Report

The Energy Challenges Facing Europe: What Can the EU Do? Lord Kerr of Kinlochard Philip Lowe Chris Lambert

iCES Occasional Paper XIV Institute of Contemporary European Studies

iCES Occasional Paper XIV © Institute of Contemporary European Studies, John Kerr, Philip Lowe & Professor John Drew.

All rights reserved.

No part of this publication may be reproduced in any form or by any means without the permission of the publishers.

ISSN 2040-6517 [online] ISSN 2040-6509 [paper] First published in Great Britain in 2014 by the Institute of Contemporary European Studies (iCES), Regent’s University London, Regent’s Park, London, NW1 4NS www.ebslondon.ac.uk/ices

Contents Foreword 3 Professor John Drew Seminar Contributions

UK and EU energy policies in a mess: What can be done about them?

Lord Kerr of Kinlochard

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Energy efficiency: Emissions, competitiveness and opportunity costs Philip Lowe

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Energy security: Frameworks, delivery and shifting parameters Chris Lambert

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Discussion 20 Background Paper The energy challenges facing Europe: What can the EU do?

The Senior European Experts Group

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Professor John Drew Chancellor and Director of the Institute Of Contemporary European Studies, Regent’s University London A former UK diplomat in Paris, Kuwait and Bucharest, John has held the positions of Director of International Corporate Affairs at Rank Xerox and Director of European Affairs at Touche Ross International. He was the representative of the European Commission in the UK and is the Chancellor and Director of the Institute of Contemporary European Studies, Regent’s University London.

Foreword The Future of UK and EU Energy Policy Energy policy in Europe and in the UK is in a mess according to Lord Kerr, who was one of the distinguished contributors to the recent joint seminar of the Institute of Contemporary European Studies (iCES) and the Senior European Experts Group (SEE).

He goes on to suggest some things that people should stop doing and proposes some things they might start doing to improve the current situation. John Kerr has held senior business positions in the energy field and was formerly head of the UK diplomatic service.

He would doubtless be concerned about EU and UK policies that seem to concentrate more on short-term actions rather than considering longer-term strategic solutions.

Thanks to him and fellow members of SEE, this seminar was informed by the paper “The energy challenges facing Europe: What can the EU do?”, which is the fourteenth in our series of iCES Occasional Papers. It is published and widely circulated thanks to the generous support, contribution and acknowledgement of the London offices of the European Commission.

Lord Kerr pessimistically begins by stating that for EU and UK energy policy there is no silver bullet solution. He then goes on to suggest positively some UK and European options.

Philip Lowe’s view on CO2 emissions is that Europe has obviously to save the world but it actually has to save itself first. He agrees that there is no one silver bullet but a considerable number are in need of firing. Energy efficiency should be measured not in terms of the rate of return to the individual person or individual company but in terms of the opportunity cost of not doing it. This opportunity cost includes investing very heavily in generation.

Until recently Director General in the European Commission, Philip Lowe has wider experience than most of the European silver bullets proposed, fired or misfired. His very last words are that no one really likes talking about “using energy better”, but the reality is that our capacity is immense to make better use of energy in buildings.

This point was taken up by Chris Lambert, Director of the Westminster Energy Forum, the UK industry association for the analysis of risks to energy policy, delivery and security.

Essentially, government sets the policy framework and wants the market to deliver, which comes down to what is a tolerable level of risk for the market to take in terms of the reward it is going to get. What policy formation needs to understand is the framework through which money will flow and infrastructure will be delivered. One thing to ask is what price are you prepared to pay for what level of energy security? How much are you prepared to pay for a guaranteed supply of energy, whether it’s electricity to your home 3

or oil or liquefied natural gas (LNG) to your country? This comes down to addressing the trade-off between affordability and low carbon and secure access.

May I commend the SEE report and the comments of the contributors to the seminar?

The SEE reports are always succinct, well researched and authoritative. iCES and Regent’s University London are pleased to be associated with them and to bring them to a wider audience through our seminars three times a year.

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Lord Kerr of Kinlochard GCMG John Kerr is Deputy Chairman of Scottish Power, a non-executive director of Rio Tinto plc and a former Deputy Chairman of Royal Dutch Shell plc. He served as the UK’s Permanent Representative to the European Union from 1990 to 1995, Ambassador to the United States from 1995 to 1997 and then Permanent Under-Secretary at the Foreign Office and Head of the Diplomatic Service from 1997 to 2002. He was Secretary General of the European Convention in 2002/03. He is now an active member of the House of Lords, Chairman of the Centre for European Reform and a member of the SEE.

UK and EU energy policies in a mess: What can be done about them?

I propose to argue that EU energy policy is a mess and that UK energy policy is a mess, and that there is no silver bullet solution. But I am going to suggest some things that people should stop doing, and I am going suggest a few things they might start doing.

Three quick anecdotes: I was on the board of Royal Dutch Shell when we decided that it was worth doing a deal with Gazprom to retain our 50 per cent interest in the enormous Sakhalin LNG plant on the Pacific coast of Russia, which was at the time the biggest LNG project in the world. We decided that we would not pull out because it was clear that the world market for LNG was going to centre on California. We built the Sakhalin plant, which was the most expensive LNG plant at that time, in order to supply San Diego and Los Angeles with LNG, and we started building on mainland America, and in Mexico, gasification plants that we are now turning into LNG (liquefying) plants because of course shale happened, a game changer in America, and there is now no possibility of anyone exporting LNG into America.

Sakhalin was still a wonderful investment because Fukushima happened and the long-term contracts linked to the oil price that Shell has with Korea and Japan (and China now) are immensely lucrative, and Sakhalin is, I think, the second most successful LNG operation anywhere; one in Qatar probably makes even more money.

The moral of that story is this is a difficult business; if energy policy is a mess it is partly because energy policy is operating in an area of considerable unknowns, known unknowns and unknown unknowns. We didn’t not know about fracking – or rather, we did know about fracking as people have fracked for thirty years – but we hadn’t spotted how the combination of horizontal drilling over two, three, four miles and improvements in fracking techniques, together with American land tenure arrangements and the availability of an enormous number of drill rigs in America, would bring about what was, at least in America, a game changer. And it happened in the last ten years. It happened very, very quickly. I would not have thought that the Japanese would switch off all their nuclear power stations. I would not have thought that Mrs Merkel would follow suit in Europe. I do not think that anyone would argue now that Shell were at fault in going ahead with the Sakhalin LNG operation. But in doing so with the intention of supplying California they were, however, completely, utterly, wrong.

Second anecdote: about ten years ago another company where I am a director was trying to work out what the price of carbon would be about now because we were thinking of buying an aluminium company that has an enormous amount of hydro power. Aluminium is made using small amounts of bauxite and absolutely enormous amounts of electricity, and if you generate your electricity burning coal, oil or gas you are going to generate a great deal of carbon. Hydro 6

power produces none. So the value of our target company was partly a function of the future cost of carbon emissions.

We consulted every known expert and the range of prices of carbon ten years ahead that we were offered was from about $25 to $30 a tonne up to about $65 to $70 a tonne. As you all know, the price of carbon today is somewhere between $5 and $7 a tonne. That means that Rio Tinto’s purchase of Alcan looks pretty expensive, although in the long term I think it will be seen as a very good deal. The point is that nobody knew in 2004 that the price of carbon now would be where it is, driven down by the recession and by shale gas. Indeed, people were wrong by a factor of about ten to fifteen times.

Third anecdote: Kyoto. It was exactly ten years ago that the United States dismissed as absurd the emissions targets that the rest of the world was signing up to at Kyoto. The USA dismissed them as suicidal for US business, “out of the question”. Actually, that was the year when US emissions turned down. The USA now more than meets the targets that it rejected as absurd – as suicidal for US business – in 2004. They have been easily met. Why? The answer is because of fracking, which has driven out coal. The transatlantic coal trade, which was dead for twenty years, has revived because the coal has to come over here to find a market; coal-fired generation is dying in America, beaten by very cheap gas. But the US government’s rejection of the Kyoto targets was hugely popular with the US public.

The moral of all three anecdotes is that prediction is difficult, particularly about the future. The fact that energy policy is a mess is partly because it is difficult.

Why is EU energy policy a mess? Because I’m sitting alongside Philip Lowe I have to say straightaway that we shouldn’t blame the Commission! It is not the Commission’s fault. In 2002 I worked on amendments to the EU treaties in a convention in Brussels, including a new article on energy policy that would have given the Commission increased powers to propose legislation on energy policy. You all know the present Article 194: it confers some powers on the Commission, quite limited powers (this is a shared competence), but there is then a huge carve-out that says that nothing in this in any way gives the European Union the power to lay down any member state’s energy mix. That is a matter entirely for the member states. So the fact that we don’t have a clear, simple, straightforward EU energy policy is partly because we don’t have a clear, simple, straightforward European Union. We have a mix between powers that we have conferred absolutely on the European Union, federal powers in areas such as monetary policy, powers that are left completely for the member states in areas such as taxation or defence, and ones like this one, a shared power where the Commission can do various things but we absolutely don’t agree that they can do other things; so don’t blame them for not doing them.

The European Parliament and the Commission didn’t like the carve-out and wanted a more muscular Article 194, but of the member states only four agreed with them. I think one genuinely agreed with them and three were trying to suck up to the Commission. So Article 194 is as it is. Don’t blame the Commission, blame the member states, blame the politicians.

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Let’s talk about Britain for a moment. The basic problem with our energy policy is that we are trying to do three incompatible things simultaneously. We are trying to keep the price down, and so you see the British government shouting at the energy companies when the price goes up and encouraging the Daily Mail, the populist press, to denounce them for putting the price up. We are trying to keep emissions down, and so you see the British government imposing various levies on the power companies to collect the money to pay subsidies to those who improve the energy efficiency of their houses or put up a windmill. You have the costs of that not on the face of the Budget, not coming through the Treasury, not coming out of the Exchequer but paid for by the consumer, so that puts up the bill, so you shout at the energy suppliers. So we are trying to do two incompatible things: keep down your emissions and keep down your prices.

We are also, and this is perhaps where the British government fails most of all, trying to keep the lights on. The lights are going to go out, probably in winter 2015-16. Perhaps not blackouts, but brownouts. The safety margin will be down under 5 per cent in winter 2015-16 because we are closing old coal-fired stations under the Large Combustion Plant Directive. We are not building nuclear generating capacity, because we lost our nerve and for a long time have not built any nuclear plants. And, because the price of coal is so low, because of what has happened in America, we are mothballing our efficient gas-powered power stations. There has been no new start on constructing a new thermal power station in the United Kingdom under this government, which means that there is going to be an energy gap in this country: nothing can be done about it.

Trying to do three incompatible things at the same time is a bad idea. Three is at least one too many. The first thing politicians should do is be honest – they have to choose.

It has to be said that the European Union makes this mistake too, partly because it has different formations of the Council for dealing with the three objectives that I have described, and partly because the European Parliament is an institution that believes you can believe three incompatible things before breakfast. There is incoherence and a lack of clarity in policy because policy objectives are diffuse and incompatible.

What should the European Union do? I will try to be constructive for a moment, breaking the habit of a lifetime. First of all, we have one extremely good invention that isn’t working but could be made to work. We have the emissions trading system, where we led the world. It is a very good idea but it isn’t currently working because the price is far too low, because far too many permits were issued early on and then recession struck. It could be put right. The Commission have proposed and the Parliament has finally agreed to a minor reform. There needs to be further reform. There needs to be a floor price, which I would guess should be set at about $30 a tonne.

I would add that we should try to take our invention global. I think the world needs an International Bank for Reconstruction and Development for carbon. It seems to me that when you approach the problem of carbon leakage and the position of the Chinese and developing countries, you are probably going to need a global system. I think the EU is quite well placed to make a constructive suggestion. Of course it would be extremely hard to negotiate and countries like China would need to be brought into the system with a wedge of free credits at 8

the start, but I would far rather have that than the more modish solutions to carbon leakage, such as tariffs and duties at the frontier. They seem to me to be extremely dangerous and liable to cause a lot of trouble down the road.

Second, the Commission should go on doing what it is doing – arguing for interconnection and arguing for storage. When you think of the position of the Baltic States today, still connected to the Russian grid, and you think of their concern about what is happening in Ukraine, it is absurd that they have been in the European Union for as long as they have and we haven’t cracked the problem. But that is not the Commission’s fault.

Storage – we do need a lot more gas storage. It would be wonderful if someone would invent a really good battery for the storage of electricity; the best we have, I think, is pumpedstorage hydro, but not much EU territory is ripe for that. But the UK and the EU as a whole clearly need more storage of gas, and it isn’t technically difficult – ask the Dutch, who have been doing it for thirty years.

What should the member states do? First they should be honest. They should have subsidies paid for through the exchequer and not paid for by the consumer. They should think more about standard-setting, and maybe this is an EU point too. When you think of the success of catalytic converters, which were made compulsory for car exhausts in the EU in 1992, I think, and which made an enormous difference; when you think of the Large Combustion Plant Directive and what it did to solve the problem of acid rain – you can do much more by setting standards, and it tends to be more efficient than raising subsidies.

I think the key thing though is honesty; I think you need to be honest about the trade-off between cost to business, and therefore jobs, and advantage to the environment. I think that people are more ready than they were to accept that we all have to act against climate change and that this involves costs. Government pretending it has no cost won’t do.

Wind power has huge costs and can’t be the only answer. In the anticyclone here during the winter in 2009 there were twelve days of extreme cold in January when the contribution that our wind industry – and I speak as deputy chairman of the company with the biggest wind farm in Europe – made to UK generating capacity was zero. Very cold weather in Britain usually happens during an anticyclone, and there is no wind so you need to have a backup. Don’t pretend that wind is the answer.

Don’t pretend that carbon capture and storage (CCS) is the answer. It may be one day, but it is going to take a tremendously long time to get that technology working. Nobody has made it work economically yet. Yes, put more money into research – and the Commission, to be fair to them, are doing just that – but don’t expect it to solve today’s problems. CCS may be the solution a decade ahead, but people have been saying that for two decades.

Fracking is not the silver bullet either in Europe. Of course we should resist those who are against fracking for all the wrong reasons, but I think that in the EU we will not replicate the speed of the 9

American change with fracking. There are bits of European geology where major exploitation of shale gas and oil is possible: Ukraine is a case in point. But it will take time and massive investment, which means political stability and perhaps partially explains why the Kremlin seems to want to destabilise Ukraine, discouraging investment in a potential energy competitor.

Finally, I would say don’t tinker with the regulatory environment. Too much tinkering is an extremely bad thing. I think that Mrs Merkel’s most uncharacteristic reaction to Fukushima was the single worst development in European energy policy in the last decade. Predictions about technology, geology and markets aren’t easy as my three anecdotes showed, and political unpredictability compounds the problem. What the European energy industry needs from governments is less volatility and more honesty and consistency.

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Philip Lowe Philip Lowe has recently stood down as Director General Energy in the European Commission. He was appointed a non-executive director of the Competition and Markets Authority (CMA) Board on 15 July 2013. His previous posts at the Commission include Director General for Competition, 2002 to 2010; Chef de Cabinet to the Vice President for Administrative Reform of the Commission, 2000 to 2002, and to the Commissioner for Transport, 1995 to 1997; Director General for Development, 1997 to 2000; Director for Rural Development (Director General Agriculture), 1991 to 1993; and Chef de Cabinet to the Commissioner for Regional Policy, 1989 to 1991.

Energy efficiency: Emissions, competitiveness and opportunity costs Well, I agree with John [Kerr] that there is no silver bullet to the energy challenges in the UK and Europe as a whole. In the course of the last twenty minutes he has in fact fired at least fifty bullets as solutions … and I will now try to connect in to some of them.

First of all, as an immediate reaction to some of the issues: how can we be serious about saying that we don’t like coal if we don’t get some kind of global agreement on reducing CO2 emissions? There is a major negotiation coming up in Paris on this in 2015, but so far none of the other big CO2 emitters in the world – the US, China, India – have given any indication that they would make commitments similar to European intentions. So it is all very well for Europe to go ahead and say we are going to impose a more ambitious emissions reduction target or a carbon tax, but don’t forget that Europe accounts today for only 11 per cent of world CO2 emissions and in 2030 it will only be 4 per cent. So our contribution to the UNCCC Paris negotiation will certainly be important in terms of advocating the best solutions but will not be significant on its own in containing global emissions. At the moment coal remains the cheapest fuel for electricity generation in the European Union. As John has pointed out, gas has become the favourable power source in the USA and therefore a lot of coal has been diverted to the EU, notwithstanding the fact that countries such as China and India have substantially increased coal-fired electricity generation.

I’m not sure that the answer lies in having some kind of Europe-wide policy on energy mix.

Europe-wide emissions targets make sense, but find me the European country, find me public opinion in any European country that is prepared to live with a decision taken in Brussels on whether you should allow nuclear energy to be produced, for example, in Austria or Germany, whether you should have onshore wind, like in England, or whether you should be forced to have CCS to deal, as in Poland, with very coal-based energy markets. These are the kind of issues that have to be debated locally, regionally and nationally before you get to any kind of European view on energy mix, notwithstanding the basic issue of whether we are in favour of moving towards low-carbon technologies and reducing dependence on fossil fuels. Based on the growing scientific consensus on climate change, it makes sense for the energy industry of Europe, and worldwide, to make a substantial contribution to the fight against global warming by moving towards low-carbon technologies.

Before we get into the issue of what changes in energy policy are now necessary, can I say that neither the European Commission nor any national government in Europe is exempt from responsibility for the failure of present energy policies in Europe to deliver the outcomes we need in terms of competitiveness and affordability as well as security of supply? But let’s recognise that this is quite a difficult industry. It requires long-term and heavy capital investments, and the propensity for things to go wrong is high. Global markets for oil and coal 12

are sensitive to political as well as economic changes. Environmental factors such as global warming and air pollution weigh heavily in decisions on future investments. Public acceptance of the need for new generation or infrastructure investments is crucial. Hopefully public policies facilitate trade and investment in energy but sometimes they frustrate business decisions by creating a climate of uncertainty and unpredictability. In the end, though, markets and not governments decide, and that’s what has happened with coal.

Let’s also look at the comparison with the USA – first of all on emissions. Not many people realise that half of the contribution made by the USA in reducing its CO2 emissions has not come from the change from coal to gas but from the application of new fuel emission standards for vehicles on the same basis as those decided by the EU fifteen or twenty years ago. Fifty per cent of the reduction of US emissions in 2012 and 2013 come from these new standards and not simply the coal-to-gas transfer.

An additional element in the US-EU comparison is that Europe has a much better track record than the USA in using energy efficiently. I refer you in particular to the latest study we put to the European Council from the Commission on the drivers for increases in prices and costs in Europe, which by the way are very different in different countries. Europe has been consistently better at using energy. Our energy efficiency in industry is very good, but obviously, because gas prices are three to four times lower in the USA than in Europe, it is no longer possible to rely on energy efficiency to remain competitive. We have a real problem here.

How do we go about tackling this problem? As you have noticed, I am deliberately not talking immediately about climate change policies. I am going to talk first of all about competitiveness, affordability and security of supply. I hope we have made that clear in what we said in our proposals for 2030 at the beginning of the year, which by the way only include binding national targets on CO2 emissions, leaving member states (and companies) to use the technology that they feel is the most competitive without subsidy. Don’t forget that low-carbon technologies in Europe at the moment are all subsidised in some way or another – whether nuclear or renewables such as onshore wind and solar voltaic. By the way, the costs of these two technologies have come down substantially but they are still subsidised. We hope they won’t be in five years, but that is the reality today. As far as nuclear is concerned, you can call a horse a cow or a camel, but a subsidy is a subsidy and there is no nuclear plant in the European Union or anywhere in the world that does not have an element of public support in it, whether legitimate or not. You also have to ask yourself the question when you subsidise nuclear power whether you are genuinely doing it in order to meet a security of supply gap or simply because it is a source of energy that is more acceptable to the public than any other. In the UK, public opinion and the UK parliament have fundamentally endorsed the idea of a substantial nuclear contribution to the UK energy mix. Should the European Commission call that choice into question? Certainly not. It is a low-carbon technology and it meets the CO2 emissions objectives so it may merit a degree of state support for a transitional period. But don’t say that nuclear is being backed purely for security of supply reasons, because investing in nuclear now will not help security of supply for more than a decade.

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Just two minutes on the competitive situation. What do you do if the price you pay for gas in Europe is increasingly influenced by Asian prices, which are in turn driven by Asian growth? Global growth in fossil fuel demand means that Europe is increasingly a price taker, in oil, in coal and in gas. Even if gas consumption has gone down in the last two or three years for economic recession reasons, we know that our fossil fuel dependence is growing and growing every year.

The first reaction to that, forgetting the European Commission, forgetting the UK government, would be to say: have we got any gas or oil in the European Union that we can use ourselves without going to unstable countries, without going to places where other energy-consuming countries are prepared to pay more than us? There hasn’t in fact been enough attention paid to continuing to develop Europe’s indigenous sources of fossil fuels. Bulgaria and Romania have gas resources in the Black Sea that US companies and others are prepared to exploit, including ones that John has been on the board of. In the Mediterranean, leading figures in the industry have told us that if you have gas off the east coast of Cyprus and off the west coast of Israel it is almost certain that the gas will be in a geological horizontal belt across the Mediterranean, even if in more difficult conditions. We shouldn’t ignore the continued potential to develop indigenous sources of gas in Europe. Even if in a low-carbon world we will consume less gas than today, we will still need gas to deal with the intermittency of renewables. Gas can also be a good lower-carbon substitute for oil and coal in transport, heating and industry. We have problems of public opposition, indeed legitimate opposition, to certain aspects of shale gas exploitation. But can a fossil-fuel dependent Europe ignore shale gas? I don’t think so. It should investigate how shale gas can be exploited in conditions that most respect the environment and the quality of life of the communities who are affected. Of course, we are still at a very early stage. Shale gas produced in Europe is unlikely to make a significant contribution to the EU energy balance before 2025. But there is strong commitment to investments in the sector in Poland, Lithuania, the UK and Ukraine.

Of course, if we are able to develop low-carbon energy sources over the next ten years on a cost basis that is comparable with fossil fuels then we will have made a lot of progress. But the last ten or fifteen years have shown that we have already had a lot of difficulty in giving support to renewables without over-subsidising them. The price of electricity should be based on electricity demand and supply, not on subsidy.

It is hugely important for the UK and Europe as a whole to tackle that issue by establishing what renewable technologies are mature enough for us to get to a competitive cost level in a reasonable period of time – by 2020, for example – and what other technologies may need longer-term support, in particular through R&D and funding for demonstration projects.

By the way, on the energy mix question, if you set an emissions target for the European Union as a whole and you divide that down into national targets, are you expecting Poland to close all its coal mines in two or three years? Every single aspect of European policy in the past has allowed for transition towards certain final objectives and there is no reason that there should not be a differentiated approach, particularly as there are probably more than half a million people directly or indirectly employed in this industry in Poland. Think of imposing the same CO2 emissions targets on the UK in 1975! Mrs Thatcher would perhaps have relished another argument in favour of closing coal mines, but we must have more flexibility for countries like 14

Poland to be able to contribute to the CO2 emissions targets while remaining competitive and carrying out the restructuring that is necessary for the longer term.

For thirty years, supported in particular by the UK, the European Union has been striving to create an open, integrated, interconnected market in electricity and gas in Europe. Does the analysis of our competitive assessment today show that this is not needed anymore? On the contrary: from what John said there is even more argument for it. I sit as a non-executive member of the new UK Competition Authority (the CMA) and we were talking the other day with several government agencies about barriers to entry into the UK energy market. Curiously none of them mentioned the lack of interconnection with neighbouring countries as a barrier.

In any market, you can have a new investment by acquisition, you can have a new investment by someone coming in fresh and building a power plant, but if you have an interconnection you have the possibility of trading immediately in electricity and gas across borders, which is a reality today between France, Germany and the Benelux and Central countries. But it is not a reality for the British Isles. It is not a reality for Spain and Portugal who have structural over-capacity in modern gas-fired plants but cannot sell their gas or electricity in the European market because of the paucity of the interconnection with France.

There is now a major programme, agreed at the end of last year, to get interconnections going.

But even after that programme of nearly 250 projects has completed there will still only be a six per cent coverage of interconnection between France and Spain. Six per cent! It is now three per cent and the figure for the UK is something like four or five. The Baltics, as John says, are in a very difficult situation. Things have improved in gas but they are a hundred per cent dependent on Russia for electricity. They would be very happy if we had a long-term objective of synchronising their electricity systems with those of Western Europe, but that is a major project in investment terms (tens of billions of euros). If we could at least get DC connections between the Baltics and Poland and Germany then we would have made progress. If we realised the vision of an integrated European energy market, which the UK has been promoting for more than twenty years, we would keep prices in check and would strengthen security of supply in all our countries. The arguments for doing this are much stronger than they were twenty years ago: we are now much more import dependent and world prices are rising and volatile.

So let’s get on with it. We need the existing EU legislation of the Third Energy Package to be implemented in all member states. We need the EU Infrastructure Regulation to be applied and the funds of the new EU Connecting Europe Facility to be deployed to get things moving on interconnections. And we need the energy regulators and the competition authorities of the European Union to be vigilant in ensuring that there is a dynamic of competition in wholesale and retail energy markets. They also need to ensure that investments in the energy industry are carried out on a competitive basis but nevertheless allow investors to get a fair return.

Investors always say energy prices are too low and consumers say that prices are too high. Well, they are both right. The fact is that in an industry like energy you need to have a minimum level of certainty, a tolerable level of certainty, to make an investment that is going to last twenty or sixty years. That cannot be the case by simply relying on spot markets. You need long-term competitive contracting of electricity to make it work. Within the framework of long-term competitive tendering you should build in first the obligation to keep the lights on, second the 15

obligation to use a sufficient proportion of low-carbon energy, but also third an obligation on suppliers to provide the reserve capacity to deal with intermittency. This would absolve the need for the public purse to pay for capacity mechanisms all over the place, paying people to keep capacity in reserve. All these aspects of the problem underline the need for more competition in the sector.

I just want to say that with more renewables in the energy system, the system itself, the networks, needs a lot more attention. The need to create a better climate for investments in smart infrastructures is absolutely critical now. We are coming out of a period of economic recession. It should be possible, it is already the case, that there is a lot more interest in the financial sector than before in energy networks. To be optimistic about it, I think it is possible to invest profitably in interconnection domestically and across borders and by doing so contribute to the creation of modern, smart energy networks And on CO2 my last message here is that Europe has obviously to save the world but it actually has to save itself first. If it is going to save itself it can’t enter into a negotiation on global emissions in a situation where it makes a unilateral offer with absolutely no link at all to the response on the other side. The Chinese and the US approach to climate change – and John and others here know this better than I do – is to say that we realise that climate change is a reality, we are not denying it unlike some politicians, but we think the best way to deal with it is to invest in new technologies. Unfortunately that is also not good for Europe because instead of being number one in R&D and investment in renewables and energy efficiency we are now number three because the US and China invest more in R&D and in demonstration projects in renewable energies, and, by the way, even India invests as much as we do in energy efficiency measures.

A very last word: no one likes talking about using energy better, but the reality is that our capacity to make better use of energy in buildings is immense. There are a lot of lies, frankly lies, talked about the low rate of return on investments in heating and air-conditioning of buildings, as well as in products. Despite all the fuss about electric light bulbs, if you count the billions saved through making products more energy efficient it is going to make a huge difference to Europe in terms of competitiveness, affordability, security of supply and import dependence.

We calculated, and it has been confirmed, that the 20 per cent improvement by 2020 in the use of energy in Europe means that the European Union’s companies and governments will have to build one thousand fewer 500MW coal-fired power stations, or a million fewer wind turbines.

Start measuring energy efficiency not in terms of the rate of return to the individual person or individual company but in terms of the opportunity cost of not doing it, and the opportunity cost includes investing very heavily in generation.

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Chris Lambert Chris Lambert is Director of the Westminster Energy Forum, the UK industry association for the analysis of risks to energy policy, delivery and security. In 2003, Chris founded the Westminster Energy Forum to maintain a cross-industry dialogue with policymakers, leading the UK’s public policy dialogue on nuclear new-build acceptance. The forum now delivers an annual seminar programme on energy policy delivery for over 200 organisations across the sector. Chris also works as an independent consultant on geopolitical risk and international affairs for a range of clients, including the United Nations, the G8 and the UK government.

Energy security: Frameworks, delivery and shifting parameters A little bit of background on what I thought it would be useful to talk about, which I think bookends quite nicely with what John [Kerr] said. I run the Westminster Energy Forum, which shouldn’t really exist; its role is to facilitate a sensible discussion between policymakers, government departments, private sector and NGOs by looking at the strategic risks affecting the deliverability of UK energy policy. So it should not exist if everybody is doing their job, but of course external factors come into play and you can also factor in varying degrees of competence in market or government depending on which side of the fence you are on.

Essentially, government sets the policy framework and wants the market to deliver, whereas our premise after the 2003 White Paper was to say: are we really understanding the criteria by which the market is prepared to deliver something and invest, which primarily comes down to what is a tolerable level of risk for the market to take in terms of the reward it is going to get? So that’s what policy needs to understand – the framework by which money will flow and infrastructure will be delivered. This goes back to John’s previous point about not mucking about with the regulatory system, because if you introduce political risk the money disappears and waits quite a long time to come back, until there is certainty.

My discussion today is really to throw out a few points relating to energy security and what that means, and the shifting parameters that policy has to deal with.

A few pointers then: a lot of attention has been paid to Russian gas and Ukraine this week.

Obviously most of the UK’s gas comes from Norway and Qatar (Qatar in the form of LNG through Milford Haven), but the real hidden issue for the UK is coal. A brief note that in quarter three of 2013, Russia provided 50 per cent of the UK’s coal and that coal in turn provided 40 per cent of our electricity. So there is a link but not the obvious one that you would necessarily think of.

What do we mean by energy security? Is it the degree of exposure that a nation has to interruptions in the supply of fuel and electricity into its country and within its country? If so, there is a huge range of risk factors that can affect the continuity of that supply. We have heard about the capacity gap and we have heard about the potential for rolling brownouts for industry. (They will never let blackouts and brownouts happen in the retail sector because then you will not have a government the next day and there will be a general election pretty sharpish.) There are emergency measures in place, but what I really want to do is look at the origin of all these energy security issues in a global context, particularly oil, and really, certainly for the students here, to understand that there is nothing new under the sun. This isn’t an issue that is going to go away. It will play into this concept of what I will call a hierarchy of need, and I will talk about that in a moment.

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One thing to be aware of is what price are you prepared to pay for what level of energy security? How much are you prepared to pay for a guaranteed supply of energy, whether it’s electricity to your home or oil or LNG to your country? This comes down to addressing this trade-off between affordability and low carbon and secure access, and by the way let’s not forget the people who cannot afford to pay or even get access to electricity and fuel throughout the world. There are so many trade-offs and vested interests involved and when you put in the geology of where hydrocarbons are found throughout the world there are issues. Also, the shift of capital from the West to the East as Asia grows is a significant factor.

One little pointer about Saudi Arabia: 16 per cent of oil is exported from Saudi and 40 per cent of oil for the world goes through the Straits of Hormuz. To protect its oil infrastructure Saudi spends about $2 billion a year, but the USA spends on average $220 billion a year securing the Gulf. US defence spending in the Gulf works out at about $83 per barrel of Saudi oil exported, but America only takes about 20 per cent of Saudi oil. So as shale oil production in the USA grows there is strategically little point for the USA to spend so much on defence in the Gulf. Arguably China should be doing it because China’s consumption is going to grow and grow and grow, but this has implications for the trade routes through Asia. We start to get into the geopolitics of it. There have been terrorist attempts on both Qatari and Saudi oil and gas infrastructure, and cyber threats occur on an almost daily basis – 30,000 Saudi Arabian RAMCO computers were taken down. So the threats are the obvious hard security and resilience ones, but there are many, many others that arise from the competition for resources.

I will give you my conclusion now: the conclusion is that we haven’t really mentioned energy efficiency very much. The best energy you use is the stuff that you don’t actually use. That’s the key to energy security: you reduce the need to import your energy resources. The bottom line is that energy import is quite a high-risk strategy for any nation. If you ask Japan or Spain, these countries are really on the edge of energy imports, of hydrocarbons in particular. The UK is rising up that agenda as well as North Sea production goes off. It does give you some pointers as to the effects of defence spending in the Gulf and the shift of influence to the Far East, and part of that is accelerating the US investment in gas and oil indigenously. And by the way, isn’t the export of cheap shale gas into Europe from the US another sort of interplay with Russia?

Energy is upstream of the economy, it is a national economic security issue – it always has been.

I think it started in 1805; it will be interesting to hear what John thinks with his background.

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Discussion

Asked whether the energy price gap between Europe and the US will make European industry uncompetitive and will last for as long as twenty years, John Kerr replied that it depended on which business you are talking about: “I think that petrochemicals and parts of the chemical business in general in Europe are dead – no way can they compete against American competition.” He added that if “hydrocarbons are a large part of your input costs, that plus European labour costs is going to kill you. But I don’t think this applies right across the industrial sector and manufacturing.” He also believed that the damage could be mitigated through more interconnection, greater storage and more use of LNG. Questioned about whether David Cameron and Ed Miliband appreciated how urgent the energy situation might be politically and socially, Lord Kerr replied, “It depends what you mean by appreciate!” Referring back to his earlier point that by 2015/16 the estimate of the margin was under five per cent, he said that was an Ofgem estimate and their job was to “give such warnings to government”. But he didn’t think that “Mr Miliband is listening because Miliband’s promise of a price freeze for the first eighteen months to two years of a Labour government, if one came in, is the last nail in the coffin of any hope for now of investment in generating capacity in the short term to medium term”. He went on to say that “none of the six majors that generate electricity in this country is going to build new generating plant while the government tells them they are crooks because they are trying to make a profit – which is an evil, wicked thing to do – and the possible next government says it is going to make sure they don’t make a profit from generation.”

One of the Regent’s students enquired about the role of coal in the European energy mix in the next twenty years and was told by Lord Kerr that, “I think there is no doubt that we will be burning coal for another twenty years. Of course governments should be trying to devise ways of phasing coal out, but countries like Poland, where it is crucially important, can rely on the carve-out in the European Union Treaty. There is no way in which they can be compelled [to give up coal].”

Lord Kerr said that he was sceptical about targets. “I do not agree with targets. It seems to me that targets are a cop-out and the concept of legally binding targets is even more of a cop-out.

Politicians tend to square the circle by setting a target for 2030 or beyond, knowing that it will be successor governments that have to deal with the problem of meeting it. The concept of targets being ‘legally binding’ on future governments is fairly meaningless; if the next government doesn’t like it, it can change it.”

Philip Lowe was told by one questioner that the cost of wind power and the unreliability of it was discrediting both renewables and the EU. Saying that he sympathised “with some elements of that”, Philip Lowe noted that it was the EU member states who had decided in 2008 “that 20

subsidies for renewables should be entirely decided by national policy”. He observed that, “There is no power in the EU to say that you should not support wind,” but that the Commission did have “a power, which is in the competition and state aid rules, to stop things being over-subsidised when they are distorting competition. That is what we have said we are going to do and [why] the present Commissioner will come out with guidelines on that soon.”

Lowe argued that the public acceptance issues were largely associated with the “aesthetics and environmental impacts” of wind turbines rather than the costs. This was not an area for the EU to act, although there was a body of EU legislation on the procedures for assessment of environmental impact. “This is an area where it is not for Europe to decide whether or not there should be wind turbines in a particular place. That is something for local discussion and also for the companies themselves to make the investments in a way which is tolerable and sustainable and where they can point out the advantages, for example to local communities and to individual farmers.” He went on: “This sort of energy mix question has to be debated at a local and regional level and cannot be imposed by a European or national policy.”

Turning to the impact of the crisis in Ukraine and its effect on EU policies in the future, Philip Lowe pointed out that the situation in the gas market “is a lot better than it was in 2009 because since then there has been a lot of investment in interconnection and reverse flow of gas”. Previously most of the pipelines were sending gas only from east to west. That meant that if the situation in Ukraine continued “there were now reverse flow possibilities from Hungary, from Bulgaria and from Slovakia … Compared to 2009, the issue for Europe is therefore no longer one necessarily of interruptability but of price,” he added.

That price issue affects the European Union’s situation vis-à-vis Russia as a whole, he explained.

“If there was an attempt to restrict Russia’s exports of gas and coal into the European Union that would certainly be a double-edged sword for the European Union. Russia is one of our major sources of coal, it’s one of our major sources of oil and it is one of our major sources of gas.” If there was an interruption in the supply of Russian gas, there would be “two or three weeks of turmoil but then LNG would start to flow”. LNG is not competitive at the moment on price but in a crisis it could keep the supply of gas flowing. It would certainly be a major crisis but a crisis also with implications for Russia as well because of the interdependence that exists in energy between Russia and the European Union.

Philip Lowe went on to remind the seminar of the Nordstream pipeline, which runs from St Petersburg to the north coast of Germany: “At the moment this is only half used because of conditions imposed by the European Commission in 2009. They must give a certain percentage of that gas to competitors in the Czech Republic where they have a dominant position in the market.” Lowe explained that the Commission had “come to the view since that this was an excessively pernicious condition placed on Gazprom in 2009. Lifting that condition while allowing some competition into the Czech Republic would release an enormous amount of gas directly into Europe and not involve Ukraine, which has a very problematic relationship with Russia in the gas sector.”

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That raised another issue: whether Ukraine is a reliable transit country both for Russia and for the European Union. Lowe said: “The answer to that question up until the summer of last year was definitely no on both sides … because Ukraine was not prepared to put in place the legislation and the regulations which could guarantee investors that if they put money into the infrastructure in Ukraine they would get the necessary returns out of it. That has been a major stumbling block that has prevented the European Union making an offer to Ukraine on the financial side, particularly for its gas infrastructures, before the end of last year, and it has contributed in itself to the situation of turmoil which exits now.”

Asked about the Azerbaijan-South East Europe pipeline and its progress amid claims that it had been delayed by political problems, Philip Lowe told the seminar that he thought the Southern Corridor pipeline was one of the EU’s successes because it had “pushed through to a first investment decision of the major companies concerned at the end of last year”. He acknowledged that the agreement was for less gas than previously expected (10 billion cubic metres [BCM] a year and not 30 billion as originally planned), but this was “Azeri gas, without Russian influence, coming directly into Europe”.

Lowe accepted that there had been “political obstacles against an agreement”, but there was also “a lot of commercial uncertainty inside the European Union because a number of the companies said ‘well, as long as the gas market remains stagnant we don’t see why we should go to 30 BCM’. Whereas we were saying, if you go to 30 BCM, yes, there will be lower returns in the short term but in the longer term you will build up a big market in the Balkans and in Bulgaria and Romania and other countries who are relying entirely on Russia at the moment. Russia in the meantime has stepped up the advocacy for the so-called South Stream project precisely to discourage the Southern Corridor project from expanding from 10 BCM to 30 BCM. But I think that things are going in the right direction because at least a first commercial investment decision has been taken.”

In his final comments Lord Kerr said: “I think Philip Lowe demonstrates convincingly that it’s not the Commission’s fault that we are in this mess in Europe. I think it is the member states’ fault. I think he is also correct that it would be unrealistic to expect in the current state of the development of Europe that the member states will decide to transfer to the centre the power to decide on national energy mix. I described the convention in 2002/03 when the huge majority of member states said ‘no, we are not going to cede that power to the centre’, and I don’t think that has changed. Philip is quite right to say, ‘don’t blame us for the windmill you don’t like, for the turbine you don’t like on your local hill, it is nothing to do with the Commission’; these decisions are local decisions and I think at this stage they should be local.

“My only disappointment with what Philip said was that he didn’t react to my amazingly farsighted proposal for global emissions trading banks, an IBRD for carbon. I think we need another Bretton Woods – this time Keynes will be played by John Drew. The Keynes trick was to persuade the United States, to persuade Congress, that it would make sense to transfer quite large sums of money to developing countries. If that had been done through the US Budget, if Congress had been invited to vote that money, year by year, it would have been completely

impossible, even in the period of great men like George Marshall. The trick was to say that there has to be an institution, sited in downtown DC and run by an American: it worked, and enormous amounts of American money are recycled through the World Bank and do a great deal of good in developing countries.

“Now if we are going to get real global action against global warming we shall have to transfer quite a lot of money [to countries] who say, ‘our per capita emissions are very low compared to yours, we are still having our industrial revolution, mind your own business.’ They are going to have to be bribed, and one is not going to get that money out of Congress and the US Treasury unless one is very clever, like the heroes of Bretton Woods. My advice to this university is to run with the idea of a global emissions trading system run by a global institution; it may well have to be run by an American, but there will be a statue of John Drew in the courtyard.”

Background Paper The energy challenges facing Europe: What can the EU do?

Written by the Senior European Experts Group

Introduction Over the last five years there has been a developing awareness that a large number of challenges to energy policy are emerging around the world but particularly in Europe.

Increased demand in emerging markets, the emergence of shale exploitation, shorttermism, a failure to invest in some Western countries and an over-dependence on fossil fuels, which damage the environment and are often found in unstable regions of the world, have combined to produce critical choices in energy policy in Europe to which neither its individual member states nor the EU as a whole have yet found convincing responses.

What can the EU, with its limited competence in this field, contribute to solving these problems? Amid all the doom-laden talk of the lights going out across Europe, its obligations to reduce greenhouse gas emissions and third-country blackmail of EU member states over their energy supplies in the future, is there not an economic opportunity here? Troubled by high unemployment and low growth, surely the huge investment that Europe’s energy infrastructure needs is an opportunity as well as a problem?

The Institute for Contemporary Europe Studies at Regent’s University London and the Senior European Experts group felt that the spring of 2014 was the right moment to debate these issues as policymakers in member states and in the EU institutions grapple with the question of what they and the EU can do to address these problems.

Background Rising Demand A combination of factors has created a potential crisis in energy: one of the most important has been the doubling of global demand for energy in thirty years – and demand is still rising.1 US government forecasts suggest a 56 per cent increase in world energy consumption between 2010 and 2040 and that 85 per cent of that rising demand will occur in developing nations outside the OECD (including China and India).2 As the world’s population continues to rise – the point at which it will peak is Cited in speech by Secretary of State for Energy & Climate Change: https://www.gov.uk/government/speeches/the-myths-and-realities-of-shale-gas-exploration 2 US government forecast: http://www.eia.gov/forecasts/ieo/world.cfm 1

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disputed but analysts broadly agree that it will rise from today’s 7.2 billion to at least 8 billion by 21003 – demand for energy will also grow as the world’s most populous countries also experience high levels of economic growth. Experts disagree as to whether energy consumption in Europe will grow or fall over the next thirty years; US experts suggest it will grow by half of one per cent from 20102040, but a recent study published by BP suggested a fall of 6 per cent by 2035.4 Supply There are many uncertainties in terms of the supply of energy in Europe, not least because of the exploitation of shale oil and gas in the USA (see below). The supply situation is changing as the stocks of North Sea oil and gas run down and nuclear power stations go offline because of their age or because of policy change, and there is uncertainty in the global oil market.

The emergence of a rapidly expanding shale oil and gas industry in the USA providing abundant supplies of cheaper energy to one of the EU’s main industrial competitors has introduced a new element into all energy market calculations, which has not yet been fully appreciated or factored in. The shale gas “revolution” in the USA has had two main impacts for Europe: (a) it has depressed global coal prices5

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this has led to an increase in coal-fired electricity generation across Europe, in conflict with decarbonisation goals (and at a time when the EU Emissions Trading System is failing to mitigate that effect, see below)

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it is damaging European coal production, which cannot compete with production abroad at the new, lower, prices;

(b) the geographically isolated nature of the US gas market means that it has led to a significant fall in energy prices in the USA

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this is making the USA a far more competitive environment for energy-intensive industries, so much so that disparities in labour costs between the USA and less developed countries are far less significant than they have been in determining where manufacturing takes place

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in addition, it has increased the level of security of fuel supplies in the USA, although it is difficult to place a value on that factor.

Taken together, these US developments have multiple effects on Europe because they run UN forecast cited in New York Times, 20.09.13: http://www.nytimes.com/interactive/2013/09/20/business/World-Population-Could-Peak-by-2055.html?_r=0 4 Figure is for OECD countries in Europe; table from US Energy Information Administration [note 2]; BP Outlook to 2035: European Union, http://www.bp.com/en/global/corporate/about-bp/energy-economics/energy-outlook/country-and-regional-insights/ european-union.html 5 See, for example: http://www.cnbc.com/id/101152985 3

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counter to EU objectives on climate change and economic growth and may make the USA less sensitive to security of supply issues at a global level.6 Decarbonisation, Energy Insecurity and Competitiveness For the member states of the European Union, there are three particular challenges that need to be addressed together: decarbonisation, energy security and competitiveness.

The progressive decarbonisation of electricity generation in the EU is the main objective of the carbon emissions reductions targets adopted by the EU as part of its policies to tackle climate change (see below). EU countries are gradually phasing out coal-fired power stations because they are high producers of CO2 and using renewables that emit lower levels, such as nuclear, gas or biomass, instead (notwithstanding the current surge in coal use noted above). The UK, for example, generated about 32 per cent of its electricity using coal in 2009; by 2020 that figure will have fallen to 22 per cent despite the closure of some nuclear power plants.7 The EU has sought to reduce carbon emissions partly through creating a market in which producers of large amounts of carbon dioxide would have to pay for permits to emit this CO2.

These permits can be traded, so that those who produce large amounts of CO2 can buy the necessary permission and those who have reduced their emissions can sell their permits. But the system has been flawed from the beginning because of the excessive number of permits issued when the emissions trading scheme (ETS) was launched and because the price of carbon in the ETS was already too low and has fallen dramatically.8 The EU ETS is part of a growing trend across the world to place a price on carbon emissions that began in Europe but has now spread to the USA and Canada and to Australia. There are now plans for a national emissions trading scheme in China from 2015.9 This developing trend has important implications for future energy policy in the EU and beyond.

The second big challenge facing the EU and its member states is energy insecurity because they are over-dependent on imported energy (both oil and gas), much of which comes from the unstable Middle East and from Russia. The EU is the largest importer of natural gas in the world and Germany is the largest importer of natural gas in the EU (39 per cent of which came from Russia in 2010).10 Although EU dependence on Russia for natural gas has declined (from 45.1 per cent in 2003 to 31.8 per cent in 2010), it still supplies the largest share,11 and the EU remains dependent on Russia for both oil and coal; Russia was the main supplier of both crude oil (34.5 per cent) and coal (27.1 per cent) in 2010.12 The impact on European policy of cheap coal was discussed in The Economist: http://www.economist.com/news/ briefing/21569039-europes-energy-policy-delivers-worst-all-possible-worlds-unwelcome-renaissance 7 Cited by Cornelia Meyer in ‘Energy & Europe’ in The UK & Europe: Costs, benefits, Options, Institute of Contemporary European Studies Occasional Paper 12, p.16, Regent’s University, 2013.

8 Discussed in ‘EU Carbon price crashes to record low’, The Guardian 24.01.13: http://www.theguardian.com/ environment/2013/jan/24/eu-carbon-price-crash-record-low 9 http://files.eesi.org/FactSheet_Carbon_Pricing_101712.pdf 10 Figures from Energy Delta Institute, www.energydelta.org 11 http://epp.eurostat.ec.europa.eu/statistics_explained/index.php/Energy_production_and_imports 12 Ibid.

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In meeting all these challenges there are significant questions of affordability and capacity because of the scale of the investment required and a need for public sector intervention because the market cannot handle these questions on its own. Political instability in the Middle East, for example, cannot be resolved by the market, and the long timescales needed for energy infrastructure investment to produce a return make it difficult for ordinary market mechanisms to operate effectively.

Member State Problems There are different energy policy problems in each member state. A few examples are:

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Germany, despite its high level of renewables, has high dependence on imported natural gas from Russia, as mentioned above, all of which must come by pipeline as Germany has no facilities to process LNG. Nuclear power is being phased out in Germany following a policy change after the Fukushima disaster. One consequence of this change in policy is an increase in coal consumption and imports with adverse effects on Germany’s carbon emissions.

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Britain is no longer a net exporter of fossil fuels but a net importer as production falls in the North Sea (and a vote for independence by Scotland in September 2014 would affect this). The UK imported in 2012, for example, 41 per cent of its natural gas (mostly from Norway), 21 per cent of its oil and 61 per cent of its coal (the largest share of the last came from Russia). With 45 per cent of the UK’s electricity generated from gas, this is a significant change and one that leaves the UK more exposed to interruptions in supply or fluctuations in price than in the past.13 The absence of a coherent British energy policy for thirty years, as nuclear plants are reaching the end of their operating lives just when decarbonisation means a run-down of coal-powered generation and at a time when the population and the number of households are growing, has created potential crisis conditions in the period ahead.

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France, by contrast, faces no difficulties in electricity generation as 75 per cent of its electricity comes from nuclear power. However, it is dependent on imports for oil and gas as it has little natural gas production and has prohibited shale gas exploration.14

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The Central and Eastern European (CEE) member states have a different set of problems, remaining heavily dependent on imports of gas (some totally) from Russia. The Baltic States are not connected to the Western European power grid, so cannot import (or indeed export) electricity. There is still extensive use of coal in some CEE countries; for example in Poland coal represented 55 per cent of primary energy consumption in 2012.15

Meyer op cit, p.16. http://www.eia.gov/countries/country-data.cfm?fips=FR 15 http://www.eia.gov/countries/country-data.cfm?fips=PL 13 14

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A common thread running through member states’ energy policy problems is the difficulty of making the kind of long-term, strategic decisions energy policy needs within far shorter political cycles and the inadequacy of any solutions based on a narrow, national set of policies.

The global financial crisis exacerbated this problem by making raising the necessary finance for infrastructure more difficult.

The Role of the EU EU Competence The EU has only had limited competence in the field of energy, primarily relating to the use of state aids and other competition questions. Until the 2009 Treaty of Lisbon there was no specific treaty article referring to energy. The Lisbon Treaty inserted Article 194 into the Treaty on the Functioning of the European Union (TFEU; formerly known as the Treaty of Rome). The article reads:

In the context of the establishment and functioning of the internal market and with regard for the need to preserve and improve the environment, Union policy on energy shall aim, in a spirit of solidarity between Member States, to: (a) ensure the functioning of the energy market; (b) ensure security of energy supply in the Union; (c) promote energy efficiency and energy saving and the development of new and renewable forms of energy; and (d) promote the interconnection of energy networks.

Any legislation to achieve these aims is agreed in the ordinary legislative process (i.e. by qualified majority voting in the Council and by agreement with the Parliament). But there is an important safeguard in subsection 2:

Such measures shall not affect a Member State’s right to determine the conditions for exploiting its energy resources, its choice between different energy sources and the general structure of its energy supply, without prejudice to Article 192(2)(c).

As is set out in the government’s recent Balance of Competences Review background paper, there is a question about whether the introduction of Article 194 amounts to a significant shift in EU law in theory but not necessarily in practice.16 The article gives the EU a new shared competence with member states in the field of energy policy, but the caveat in subsection 2 (included partly at the urging of the UK) limits what the EU can do.

https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/252456/Call_for_Evidence_-_Final.pdf pp.6-7.

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This limited EU competence raises questions about what role the EU can play in helping to resolve Europe’s energy challenges. The EU does have a prominent and important role in global climate change negotiations (covered by Article 191 of the TFEU) but it does not have the powers to follow through decisions on climate change agreed at EU level in terms of national energy policy, except as regards the share of energy production from renewable sources and energy efficiency on which the EU has legislated. It relies on member states working together.

But this does not always happen. For example, the decision by the German parliament to phase out nuclear power in Germany by 2022 after the Fukushima disaster in Japan (reversing a previous decision to extend it to 2038) was taken for domestic political reasons despite the implications this decision could have for other member states (Germany is likely to need to import electricity at certain times of the year to make up for the shortfall).17 This lack of competence is arguably also a problem for the EU in its external relationships, in particular with Russia. As the EU member states are collectively big purchasers of energy resources from third countries they have, potentially, considerable buying power. But as they deal with third-country suppliers individually and not collectively that has weakened their negotiating hand.

Competition The competition role of the Commission can be both positive and negative; it is a powerful tool for breaking up monopolies and for tackling abuses of state aid in a market where there are few competitors in most member states. However, such interventions could also threaten investment if the policy were enforced too rigidly without regard to the specific challenges of the energy sector.

Euratom There is some interaction with the European Atomic Energy Community Treaty (Euratom), the last of the original EU treaties from the 1950s, which was agreed in 1958 as part of efforts to promote civil nuclear co-operation between member states. It has a separate legal base from the rest of the EU but has the same member states and institutions. Today it is involved in the funding of nuclear energy, research into nuclear fusion, the pooling of knowledge in the sector and nuclear safety.

Current EU Energy Policy With the exception of competition issues, it is striking how recent the EU’s involvement in energy policy is; it was not until the informal European Council at Hampton Court in 2005 that the EU began to discuss having a comprehensive energy policy. Up to that time the focus was on two packages of market reforms designed to open up the gas and electricity sectors to competition.

Oil is not affected by EU single market legislation because of the global nature of the oil trade.

http://www.pik-potsdam.de/members/knopf/publications/Knopf_Germanys%20nuclear%20phase-out_EEEP.pdf

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The failure to adopt an EU energy policy in the 1970s and 1980s was primarily due to the reluctance of member states to share control of their own supplies of fossil fuels in the period of uncertainty after the 1973 Yom Kippur War and the later fall of the Shah of Iran in 1979. By 2005 the picture was changing as supplies of oil and gas in the North Sea ran down, the rigidity of the internal energy market was seen to be a brake on EU competitiveness and an enlarged EU contained many member states highly dependent on a single supplier of imported energy.

EU aspirations to play a leading role in the climate change debate, especially in the post-Kyoto regime, had inevitable implications for its approach to energy policy. The 2009 disconnection of gas supplies by the Russian state-owned company Gazprom to Ukraine, which (at the same time) severely affected several EU member states in Central and Eastern Europe, acted as a further stimulus to develop EU policy.18 Over the last eight years the EU has begun to develop a comprehensive energy policy. Current EU energy policy has several aspects to it:

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the reform of the single market in energy to stimulate greater competition, lower prices to the consumer and innovation; the 2009 third package of market reforms is designed to help the market develop; support for new infrastructure to help create a proper market, for example new electricity interconnectors, including adding the Baltic States to the existing grid by 2016, and pipelines to enable the import of gas from the Caucasus and to facilitate transport of gas between member states by routes avoiding Russia; emission reduction targets in the context of climate change (see below); carbon pricing and the ETS; renewable energy targets; promoting greater energy efficiency (see below) in order to reduce demand; action to protect the security of supply of gas, including establishing new links between member states and emergency planning to deal with future interruptions to supply.

In the aftermath of the global financial crisis the EU used the need for economic stimuli as an opportunity to invest in energy infrastructure. The fifty-nine EU-funded projects so far include forty-four that concern gas or electricity infrastructure, nine offshore wind generation projects and six that concern carbon capture and storage (the latter is designed to make future coalbased energy products less damaging to the environment).19 The area of policy where change is most likely to be visible in the near future is the development of the single market in energy as the measures in the 2009 package of reforms begin to bite. The intention of these measures was to “unbundle”, that is to separate energy See Balance of Competences paper, op cit, for a useful discussion of developments in EU energy policy. http://ec.europa.eu/energy/eepr/

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generation and supply from the ownership of energy transmission systems such as power grids and pipeline networks. This is controversial in some member states that have not yet liberalised their energy markets in the way the UK did in the 1990s, and also in relations with Russia, which has tried, unsuccessfully, to prevent the policy affecting Gazprom. The dominance of stateowned utilities remains a factor in some member states.

Climate Change and Emissions Reduction In 2007 the European Council agreed its climate change policies including the targets for reducing greenhouse gas emissions. The targets adopted are:

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a 20 per cent reduction in EU greenhouse gas emissions (compared to 1990 levels) in each member state by 2020; 20 per cent of all energy consumed in the EU to be from renewable sources by 2020, with a separate target set for each member state; and a non-binding target of a 20 per cent improvement in energy efficiency in each member state by 2020 compared to a 2007 baseline.20

These targets were ambitious and required major changes in policy in almost all member states to reach them. And some member states, including the UK, wanted to go further by setting a target for reducing greenhouse gas emissions of 50 per cent by 2030.21 In January 2014 the Commission published revised proposals based on setting a target of a 40 per cent reduction in greenhouse gas emissions by 2030 compared to 1990 levels. It suggested dropping country-specific renewable targets and instead adopting an EU-wide target of 27 per cent of energy to come from renewable sources by 2030.22 This met objections from the UK and other member states who have struggled to match the renewable energy performance of the best performers, largely because of the high cost of some renewable sources (such as offshore wind power) and public objections to onshore wind farms and solar farms. The Commission’s proposals require the consent of the Council and the Parliament before they can be agreed.

An earlier set of targets adopted by member states before the enlargement of 2004 under the UN’s Kyoto Protocol, to reduce emissions by 8 per cent by 2008-12, were met, but the more recent and more ambitious targets impose greater costs and are not being matched outside the EU. The difficulties in getting agreement on global emission reduction targets have led to a debate within the EU about whether the speed and scale of the EU’s targets make sense, not least because of the implications for industrial businesses and domestic consumers. The debate about the cost of energy for domestic consumers in the UK in the autumn of 2013 and the calls for the removal or reduction in some of the “green” levies on energy bills were examples http://ec.europa.eu/clima/policies/brief/eu/index_en.htm Ed Davey MP at the UN Climate Change talks, Warsaw, 20.11.13: http://www.reuters.com/article/2013/11/21/us-britain-eu-emissions-idUSBRE9AK14W20131121 22 http://europa.eu/rapid/press-release_IP-14-54_en.htm 20 21

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of how the costs of meeting the climate change targets can have substantial political impact.

However, most member states show no sign of wanting to retreat from previously agreed targets, although some may adjust their domestic policies in response to public concerns.

A key weapon in reaching the greenhouse gas targets is greater energy efficiency. Member states have adopted their own policies to increase energy efficiency, often involving insulation programmes for older homes. The EU is also playing its part, for example through tough requirements on the energy efficiency of new buildings, placing targets on member states via the Energy Efficiency Directive and through energy efficiency labelling of certain consumer goods such as “white goods” and TVs. Part of the EU’s approach to meeting the targets has been to look for innovative ways of better managing greenhouse gas emissions. EU funding supports several carbon capture and storage projects to ascertain whether this technology could be used to help achieve the targets. The low price of carbon in the ETS holds such innovation back, however, because of the lack of incentive for investors to support new technologies.

EU Policies Policies to address the energy challenges in Europe divide into several different categories including: renewable low-carbon energy sources; fossil fuels, including shale gas; and reforms of the energy market within the EU. Low-Carbon Energy Sources Nuclear: New reactors are under construction in Finland, France, Romania and Slovakia. New plants are planned in the UK (funding has been agreed for the first one) and in Spain, Poland and Bulgaria.

Outside the EU but still geographically in Europe, new nuclear plants are planned in Belarus, Russia and Turkey.23 The uprating of existing plants to add to their generating capacity is either underway or has recently been completed in Belgium, Finland, Germany and Sweden (and also Switzerland).24 While nuclear power has a significant part to play in alleviating energy shortages in Europe, the difficulties of managing nuclear waste and public opposition (stronger in some member states than others) are still significant obstacles to expansion of its use. In addition, the run-down of nuclear power in Germany by 2022 will to some extent offset gains from the expansion of nuclear elsewhere in Europe.

Expansion of renewable sources of energy has been a major area of development in the EU. Renewable energy production in the EU grew by 72.4 per cent between 2000 and 2010.25 The http://www.world-nuclear.org/info/Current-and-Future-Generation/Plans-For-New-Reactors-Worldwide/ Ibid.

25 Eurostat figures: http://epp.eurostat.ec.europa.eu/statistics_explained/index.php/Renewable_energy_statistics 23 24

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largest producer in the EU is Germany (19.6 per cent), but only two other member states have production in double figures (France and Sweden).26 The difficulties of renewables include their dependence on subsidies to make them viable, at least until they reach a scale where they are attractive to investors without a subsidy, and the intermittent nature of some renewable sources. The bulk of renewables in the EU are power generated from waste and biomass (76 per cent of renewables in the UK for example), but wind and solar power are subject to fluctuations so there has to be spare capacity in other generators to make up for this.

As with other “green” measures, the debate about the costs versus the benefits of renewables and about who should bear those costs is intensifying in several member states. In addition, the impact of some renewables (e.g. onshore wind power and biofuels) has led to claims that these forms of renewable energy in fact damage the environment.

Fossil Fuels The discovery and exploitation of shale oil and gas in the USA, as explained earlier, has had a transformational effect on its energy market and more widely. Shale gas production has increased by twelve times in the last decade and now accounts for 23 per cent of its gas supply; as a consequence, gas prices in the USA have halved in recent years.27 Europe’s largest nuclear generation company, EDF, has withdrawn from nuclear power projects in the USA because of the impact of shale gas on the market there.28 The developments in the USA have caused considerable interest in Europe, where there are also significant deposits of shale gas, but up to now its value has been hard to calculate and may well not be as great as some claim. There are significant environmental and other issues in extracting shale gas onshore that may limit its exploitation in Europe.29 The value of shale gas in Europe is probably as a bridge to cover the gap from current energy sources to a different mix in the medium term.

To improve their energy security the EU member states need long-distance pipelines to enable oil and gas to reach the EU and to enable gas transport between them. The recent agreement to bring Caspian gas to Europe via Georgia and Turkey, which the European Commission facilitated, is an important development. Such projects would reduce dependence on Russia, for example, for gas supplies, but pipelines are expensive to build and are medium to long term in terms of delivery timescale. Recent setbacks to the Nabucco West pipeline project over financial and other difficulties demonstrate the problems.30 Equally, investment in LNG terminals to bring in gas from, for example, Qatar and/or North Africa and potentially also the USA will be important for some member states. Improved interconnection within the EU can help to ensure shortages can be rapidly addressed and sharp price fluctuations can be avoided.

Ibid.

Impact of shale gas production on the market fundamentals and energy security of certain countries, Ekaterina Zelenovskaya, International Center for Climate Governance, 2012: http://www.iccgov.org/FilePagineStatiche/Files/Publications/Reflections/06_reflection_april_2012.pdf 28 http://www.ft.com/cms/s/0/d4ee1214-f8e8-11e2-a6ef-00144feabdc0.html 29 House of Commons briefing paper: Shale Gas & Fracking, SN/SC/6073, 10.09.13.

30 http://oilprice.com/Geopolitics/Europe/Romania-pulls-plug-on-Nabucco-pipeline.html 26 27

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Reforming the EU Energy Market The creation of an EU single market in energy has been frustrated by a legacy of national monopolies and other restrictions that prevent a level playing field being established. The need for more electricity and gas interconnectors between member states has accentuated this problem, not least because power is often generated some distance away from consumers (e.g. offshore wind).

The 2009 package of measures to complete the single market in energy by 2014 is now well advanced.31 If it is successful in rebalancing the market the benefits will include lower prices and an increase in the number of jobs as well as greater energy security. Member states will review progress on this aspect of energy policy at a meeting of the European Council in February 2014.

Conclusions The energy challenges facing Europe are complex and while EU action is relevant it may well not be decisive. As competence largely lies with member states it is they who must act first and foremost. Establishing an effective energy single market could make a big difference to the competitiveness of the sector and increase security of supply.

The situation is different to climate change where the EU can influence global policy because of its combined weight as the world’s largest economy. This is a powerful tool for member states collectively and they would not have the same influence as individual countries. This will be important in 2015 when a United Nations conference in Paris is due to reach decisions on the future of the process that began with the Kyoto Protocol.

The EU’s role in energy policy will continue to be shared with member states. Through judicious use of its limited competence it can help member states to develop a range of policy measures and ensure that they are not over-reliant on any one of them. If it could make its relationships with third-country energy producers more effective it could weaken the market power of those countries, thus helping member states to make their own policies more effective.

Senior European Experts January 2014

Discussed at the December 2013 Energy Council: http://www.consilium.europa.eu/uedocs/cm 31

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Department of Development & Alumni Relations Regent’s University London Inner Circle, Regent’s Park London NW1 4NS Regent’s University Lectures and Seminars T +44 (0)20 7487 7792 E lectures@regents.ac.uk