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Is Europe shooting itself in the foot (to the benefit of Russia)?

July 6th, 2010 by Pierre Noël, University of Cambridge

The logic behind the question in the title is straightforward. Iran is a country with very large reserves of natural gas, a lot of it relatively low-cost. With the right investment it could become an exporter of global significance in about a decade. Europe is one of the largest gas markets in the world. Its combination of liberalised electricity markets and ambitious environmental policies favour gas in power generation, at least in the mid-term. Russia’s position in the European gas market raises concerns of market power and politicisation. The EU supports new gas pipeline projects from Central Asia and the Middle East through Turkey and the availability of Iranian gas could be essential to the success of this diversification strategy. Russia, on the other hand, should want to prevent or delay the emergence of Iran as a large gas exporter.

However, there are a number of uncertainties which, taken together, significantly weaken the above reasoning to the point of questioning its practical validity.

At the moment we do not know to what extent the latest EU sanctions will add to the difficulties experienced by the Iranian oil and gas industry to source technology and finance. Those difficulties are known to be considerable already. There is a lot of oil and gas activity going on in Iran (more on this later) but large scale gas export projects combining complex financing and cutting edge engineering are already impossible to do. This is certainly the case for LNG projects where the technology is still largely controlled by western companies; it is unclear to what extent big pipeline export projects could be carried on.

More fundamentally, it is far from certain that becoming a large gas exporter is a strategic priority for Iran, or even a clearly defined objective. Iran has been seen as a potential large gas exporter for decades, but it never materialised (Iran imports roughly 5bcm/y from Turkmenistan and exports the same amount to Turkey). The small export contract with Turkey is notoriously unstable and has led to numerous rows over price and delivery. European majors such as Total and Shell have had a terrible experience negotiating with Iran over their LNG projects there (and, by the way, their oil projects in the 1990s as well); when the European companies withdrew three years ago because of the sanctions, they were not in a position to make a final investment decision. Becoming a large gas exporter would require a strategic decision by Iran, based on a wide political consensus – such as the one underpinning the Iranian nuclear programme – to open the sector for real to foreign investors. There is deep opposition to such a move in the Iranian political culture and the culture of its oil and gas bureaucracy, rooted in the memories of the US-sponsored coup of 1953 following the nationalisation of the British oil concessions by the nationalist government of Mosaddegh. If becoming a large gas exporter was a strategic objective for Iran, then the Iranian government would appear hopelessly incompetent at pursuing it. But geology is not destiny; Iran may not want to be the next Qatar.

Furthermore, Iran is itself a large and fast-growing gas market, now 30% larger than the largest European markets, the UK and Germany (see chart). The country needs to continue developing some of its reserves to supply the domestic market; that is what the Iranian exploration and production activity has been about for now and, I would suggest, will continue to be mainly about. The existing sanctions have been effective at killing the LNG export projects (which might not have gone ahead without sanctions anyway) but there is no indication of any impact on gas production growth in Iran. I don’t know to what extent the Iranian industry’s exploration and production effort rely on European technology and services that would be made unavailable by the EU sanctions, and not replaceable by technology and services from Asian or South American companies.

Data source: BP statistical review of world energy

It does not mean that Iran has no strategic energy policy, though. In the context of the stand-off with the “international community” over its nuclear programme, Iran is obviously trying to use the attractiveness of its energy resources and geographical position to its political benefit. The growing interest of Chinese oil and gas companies for Iran has been widely documented – it has not led to any gas export project though. Turkey’s ambition to increase its access to Turkmen gas via Iran has already been discussed on TheRaceForIran.com. Given how strategic Turkmen gas (and the trans-Caspian pipeline) is to Europe’s Nabucco concept (more on it later), Iran has the option to provide Turkey with both access to gas and leverage on Europe. The Iran-Pakistan pipeline project, for which the Pakistani government has just reaffirmed its support, is another example where Iran uses its energy assets strategically to raise the cost of the US-EU Iranian policy.

The final point is about Europe’s plans for a large pipeline across Turkey that would bring gas from Central Asia and the Middle East to the EU, especially south-east and central Europe. The noise around the “Nabucco” project, as it is known, is inversely proportional to its commercial and political credibility. The idea of a multi-billion ‘merchant’ pipeline being built across Turkey in the hope that exporters would then use it to ship gas to Europe is so unrealistic that it should never have been taken seriously outside Brussels. From high-level conferences to political agreements via feasibility studies, the project is still what it was 10 years ago: an unrealistic concept. Nabucco is a typical Brussels project with very little real political support from member states outside central Europe. It certainly is not the cornerstone of a European external energy policy – something which does not exist and that Europe does not need. European gas supply has been diversifying for four decades and the trend is accelerating sharply; the EU does not need a diversification strategy (though it badly needs an effective gas market, a real job for Brussels). It is true that Brussels energy bureaucrats have long had dreams of importing Iranian gas by pipeline but they are just dreams; one cannot conclude from this that European leaders are frustrating Europe’s energy security interests by further isolating Iran.

The bottom line is that European countries have very little to lose materially from being tough on Iran. The idea that Iran would save Europe from Russia’s gas grip if only we could do business with the Islamic Republic is factually wrong, and the issues around Russian gas are not perceived that way in most of Europe anyway. European energy companies and key EU member states are actually busy helping Russia bypass Ukraine rather than scrambling to sign contracts east of Turkey. The first element of an explanation to why Europe is going tougher and tougher on Iran – on top of the fact that there is genuine and widely shared concern in Europe about the future of nuclear non-proliferation – is that those sanctions do not have any significant material cost.

But there is more. Europe has a lot to gain politically from being ahead of the pack on sanctioning Iran. First, it allows European countries to show complete solidarity with the US on the top item on Obama’s foreign policy agenda, at a time when Europe is marginalised in US foreign policy and criticised by the Obama administration for not doing enough in Afghanistan. Furthermore, it helps Europe balance its increasingly critical attitude towards Israel. Finally, one should keep the wider context in mind: for a Europe that is battling economic dislocation internally and political irrelevance externally, any issue that allows EU member states to present a united front and make Europe exist on the world stage looks like a gift from heaven. The Iranian nuclear issue is exactly that – at least as long as there is no real risk of a military confrontation.

Pierre Noël, University of Cambridge (EPRG) and European Council on Foreign Relations (ECFR)

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2 Responses to “Is Europe shooting itself in the foot (to the benefit of Russia)?”

  1. Nick Grealy Says:

    What gas grip is it exactly that Europe is in? The new reality of world gas abundant everywhere, makes worrying about Russian, or Iranian gas rather old fashioned.

  2. Paul Hunt Says:

    This is an interesting, provocative and largely persuasive post. Quite apart from the geopolitical aspects, some interesting economic issues – an uncertainties – arise. While accepting that the recession-induced reduction in demand, a ramp-up of unconventional supplies in the US and and an increase in gas liquefaction and importation capacity have contributed to a supply overhang – particularly in the Atlantic basin – there is a question about how long this will persist – and to what extent it will have a lasting impact. Unconventional gas supplies may take some time to emerge in Europe and may need prices much higher than the current marginal cost of EU supply to prompt the required effort and investment. Gazprom may struggle to retain the oil price linkage in its EU supply contracts, but it is unlikely to give up without a protracted battle. The unwillingness of the EU’s TSOs to invest in interconnection across internal borders (without public subsidy) and the relatively limited extent and co-ordination of existing infrastructure is impeding the emergence of a genuinely competitive, EU-wide, wholesale market. It appears that dual-pricing (mainly oil-linked pricing in the existing long term contracts and spot market pricing) may co-exist for some time.

    And as for Iran, it seems happy to forgo western technology and investment (and the exports and revenue these could generate) and to leave substantial reserves under-exploited while relying, mainly, on its own resources to supply a highly-subsidised domestic market.

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