How could Europe overcome its energy infrastructure challenge in the era of uncertainties?

How could Europe overcome its energy infrastructure challenge in the era of uncertainties?

2012. 10. 16.

Energy infrastructure serves as a backbone of the European economy as it is a prerequisite to most of our goods and services. Therefore, maintaining a state-of-the-art energy infrastructure network – which ensures a secure, affordable and sustainable energy supply – is one of the top priorities of the European Union.

The infrastructure challenge

Between 1995 and 2005 investors comfortably invested into energy network development as energy infrastructure projects provided a fair rate of return associated with moderate risks. While energy consumption grew continuously, regulated tariffs ensured stable profitability. Furthermore, high upfront investments required by infrastructure projects could be easily financed by cheap financial resources available on the financial market. Consequently, infrastructure development was seen as a safe bet.

However, in the past couple of years, these comfortable and predictable market characteristics have disappeared. Several unprecedented events took place: oil prices skyrocketed, the financial markets collapsed, the Russian gas supply via Ukraine was cut off for weeks and the Fukushima disaster had to be faced. Taking into account the heavy pressure on state budgets, the lack of financial resources and the depressed energy demand, energy network development had become less and less attractive. The risk of not achieving a fair rate of return augmented significantly. Consequently, investors are hesitant on infrastructure development and they have postponed investment decisions waiting for the return of stability and prosperity.

Despite the current hesitation of investors, the upgrade of the European energy network cannot be postponed. The EU's energy infrastructure is ageing and it is not suited to match future energy demands in its present state. Several events during the last years demonstrated that the existing system provides an insufficient buffer, it cannot cope with significant changes in energy supply patterns.

In order to create a state-of-the-art energy infrastructure network by 2020 – which provides secure, affordable and sustainable energy supply – 200 billion EUR shall be invested into European energy grids according to the latest estimations of the European Commission. Consequently, investment volumes from 2011 up to 2020 shall be increased by 30% for natural gas and up to 100% for electricity compared to current levels. This investment challenge clearly distinguishes energy infrastructures from infrastructures in other sectors.

Flexibility as the key success factor in changing energy markets

Energy infrastructure projects are typically characterised by vast upfront investments and a 20-60 year operational lifetime. Thus, the structure of energy supply in 2050 – when the current economic crisis will only be a faint memory – is already determined from this point onwards, over the coming years. However, encouraging long-term energy network investments when short-term business environment is highly unpredictable is an even tougher nut to crack. Project promoters – who got used to constant growth and stability – cannot cope with the increased level of unpredictability. Therefore, the "wait and see" strategy prevails.

I am afraid that we are simply wasting our time if counting on the return of high growth and stable cash-flows. European decision-makers and investors shall be prepared to face unexpected challenges. Therefore, new strategies and innovative instruments shall be developed to encourage investments enabling a quick adaptation to the rapidly changing conditions. This will allow us to make the right decisions and speed up the upgrade of our energy network in spite of current uncertainties.

Taking into consideration the unprecedented events in the past couple of years, I firmly believe that flexibility will become the key success factor when it comes to the upgrade of our energy network. We should promote those investments which enhance the robustness of energy markets and provide our grid with sufficient flexibility to cope with unexpected events. Our future energy network should be able to handle prompt changes in our energy mix and deal with variable energy production coming from renewable sources. Additionally, it should provide sufficient safeguards against shocks in order to maintain security of energy supply.

There is no doubt that creating a trans-European energy infrastructure providing this flexibility is one of the biggest challenges which the Union will face in this decade. The unforeseen events in the past couple of years clearly demonstrated that flexibility and security will represent a significant value in future energy supply.

Diversified external energy supplies and routes

Taking into consideration the need for flexible energy networks, diversified external energy supplies and transit routes play a crucial role. A significant share of our constantly fluctuating energy demand shall be covered by external energy sources which are located several thousand kilometres from the EU’s borders. The high European import dependence is a problem which should be managed by adequate policy decisions as it is not wise to put all our eggs in one basket. In order to maintain security of energy supply and keep prices at an affordable level, a robust transit infrastructure – providing access to different supply sources and counterparts – is inevitable. Without this, our efforts in other areas are futile.

In spite of our well-defined diversification strategy, there are big differences between regions and member states. The Baltic-states for example, are completely dependent on one single natural gas source without any backup solution. In Central and Eastern Europe, 80% of the gas supply comes from Russia. Due to the lack of alternative supply, there is no real competition between different supply sources. Consequently, trade relations between consumer and supplier countries may easily become unbalanced.

Concerning the competition of different gas sources, LNG and the Southern gas corridor play a crucial role in achieving a balanced gas supply portfolio in Europe. The Southern gas corridor has the critical size to completely reshape Central-Eastern gas markets with low liquidity. Smaller LNG projects can provide enough flexibility to be able to cope with the fluctuation of supply and demand. New sources and counterparts could introduce real competition between different gas sources and enable Europe to benefit from its diversification strategy.

Of course a well-established import infrastructure network would not reach the hoped result without EU-level coordination in negotiations concerning supply from third countries. Currently, energy exporting countries take advantage of the lack of EU coordination by maintaining different contract terms in different member states. In order to represent our 500 million consumers effectively and to improve the negotiating power of the EU, it is important to improve exchange of information between member states, keep the Community perspective in mind and make it clear to our partners that the "divide et impera" strategy is not viable any more. We are a strong player in the global competition for energy resources when the EU makes decisions with one voice.

Creating a robust trans-European energy infrastructure

Further to the diversification endeavours, a second element of our energy strategy, the robust internal energy infrastructure, becomes crucial when the energy molecule reaches our borders. In order to increase the flexibility of the trans-European infrastructure network, a step-by-step approach should be followed.

As a first step, the implementation of existing legislation shall result in higher utilisation of existing assets. We should apply the "use-it-or-lose-it" principle as soon as possible. This enables us to avoid our infrastructure being underutilised due to a number of short-term and particular interests. I am convinced that we could save a lot of resources by avoiding the creation of overlapping infrastructures.

As a second step, we have to build the missing links of the network which are necessary to complete the internal market. Currently, several countries are facing low market liquidity and high prices due to the lack of sufficient interconnections. The significant price differences between national markets clearly show that we need stronger cross-border access and a more flexible network.

Trans-European infrastructure guidelines to boost investment

The January 2009 gas supply crisis was an important wake-up call for Europe. Despite the existence of a well-elaborated strategy, the two-week-long disruption of the Russian gas supply clearly demonstrated how rigid our energy markets are. It became obvious that we cannot stop at this stage; the crucial part of implementing the strategy is still ahead of us. Concrete actions and the acceleration of investment activities are inevitable to maintain a secure, affordable and sustainable energy supply.

In order to reduce the risks associated with energy infrastructure development and to make investments happen, new instruments and effective regional cooperation are indispensable. One of these instruments, the guidelines for trans-European infrastructure currently debated in the European Parliament aims at completing the missing links of the internal energy market and accelerating investments.

In its proposal, the Commission clearly defines the so-called "energy infrastructure priority corridors" where accelerated investments are needed to finalise the single energy market. In order to find the best value-added investments, "regional groups" will be entitled to propose projects with EU-level importance. The European Commission will select the "projects of common interests" (PCIs) based on a transparent selection process. Thanks to this special label – which allows for an accelerated permitting procedure and financial assistance from European Union funds – the risks associated with infrastructure development projects could be substantially decreased.

The concrete measures proposed by the European Commission provide appropriate answers to the infrastructure challenge of Europe by mitigating several types of risks associated with energy infrastructure development. A dedicated budget provided by the European Union will be distributed between a limited number of projects with common interests, resulting in a significantly lower capital expenditure of the selected investments. Additionally, the acceleration of the permitting procedure reduces the risk of delays in the phase of project execution. Furthermore, the establishment of regional groups will enhance regional cooperation by increasing the transparency and accountability of member states.

In spite of market uncertainties, the guidelines will encourage investors to invest into energy infrastructure development. They will benefit from a more predictable regulatory environment and from an effective regional coordination significantly reducing the risks associated with cross-border infrastructure development.

Danube Strategy: a successful regional cooperation

According to the proposed Guidelines, regional groups of member states play an outstanding role in the completion of the single energy market. However, taking into consideration the different market structures and divergent interests, will member states manage to define a joint regional position on infrastructure development? The answer is yes: there are already several pioneering initiatives.

The cooperation of member states in the Danube region is an operational example. These countries have learnt during the last 50 years that security of natural gas supply cannot be ensured by a central planning authority or by divergent national strategies. More coordination, joint efforts and concrete actions are needed to create the required flexibility of energy networks.

The similar market characteristics in the Danube region and the high level of vulnerability have historical reasons. During the Soviet COMECON era (Council for Mutual Economic Assistance), current gas transit pipelines from East to West – without any North-South interconnection – were built so that the exclusive supplier could only be Russia. Consequently, despite the catchy name of "COMECON" – which was about mutual economic assistance between member countries – it was highly unlikely that member states could establish any efficient form of bilateral energy cooperation.

The situation became even more challenging when the region's only gas supplier – the Soviet Union -, collapsed. In order to avoid a regional crisis, the aim of energy diplomacy was to maintain the existing gas supply obligations of Russia. The national energy strategies elaborated during those years – which consisted of many uncoordinated investments and individual regulatory frameworks – could not reduce the vulnerability of the region. The difficult economic situation, the high share of energy imports, the fragmented national markets and the rigid regional infrastructure network left no room for manoeuvring.

Finally, new perspectives have emerged by joining the European Union. Having recognised that these countries face similar challenges in their gas markets due to historical reasons, the Danube Strategy adopted in 2011 during the Hungarian EU Council Presidency offers an excellent platform for close cooperation in this field. The strategy provides a unique opportunity for the participating states to give a coordinated response to global challenges, which can only be solved through a cross-border approach. Providing a secure, sustainable and affordable energy supply is surely one of these challenges.

The European Union Strategy for the Danube Region and its Action Plan emphasizes that the interconnections between national markets have to be improved in order to diversify the region's gas supply. The Action Plan highlights that reinforcing the gas infrastructure network will be key for preventing supply disruption in the future. Furthermore, the Action Plan foresees the development of a joint position of the Danube region regarding natural gas PCIs within the framework of the new guidelines on trans-European infrastructure. Such a joint position could help the region to gain European support for projects with outstanding regional relevance.

The implementation of the strategy is in progress and one of the first results is the Danube Region Gas Market Model. This pioneering initiative coordinated by the Sustainable Energy Priority Area of the Strategy helps in quantifying the impact of new infrastructure projects and defining the Danube region's joint position in a structured way. The model provides an objective methodology on how to establish a priority order among the regional infrastructure development projects. Furthermore, it helps to understand the impact of new infrastructures on the flexibility of the regional gas infrastructure, prices and supply security.

Meeting our energy challenge: an opportunity to deepen European integration

The Guidelines on trans-European energy infrastructure and the Danube Region Gas Market Model are two working examples which prove Europe's capability to set the right directions and provide the necessary tools in order to meet the infrastructure challenge. Many stakeholders already realised that the challenge Europe is facing also means a huge opportunity to deepen European integration and act jointly on regional and European level. In order to ensure a secure and sustainable energy market with affordable prices, we will work on deepening the integration of the currently fragmented European markets and fostering the realisation of the single energy market. At the same time, we should resist the urge to follow particular and short-term interests. This is the only way that we can guarantee Europe’s long-term competitiveness in a constantly changing world and enable our citizens to capitalise on the opportunities provided by the European market. Therefore I wish Europe a lot of enthusiasm to overcome its energy challenge by building a flexible energy infrastructure network.