Partnership between Russia and the European Union in the energy sector: mapping the bottlenecks

1. Partnershipbetween Russia and the European Unionin the energy sector:mapping the bottlenecks Alexander DYNKIN, IMEMO RAS 7th Energy and Geopolitics Forum 12-14 November 2008 Page 1

2. New PCA agenda • Europeans was drawn to the enlargement and internal reforms of the EU. • Strengthening of “euroskeptics” positions in Russia can be observed. • Domination of the EU vector is notconsidered as an optimal for Russia, although business relations between Russia and the EU become stronger. • “Maturing” of both sides changes the request for final results. The “weak” wording is insufficient for the real improvement. But that may be the only current solution. We need a breakthrough in some direction. Crisis does matter. • The European Union supposes that energy sector attracts great mutual interest. However the problem is more acute for the EU because both European countries with rich oil and natural gas resources – Russia and Norway – are not the EU members. Nevertheless this fact makes vital the energy security for both the EU and Russia. Page 2

3. Taxonomy of foreign investments for Russian oil and gas companies • Development of Russian “classic” TNCs in oil and gas sector by outward FDI • Strategic partnership with foreign TNCs by asset-swap deals or even merges • Internationalization of Russian oil and gas companies by foreign portfolio investments Page3

4. Number of companies in the top-list by total production Foreign fixed assets of Russian oil and gas TNCs (end of 2007) Lukoil $ 9-10 billion (total Lukoil’s foreign assets - $ 20 billion) Gazprom $ 8-9 billion Zarubezhneft $ 1,4 billion Rosneft $ 0,7 billion TNK-BP $ 0,4 billion Itera $ 0,3 billion Slavneft $ 0,2 billion Total foreign assets of world’s leaders (2006): BP $ 170 billion Shell $ 161 billion ExxonMobil $ 155 billion Total $ 121 billion ConocoPhillips $ 90 billion Russian firms among the world’s largest oil and gas extraction companies Page4

5. Russia providesapproximately 2/5of natural gas imports and almost 1/5 of oil imports of the European Union. The majority of pipelines from Russia leads to the EU. Moreover, the share of oil and natural gas was about 45-50% of Russian exports (when prices were high) while extraction tax and export duties gave more than 45% of federal budgetrevenues (at the same time oil and gas industry made less than 10% of Russian GDP). The EU needs stable supply of cheap oil and natural gas. The control of their extraction and transportation is desirable in such situation. It is useful for Russia to raise its earnings from oil and gas sector. The development of hydrocarbon manufacturing and the strengthening of control of downstream activities abroad are the most productive strategies. Interdependency and contradictions between Russia and the EU Page5

6. Energy supply of the EU, 2007 • EU-27 share in world proved reserves of oil– 0,5% • EU-27 share in oil world production – 2,9% • EU-27 share in oil world consumption– 17,8% • EU-27 share in world proved reserves of natural gas – 1,6% • EU-27 share in natural gas world production–6,5% • EU-27 share in natural gas world consumption –16,4% EU-27 dependencyon imports: oil – 84%, natural gas – 60% Page6

7. Trade movements of natural gas (including liquefied gas) into the leading importers among the EU members (2007) Page7

8. Problems of cooperation from the Russian point of view: oil and gas extraction • In line with current global trends Russia claims its control of strategic oil- and gas-fields by owning at least 50% of shares. • At the same time Russia needs advanced technologies of leading TNCs. • Gazprom has really expanded at the expense of TNCs from EU countries with an understandable aim to win back failures of the 90ties. However it is more important that nowadays Gazprom wants to save its partnership with European TNCs. Page8

9. Problems of cooperation from the Russian point of view: transportation of raw materials • Russia always provided stable oil and gas supply for the EU, even during the Cold War. This fact is well-known. • Thus the politicization of the task of alternative pipelines construction has mainly economic roots, i.e. who will get main profits from transportation? • Naturally Russia worries about pipelines without its participation because Russia tries to compete in the “transit markets”. Page9

10. Problems of cooperation from the Russian point of view: development of manufacturing • Russia longs for the diversification of its economy. Manufacturing of raw materials is a way to achieve it. • The development of export-oriented electric power industry and some petrochemical plants will limit Russian possibilities of raw materials exports to the EU. • Russia needs FDI from the EU and other partners for such ways of diversification. However are European companies ready to stimulate their competitors in Russia? Page10

11. Problems of cooperation from the Russian point of view: oil and gas trading in the EU • Participation in the gas retail is rather profitable, although possibilities vary significantly from one EU country to another. • Gazprom expands without real problems in Germany, Austria and some other EU members. At the same time strong opposition against its expansion exists in the UK. Mistrust can be observed in the Baltic States as well. • Corrected initiatives of electricity and gas market liberalization can only strengthen the difference in attitudes to Russian companies in EU countries. Page11

12. Problems of cooperation from the Russian point of view: development of modern energy sector • Russia has significant potential in nuclear energy, although the skeptic attitude to the whole sector remains in the EU. Some protectionism against Russian companies also exists. • Strategic interests of Russia and the EU coincide in the necessity of common efforts in the field of ecology and new efficient technologies in energy production and consumption. Page 12