Workshop Review: Davide Tabarelli – Italian Energy Security and the Missing South Stream

by Filippo Verdolini

On October 3rd the European University of Saint Petersburg hosted a prestigious round table discussion. The main topic was energy security, specifically “Pan-European Energy Security in the Post-Ukraine Crisis: Future Scenarios and Possible Solutions”. Experts from different countries and with different backgrounds were invited. Divergent points of views and interests were shared through an interesting and highly informative debate.

Being Italian, I paid particular attention to the topic brought up by one of the guest speakers – Professor Davide Tabarelli at the University of Bologna, and president of Nomisma Energia, an independent research company that deals with energy and environmental issues and is committed to understanding energy markets and their short- and long-term trends. He spoke about the Italian approach to the current gas crisis, focusing on the “bel paese, ” (literally ‘beautiful country’) energy strategy and on the importance of the South Stream gas pipeline (which has since been cancelled) for Italy and southern Europe.

Professor Tabarelli spoke about the Italian approach to the current gas crisis, focusing on the “bel paese, ” (literally ‘beautiful country’) energy strategy and on the importance of the South Stream gas pipeline (which has since been cancelled) for Italy and southern Europe.

Understanding the “bel paese” energy strategy requires an understanding of the current Italian energy situation. As such, I will briefly outline the Italian energy sector. It will be followed by a description of the South Stream pipeline and the issues related to it that caused Russia to pull out of the project. After the description of South Stream, I will provide the highlights from Professor Tabarelli’s presentation at European University, and will close with conclusions about Italian’s current energy situation.

Overview of energy in the “bel paese”

Italy’s Primary Energy Mix:

  • Natural Gas Consumption: 82.981 bcm/year
    • Imports: 75.431 bcm
  • Oil Consumption: 1.54 million bpd
    • Imports: 1.39 million bpd
  • Coal Consumption: 23.12 metric tons
    • Imports: 23.07 metric tons

Italy is currently affected by a serious social, political, and economic crisis. Organizing a well-shaped energy strategy to Italian needs is a greater challenge now than it has previously been. Following the 1978 referendum on the abolition of nuclear power from the Italian energy mix, the country’s energy policy has grown increasingly complex, formed by a large number of decrees, rules, and regulations, often not tied to a cohesive long-term plan. Various laws have been enacted to comply with European regulation or to correct old policies. The tangled maze created reflects the similarly complex political and economic situation. In 2010, after the Gulf of Mexico oil spill disaster, the Italian Government banned offshore operations, rendering worthless Italy’s 1.4 billion barrels of proven oil reserves and 2.3 trillion cubic feet (Tcf) of proven natural gas reserves.

Italy is a net importer of hydrocarbons (oil and natural gas), so it is heavily dependent on imports to meet its energy necessities. It is important to note that 88% of domestic demand is met with energy imports. For example, net imports of crude in 2013 were over 1.1 mb/d. Whilst Italy is a major refining center in Europe, with the second largest refining capacity (2.1 mb/d) after Germany, Italian refineries are now at risk because of the decreasing consumption of petroleum products, whose markets are losing out to gas and renewables (expected to be 23% of primary energy consumption by 2020) and by strong competition from Asia, where the process of refining is cheaper and less regulated.

There have never been major historical and geopolitical controversies between Italy and Russia. As such, last May ENI and Gazprom signed the first non–oil indexed gas contract in 50 years, which brings a favorable discount for the Italian company.

With regards to natural gas, Italy is the second largest importer in Europe after Germany. Imports in 2013 were around 2.2 trillion cubic feet and most of the imported gas comes from Algeria and Russia via pipelines like TransMed and TAG. Italy was considered by Gazprom as a possible end point of the South Stream pipeline project. Additionally, imports of natural gas from Russia are around 25.32 bcm, which amounts to almost 36% of Italy’s gas consumption.

The largest Italian energy companies are ENEL and ENI. The former is Italy’s largest power company and second largest in Europe vis-à-vis installed capacity – it produces, distributes, and sells gas and electricity. ENEL is also the second largest Italian operator in the natural gas market and is partially privatized. ENI is about 30% owned by the government, 3% by the state Treasury, 26% by the Italian bank Cassa Depositi e Prestiti. Another 2% belongs to the People’s Bank of China. The remaining 39% is divided among other institutional investors and retail. Whilst the EU is constantly pushing for diversification away from Russia, Italy is more pragmatic about its bilateral relations with Moscow. Italian firms believe that marginalizing Russian gas supplies to comply with a pan-EU vision of supply security is unrealistic. ENI has been active in Russia since 1969 and it is one of the main international partners of Gazprom. There have never been major historical and geopolitical controversies between Italy and Russia. As such, last May ENI and Gazprom signed the first non–oil indexed gas contract in 50 years, which brings a favorable discount for the Italian company. The only times Italy has suffered an interruption or a reduction of gas flows coming from Russia was in 2006 and 2009, which were due to the two Ukrainian gas crises. This demonstrates that Russia is a reliable partner for Italy, which has never been directly targeted. For some Europeans these two crises can be considered as evidence that the Russian Federation is not as reliable as Italy thinks.

Importance of the gas crises for South Stream development

In 2006 Russia wanted to create a balance between the prices of gas sent to the EU and to Ukraine. There was a three-day long cut and ENI announced a 24% import reduction of Russian gas. In 2009, Russia and Ukraine failed to agree on a price for gas supplies or a tariff for the transit before the end of the previous contract (31 Dec. 2008). The 1st of January saw exports to Ukraine cut off. From the 7th to the 22nd of January no gas transited through Ukraine to 16 EU member states, Italy being one of them. Around 65.2 billion cubic meters of gas was lost and Europe was in panic. The expectation of a future interruption worries both European countries and Russia. These two crises were the main reasons from which the decision to create two new pipelines bypassing Ukraine came. The two gas pipelines are Nord Stream and South Stream. The combined maximum capacity of the two pipelines is the exact amount of the flow passing via Ukraine: 110 bcm (N.S.) + 63 bcm (S.S.)= 173 bcm. The fact that these pipelines both add up to Ukraine’s capacity is no coincidence, and it shows that Russia is committed to avoiding similar events such as the two Ukraine crises in 2006 and 2009.

South Stream and its failure

The pipeline project was sponsored by Russia and strongly supported by Italy. It should not come as a surprise that the Memorandum of Understanding for the construction was signed in Rome by the former CEO of Italian energy company ENI, Paolo Scaroni, and the vice-chairman of Russian Gazprom Alexander Medvedev in 2007. Under the agreement, the existing contracts for Russian gas supplies to Italy were extended to 2035. More intergovernmental agreements were signed between 2008 and 2010 between Russia and other interested countries. South Stream’s offshore section (with a total length of 930 kilometers) would have run along the floor of the Black Sea through the exclusive economic zones of Russia, Bulgaria and Turkey. The maximum depth would have been more than two kilometers and the design capacity 63 billion cubic meters. The onshore section was supposed to cross Bulgaria, Serbia, Hungary and Slovenia. The gas pipeline planned end was the Tarvisio gas metering station in Italy. Gas branches from the main pipeline route were meant to be built toward Croatia and to Republika Srpska (the state within Bosnia and Herzegovina).

In December 2012, construction of the South Stream gas pipeline started in Russia in the Krasnodar Territory. At the end of October 2013 the first joint was welded in the Bulgarian section. The month after, construction was launched in the Serbian section as well. The first gas supplies were expected in late 2015. But before piping the gas, there were some legal issues that had to be solved, for instance, energy producers also owning transmission networks (ownership unbundling). There were other issues related to South Stream that breached several EU rules, such as the EU’s state aid rules; for instance, Bulgaria had committed to provide a most favorable tax regime to Gazprom.

The European Union, now that the South Stream project has failed, will have to deal with Turkey to bring gas inside its borders. Of course this is an indirect effect of the current crisis between Russia and the West.

These projections were made before the advent of the latest Ukrainian crisis and the consequent sanctions. With the West, Russian relations are getting more and more tense, a worrying development that made Mikhail Gorbachev, former Soviet Union leader, warn of the risk of a new Cold War. This considerably affected the political viability of the South Stream project; the European Union Commission forbade carrying on further construction. A clash between the EU Commission and its member countries interests is ongoing. For instance, Hungary’s parliament recently (November 3rd) approved amended legislation aimed at circumventing EU law, opening the way for the construction of the pipeline section on Hungarian territory. This situation of stalemate and indecision increased Russian frustration. The European Union’s inability to take a decision and separate politics from business led the Russian Federation to search for more viable alternatives. This is how the Russian decision came, at the beginning of December 2014, to withdraw from South Stream, planning another pipeline toward Turkey. The new project would run toward Turkey, making it a natural gas hub instead of Bulgaria. The planned capacity is the same as South Stream had. The main goal remains to bypass Ukraine. The European Union, now that the South Stream project has failed, will have to deal with Turkey to bring gas inside its borders. Of course this is an indirect effect of the current crisis between Russia and the West. South Stream would have been a win for the European side, with more than one country benefitting from the pipeline, but the EU chose to save Ukraine over its own interests.

 

South Stream’s planned route. http://www.south-stream.info/route/maps/.

 

Professor Davide Tabarelli

In this section, I will paraphrase what Professor Tabarelli said in his October 3rd presentation at European University:

Italy is part of Europe, and we can show that when there is common ground and economic interests to share, civilization can be built. Italy and Europe are together and share important cultural, economic, and political ties – which underlines interdependency. Importantly, however, Italy has different interests, which have key implications for natural gas policy. In Italy gas is used mainly for power generation and constant electricity supply is at the base of a country’s economic power. So what is of concern here is the security of supply, one of the main pillars of the New Italian Energy Strategy, approved in March 2013. This goes along with new environmental targets, economic growth and competitive prices. These goals are in accordance with the European Union, and are conflicting with each other. First, increasing the share of renewable energy requires a strong political will, and significant financial efforts, due to the necessary subsidies and the following high prices for consumers. An increase in energy prices for industries and households means a decrease in competitiveness of the Italian (and European) economy, which is important, as Italy is the 2nd largest manufacturing economy of Europe. In Italy the actual cost of electricity is 20 Euro cents/kw hour, compared to 6 in the U.S.A. and 4 in China. Besides importing gas from Russia, Italy can rely on few other options to receive gas, for instance:

  • S.A.: the price of their gas will be too costly.
  • Algeria: politically unstable and Italy is scared of a Libya 2.0 episode.
  • Iran: when will it be able to supply gas again?
  • LNG: Italy has 3 regasification terminals operating at only 45% of their capacity.

Russia remains the only stable main supplier. The Kremlin can’t easily shift toward east as claimed by the media. The recent gas deal with China is not that simple to implement, and may be supplied by different networks and gas fields. Time, routes, and control over the pipelines are crucial questions waiting for an answer. Russia is part of Europe, it is part of the European gas market, and is able to provide the cheapest gas, having the cheapest production costs. It does not make sense for Italy to move away from the lowest-cost supplier.

“Russia is part of Europe, it is part of the European gas market, and is able to provide the cheapest gas, having the cheapest production costs. It does not make sense for Italy to move away from the lowest-cost supplier.”

However, several observers at the conference raised doubts about the economic viability of the South Stream project – considering it unreasonably costly without concrete assurance of the future gas demand of European countries – as such its construction would be a mistake. Another idea opposing South Stream is related to the suspicion that Gazprom needs the pipeline only for geopolitical reasons, in other words, to prevent the construction of rival projects like the Southern Corridor, the Nabucco and more pipedreams which are devised to pipe gas to the same market. In Italy antagonists of South Stream are pointing out that first, it would merely diversify the origin of the gas, and second, that transit problems can occur in the Balkan states as well. In addition, more criticisms are raised stating that the Italian government backed South Stream, and not Nabucco, because of a convergence of interests with ENI, not because it was more efficient in securing Italian energy needs and security. Defending South Stream, it can be said that the other pipelines endorsed by the European Commission were either as expensive or wouldn’t have been able to work at full capacity.

“South Stream [would have been] the most practical project for Italy, as Gazprom [would have taken] the bulk of the costs, and other countries [would have benefited] from this too. Moreover, other pipelines such as Nabucco, have failed to materialize.”

Nonetheless, given the cautious expectation of a recovery in the Italian economy, more gas will likely be needed in the future. New infrastructure is needed to cope with this increase in demand. South Stream [would have been] the most practical project for Italy, as Gazprom [would have taken] the bulk of the costs, and other countries [would have benefited] from this too. Moreover, other pipelines such as Nabucco, have failed to materialize. In summary, Italy and Europe are simply postponing the problem of inadequate infrastructure due to a (potentially temporary) fall in demand; whether Europe desires it or not – Russia is going to be our main energy supplier and Italy must adapt policy to this reality.

Conclusion

One of the other guest speakers at the October 3rd conference enlightened us with a statement about European energy needs: if we consider the overall gas need with a projection to 2030 and the capacity provided by proposed LNG terminals, Europe will have 900 bcm import capacity (factoring in the cancelled South Stream), when only 300 bcm will be needed. The best way to strengthen the European Union and Italian energy security will be to create alternative choices for consumers. For instance, we never read or hear complaints and fears about oil or coal. That is because Europe and Italy have different options from where to import, and it is much easier to transport them compared to natural gas. The speaker commented that as Europe seeks a more liberalized market and more competition, sticking to the rules of a competitive market it should buy gas where it is sold at the cheapest price: that means it would buy it from Russia anyway, whatever the route or the way the gas will be sent. So, even if South Stream would have brought useless additional capacity for Italy, it would probably have been used if built, as it would have piped the cheapest gas available in the market, leaving behind the troublesome Ukraine.

In conclusion the South Stream project has been shut down. Italy needs to consider its own interests above those of the European Union, which should have recognized the potential gains from the South Stream pipeline and should have worked towards its implementation. However, to strengthen its energy security, Italy should also create infrastructure and a political situation that allows it to have alternative choices in the face of supply crises – through a liberalized and more competitive market of diverse supply (such as coal or alternative energy).

Filippo Verdolini is a master’s student in the ENERPO program at European University at St. Petersburg. 

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