The prosperity and economic stability of the European Union (EU), and wider Europe, is dependent on a stable, abundant, diverse and competitively priced supply of energy. Most of the EU's 28 Member States are used to uninterrupted energy supply at all times and in all circumstances. However, in January 2006 and January 2009 eastern EU countries experienced temporary disruption of gas supplies when Russia's Gazprom cut off gas supply to the Ukraine. Recent tensions between Russia and the Ukraine have again highlighted concern over security of energy supply to the EU.

In this article we look at the challenges facing the EU in terms of energy supply, and consider what is being done at an EU level to address those challenges. In particular we consider whether either European shale gas, or US LNG exports could offer a solution to the EU's concerns over energy security.

EU's Energy Demand and Import Dependency

Total demand for energy in the EU increased slowly between 1995 and 2006 but since then has been falling gradually. Over the same period the EU's dependency on imported energy increased by almost a quarter: so while the EU was consuming less energy more of what it consumed came from outside the EU. Since 2006, the EU's import dependency has stabilized, but it remains a fact of life for the EU.

Today the EU imports about 53% of the energy it consumes at a cost of more than Euros 1 billion (approx. US$ 1.24 billion) a day. In 2012, EU import dependency (percentage by consumption) was:

88% of crude oil;

66% of natural gas;

42% of solid fuels (mainly coal); and

4% of renewables.

Import dependency varies widely across EU Member States, both in volume and type of fuel. At one end of the spectrum Denmark is totally self-sufficient, whilst at the other end Malta's energy needs are meet 100% from imported fuels. The major EU economies of Germany, Spain and Italy all imported well over 50% of energy consumed in 2012.

EU Energy Security Strategy

Security of energy supply is now high on the EU Commission's agenda. In May 2014, the Commission published its "European Energy Security Strategy" which was followed in July 2014 by a 263 page "In-depth study of European Energy Security." At the core of the Commission's strategy is cooperation between Member States, and the development of a fully integrated and transparent energy market in the EU. The EU Commission identifies the many hurdles to achieve a well-functioning internal energy market, and recognises that they can only be overcome with a combination of new EU Directives to be adopted across all Member States, and new infrastructure – particularly in the EU's most vulnerable areas.

The key measures introduced by the EU Commission include:

The Third Energy Package: The Third Energy Package is comprised of separate Directives concerning common rules for the internal EU market in gas (Directive 2009/73/EC) and electricity (Directive 2009/72/EC), which EU Member States are required to implement into national legislation. The combined purpose of the Directives is to open up further the gas and electricity markets in the EU. Core elements of the Third Energy Package include ownership unbundling, which stipulates the separation of companies' generation and sale operations from their transmission networks, and mandatory third party access to infrastructure, including pipelines.

EU Projects of Common Interest (PCI): Current energy infrastructure in parts of the EU is outdated and often isolated. The EU Commission has identified the need to build new infrastructure, including cross border pipelines, and to update existing infrastructure and interconnectors to allow higher diversification of suppliers, promote the efficient integration of EU Member State energy markets, and generally increase EU security of supply. In October 2013, the EU Commission presented a list of 248 energy infrastructure projects of common interest to the EU. These projects were intended to be launched between 2014 and 2020 at an estimated cost of Euros 40 billion (approximately US$ 50 billion). Twenty-seven of these PCIs, mainly in the more vulnerable eastern EU Member States, have been identified as critical for the EU's energy security, and include a number of reverse flow interconnectors.

The Challenges and Solutions for Oil

Oil consumption in the EU is decreasing slowly (by 13% between 2005 and 2012), but it remains the largest single primary energy source in the EU. Oil has the highest import dependency of all fuels in the EU (almost 90%, with Russia being by far the largest supplier) leaving the EU exposed to changes in the global oil market. However, the risks associated with oil supply in the EU are global and, in the main, are not unique to the EU. The only major exception is for refineries in Germany, Poland, Czech Republic, Slovakia and Hungary that are solely dependent on oil supply from Russia that is transported through the Druzhba pipeline system.

Whilst long-term security of oil supply is not a key concern for the EU due to market liquidity, the EU is concerned by the transport sector's dependency on oil, and on reducing consumption of oil in favour of cleaner fuels. The EU Commission has introduced three legally binding policies to promote use of cleaner fuels over oil: (i) 2020 Climate and Energy Package; (ii) 2030 Framework for Climate and Energy; and (iii) 2050 EU Energy Roadmap.

The Challenges and Solutions for Gas

The share of gas in the EU's total energy demand increased from 20% to 23% between 1995 and 2012. During the same period, the EU's gas import dependency has increased as the EU's own gas reserves decline. Around 50% of gas imported to the EU is from Russia via pipeline through the Ukraine, representing about 15% of the EU's total gas consumption. The EU's increasing dependency on gas imports has increased the risks associated with security of gas supply. The challenges are greatest in Central Eastern European (CEE) countries, which are dependent on Russia as their sole supplier of gas. Today, gas supply is high on the EU's political agenda, and the EU Commission is looking at ways to guarantee a stable and diverse supply of gas to the EU whilst reducing dependency on Russian gas.

The EU Commission believes that security of gas supply requires a fully transparent, liberalized and connected EU gas market. The Gas Energy Package and PCIs are aimed at promoting security of energy supply over the long term. In 2009 the European Energy Programme for Recovery was set up to support the building of missing infrastructure links with around Euros 1.4 billion allocated to gas projects. The 2010 Security of Gas Supply regulation requires natural gas undertakings to secure supplies to protected costumers (notably households) under severe conditions, and Member States have to develop preventive and emergency plans for short term shortages.

The progress in the EU towards security of gas supply is by no means insignificant, but the EU Commission recognizes a lot remains to be done. The following are some of the key outstanding challenges for EU security of gas supply:

• Development of competitive and well integrated markets in the Baltic States and South East Europe lags behind;
• CEE gas markets remain small and poorly integrated/many landlocked;
• Gas trading infrastructure in CEE is relatively immature;
• Absence of energy hubs in SW Europe and CEE; and
• Inter-connector rates are still low.

Possible Impact of European Shale Gas

Europe has significant shale gas resources, although the estimates vary greatly. In 2013, the US Energy Information Administration estimated that Europe has 470 tcf (13.3 tcm) of technically recoverable shale gas reserves, compared to 567 tcf (16 tcm) in the US. The EU Commission has acknowledged that shale gas could partially compensate for declining conventional gas production, however development of an EU-wide policy on shale gas is still in its infancy, and there is a lack of consensus on shale gas development across EU Member States. To date, shale gas exploration in Europe has been minimal.

Poland is the most advanced EU Member State in terms of shale gas exploration. The US EIA has estimated that Poland's shale formations hold 148 tcf of technically recoverable reserves and are enough to supply domestic consumption for 250 years. However, Poland's shale gas sector has recently experienced a number of set-backs including disappointing well results causing a number of major players, such as ExxonMobil, to exit. The major EU economies of France and Germany have both imposed moratoriums on hydraulic fracking. The UK Government, on the other hand, supports shale gas development and has introduced tax incentives to promote investment in the sector.

Some of the hurdles for shale gas development in Europe (particularly when compared to the shale boom in the US) include:

• Absence of a clear legal and regulatory framework at both the EU and Member State level;
• Public opposition to drilling activities due to environmental concerns is greater in Europe than in the US. Over the last few years there have been major protests against fracking in Bulgaria, France, Germany and the UK;
• Costs of shale gas exploration are higher in Europe than the US due to harder geology and the absence of a large onshore oil services industry which has created a competitive market in the US;
• The government typically owns mineral resources in Europe. Unlike in the US, the government rather than individual land owners gets the benefit of shale gas production, which reduces the incentive to permit shale gas activities on privately owned land;
• Western Europe particularly is densely populated with fewer available development sites away from communities; and
• Shale gas resources are often a long way from existing infrastructure to transport the gas to end markets, particularly in Eastern Europe.

Possible Impact of US LNG

The subject of who will buy US LNG exports when they start in late 2015/early 2016 is being widely discussed by the energy community. In Europe, the EU Commission and gas suppliers are considering whether US LNG can help with the EU's concerns over long term security of energy supply.

Europe has 22 LNG regasification terminals (excluding small scale LNG) with a total capacity of approximately 200 bcm/year at the end of 2013, most of which is in Western Europe. Since 2009, average capacity utilisation rates in European regasification terminals have fallen dramatically to about 25%. This drop is largely due to stagnant demand for natural gas in Europe as subsidised renewables and cheap coal squeeze gas out of power generation, and strong demand for LNG and higher prices in Asia and Latin America combined with weak demand and lower prices in Europe.

To a large degree, any view on where US LNG will be consumed is speculative as most of the existing sales commitments for US LNG are on an FOB basis (and hence the destination is unknown). The widely held view in the market is that Europe is not a prime market for US LNG, as Europe cannot compete with Asia on price. At a recent London Stock Exchange breakfast briefing on Europe's energy future, the message was clear that LNG will fail to dominate the European gas sector and cannot be an absolute guarantor of energy security. Some analysts predict that the US will supply a significant amount of LNG to Europe. However, Marina Petroleka, Business Monitor International's (BMI) head of energy and infrastructure research has said that although US LNG would "assist" the European Union in its goal of diversifying its gas imports away from Russia, "a lot of the talk is pure hyperbole."

Nina Howell
London
+44 20 7551 7543
nhowell@kslaw.com
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