-European energy other than the EU (see SWP Research Paper corridors and transnational oil, gas and 4/2017). China’s Belt and Road strategy, electricity networks. In the interests of which is successively bringing in individual ensuring security of supply it is crucial for EU member states through moves like the cross-border infrastructure and energy trad- 16+1 initiative, is the most prominent ing to function without a hitch. example. In general terms, it is energy in- 2) Compatibility and the free-market model. frastructures and interconnectivity that If European businesses are to enjoy market create and shape integrated energy spaces. opportunities, it is central that the norms, If diverging legal and regulatory spaces standards and rules of the EAEU be compat- now emerge, new fault lines, barriers and ible with the EU mechanisms. Otherwise the fractures will appear where they meet, with EU risks ending up in the role of “rule-taker”. repercussions for commercial activity and Being forced into adapting to standards market transactions. Ostensibly technical “from the east” could prove a costly business. and commercial processes have potentially In view of the crisis of free-market trade major political effects; they can disrupt the and the rise of China’s mercantilist trade operation of infrastructures, deepen divides model (on which its Belt and Road strategy and exacerbate geopolitical conflicts. is based) the EAEU acquires more than an

SWP Comment 5 January 2018

5 important bridging function. As an impor- border export pipelines have repeatedly tant energy-producing region it also plays generated public concern. With regard to a key role in constructing a (globally) liber- Russian-Ukrainian relations, discord of a alised energy market. regulatory nature could recur in 2018/2019, 3) Maximising the geographical scope of mar- given that the transit agreement between kets. The EU’s reticence is also surprising in Russian and Ukraine expires in 2019. As a view of the history of member of the Energy Community, Ukraine and the EU’s “integrative DNA”. In the 1990s, will have to ensure that the new transit the EU was working to establish and expand regime conforms to the rules of the Energy relations with other integration formations. Community and the EU’s . Yet even then, bilateralism predominated Legal and regulatory questions will need to towards former members of the Soviet-led be clarified, including that of an independ- . Today the EU is concentrating ent operator for the transmission system on consolidating its own energy market, (the transit pipeline). So interoperability and rather than pursuing the objective of ex- transparency pose great challenges. Firstly, panding the market space. This underlying the region’s gas network is still shaped pattern is amplified by mistrust towards by the legacy of the . Secondly, Russia and its plans. But dismissing the regulatory disruptions that could inflame EAEU as Moscow’s project would mean yet the security conflict between Moscow and again viewing the region solely through a Kiev need to be avoided. Thirdly, gas exports geopolitical lens. This risks driving market via Ukraine should be maintained – presup- segmentation and wasting strategic ad- posing legal, technical and economic steps vantages. supported by all parties and “gas neigh- New markets are in fact at stake, but also bours”. This situation bears risks of spill- adaptation to the new realities of a multi- over into the broader security conflict. polar world. The EU can only profit from a 5) Operation of export pipelines. The rules, multivectoralism that relativises China’s norms and standards developed for trans- influence (and Russia’s). Some members of port networks and their operation in the the EU and Energy Community share such EAEU are also significant in relation to an interest in diversifying economic rela- other export pipelines. At the very least, tions with the members of the EAEU – in the rules will affect upstream pipelines and particular those that experienced bloc alle- interconnectors within the EAEU that link giances in the past and hoped they had left into export pipelines of the EAEU countries. these behind them. Article 7 of the EAEU Treaty also offers a These abstract reasons would suggest degree of leeway for external relations. that the EU should follow and support the Thus, these are important course-defining EAEU’s energy market processes at the tech- decisions for the EU as well. nical, operational and regulatory levels. 6) Desynchronising from BRELL. Estonia, Compartmentalisation of energy questions Latvia and Lithuania are still connected to is advisable and expedient because the EU is the Soviet-era BRELL ring, with otherwise pushing ahead with its own internal Energy only an HVDC connection to the Scandina- Union, because Brussels already has an in- vian Nord Pool electricity market. In spring strument at hand in the Energy Community, 2017 it was decided to synchronise the Bal- and because steps have thus already been tic states with the European ENTSO-E net- undertaken to shape the own external rela- work by 2025, via Poland. This “BRELLxit” tions. With such an approach it will also will have considerable economic repercus- be possible to find answers to the concrete sions for both sides, the Baltic states and problems outlined in the following: Russia/Belarus. The latter have started in- 4) Gas transit through Ukraine. Disputes vesting in new transmission lines and ex- about operating arrangements for cross- pressing claims for compensation. Issues

SWP Comment 5 January 2018

6 that will have to be accommodated include Armenia are drawn into the orbit of the the Belarussian nuclear power plant under EAEU. Yet in pursuit of multivectoralism construction at Ostrovets, which was in- Armenia is also seeking ties with the EU; tended to supply electricity to the EU; nu- Belarus is a member of the EAEU, but has clear safety issues are also at stake. Another also requested observer status in the Energy big question mark is Kaliningrad. It remains Community. The EU needs to find answers unclear whether the exclave will be sup- to these countries’ desires for balance be- plied (asynchronously) and/or operated in tween power blocs. That again speaks for isolation or connected to Russia by some dialogue between Brussels and the EAEU. other means. Particular vulnerabilities 10) Climate and transformation agenda. could also arise in the transition phase, if Dialogue and exchange would be especially processes are not closely coordinated among useful in relation to global climate pro- the affected parties and a desynchronisa- tection. Here the EU could engage with tion is realised unilaterally. Given that the existing plans: energy-efficient technologies EAEU intends to realise a common elec- are increasingly important to the EAEU. tricity market by 2019 it represents an The interest in exchange on “best and worst obvious and central partner. practices” in the areas of renewables and 7) Synchronisation of Ukraine. At the end energy efficiency is remarkable. Since 2016 of June 2017 the Ukrainian transmission the Energy Department of the Eurasian system operator UKRENERGO concluded an Economic Commission has been discussing agreement with the European Network of questions relating to corresponding (and Transmission System Operators for Elec- harmonised) legislation and the introduc- tricity, ENTSO-E, as the first step towards tion of energy-efficient technologies espe- integrating and synchronising Ukrainian’s cially in the area of energy infrastructure. electricity grid with the EU’s. Here again, Thus for example the oil market programme even if synchronisation is a long-term affair names the development and enforcement (in the case of Turkey it took about ten of environmental protections as a joint years), the problem of emerging technical responsibility. At the moment Kazakhstan and regulatory barriers at the borders with is the only member of the EAEU with an the post- Soviet UPS/IPS system should be emissions trading system. addressed at an early stage, in order to avoid cementing military fronts and de facto borders in and eastern Ukraine. Conclusions 8) Synchronisation and neighbouring coun- It is hard to see why the EU should sideline tries. The economic repercussions of (de-)syn- itself from the emerging energy markets of chronisation processes on neighbouring the EAEU. Interoperability and transparen- countries need to be taken seriously. The cy are increasingly important, not only for potential downsides are illustrated by the the old physical networks but also in con- example of Turkey and Georgia. When Tur- nection with the growing application of key synchronised with the ENTSO-E net- information and communication technolo- work, Georgian investments made under gies (see SWP Research Paper 4/2017). If the the expectation of export opportunities to EU wishes to avoid ceding the initiative to Turkey became unprofitable. The costs were actors like Russia and China, and wants in- then reallocated to the Georgian popula- stead to exploit its strategic advantages as tion. an integration space, it should gradually 9) Risky overlaps. Overlaps between the seek dialogue at the technical and regu- EU/Energy Community and EAEU exist in latory level with representatives of the EAEU. regions where “frozen conflicts” smoulder. In the event that this cannot immediately Georgia is a member of the Energy Com- be transposed to the political level, an EU- munity, while , and EAEU advisory forum could be established,

SWP Comment 5 January 2018

7 to include representatives of the European network operators (ENTSO-E and ENTSOG) and regulators (ACER), but also of the Energy Community. In any case dangerous rivalry over integration in the strategic field of energy needs to be avoided. Instead con- vergence of market areas should be pur- sued, in order to open up opportunities for political and economic liberalisation and diversification.

© Stiftung Wissenschaft und Politik, 2018 All rights reserved

This Comment reflects the authors’ views.

The online version of this publication contains functioning links to other SWP texts and other relevant sources.

SWP Comments are subject to internal peer review, fact- checking and copy-editing.

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ISSN 1861-1761

Translation by Meredith Dale

(English version of SWP-Aktuell 4/2018)

SWP Comment 5 January 2018

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