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Energy Security, Trade and the EU

Regional and International Perspectives

Rafael Leal-Arcas, Costantino Grasso and Juan Alemany Ríos

Energy security is a burning issue in a world where 1.4 billion people still have no access to electricity. This book is about finding solutions for energy security through the international trading system. Focusing mainly on the European Union as a case study, this holistic and comprehensive analysis of the existing legal and geopolitical instruments strives to identify the shortcomings of the international and EU energy trade governance systems, concluding with the notion of a European Energy Union and what the EU is politically prepared to accept as part of its unified energy security.
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Chapter 4: Unconventional fossil fuel sources and EU energy security

Rafael Leal-Arcas, Costantino Grasso and Juan Alemany Ríos

Energy Security, Trade and the EU

I.  INTRODUCTION

This chapter examines the system of law and governance of of Longmont in Coloradointernational trade in unconventional fossil fuels.1 Recent developments in extracting energy from unconventional fossil fuels will have consequences for the governance of global energy trade and European energy security. When it comes to trading energy, there is a clear difference between oil and gas, in that oil can be easily transported, whereas gas needs to be liquefied or transported through pipelines and, consequently, the technological and political challenges are greater for gas than they are for oil. The chapter’s main argument is that shale gas and shale oil will revolutionize world energy politics and economics. Irrespective of whether environmentally acceptable extraction technologies and political consensus for the extraction of unconventional fossil fuel sources in Europe can be found, the EU will not be able to avoid its impacts on global energy markets and will have to adapt EU internal and external energy policies accordingly. Since the entry into force of the Lisbon Treaty, the EU’s internal and external governance framework has evolved; however, EU energy policy is only partially ready for the unconventional energy revolution. The EU has taken remarkable steps towards addressing its Member States’ energy security in a more cohesive manner, although issues do exist in terms of the distinct energy interests of EU Member States that undermine cohesive EU action.

After this introduction, Section II explains the current development of unconventional sources of fossil fuel and how it may geopolitically impact the EU. Section III concludes the chapter and provides some policy recommendations.

II.  REVOLUTION OF UNCONVENTIONAL SOURCES OF FOSSIL FUEL

A.  The Basics of Shale Gas Extraction

This and the following sections focus on shale gas. As indicated before, oil can be easily transported, whereas gas needs to be liquefied or transported through pipelines. Therefore, the technological and political challenges are greater for gas than they are for oil. Shale gas is an unconventional2 natural gas that is located within shale rock formations that include quartz, clay and other minerals. These formations are found both onshore and offshore. Shale gas is located deeper in the ground than other sources of natural gas.

To extract shale gas, hydraulic fracturing, or the so-called ‘fracking’ process, is used, namely ‘the injection of high-pressure streams of sand, water and chemicals into underground shale and other rock to unlock oil and natural gas trapped there’.3 Fracking is also having an impact on domestic oil production in that most drilling today is for oil in shale and tight rock formations.4 The rise in shale gas extraction could potentially translate into larger volumes of gas becoming available on gas markets. This development has assisted the US on its path towards energy independence and makes it a potential competitor of Russia as a supplier of gas to the EU. In what has been lauded as a positive consequence of the rise of shale gas fracking, gas reserves that had been too difficult to extract previously now reach energy markets.

This development could lead to reduction or even displacement of highly polluting coal as a primary resource for the production of energy. It is also worth noting that gas is chiefly traded regionally, i.e., gas markets are largely more regional than global. That said, the prospect of more gas reserves – be it through shale fracking or conventional extraction processes – becoming accessible and exploitable, alongside technological developments around gas storage and transfer, may pave the way towards the integration of gas markets into a more global gas market.5 Shale gas and shale oil are distributed throughout the world. Table 4.1 shows the breakdown by country of estimated recoverable shale gas, analysed in a report regarding shale formation as of May 2013.6

Table 4.1  List of countries by estimated recoverable shale gas resources

CountryEstimated recoverable resources (trillion cubic feet)Date of information
–    World total7,2992013
1    China1,1152013
2    Argentina8022013
3    Algeria7072013
4    United States6652013
5    Canada5732013
6    Mexico5452013
7    Australia4372013
8    South Africa3902013
9    Russia2852013
10  Brazil2452013
–    Rest of the World1,5352013

Source: EIA, Technically Recoverable Shale Oil and Shale Gas Resources: An Assessment of 137 Shale Formations in 41 Countries Outside the United States.

B.  Legal Situation in the EU

Fracking has raised environmental concerns throughout the world. In fact, the state of New York and the Canadian province of Quebec have imposed a moratorium on fracking as a result of these worries.7 Several cities in the state of Colorado banned fracking in 2013 for at least five years.8 That said, in July 2014, a district court judge in Colorado ruled that the fracking ban imposed by the city of Longmont in Colorado is pre-empted by Colorado state law.9 A similar situation can be seen in the EU. Although the EU could make use of its own shale gas reserves, there are reasons that make shale gas extraction in the EU rather difficult:

Sources: International Energy Agency; KPMG; press reports.

Figure 4.1  Map of the legal status of shale gas extraction in Europe

(1)  as can be seen in Figure 4.1, there is no harmonized EU-level legislation regarding its extraction, so in some EU Member States, it is banned (France and Bulgaria); in others it is allowed (Belgium and Latvia); and in others it is allowed with issued permits (UK, Spain and Portugal); and
(2)  public opinion seems to be against the idea in some EU jurisdictions.10

While the legal and technical hurdles to unconventional gas extraction can be overcome if there is political will and the economics make sense, the question of whether, in the end, it should happen is ultimately linked to its ecological viability.

C.  Ecological Viability of Natural Gas as an Energy Resource

Natural gas burns in a cleaner manner than coal does. The burning of 1 million British Thermal Units (btu) of coal leads to 228.6 pounds of emitted CO2. The burning of the same amount of natural gas leads to only 117.0 pounds of emitted CO2.11 Hence the relation between CO2 emissions and energy output or heat value is much more favourable for natural gas. One could therefore argue that the increased abundance of exploitable resources of natural gas provides a chance to reduce CO2 emissions on a global scale. This can already be seen clearly at the regional level with the US reducing its domestic consumption of coal, particularly for electricity production. Total US coal consumption dropped from 1,120,548 thousand short tons in 2008 to 925,106 short tons in 2013.12

Another advantage of electricity production using natural gas is its complementarity with cyclical renewable energy production such as wind and solar. One of the major issues with wind- and solar-based energy production is that there is an abundance of available electricity only when the wind blows or the sun shines in a certain region. However, when the opposite is the case, other electricity production sites need to be activated to supplement the sudden reduction in electricity derived from these renewable energy sources. Speaking in relative terms, gas turbines producing electricity can easily be switched on and off at short notice. Energy based on gas could therefore be seen as a supplement supporting the long-term feasibility of renewable energy production, smoothing the energy supply during cyclical downturns of energy production from renewable sources. It could be used as a technology bridge until more stable and more efficient renewable energy production is available at market-based costs.13

These advantages have to be contrasted, however, with the potential negative effects on the local environment close to the extraction site and the net balance of climate-relevant gas emissions. Anecdotal evidence has shown that the so-called ‘fracking’ technology can have negative impacts on the local environment. The injection of chemicals into the water used to ‘frack’ shale formations into the ground, the massive quantities of chemically treated water which also have to be disposed of, and the risk of local micro-earthquakes have led to fears in the affected communities that led to policies ranging from the outright ban (i.e., France) on a national scale to local abolition (i.e., some US states and parts of Canada). While some of these issues might be related to inappropriate extraction methodologies that can be rectified (for example, better monitoring and capturing of the redundant chemically treated water that is used during the fracking process), more research is needed to evaluate these local risks and the impact of appropriate technical regulation to avoid such negative local impacts.

Other critics, while admitting that the direct effect of electricity production using gas on the environment and climate change is positive, make the argument that one has to look at the net effect. These authors often refer to the methane emissions which can occur during the extraction phase.14Methane is known to be a much more dangerous gas than CO2 for global warming. Estimates show that the global warming potential of methane is more than 20 times greater than that of CO2 at 100 years and more than 50 times greater at 20 years of effect in the atmosphere.15 Thus, methane has particularly strong short-term effects on global warming. Studies on the effect of methane emissions differ and currently various research projects are trying to find reliable estimates.16 This is complicated by the regulatory environment in the main extraction region, North America, where it is often local or state-level authorities which can regulate so that environmental rules differ on a case-by-case basis. It has also been noted that the practices of local extraction teams in avoiding methane emissions seem to play a relevant role.17 While the latter two arguments could indicate that there is substantial potential for improvement through proper regulation, it is important that the ongoing research be deepened to get a better understanding of the net effects of unconventional gas extraction. Also, if the export potential through liquefied natural gas (LNG) is to be considered, the effect of transport and energy resources necessary for the cooling process on LNG transporting vessels should be incorporated in the calculations.

In addition to the potential problems cited above, one can also refer to the argument that, even if the use of gas in electricity or heat production could be positive for climate change in its net effects, the energy sources which are replaced will simply be used elsewhere on the planet and the global warming-relevant effect is not necessarily positive (i.e., carbon leakage). One could cite the US increase in coal exports to the rest of the world as an example. US coal exports rose dramatically from 81,519 short tons in 2008 to 117,659 short tons in 2013.18 While the logic of the carbon leakage argument cannot be denied, the value of the argument is obviously diminished by the fact that, ultimately, this is also true for any other cleaner energy technology, including wind- and solar-based energy production.

Finally, one could also argue that an additional and sudden increase of available fossil energy resources will slow down or disincentivize the use of renewable energy sources. The immediate effect of more abundant fossil energy resources could be a price decrease for energy, which will render the still-not-fully competitive renewables even more difficult to finance. It is argued that with a delay of investment in these new technologies, additional fossil fuel energy resources could lead to a slowdown in the technological development of these new technologies and consequently a prolongation of carbon-based energy production.

There are clear environmental risks associated with unconventional gas extraction. Some of these are speculative, such as the crowding-out effect on renewables or the carbon leakage argument. For other environmental impacts, there is clear anecdotal evidence, such as methane gas emissions in the establishment and operation of wells and the local environmental risks related to the disposal of chemically treated water used in the extraction process. For the moment, the literature on unconventional gas extraction is not conclusive on the question of whether the net balance for the environment is positive or negative. In the coming years, it will be important to devote serious efforts to further technical research on the matter.

D.  Geopolitical Impact on the EU

Irrespective of the final judgement on the ecological viability of unconventional fossil fuel sources, unconventional gas and oil extraction is already happening. These vast new fossil energy resources that are potentially accessible can have a dramatic impact on the EU. The extraction of these unconventional fossil fuels could fundamentally change the EU’s position in world energy markets and also has broader foreign policy and security policy implications.

Following the discussion above, let us leave aside for a moment the possibility of exploration of unconventional gas and oil in the EU itself and focus on the effects of the estimated worldwide resources and their entrance into world energy markets. Starting the analysis from a basic supply and demand framework, and on the assumption that these estimated resources prove to be existent and exploitable, one could assume that additional quantities of worldwide fossil energy resources, paired with an unchanged demand curve (structure), will lead to lower world market prices for these energy sources. In strict economic terms, such a supply shock will generally benefit the market position of the buyer (consumer) and disfavour the seller (producer) of the resources.

Figure 4.2 shows the impact of a supply shock, as would be the case with the additional gas quantities reaching the world energy markets. The aggregate demand structure for energy resources (AD) at a given point in time remains unchanged, while the aggregate supply structure for energy resources shifts from AS to AS’, reflecting the additionally extractable energy resources. We see that, as a consequence and under the conditions of liberalized markets, additional output of energy resource production (Y’–Y) leads to generally lower energy resource prices P’ compared to P. It can be shown that the area between the two price lines and the demand curve represents the additional consumer rent, which can be interpreted as increased economic welfare of energy consumers.

Figure 4.2  Supply shock resulting from additional energy resources output

From a purely economic and energy security perspective, the EU, as a large energy consumer, has therefore principally an interest in widely (and additional) available energy resources as well as open (and stable) energy markets, which allow these resources to be traded. Unfortunately, the world energy market is not as simple as the graph above suggests. This is because such a simplistic model of a world energy market does not account for transaction costs, such as transportation costs (gas can only be transported in liquefied form overseas and has to be cooled to −161 degrees Celsius19 throughout its journey to the pipeline network of the consumer), network externalities (pipelines and gas terminals are very costly to build and maintain and imply high sunk costs), political risk and risk aversion (Western Europe opted for stable energy supply from Russia through long-term fixed contracts)20 and export restrictions for gas and oil, etc. As a consequence of these factors, and focusing on gas, one could broadly speak of three separate energy markets that exist with interlinkages (mainly through LNG spot markets), but which are de facto still operating relatively distinctly from each other: Europe, Asia and North America.

While the European energy market is historically dominated by massive oil and gas inflows from Russia under long-term supply contracts linked to the oil price, the Asian energy market, with its dominant consumers, namely China and India, and its absence of a dominant supplier (Russia is only beginning to pivot towards Asia), is somewhat more diversified. Local gas prices in Asia are therefore potentially more volatile and partially more oriented towards spot markets. Generally, the Asian gas market price has been higher than in Europe, which is related to Asia’s geographically less favourable position, but could also indicate higher risk aversion or more insecure buyer–seller relationships. The third big energy market, North America, mainly links US and Canadian suppliers and consumers. If the current trend of exploitation of unconventional gas and oil resources continues, we will start seeing a local market situation in North America of relatively stable energy demand,21 paired with abundantly available local energy resources.

In addition, the US and Canada are not the only places where large basins of shale gas and potentially also shale oil are estimated to exist, leading to a large additional gas and oil occurrence topping up the worldwide estimations of conventional gas and oil resources.22 In this section, we will analyse the impact of this on the EU and its energy policy and energy supply security by looking at the dominant actors in world energy markets (namely the US, China, Russia and OPEC) and how these actors will or might have to adapt to a potential global boom of unconventional gas and oil.

1.  The United States

A declining trend of local oil and gas production in the US led to a seemingly ever increasing trend of dependence on oil and gas imports. During the 1990s, huge investments were made in LNG import infrastructure, in particular in large terminals on the East Coast, to allow for increasing gas imports from the Persian Gulf, mainly Qatar, in anticipation of a further decline of domestic gas production. Since around 2005, this trend of local production decline is reversing, however, with new unconventional gas and oil production methods resulting in dramatic increases of local gas and oil production on the North American continent.23 The US is approaching energy independence at least for gas24 and the abundance of natural gas accessible through newly applied technologies such as fracking could turn the US from one of the biggest net consumers into a large net supplier of fossil energy resources in the future.

This can have two consequences for the EU and its energy supply security. On the one hand, a nearly energy-independent US will have diminished interest in securing international energy sources and their supply routes such as the Persian Gulf region, in particular the Strait of Hormuz, the Gulf of Guinea or other major shipping routes, including the Suez Canal and the Somali coast. However, given its broader economic and security interests, the US will most likely not fully withdraw its military and naval presence in these regions. Still, the US is now pivoting towards Asia, which can be seen in the regrouping of its naval presence, with a more limited presence in the dominant oil and LNG transport route towards Europe and an increased presence in Asian waters.25 At this stage, it is clear that neither the EU nor China, the other major clients of Middle East oil, is willing or able to fill in the gap of backing up the US’s energy supply security interest in the region with the full toolbox of foreign policy, including the military option.

On the other hand, the abundance of natural gas on the North American continent will lead to increased foreign and domestic pressure to export the gas overseas in the form of LNG. Currently, the US applies export restrictions26 both to its domestic gas and oil, which, together with a restrictive maritime transport policy and a lack of export facilities, hampers the export potential for LNG. At the same time, the practice of the US has been to drastically simplify its export regime for gas with trading partners with which it has concluded a free trade agreement (FTA). The current negotiation of the Transatlantic Trade and Investment Partnership (TTIP) does therefore offer the EU the potential of tapping into the vast US sources of unconventional fossil fuel.

From a pure economic theory point of view, one could even argue that it does not matter whether the US will export gas and oil to the EU or anywhere else, since the demand shortfall on the LNG spot markets would allow the EU to acquire the resources under better conditions, given its improved position as a buyer on the world markets for oil and LNG. This is only partially true, however. While some of the LNG originating from the Persian Gulf has been redirected to Europe27 the structure of the European gas market with its long-term contracts for Russian gas supply and its price fixation to oil does not allow the EU to immediately benefit from its improved position on world gas markets. It has been a political choice of Europe to bind itself to Russian gas supply,28 which, so far, with only limited exceptions,29 has been proven to be reliable. Heavy recent investments, such as the Nord Stream project,30 have confirmed this relationship.

From a European policymaker’s perspective, this might have made sense in the past, but is not necessarily true for the future. Confronted with the choice of partially abandoning the relatively secure gas supply from Russia for LNG from the politically rather unstable Persian Gulf, a European politician might have rationally opted for the former. Given the choice of possibly establishing a long-term customer–buyer relationship with the US as gas supplier, the politician might choose differently, however, weighing both supply security and political risk. The shale gas boom on the North American continent, seen simply from a supply security point of view, is therefore a chance for the EU to diversify its world market position as a gas consumer and possibly reduce its dependence on Russian conventional gas.

2.  China

Surpassing the EU and the US in 2010, China is the largest energy consumer in the world.31 Its economic model is still mainly based on manufacturing and highly energy dependent. At the moment, a large amount of highly polluting domestic coal paired with gas and oil imports are the energy base for the Chinese economy.32 During the last decade, China has begun to strategically invest politically and economically in regions supplying its resource-hungry economy, such as Africa and Latin America.33 From a European perspective, these investments have sometimes been considered as undercutting the EU’s intention of conditioning its development aid and investment to political conditions, which China did not feel it had to replicate. But China is also investing in the shale gas industry in the US.34 While this could also be interpreted as a strategy to acquire knowledge on shale gas production methods (China is estimated to have the world’s largest shale gas reservoirs),35 it could, on the other hand, also signify a long-term Chinese interest in more abundant and accessible worldwide gas supplies.

China is principally starting from a similar position to that of the EU. It has relatively large domestic shale gas resources, which, for different reasons from those of the EU (a large part of the Chinese shale gas lies in the water-poor Western part of the country; technology constraints),36 are not easily accessible, but, at the same time, it also has a strong interest in a stable and low-price supply of natural gas as well as in diversifying its gas sources. However, in stark contrast to the case of the EU, its energy consumption is expected to rise dramatically and China will consequently have to look for a continually increasing supply of energy resources. The natural strategy of China might therefore not differ so much from the strategy the EU has been following in the past: establishing a long-term buyer–seller relationship with Russia,37 while using the current low spot market prices to control prices. It is clear that, as a net consumer, it would principally benefit from more available energy resources that could put downward price pressures on and diversify its supply.

While China could, in a similar fashion as potentially the EU, aim at trying to tap into the future worldwide shale gas supply, its geographical and political position in the world might render this endeavour less fruitful. On the one hand, its domestic gas and oil industry so far lacks the technology to exploit shale gas basins abroad in places such as South America or South Africa, not to mention the political and technical feasibility of exploiting the potential shale gas resources in Russian Siberia. On the other hand, its political clout to get a foot in the door of the currently most promising and politically stable potential gas market, namely the US, is rather limited. For political and economic reasons, if the US were to massively open its gas resources to other energy consumers, a choice between establishing a long-term buyer–seller relationship with the EU or China could most likely lead to the EU getting the larger share of the deal, as it is clear that the discussion in the US on whether to ease its export restrictions is limited not only to industrial policy arguments, but also to its geopolitical dimension.38

Based on the above, a nearly energy-independent US, with its lessened interest in securing the global shipping routes of oil and LNG from the Persian Gulf as well as a potentially more diversified sourcing of energy resources throughout the world, will also lead to more Chinese awareness of its dependence on secure transport and production environments. Whether the Chinese strategy will predominantly be one of trying to monopolize its sourcing relationships with privileged partners or whether it will arrive at the conclusion that it has a joint interest with Europe and the US in stabilizing certain regions such as the Middle East or the shipping routes of energy resources, remains to be seen. The participation of its navy in the anti-piracy activities off the Somali coast could be interpreted as a promising sign, while its common front with Russia when it comes to regime change and institution building in unstable regions of the world is showing diverging evidence.

3.  Russia

Russia could be the biggest loser in the aftermath of a worldwide shale gas development. While Russia itself is estimated to have large amounts of unconventional gas, a broad diversification of available energy resources and suppliers worldwide can only undermine its market position vis-à-vis its main client (Europe) and its potential future main trading partner in energy matters (China).39 It could be forced to abandon its price peg to oil, and the unconventional gas and oil boom could also lead to even more price fluctuations. For an unstable economy so dependent on oil and gas revenues, this might have consequences, in terms of both economic and political stability. While a politically unstable Russia is clearly not in the interest of the EU, the reduced capacity of Russia to use its energy supply to Europe as a means of political influence could be a welcome development for Europe.

4.  OPEC

In a similar vein, the OPEC cartel can be expected to be on the losing side of a potential diversification of worldwide gas and oil supply. Already the loss of the North American gas market has shown its consequences for the spot market prices of LNG, with abundant Qatari gas that would have been exported to the US putting downward pressure on global prices as it is diverted to other markets, in particular Asia. Even though tremendous financial efforts have been made to diversify the economies of some of the OPEC members, the impact of increased competition from other suppliers for energy resources, in particular oil and gas, could be a destabilizing element in the economies and societies of the OPEC members. Again, for the EU, this is not necessarily a positive development, as it might potentially increase the necessity for political intervention in the region. This is under the assumption that a more reluctant US, currently playing the role of some sort of world police in the interest of the West, will reduce its political and military engagement in the Persian Gulf region.

The impact on OPEC members might be less than on Russia, however, since in many cases OPEC’s cost of production of both oil and conventional gas is well below that of the Russian gas and oil fields mainly situated in Siberia. OPEC members are also more flexible in their export structure, which is mainly by sea (both for oil and gas). This flexibility could dampen the destabilization forces but would lead to a smaller margin for the oil and gas exporters. In fact, the downward pressure on the oil and gas price could force the OPEC cartel to change its current pricing and production policy, opening the oil and gas tap even further to finance its population. While this might not necessarily be in alignment with the EU’s goal to strive for reducing greenhouse gas (GHG) emissions or creating a worldwide environment to prepare a shift from fossil fuels to renewables, it would clearly be in the short-term interest of a highly energy-dependent EU and other large energy consumers such as China.

III.  CONCLUSIONS AND POLICY RECOMMENDATIONS

Following the analysis above, the EU will have to adapt to the likely change of energy politics and economics that derive from the unconventional gas and oil revolution. In our view, the environmental risks that clearly exist should not lead to a complete discarding of the new extraction technology. On the contrary, the energy revolution will take place with or without the EU. It is therefore in the interest of the EU not only to benefit from enhanced energy security through the exploration of new and relatively clean fossil energy resources, in particular gas, but, moreover, to be able to influence the discussion about which technologies and regulatory environments shall be applied for the exploration of these newly accessible resources. In combination with solar and wind energy, energy production from gas could become a powerful complementary technology towards the long-term goal of sustainable energy production.

In our view, the EU should therefore not stand aside, but should try to shape the global environment in which this possible energy revolution will take place. Embracing any new technology is never without risk. However, letting others develop (or not develop) the right technologies or the necessary international policy frameworks should not be an option for such a highly energy-dependent global actor as the EU.

In its reaction to the foreseeable shale gas development and taking into account the internal and external policy framework of the EU, we think the EU should therefore consider the following two areas of political action:

1.  Carefully study and explore its shale gas reserves, where necessary with test drilling and, if the appropriate technology for protecting the local environment can be found, with commercially viable extraction.
2.  Work towards a truly global energy market by developing an international framework for energy trade based on open markets and consequently adapt its gas supply infrastructure to benefit from the possibility of diversifying its gas imports.

To implement the first policy recommendation, two basic components are necessary. On the one hand, we need to learn more about the best technologies for extraction and its environmental impact. For obvious reasons, energy companies are not the most reliable source of information for this research. More independent technical research, where necessary publicly funded, should be conducted to come to a better conclusion about the environmental impact of shale gas extraction, both with regard to the local environmental impact as well as to the net climate balance.

On the other hand, and on condition that technical research has reasonably concluded that the unconventional gas extraction is environmentally viable and that the net climate impact of shifting from coal to natural gas is indeed positive, taking into account both the methane gas emissions and the eventual transport and liquefying of natural gas, the EU should consider regulating the sector horizontally at the supranational level. A European-wide regulation would avoid a regulatory fragmentation and possible regulatory arbitrage of extraction companies seeking to explore the resources where the environmental standards and regulatory overview are lowest. Developing and setting technical standards could also lead to pressure on the extraction industry and exploration in other places throughout the world to use the safest available technology.

To implement the second policy recommendation, the EU can build on its past efforts codified in the Energy Charter Treaty (ECT). The ECT is an international agreement which aims to provide a ‘multilateral framework for energy cooperation’ based on the principles of ‘open, competitive markets and sustainable development’.40 By binding governments to commitments that guarantee open markets, non-discrimination and access for foreign investment,41 the ECT aims to strengthen the global rule of law on energy issues and thereby reduce the risks associated with energy-related investments and trade.42 The ECT itself rests on five primary areas: investment protection,43 trade,44 transit,45 environmental protection46 and dispute settlement,47 while there are optional protocols on various topics, including energy efficiency and the environment.48

As a bottom line, it is probably not wrong to say that the ECT is the EU’s attempt to codify its need for the security of energy supply through the operation of more open and competitive energy markets on a global scale. In a political environment with monopolized supply (e.g., OPEC, Russia), this was clearly a difficult goal to achieve, since it is not in the interest of monopolies to bind their hands with regard to pricing and the organization of their internal and external energy policies. For example, Russia signed the ECT and was applying it provisionally until 18 October 2009, but never ratified it. Russia notified the Energy Charter Secretariat that it would withdraw from the ECT’s provisional application from that date.49 This assumption is also supported by the fact that there is no agreement at the World Trade Organization (WTO) level on energy provisions when it comes to non-discriminatory conditions for trade in energy materials, products and energy-related equipment as well as provisions to ensure cross-border energy transit. More broadly, the WTO rules, while relatively strict on import-related restrictions, provide only weak rules on export restrictions, which are the main instrument to limit the free flow of energy resources. Export restrictions and the obvious link to energy resources are equally the stumbling block for the bilateral FTA between the EU and the Gulf Cooperation Council.

While it is by no means sure that the new energy landscape with multiple new large consumers (for instance, China and India) and many more potential suppliers scattered throughout the world (North America, South America, Australia, South Africa, etc.) will lead to a more cooperative spirit when it comes to the codification of free market provisions on energy trade,50 the break-up of the energy monopolies of OPEC and Russia and de facto more competition on world energy markets could lead to a broader interest in common rules with regard to energy trade.

Given the slow process of WTO rule making (the Doha Development Agenda has been under negotiation since 2001 and at the 10th WTO Ministerial in Nairobi in December 2015 it was agreed that that was the end of it), it is not likely that a controversial topic such as energy, which is currently not even on the agenda of multilateral trade negotiations, will be appropriately dealt with in the near future. It is nevertheless in the interests of the EU to further develop international rules, taking into account the new global energy environment with the more diverse supplier–consumer relationships. A prime possibility to develop such prototype rules could be the TTIP, currently being negotiated between the EU and the US. A broad set of commonly agreed and internationally codified rules between one of the world’s largest energy importers (namely the EU) and the possibly future largest energy producer (i.e., the US) could set, if not the new world standard, definitely a benchmark that will influence the new energy world order when it comes to codified rules on energy trade. A more scattered and less monopolized supplier situation, in which the energy-producing countries have less leverage on global energy markets, could, in the medium term, lead to a broader acceptance of such rules and, in the long run, to a possible incorporation in the network of the WTO and other multilateral rule-making fora.

From the outset, the EU was clear about its intentions on energy-related provisions in the TTIP. In an initial position paper, the European Commission stated that the TTIP could make an important contribution to the development of open trade and non-discriminatory access for energy resources.51 Such provisions could provide a basis to take the issue of energy trade forward in a more comprehensive manner by providing an ‘open, stable, predictable, sustainable, transparent and non-discriminatory framework for traders and investors’52 of energy resources in a way that also serves wider shared ‘geo-strategic and political objectives’.53 Disciplines agreed in the trans-Atlantic context could serve as ‘a model for subsequent negotiations involving third countries’.54 The TTIP could also send a powerful signal to other countries that ‘trade in energy can be subject to global governance, including the fundamental principles of transparency, market access and non-discrimination’.55

The immediate impact of the codification of open trade and non-discriminatory access to energy resources between the EU and the US would be the lifting of the US export ban for LNG and potentially light crude oil to the EU. This, in turn, would mean that the EU would diversify its potential sources of energy and therefore enhance EU energy security.56 A market-based arrangement between the EU and the US, with its underlying magnitude of potential future trade flows in energy resources, is likely to have an impact on similar arrangements because it could shape global energy markets in such a way that incumbent suppliers of oil and gas will see their traditional monopoly market power on European energy markets diminished. Irrespective of whether the long-term goal of a global set of rules is within reach, such a market-based arrangement could shake up global energy markets in the EU’s long-term interest. It will ultimately set a price ceiling for LNG imports to Europe and secure availability in case of physical supply interruption.

To benefit from such a situation, there is obviously homework to be done. In the case of a joint response by EU Member States and the EU institutions to the shale gas developments, the import and supply infrastructure network for LNG will need to be further developed. This means, on the one hand, an EU-wide coordinated approach towards an LNG import terminal infrastructure. These are investments that imply high sunk costs and history has shown that long political haggling over the geographical location of these terminals is dominated by local and national considerations.57 On the other hand, a coordinated approach towards a joint and strategic LNG import terminal infrastructure would require a better integration of the EU gas pipeline network, currently set up to mainly import gas from Russia and the Maghreb into the EU. Pipelines will have to be adapted to potentially reverse the flows of gas, a better coordination of the management of the EU-wide network might be necessary and, in some cases, even new pipelines might have to be built to distribute gas coming by sea to the final consumer or to the existing networks.58 In sum, it would require a better coordinated EU policy towards the EU gas import infrastructure and the EU energy distribution network. Moreover, reverse flows and interconnectors between EU Member States (plus Switzerland and Norway) should be built in order to better respond to supply disruptions or imbalances.

While all of the above-mentioned policy options are in the realm of the possible, they will require political will, courage and patience: the political will to cooperate in the EU institutions in order to find consensus to regulate unconventional fossil fuel sources, the courage to leave aside energy nationalism when it comes to energy import infrastructures, and the patience to constantly keep the development of a global energy governance structure on the intentional agenda. In our view, it would be worth a try.

The next chapter analyses the role of renewables in the context of EU preferential trade agreements as legal avenues to enhance energy security.

1 Unconventional sources of fossil fuel include tight gas, coal bed methane, unconventional oil, and shale gas, among others. For the purposes of this chapter, we will focus on shale gas.
2 We draw a distinction between conventionally extracted gas and that extracted through fracking, given that shale gas extracted through fracking is environmentally harmful. See the British Geological Survey’s (BGS) website, where the BGS lists its concerns (e.g., degradation of water bodies, methane leakage, increasing seismic volatility, etc) in relation to shale gas extraction, available at http://www.bgs.ac.uk/research/energy/shaleGas/environmentalImpacts.html.
3 Krupp, F. ‘Don’t Just Drill, Baby – Drill Carefully: How to Make Fracking Safer for the Environment’ (2014) 93(3) Foreign Affairs 1–20, 15.
4 Ibid.
5 de Jong, D., van der Linde, C. and Smeenk, T. ‘The Evolving Role of LNG in the Gas Market’ in Goldthau, A. and Witte, J.M. (eds.) Global Energy Governance: the New Rules of the Game, Washington, DC: Brookings Institution Press, 2010, 221–245 (about developments in gas markets globally).
6 US Energy Information Administration, ‘Technically Recoverable Shale Oil and Shale Gas Resources: An Assessment of 137 Shale Formations in 41 Countries Outside the United States’, June 2013.
7 Cunningham, N. ‘New York Ruling on Fracking Leaves Shale Industry Weary’, The Christian Science Monitor, 2 July 2014, available at http://www.csmonitor.com/Environment/Energy-Voices/2014/0702/New-York-ruling-on-fracking-leaves-shale-industry-weary. Reuters, ‘Quebec Seeks Fracking Moratorium in Shale Gas Rich Area’, available at http://www.reuters.com/article/2013/05/15/canada-quebec-fracking-idUSL2N0DW33620130515.
8 Coffman, K. ‘Colorado an Energy Battleground as Towns Ban Fracking’, Reuters, 6 November 2013, available at http://www.reuters.com/article/2013/11/06/us-usa-fracking-colorado-idUSBRE9A50QT20131106.
9 As of July 2014, the order was stayed pending an appeal. This means that fracking is suspended. For the full order granting summary judgment, see http://www.courts.state.co.us/userfiles/file/Court_Probation/20th_Judicial_District/Cases_of_Interest/13CV63%20Order%20Granting%20Motions%20for%20Summary%20Judgment.pdf. In September 2015 the Colorado Supreme Court agreed to hear an appeal from the city of Longmont. See http://www.law360.com/articles/705833/colo-supreme-court-to-rule-on-local-fracking-ban.
10The Economist, ‘Conscious Uncoupling’, 5 April 2014, 30.
11 EIA, ‘Frequently Asked Questions’, http://www.eia.gov/tools/faqs/faq.cfm?id=73&t=11.
12 EIA, ‘US Coal Summary Statistics, 2008–2014’, http://www.eia.gov/coal/production/quarterly/pdf/tes1p01p1.pdf.
13 Compare with Jacoby, H.D., O’Sullivan, F.M. and Paltsev, S. ‘The Influence of Shale Gas on US Energy and Environmental Policy’ (2012) 1 Economics of Energy & Environmental Policy; Levi, The Power Surge: Energy, Opportunity, and the Battle for America’s Future, New York: Council on Foreign Relations, 2013; and MIT, The Future of Natural Gas, Cambridge, MA: MIT, 2012. For a focused presentation on exploration and drilling techniques, see Boling, M.K. ‘Balancing Environmental, Social and Economic Impacts of Shale Gas Development Activities’, webinar presentation for The Yale Center for Environmental Law and Policy, available at www.vimeo.com/58162903.
14 The issue of methane gas emissions is discussed in Bradbury, J., Obeiter, M., Draucker, L., Wang, W. and Stevens, A. Clearing the Air: Reducing Upstream Greenhouse Gas Emissions from U.S. Natural Gas Systems, Washington, DC: World Resources Institute, 2013; Alvarez, R.A., Pacala, S.W., Winebrake, J.J., Chameides, W.L. and Hamburg, S.P. ‘Greater Focus Needed on Methane Leakage from Natural Gas Infrastructure’ (2012) 109 Proceedings of the National Academy of Sciences 6435–6440; Howarth, R.W., Santoro, R. and Ingraffea, A. ‘Methane and the Greenhouse-Gas Imprint of Natural Gas from Shale Formations’ (2011) 106 Climatic Change; Makan, A. and Crooks, E. ‘Shale Gas Boom Now Visible from Space’, Financial Times, 27 January 2013; Schrag, D.P. ‘Is Shale Gas Good for Climate Change?’ [2012] Daedalus; Wigley, T.M.L. ‘Coal to Gas: The Influence of Methane Leakage’ (2011) 108 Climatic Change.
15 UN Framework Convention on Climate Change, Global Warming Potentials (2014), available at http://unfccc.int/ghg_data/items/3825.php.
16 Compare, for example, with US Environmental Protection Agency [EPA], Inventory of U.S. Greenhouse Gas Emissions and Sinks: 1990–2011 (2013), (available at www.epa.gov) or Miller, S.M. et al. ‘Anthropogenic Emissions of Methane in the United States’ (2013) 110 Proceedings of the National Academy of Sciences.
17 Brewer, T.L. ‘The Shale Gas Revolution – Implications for Sustainable Development and International Trade’, Issue Paper No. 8, ICTSD Global Platform on Climate Change, Trade and Sustainable Energy, 11–13 (2014).
18 EIA, ‘US Coal Summary Statistics, 2008–2014’, http://www.eia.gov/coal/production/quarterly/pdf/tes1p01p1.pdf.
19 See California Energy Commission, ‘Frequently Asked Questions About LNG’, available at http://www.energy.ca.gov/lng/faq.html.
20 Neuhoff, K. and von Hirschhausen, C. ‘Long-term vs. Short-term Contracts: A European Perspective on Natural Gas’, Cambridge Working Paper in Economics 0539 (2013).
21 EIA, ‘Annual Energy Outlook, Early Release Overview’ (2015), ES-1, available at http://www.eia.gov/forecasts/aeo/pdf/0383%282015%29.pdf.
22 US Energy Information Administration, ‘Technically Recoverable Shale Oil and Shale Gas Resources: An Assessment of 137 Shale Formations in 41 Countries Outside the United States’, June 2013.
23 EIA, ‘Annual Energy Outlook’ (2014), MT-27, available at http://www.eia.gov/forecasts/aeo/pdf/0383(2014).pdf.
24 EIA, ‘Annual Energy Outlook, Early Release Overview’ (2015), 6, available at http://www.eia.gov/forecasts/aeo/pdf/0383%282015%29.pdf.
25 By 2020 the ‘Navy will re-posture its forces from today’s roughly 50/50 percent split between the Pacific and the Atlantic to about a 60/40 split between those oceans – including six aircraft carriers, a majority of our cruisers, destroyers, Littoral Combat Ships, and submarines.’ Leon Panetta quoted in Bloomberg. See Ratnam, G. and Ten Kate, D. ‘US Navy’s Pacific Presence to Expand, Panetta Says’, Bloomberg, 2 June 2012, http://www.bloomberg.com/news/2012-06-02/u-s-navy-spacific-presence-to-expand-panetta-says.html.
26 For a critical view on the crude oil export ban in the US, see the presentation by Larry Summers at the Brookings Institution on 9 September 2014, where he explained three reasons why the current US law banning the export of crude oil and natural gas is bad policy. Available at http://www.brookings.edu/blogs/brookings-now/posts/2014/09/larry-summers-lift-crude-oil-export-ban.
27 See Tuttle, R. and Shiryaevskaya, A. ‘Qatar to Boost Europe LNG Sales as Gas Trades at 7-Year High’, Bloomberg, http://www.bloomberg.com/news/2013-12-23/qatar-to-boost-european-lng-sales-as-gas-trades-at-7-year-high.html.
28 Schuette, R. ‘Internationale Konsequenzen der Schiefergasrevolution’, unpublished paper (on file with authors).
29 Pirani, S., Stern, J. and Yafimava, K. ‘The Russo-Ukrainian Gas Dispute of January 2009: A Comprehensive Assessment’, NG 27 (2009) The Oxford Institute for Energy Studies.
30 See http://www.nord-stream.com.
31EIA Country Analysis Brief Overview China (2014), available at http://www.eia.gov/countries/country-data.cfm?fips=ch.
32 Ibid.
33 Zweig, D. and Jianhai, B. ‘China’s Global Hunt for Energy’, Foreign Affairs, September/October 2005, 2.
34 Dezember, D. and Areddy, A.R. ‘China Foothold in US Energy’, Wall Street Journal, 6 March 2012, available at http://online.wsj.com/news/articles/SB10001424052970204883304577223083067806776.
35 As of 2013, the estimated technically recoverable shale gas of China was 1,115 trillion cubic feet. See United States Energy Information Administration, ‘Technically Recoverable Shale Oil and Shale Gas Resources: An Assessment of 137 Shale Formations in 41 Countries Outside the United States’, EIA, June 2013.
36 EIA, ‘Shale oil and shale gas resources are globally abundant’, http://www.eia.gov/todayinenergy/detail.cfm?id=11611.
37 In May 2014 Russia and China signed the biggest natural gas deal in history: a $400 billion agreement for 30 years of gas supply. See ‘China and Russia sign $400bn gas deal’, The Financial Times, 21 May 2014, available at http://www.ft.com/cms/s/0/d9a8b800-e09a-11e3-9534-00144feabdc0.html#axzz3tons1pe6. This new deal raises the following questions: Are we witnessing the unfolding of a new great game in Central Asia between Russia and China? If so, to what extent does this rivalry between them pose a threat to the fragile geopolitical equilibrium and energy security in the region? An ever-growing rivalry between China and Russia over energy resources in Central Asia has been unfolding since the demise of the USSR. The Sino-Russian rapprochement and their new ‘strategic partnership’ aim, among other things, at preventing the West (primarily the US) from further meddling in Central Asia. Both Russia and the Central Asian republics are seeking the diversification of their energy exports, hence China represents an ideal partner for them and vice versa. Soon after the collapse of the USSR, China immediately recognized the new-born Central Asian States and established diplomatic relations with them. In 1993 China’s domestic consumption of oil surpassed its domestic production and, therefore, it became of paramount importance for them to start importing energy from abroad. At the same time, the Central Asian republics’ economies lay in tatters and they were desperate for liquidity, which their former master, Russia, could not always guarantee them as its economy was also in a dire state. Thus, the Central Asian States started looking for alternative export routes. However, since all their existing export routes and pipelines belonged to Russia, they had to find new customers somewhere else. Hence, energy-thirsty China represented an ideal partner. In the 1990s China began importing significant amounts of oil from the Middle East (still in 2009, 47% of its total oil imports originated from there) via shipping routes passing through the Strait of Malacca, on which China is still nowadays dependent for over 75% of its total crude imports. However, there is increasing concern in China regarding the country’s overwhelming reliance on the Strait of Malacca because of its vulnerability to terrorism and piracy. Thus, Beijing started looking for alternatives to diminish its reliance on the Strait of Malacca and diversify its imports from other sources, such as neighbouring Russia and Central Asia.
38 Cunningham, N. ‘The Geopolitical Implications of US Natural Gas Exports’, American Security Project, 2, March 2013.
39 Clear evidence of the closeness between Russia and China is the $400 billion gas deal signed in May 2014 under which Russia will sell China gas annually from 2018 for 30 years. See Luhn, A. and Macalister, T. ‘Russia Signs 30-year Deal Worth $400bn to Deliver Gas to China’, The Guardian, 21 May 2014, available at http://www.theguardian.com/world/2014/may/21/russia-30-year-400bn-gas-deal-china. Another agreement was signed in November 2014 for Russia to sell additional gas to China through a proposed pipeline from western Siberia. See Paton, J. and Guo, A. ‘Russia, China Add to $400 Billion Gas Deal with Accord’, Bloomberg, 10 November 2014, available at http://www.bloomberg.com/news/articles/2014-11-10/russia-china-add-to-400-billion-gas-deal-with-accord. However, more Russian gas for China does not necessarily mean less gas for Europe. The gas to be exported to China will be produced in gas fields mainly in eastern Siberia, while the gas exported to Europe is produced in western Siberia and in the European part of Russia, i.e., west of the Urals.
40The Energy Charter Treaty and Related Documents: A Legal Framework for International Energy Cooperation, Brussels: Energy Charter Secretariat, 2004, 13. On trade and sustainable development, see Leal-Arcas, R. and Wilmarth, C. ‘Strengthening Sustainable Development through Preferential Trade Agreements’, Queen Mary School of Law Legal Studies Research Paper No. 174/2014, 1–24, 2014.
41 McGowan, F. ‘Can the European Union’s Market Liberalism Ensure Energy Security in a Time of “Economic Nationalism”?’ (2008) 4(2) Journal of Contemporary European Research 90, 97.
42The Energy Charter Treaty and Related Documents: A Legal Framework for International Energy Cooperation, Brussels: Energy Charter Secretariat, 2004, 14.
43 Part III ECT.
44 Part II ECT.
45 Article 7 ECT.
46 Article 19 ECT.
47 Part V ECT.
48 Protocol on Energy Efficiency and Related Environmental Aspects (PEERA), 1994.
49 See http://www.encharter.org/index.php?id=61 in relation to ECT membership, pending ratifications and the Russian position. For further details, see Leal-Arcas, R. and Filis, A. ‘The Energy Community and the Energy Charter Treaty: Special Legal Regimes, their Systemic Relationship to the EU, and their Dispute Settlement Arrangements’ (2014) 12(2) Oil, Gas & Energy Law Journal 1–42; Leal-Arcas, R. ‘The EU and Russia as Energy Trading Partners: Friends or Foes?’ (2009) 14(3) European Foreign Affairs Review 337–366.
50 On international cooperation in the energy field, see Leal-Arcas, R. and Filis, A. ‘The Fragmented Governance of the Global Energy Economy: A Legal-Institutional Analysis’ (2013) 6(4) Journal of World Energy Law and Business 1–58.
51 European Commission, ‘EU-US Transatlantic Trade and Investment Partnership: Raw Materials and Energy’, Initial EU Position Paper, available at http://trade.ec.europa.eu/doclib/docs/2013/july/tradoc_151624.pdf.
52 Ibid, 2.
53 Ibid.
54 Ibid.
55 Ibid.
56 For further details on EU energy security, see Leal-Arcas, R. and Filis, A. ‘Conceptualizing EU Energy Security through an EU Constitutional Law Perspective’ (2013) 36(5) Fordham International Law Journal 1225–1301.
57 See ‘Estonia to Finland: Let’s Both Build LNG Terminals’, Reuters, 17 January 2014, available at http://www.reuters.com/article/2014/01/17/-finland-estonia-lng-idUSL5N0KR1EW20140117.
58 For an analysis of energy transit pipelines, see Leal-Arcas, R. and Peykova, M. ‘Energy Transit Activities: Collection of Intergovernmental Agreements on Oil and Gas Transit Pipelines and Commentary’, Queen Mary School of Law Legal Studies Research Paper No. 177/2014, 1–54, 2014.

Extract

Chapter 4 examines the system of law and governance of international trade in unconventional energy sources. Currently, there is no cohesive governance for global energy trade. On the contrary, governance of energy trade mainly arises by default, rather than design, through the ad hoc interplay of different aspects of the international economic and political system. This has implications for the European Union (EU), which relies heavily on the rest of the world for its energy supply, and consequently its energy security. The chapter provides some background to EU energy policy; it then explains the current revolution in unconventional sources of fossil fuel and how it may geopolitically impact the EU. The last section concludes the chapter and provides some policy recommendations.

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