Energy Transit: Experience and Perspectives Report of the Ifri's Tuesday in Brussels on November 18, 2008

Ralf Dickel, Director of Trade and Transit at the Energy Charter Secretariat, started his presentation by outlining some basic facts about energy transit. First of all he defined the notion of energy transit, referring to Article 7 of the Energy Charter Treaty (ECT): that energy transit is the carriage of energy materials through the area of a contracting party (i.e. a national state). Energy transit issues concern all forms of energy, be it resources like oil and natural gas, or a final product like electricity. Mr. Dickel underlined however, that there are important differences between the transport of oil, gas and electricity and that compared to oil, the transport of natural gas is specifically more expansive and needs a highly complex infrastructure for distribution. In the following, Mr. Dickel concentrated mainly on gas transit, as this is the trickiest issue in the context of energy transit.

The very definition of gas transit raises one important question in Europe: due to the existence of the single market in the EU, it can be disputed if the transport of gas inside the EU across a specific member country should be considered as transit. This is a crucial point of discussion between Russia and the EU, as Russia considers the transport across single EU countries as transit, but the EU, in the context of the draft Transit Protocol discussions, does not. This problem needs to be put into the context of the future’s increasing needs for gas imports by the EU, and the resulting transit requirements.

There is a growing need for the EU to import gas by long transit pipelines. Transporting gas through long international pipelines constitutes a specific feature of the European gas market (as compared to Asia and North America, where imports are almost exclusively by LNG).

Ralf Dickel recalled that the need for transit is more often linked to the creation of new transport capacity and decisions to build new transit pipelines, than to questions of access. Economically, there are no reasons to build spare capacity, so there is usually no spare capacity available. Investments in transport pipelines indeed have a high specificity compared to other investments as they are very capital-intensive and decisions are taken in a very long-term perspective: a pipeline has to be fully used for a long time in order to be cost-effective, and cannot be used otherwise than for transportation related to a specific project. Because of that high specificity of investment, partners in such projects (from producer, transit and consumer countries) need to cooperate for a long time and protect themselves against obsolescent bargaining, as the power balance is changing once a pipeline is built. Protection of specific investment or other long-term decisions against obsolescent bargaining is one of the crucial philosophies of the Energy Charter.

The role of economics and politics

In recent debates, the political aspects of pipelines often dominate. But according to Ralf Dickel, one should not forget the basic transport and pipeline economics, which are as important as political considerations, and may even prevail. This is due to the fact that transport costs constitute a high share in the market value of gas. It is interesting to note in this context that high transportation costs, especially in a system of replacement value / net back pricing, are at the expense of the resource rent and so mainly hurt the supplier. The transport costs are mainly determined by the huge investment costs of pipelines and the costs of financing. What is more, pipelines tie a specific production to a specific market, and implies a risk of obsolescent bargaining e.g. by transit countries. LNG projects also have very high costs, but their operation is more flexible than in the case of pipelines.

Our speaker then analysed the interests of the different players in the “transit game”: that the export country is interested in a reliable income and in maximising its resource rent as a compensation for the depletion of a finite resource. The transit country mainly seeks protection against risks and negative impacts on public health and the environment. It has a right to cost recovery for the transport service and to levy transit fees in line with the taxation scheme of the transit country or services rendered by the transit country, but in line with the principle of freedom of transit (GATT V), it cannot expect the payment of a scarcity rent. In brief, a transit country has a more limited interest in transit compared to the resource holder and the consumer, which can explain the problems sometimes arising from transit. The consuming country wants secure supply at competitive prices, and consumer countries are also interested in the taxation of the consumers.

Whether a pipeline is built onshore or offshore has important consequences on transit issues, as the permits for onshore pipelines are more difficult to obtain, especially for transit purposes. In the case of onshore pipes, the interested parties often need to obtain permission from the private land owners, which can prove very difficult, and in the end need recourse on the legal instrument of eminent domain to ensure the right of way all along the pipeline route. In the case of offshore pipes, the interlocutors that apply for construction permissions and deal with national environment obligations must be states represented by their Governments when the pipeline route is within the territorial waters or the economic zone.

Concerning the political aspects of gas transit, Mr. Dickel underlined the special case of pipelines linking Russia to Europe. Usually pipelines are designed and built taking into account existing national borders. This is obviously different in the Russian case, as the breakup of the USSR created new borders that transformed many of the existing domestic (Soviet) pipelines into cross border and transit pipelines. In consequence, the issue of transit, barely existing before, has become very important since 1990. Moreover, the main delivery points of Russian gas (Baumgarten and Waidhaus), which used to be on the border between the COMECON space and the EU, are now inside the EU because of the EU’s enlargement to the East.

Ralf Dickel raised the issue of gas storage, which has come to the forefront in recent debates about supply security. According to our speaker, the discussion about supply security is much of a phantom discussion, as there was no real problem concerning the security of Russian gas deliveries to the EU since their start. Russia (and respectively the USSR before 1991) never failed to deliver the contracted quantities of gas since deliveries to EU countries began in 1973. Concerning the current discussion on creating security of supply storage capacity in Europe, Ralf Dickel underlined the opportunities of the existing large, partly underutilised, storage capacity at the Western border of Ukraine, close to the delivery point of Russian gas to the EU, as well as the large production capacity of the Groningen field close to the inlet point of the Norwegian gas.

International legal frameworks for transit: GATT/WTO and ECT

Article V of GATT 1947, sets forth the principle of the freedom of transit on a basis of non-discrimination. It further stipulates that goods in transit should be exempt from customs or transit duties. But these rules are not well adapted to energy transit, as they do not take into consideration the specific need of fixed infrastructure for gas, landlocked oil and electricity. Furthermore, WTO rules do not specifically address energy issues either. So the Energy Charter is the first and only multilateral framework that explicitly addresses energy transit in its Article 7, which specifies general GATT/WTO rules to energy transit, especially with respect to the need for fixed infrastructure. The rules of transit have been further elaborated in the draft Transit Protocol of the ECT. A basic text of this draft protocol was finalised in 2002 (document CC251, which is publicly available on the Energy Charter’s website), but the consultations on three remaining points are still ongoing in a multilateral framework: the aforementioned issue of the status of energy transport inside the EU is the major open point. So it remains to be seen what solution can be found to accommodate Russia’s concerns within the acquis communautaire. In any case, one needs to stress that the freedom of transit for grid bound energy will never be absolute, and that it should be defined in a non-discriminatory way by rules e.g. applying to health, social and environmental issues.

Mr. Dickel’s presentation was, as usual, followed by a question & answer session with the public. Questions touched upon issues like political interference in the Russian energy sector, the Energy Community in South-Eastern Europe, the need for investments in further transit capacities and the added value of the ECT compared to other international organisations like the WTO and the IEA.