European Affairs

What is this idea of “a European energy industry?” That is a myth: it does not exist. When it comes to natural gas, countries such as Norway, the UK and Denmark are essentially self-sufficient or they are exporters. Countries like Spain and Italy are supplied primarily from the Mediterranean. The French rely very little on natural gas. The Germans use a lot of natural gas, but they get it from Norway and Russia. Then you have countries that are really stuck (as the latest crisis showed): eastern European countries such as the Czech Republic, Bulgaria and others. One of the problems you see when you look at a map is a relic of the Cold War: in the European pipeline grid, all the pipelines running west from Russia go up to the old Iron Curtain – basically to bring Russian gas to their former satellites. If you look at the gas grid west of the Iron Curtain, it goes north and south and east and west. So it gives much, much more flexibility to these countries.

A lot of the crises that have taken place are a function of the fact that there is no Europe-wide market. There is a complete failure of leadership by politicians and, frankly, by Brussels to create an efficient continental market. Instead, the market is Balkanized: natural gas in places like Germany is amongst the most expensive in the world and, frankly, big utilities such as E.ON and RWE like it that way and are going to do everything they can to keep it so. They are very, very powerful.

This lack of investment and infrastructure, as well as a lack of deregulation has caused a lot of these problems. Another example: Italy did not have a problem in the last couple of weeks. Why? They had storage – which is a related issue. Storage costs money, and the economics of storage are a function of regulation. And it takes investment. I realize it is a pesky detail, but if you do not want to make the investment, that means you do not want to have a flexible system, and then you have no right to complain. Alongside the question of European gas regulation, which makes Europe more vulnerable to Russian manipulation of supply, there is a serious question about the condition of Russian oil and gas industry. Prime Minister Putin likes to stride around the globe saying that they are an energy superpower. It is nonsense. The Russians have an economy that is dependent on oil and gas. Their production is declining. Their infrastructure is in shambles. The capital structure, which they have worked on over the last five years helped the Russian government avoid debt but has left the big Russian companies such as Gazprom heavily in debt – largely to German banks. One of the basic aspects of the oil and gas business is it requires constant and massive reinvestment. A lot of money is generated by the oil business and gas business, but you must keep putting it back in, and the Russians have failed to do that in both oil and gas. In order to ensure that Putin’s government has large financial reserves, the oil and gas businesses essentially have just been harvesting the low-hanging fruit and not been making the kind of investments they really need to make. One of the challenges for Europe is the serious problem about the outlook for long-term supply from Russia. The resources are there, but the investment and infrastructure is not. Efficient markets and regulation do not exist in Russia. I don’t think that Putin really understands investment and capital markets.

I’m also very skeptical about the notion that gas will be flowing from the Caspian to Europe any time soon. The Nabucco pipeline is another issue challenged by small details: I do not know where the gas is going to come from to supply Nabucco. Even building it faces big problems with obtaining the rights of way. Turkey, which is very important to Nabucco, is not very enthusiastic about the project now and is trying to use it as a lever in its membership negotiations with the European Union. Some policy makers in Washington believe they can squeeze the Russians and reduce Russian leverage in Europe by new delivery schemes, but I do not think they are very practical so I do not think anything is going to happen any time soon. In the U.S. energy industry there are these broad brushstrokes in Washington. But significant changes take massive investment and very long lead times.

Take ethanol for example. We have been through our first generation ethanol, and the proponents of corn-based ethanol say we are going to be producing seven billion gallons of ethanol a year. They are kind of saying “that sounds like a lot.” In the oil business, we talk about “barrels per day” and not “gallons per year.” So you divide the gallons per year total by 42 (gallons in a barrel) and 365, and the result is a lot smaller number. Then people talk about second and third generation ethanol. Great, but I just do not know what it is. And to base an economy on technology which does not exist, I just do not understand. And then there is this question of scale. To replace hydrocarbons requires enormous volumes and, if you are going to go to switch grass or algae or whatever, the amount of algae or switch grass or whatever you are going to have to process to be able to generate five million barrels a day is a staggering quantity. So a) there is going to be long lead times; b) the economics is very unclear and c) there is the question of scale. Just how do you get it big enough?

People talk about carbon capture and sequestration as the silver bullet to the whole issue of carbon. Well, I know that there are some demonstration projects in Germany with Shell, in France with Total and in Algeria with BP. But these are demonstration projects and they are very small. In North America, if you could figure out a way to capture the carbon, to move the carbon would require infrastructure larger than the existing North American natural gas grid. Again, we are talking about scale and a level of investments which are just staggering.

Some have called for solidarity about energy, noting that it played such an important part in the founding of Europe. I could not agree more of the need for solidarity, but I think there has been a lack of solidarity and of will. Europe has allowed Russia to play it like a fine-tuned instrument because of the refusal by Europe to deregulate its own internal energy market, the refusal to look at the interest of the whole – the common good – rather than just certain people who want to harvest the maximum return from certain markets. So I think there is a long way to go. In seeking new ways to obtain natural gas, the low-hanging fruit may be efficiency. If one is concerned about Russian supply, the area of energy efficiency in Russia provides a huge opportunity. In Moscow, many buildings don’t have thermostats: so when the room gets a little toasty in the Russian winter, you open the window. There are lots of opportunities and I think for the Europeans, if the Russians will let them, this is actually an enormous potential business.

J. Robinson West is Chairman of the Board, Founder and CEO of PFC Energy. This article is derived from remarks made at The European Institute’s February 2009 roundtable on energy security and Russia

This article was published in European Affairs: Volume number 10, Issue number 1-2 in the Winter/Spring of 2009.