A recurrent theme in the EU security of supply debate is the need to diversify natural gas imports, and to reduce the EU’s dependence on a few large suppliers.
In 2008, the EU’s gas imports comprised some 65% of its total consumption, with over 80% of those imports originating from only three large sellers: around 40% from Russia, 28% from Norway, and about 17% from Algeria. The EU Commission, in its Second Strategic Energy Review, stresses the need for diversification and promises support for investment in infrastructure required to connect to new source countries.
Of course, high import shares in themselves do not necessarily warrant the conclusion that this dependence is excessive and detrimental, or that EU intervention is called for. One should motivate why individual Member States underprovide supply diversification – and why EU coordination would improve on this situation.
The Commission’s current public consultation, “Towards a new Energy Strategy for Europe 2011-2020”, suggests one such motivation. In this document, one of the issues is how the EU can use a coordinated external energy policy to ensure improved security of supply for its Member States. Such a policy could help to “leverage the EU’s buying power”. Indeed, Russia, Algeria or Norway undoubtedly enjoy market power, but the large EU buyers are not mere price takers, they possess countervailing buyer power of their own.
In a recent paper, we analyse how a joint European policy towards diversification can contribute to strengthening the individual Member States’ bargaining positions in their negotiations with external gas sellers – beyond what these Member States could achieve in the absence of coordination.
It is intuitive that diversification of suppliers will help individual buyers in improving their own bargaining positions. When a buyer has more potential suppliers to turn to, his negotiating position is evidently stronger. Yet, this individual benefit from supply diversification alone does not provide a justification for coordination among Member States.
To see why individual Member States may underprovide supply diversification from the joint EU point of view, we identify spill-over effects from the gas purchasing decisions of the Member States. We show that these spill-over effects may call for coordination to
i) reduce import dependence on specific suppliers, and
ii) increase dependence on others,
as compared to the level of dependency that importing countries would have without such coordination.
To illustrate the idea, consider a policy in which the EU would impose restrictions on Member States’ gas purchases from certain external suppliers. A limit on, for example, Germany’s imports from Russia will not be profitable for Germany (but rather weaken its bargaining strength in its relations with other suppliers, such as Norway). But such a policy will also weaken Russia’s bargaining position. As a result, the other Member States may benefit from such a measure. Thus, Italy, in its negotiations with Russia, will face a negotiator who knows that its outside option – selling gas to Germany – is not that valuable due to the cap on its exports. This positive spill-over effect on other Member States may in fact outweigh the negative effect on Germany.
Of course, in this particular example, Germany would lose from the policy measure, and such a policy would not be easily accepted without any form of compensation. However, we show that one can often find combinations of caps (e.g., simultaneous import restrictions for Germany, Italy, and France) that make every individual buyer better off.
Hence, this spill-over argument provides a justification for coordination towards restricting imports for individual importers. Indeed, such a policy of capping imports from particular suppliers is not unprecedented. Spain’s Hydrocarbons Sector Law, introduced in 1998, obliges gas marketers to limit their imports from any single country to 60% of their total portfolio. This has had the effect of limiting Spain’s reliance on Algerian gas imports. Our analysis gives support for a similar measure on the EU level.
Crucially, import restrictions should be defined at the individual Member State level, and not at the aggregate EU level – at least if the aim is to increase the countervailing power. We show that an aggregate import cap never improves EU buyer power. The limitations imposed on one producer will make the other sellers stronger, redistributing power among sellers rather than benefiting buyers. In contrast, restrictions on bilateral trade of individual member states with individual producers can have a positive effect both on the individual buyers’ bargaining power and on the buyers’ trade surpluses. On a practical level, such a measure might be applied in terms of limits on pipeline capacity between producing regions and the different buyers.
The second policy to encourage supply diversification focuses on increasing imports from new suppliers. Here the EU has been particularly active – witness the recent 200 million Euro support of the Nabucco pipeline project, under the Economic Recovery Package. Clearly, the importers who contract with new exporters benefit from the expansion of opportunities to purchase gas. However, those buyers who are not engaged with the new suppliers will also benefit. They will find themselves in a better bargaining position vis-à-vis the “old” suppliers. To see this, consider the example of Italy investing in a pipeline to buy gas from a new supplier. Russia’s potential gains from trading with Italy will decrease if Italy can buy gas from elsewhere. As a consequence, other buyers (such as Germany) also enjoy increased bargaining power when negotiating with Russia: the latter’s outside option of selling gas to Italy has become less valuable. This bargaining-power effect warrants buyers’ cooperation in increasing import capacities beyond the individually preferred level.
To conclude, considerations of buyer power can provide a rationale for EU policies aiming at increased supply diversification. It is useful to analyse the precise mechanisms through which diversification reinforces buyer power. Such an analysis provides guidance in devising effective diversification policies. For example, broad-brushed restrictions on aggregate imports from Russia are ineffective as a tool to increase buyer power; restrictions on imports by specific buyers can do a better job.
Svetlana Ikonnikova, University of Texas at Austin, and Gijsbert Zwart, TILEC, Tilburg University and CPB, Netherlands Bureau for Economic Policy Analysis
P.S. For a more comprehensive analysis of the gas bargaining game, see our working paper.