Energy security quest in Central and Eastern Europe. Achievements and challenges

The European energy sector is in the process of profound transformation which will shape its profile for decades to come. Changing global environment, the perceptions of energy itself, technologies and innovations, new sources of conventional, but also renewable energy, require an adequate answer from the European energy companies but also states and international institutions. There is a number of issues we should tackle in coming years, and one of the crucial ones is how to secure energy supplies, in order to provide our customers with stable ones and in affordable prices.

These issues are of utmost importance for Central and Eastern Europe where energy security, due to history, but also geopolitical factors, always stands high on the agenda. The disruption in gas supplies witnessed in recent years, the ongoing Russia-Ukraine conflict and Gazprom’s announcement to halt transit to Europe through Ukraine after 2019, result in persistent uncertainty over the stability of Russian gas supplies to Europe.

These concerns are amplified by preparations to build new lines of the Nord Stream gas pipeline as well as the European Commission’s recent decision to grant to Gazprom increased capacity usage of the OPAL pipeline. There is also an ongoing debate on a proposal for a revised, based on a more regional approach, regulation on the security of gas supply.

Meanwhile, the security of electricity supply draws more and more attention. The adequacy of traditional generation capacities and the stability of power grids in Central and Eastern Europe are under severe pressure due to ageing, low wholesale prices, the expansion of renewables, uncontrolled loop flows and the EU’s climate policy. Moreover, the European Commission has just presented a package Clean energy for All Europeans covering new electricity market design and security measures, which could profoundly reshape how power is generated, traded and transported.

In this dynamic context fundamental questions are being raised. Is Central and Eastern Europe prepared for potential gas and power supply disruptions? How real is this threat, and how can we mitigate potential risks? What should be on the agenda in light of the different interests and approaches to energy security within the EU? What is the role of the regional cooperation in this area?

This brief policy paper will not answer all these questions. We would rather draw your attention to the peculiarities of energy markets in the region, as well as would present the main achievements and new challenges for energy security. We particularly focus on the Visegrad Group countries (Poland, the Czech Republic, Slovakia and Hungary) as well as on Ukraine, which is an indispensable part of any debate over energy security in the region. We also concentrate our analysis on gas and electricity, as these two sectors are currently the focal point of energy security debate in Europe.

 Snapshot of energy markets in Central and Eastern Europe

Central and Eastern Europe represents a diverse energy region, with some common traces and challenges ahead. The national markets significantly differ in size, as well as in their energy consumption. For example, Poland or Ukraine alone consume more energy than the Czech Republic, Hungary and Slovakia all together[1]. Slovakia has a well-balanced energy mix, Poland and the Czech Republic rely very much on coal, whilst Hungary depends on nuclear power to a large extent. Ukraine is somewhere in between with high coal and gas shares in primary energy consumption (See Figure 1). Among other CEE countries, Romania possesses larger indigenous sources, mainly natural gas and coal, while Estonia produces energy mainly from oil shale and Latvia has a high level of renewables (37%).

[Tweet "All countries in CEE have experienced stagnation and even decline of their energy consumption in recent years"]All countries in CEE have experienced stagnation and even decline of their energy consumption in recent years. It is worth pointing out that Ukraine has been dramatically slashing its energy demand – its total primary energy supply in 2014 (105.6 mtoe) was more than 30% lower as compared to 2010[2]. This is mostly due to severe economic crisis as well as military conflict in Donbas, where an energy–intensive industrial complex is situated.

As far as the supply side is concerned, there is a clear split over import dependency factor across the region. Estonia and Romania have one of the lowest in the EU (9% and 17% respectively in 2014) due to their oil and gas reserves. Poland and the Czech Republic have abundant and relatively cheap domestic energy resources (mainly coal), so imports usually cover only around third of energy consumption. Slovakia and Hungary depict a reverse picture, with around 60% overall import dependency, which is above the EU average. The worst off is Lithuania with close to 78% import dependency[3]. The common feature is that all of the CEE states has experienced gradual increase in their import dependency in recent years, following a general trend of the EU. Ukraine has moderate overall import dependency and has steadily decreased it (from 38% in 2010 to 32% in 2014[4]) which mirrors the general trend of falling energy consumption in Ukraine.

Overview of gas markets

The EU-11 jointly consumed around 62 bcm in 2015, which constituted around 14% of gas consumption in the EU. Adding Ukraine to the group, increases gas consumption in the region to 92 bcm. Ukraine and Poland are the largest markets with consumption in 2015 of around 34 bcm and 17 bcm respectively.

Data shows that gas consumption in all V4 countries except Poland is generally in decline. Only in Poland, there seems to be foundations for gas demand growth in the next decade mainly due to preparations to build gas power plant stations[5]. Meanwhile, gas consumption in Ukraine is in the process of a sharp drop – consumption in 2015 was almost halved compared to 2010 (See Figure 2).

[Tweet "The EU-11 jointly consumed around 62 bcm in 2015, which constituted around 14% of gas consumption in the EU"]All gas markets in Central and Eastern Europe share several common features, which are the main reasons for their similar problems. CEE in general is exceedingly dependent on Russian gas supplies, and have limited domestic production with the exception of Ukraine and Romania (producing around 20 and 10 bcm in 2015 respectively) (See Figure 3). CEE started in recent years to buy gas from the Western direction (EU internal trade) and in this sense decreased region’s dependency on Russian gas at least from a contractual point of view (not from the perspective of the physical origin of molecules). It is worth mentioning here that Ukraine is the most striking example of a move away from Russian gas. Gazprom supplied Ukraine with 14.5 bcm of gas, and 5.1 bcm came from the EU in 2014, whereas the proportions were reversed in 2015: the EU supplied 10.3 bcm, while Russia 6.1 bcm. Moreover, Ukraine entirely stopped importing gas from Russia in late 2015 and currently secures its supplies only from domestic production and EU imports.

[Tweet "The majority of CEE’s gas markets have a strong transit character due to its geographic location and historical development of the infrastructure"]The majority of CEE’s gas markets have a strong transit character due to its geographic location and historical development of the infrastructure. Gas infrastructure is still mainly East-West oriented, which is a legacy from the communist times, whereas connections on the North-South axis are limited and are used mainly as an emergency connections. In fact, three out of four main gas pipeline systems from Russia to Europe are located in the region: Brotherhood (Russia-Ukraine-Slovakia-the Czech Republic with subsections from Ukraine to Hungary), Yamal-Europe (Russia-Belarus-Poland to Germany) and Trans-Balkan pipeline (Russia- Ukraine-Moldova-Romania-Bulgaria).

The only one way of Russian supplies which bypass the CEE region is Nord Stream (See Figure 4). In a transit of Russian gas deliveries to the EU, Ukraine plays a crucial, as the transit gas flows amounted for 67.1 bcm or 66% of Gazprom’s total deliveries to Europe in 2015. As far as storage infrastructure is concerned, the dispersion of capacities in the CEE region is uneven. There are several underground storages in Ukraine with total capacities of 32 bcm/y, which currently attract the attention of European companies i.e. ENGIE. The EU-11 have a joint storage capacity of almost 23 bcm/year – the most developed systems are in Hungary (6.1 bcm) and the Czech Republic (almost 4 bcm).

Gas markets in CEE are still at a low level of development. Gas trading on exchanges and virtual trading points is gradually developing, but there is no gas hub comparable to the other hubs operating in Northern and Western Europe. There is also a low level of competition. Price regulation for households, as well as small and medium-sized enterprises, is a common standard across the region. In the V4 only the Czech Republic totally liberalised gas prices in all segments of the market. As a result consumers’ switching rate in retail markets are negligible, except in the Czech Republic.

Achievements and challenges for gas markets security

After the major gas supply disruptions in 2006 and 2009, the V4 has significantly strengthened their gas grids and increased interconnectivity, both within the region and with other EU countries. Poland completed its flagship LNG terminal project in 2015 (import capacity of 5bcm/y), thus creating the preconditions to bring a completely new source of gas into Central Europe. It also introduced reverse flows on its main transit pipeline, Yamal-Europe, which allows for gas imports from Germany. The Czech Republic and Slovakia [Tweet "Hungary has built new interconnections with almost all neighbours"]did the same on their sections of the Brotherhood pipeline. Hungary has built new interconnections with almost all neighbours: Croatia (2010), Romania (2011) and Slovakia (2014). All of these investments largely improved gas system resilience to potential supply disruption and all V4 countries fulfill infrastructure security standards (N-1). A much more difficult situation remains in South-Eastern Europe – Romania and Bulgaria made first steps in 2016 to open and reverse the main transit pipeline. In Baltic countries there is still no major improvements in connections with other CEE states. However Lithuania in 2014 launched its LNG terminal “Independence” (FSRU) and is planning to build interconnection with Poland - GIPL (Gas interconnector Poland-Lithuania).

[Tweet "Ukraine succeeded with the establishment of reverse deliveries from the EU with a total import capacity of 21 bcm/y"]As far as Ukraine is concerned, it succeeded with the establishment of reverse deliveries from the EU with a total import capacity of 21 bcm/y (the main channel is Slovakia with capacity of 14.5 bcm/y). Moreover, access to the EU gas markets enabled Ukraine to diversify supplies and to trigger competition. In 2015-2016 wholesale supplies were provided by more and more companies, including key European players such as ENGIE, Statoil and E.On. But the biggest success has been the quick adjustment to the EU gas market model. Ukraine has transposed most of the EU third energy package into its legislation, however, the unbundling of national gas company Naftogaz remains the key unsolved issue, but there is already a well-prepared plan to introduce it in 2017.

These achievements would not be possible without the establishment of regional and bilateral gas cooperation, which is another success in the region. V4 cooperation proved to be detrimental in the establishment of bidirectional gas flows and the drafting of main gas pipelines plans as a single concept – North-South Gas corridor –supported by the European Commission, which allowed the acquisition of PCI status for main interconnectors, and thus paved the way to get EU financial assistance. The North-South corridor is aiming to change the perception of gas flows in the region from East-West oriented towards North-South. Meanwhile, in South-Eastern Europe in 2015 the CESEC initiative was established, defining the main priority projects in the region, and became the main forum for the improvement of harmonisation of rules and a more transparent network access on cross-border interconnection points.

[Tweet "A key challenge in the CEE region is maintaining the profitability of gas transit systems in light of Gazprom’s plan to build Nord Stream 2"]One of the key challenges in the CEE region is maintaining the effectiveness and profitability of gas transit systems in light of Gazprom’s plan to build Nord Stream 2 project and fully stop the transit of its gas to Europe via Ukraine (and thus via Slovakia, partially the Czech Republic and possibly also Poland). From a purely financial perspective, this would mean considerable decrease of income for Ukraine (1.8 bln EUR/year) and Slovakia (i.e. circa 400 mln EUR/year) as today’s main gas supplies routes (Brotherhood and Yamal) will remain void. This loss of income could hamper gas infrastructure modernisation, which is especially necessary in Ukraine. More importantly, Nord Stream 2 would limit the number of supply corridors to Europe as in the long run, Russian gas exports to European consumers could be transferred to one spot in Germany, circumventing not only Ukraine, but also Central Europe. Consequently, CEE countries will be exposed to even more monopolisation of its markets by Russian gas, which will be the only one which can be bought from the East but also the West direction.

Moreover, the project undermines the solidarity principle and trust within the EU and would harm the EU-Ukraine partnership. The recent decision to allow Gazprom higher capacity of Nord Stream on land leg, the OPAL pipeline, threatens even more the CEE countries (the decision was severely criticized mainly in Poland and Ukraine) as it allows to spread Russian gas, form Nord Stream, to the Central Europe through Germany.

Another challenge is completing the missing links in regional infrastructure. There is no interconnection between Poland and Slovakia and Poland-Lithuania whatsoever. On the many interconnections there is no bidirectional mode (Croatia-Hungary, Romania-Hungary). This limits the chances to diversify supplies further and keeps the regional markets quite fragmented. Plans to build a Poland-Slovakia and new Polish-Czech interconnector (STORK 2) face significant challenges due to a complex regulatory environment and lack of strong market interest. In turn, the Czech Republic invested heavily in gas infrastructure in recent years and shows little appetite for any new investments. Hungary looks mostly towards better utilisation of the existing infrastructure and is also rather skeptical about new grandiose projects.

In this landscape, the Northern Gate project promoted recently by Poland, combined with LNG terminal in Swinoujscie, remains the only one which is truly willing to diversify the sources and routes of supplies to Central Europe, bringing through Denmark, the Norwegian gas to Poland and Central Europe.

In turn, Slovakia promotes Eastring transit pipeline between Slovakia, Hungary, Romania to Bulgaria (with possible de-route via Ukraine) in order to create a link between Western gas hubs and Balkans, but the project is still under the preliminary studies.

Finally, the key challenge is how to maintain market reforms and stimulate competition. There is widespread consensus that even with “hardware”, i.e. gas infrastructure, markets will not be functional and thriving unless there is “appropriate software” - transparent, stable and harmonised regulations across the region.

The Visegrad Group started to move in this direction by adopting the Roadmap towards a regional gas market in 2013, which envisioned – despite infrastructure development - the preparation of joint risk assessments and emergency plans, harmonised implementation of network codes and discussions over possible implementation of the EU gas target model. Nevertheless, there has been so far very little progress in these areas.

Overview of electricity markets in Central and Eastern Europe

Gross electricity generation in EU-11 was almost 448 TWh in 2014. The largest electricity producers in the CEE region are Poland (159 TWh in 2014), Ukraine (157 TWh), the Czech Republic (86 TWh) and Romania (66 TWh).  In 2010-2014 there was a general EU pattern of falling electricity generation, but few CEE countries actually increased net electricity generation, namely Romania, Poland, the Czech Republic, Slovenia and Bulgaria. As far as Ukraine is concerned, due to economic crisis and large territorial losses to Russia, its role in CEE production is decreasing.

[Tweet "There are strong differences in the national electricity production mixes across the region"]There are strong differences in the national electricity production mixes across the region. Poland has traditionally the highest share of solid fossil fuels (mainly hard coal) in electricity production (83.7% in 2014). Nuclear power is the main source of electricity production in Hungary (54.5%) and Slovakia (50.8%). In the Czech Republic nuclear energy plays an important role as well (35.3%), but solid fuels remain the key source for power generation (47.9%). In Ukraine 56% of electricity was produced by nuclear power plants, 39% by thermal power plants as well as combined heat and power plants, while 4% from hydroelectric power plants in 2015.

As the EU-11 economies grow and begin to catch up with their Western partners, it is expected that electricity consumption in the region will rise in the coming years. Power grids in CEE region are usually outdated with several important missing links. V4 countries have very well developed cross-border infrastructure. EU interconnection goal (at least 10% of the installed electricity production capacity by 2020) has already been reached by Slovakia (61%), Hungary (29%) and the Czech Republic (17%), while Poland (less then 10%) has finalised in 2015 its LitPol DC interconnection with Lithuania (different synchronized system). Ukraine, due to having a different electricity system, is poorly connected with EU countries from the CEE region.

[Tweet "Power grids in CEE region are usually outdated with several important missing links"]Currently, only the so called Burshtyn energy island, separated from the main part of the energy system of Ukraine, is functioning in the mode of parallel operation with Entso-E and is able to provide 650 MW of supplies to the EU.  Meanwhile, the Baltic States still remain within the IPS/UPS power system of the former Soviet Union. The EU-11 power sector has generally lower efficiency levels compared to the EU-15. It experiences higher losses in both energy production and consumption than in the rest of the EU. Distribution losses in the EU-11 amount to nearly 10% whilst the comparable statistic is 7% within the EU-15. Losses incurred during the electricity production phase are also higher in the EU-11 with around 8% compared to 6.5% for the EU-15. While transmission losses amount to 9% of total net production of electricity in the EU-11, they only account for 6% in the EU-15 economies.

Nevertheless, it is also worth noting that a generally high share of fossil fuels is a key difference between CEE and the other EU member states. Fossil fuels accounted for 64% of power generation in the EU-11, whereas only 43% for power generation in the EU-15. Consequently, higher carbon intensity and a relatively low energy efficiency of industrial production and transmission, makes energy system transformation a much bigger challenge for the EU-11 as compared to the EU-15.

Achievements and challenges for security of electricity sector

The main achievement in the CEE region for increasing the energy security of power sectors is the successful establishment of market coupling between the Czech Republic, Slovakia, Hungary and Romania (4M MC). The project started from the coupling of day-ahead electricity markets between the Czech Republic and Slovakia in 2009. Hungary joined in 2012 followed by Romania in 2014. Transmission system operators (ČEPS, SEPS, MAVIR and Transelectrica) together with power exchanges (OTE, OKTE, HUPX and OPCOM) supported by national energy regulators collaborate to develop and implement all necessary solutions which ensure technical and procedural compatibility of 4M MC with the targeted European solution, which is already implemented in other coupled European regions. Poland is coupled with the Nordic part of Europe via its SwePol undersea DC link. Market coupling intends a higher efficiency of trading and capacity allocation, which leads to a higher security of supply, higher liquidity and lower price volatility.

Another achievement is the trend of growing diversification of the power production portfolio of CEE countries, which, in general, increases power security in the long run. In fact, a recent assessment by the European Environment Agency showed that almost all CEE Member States are on track to achieve or exceed the levels of renewable energy in their energy mixes and all (except for Estonia) are on course to meet their targets on primary renewables energy consumption.

[Tweet "The share of growing renewables, however, translates into short-term risks and a decrease in power security."]The share of growing renewables, however, translates into short-term risks and a decrease in power security. The key energy security challenge for Central Europe in the power sector are loop-flows phenomena that is unscheduled power flows across the borders of the CEE countries. They are an effect of congestions in the internal power grid of Germany, unable effectively transit electricity from renewable sources (mainly from wind farms in the north) to the south of Germany and further down to Austria. As a consequence, the power grids of Poland and the Czech Republic are more and more often used by these unscheduled flows. Also, they block a significant part of transmission capacities on the borders of the CEE countries. This, in turn, not only limits possibilities for trade, but also represents a major threat for stability of power grids. So far V4 were collaborating on this issues quite successfully and prepared joint study on the negative effects of the unscheduled loop flows (ČEPS, MAVIR, PSE and SEPS in 2013[6]) and presented common position to ACER, suggesting - as a measure to solve the problem – a split of the common bidding zone between Austria and Germany into two separated trading zones which was positively assessed by the agency.

Another challenge is modernisation of the power generation park and transmission lines, which is a precondition for long term power supply security. Most of the EU-11 power generation plants are old and there is a risk that in the mid-term perspective the power shortages, as experienced in Poland in summer 2015, could happen more often. It is important to note that because of the unscheduled loop flows blocking the Polish-German border, Poland was unable to import electricity at that moment in order to alleviate its balancing problem of the day. The CEE region is pursuing several important generation investments, inter alia in nuclear capacities in Slovakia and Hungary.

Poland is planning to build the first nuclear power plant, but developments are slow. It now attempts to develop and modernise its generation fleet by introducing the capacity market in order to secure its electricity market in medium term. The Czech Republic was also considering extending power capacities of NPP, but recently the project was frozen. The main challenge will be to expand power generation facilities in a transparent manner and to create conditions for financial profitability of the power sector.

Conclusions

Energy markets in the CEE region are in the process of profound transformation. Gas markets from rigid, monopolistic, and rather isolated structures, are becoming more dynamic, competitive and integrated with neighbours. These changes are particularly visible in the V4 countries and Ukraine, but the whole CEE region is definitely moving in the same direction. The main achievement is higher interconnectivity allowing the above-mentioned countries to secure supplies in emergency situations.

The introduction of bi-directional flows on main pipelines, as well as some new infrastructural investments, have increased the region’s resilience to potential supply disruptions. However, the diversification of sources in CEE, which is the cornerstone for long term energy security, is still missing.

The only investment which can guarantee access to completely new gas sources in CEE has been the Polish and Lithuanian LNG terminal as well as Polish project of the Northern Gate. Infrastructural bottlenecks and some missing parts on the North-South Corridor, prevent gas diversification across the region.

[Tweet "Nord Stream 2 as well as increased access of Gazprom to OPAL pipeline increase the risks of gas supply distortions to the CEE region"]In turn, Nord Stream 2 project as well as increased access of Gazprom to OPAL pipeline as a result of European Commission decision, increase the risks of gas supply distortions to the CEE region and represent a challenge for use of current gas infrastructure as well as the legal constraints. The European Commission decision on OPAL pipeline increased the risk of supplies disruption on current routes and decreased the trust between CEE countries and the European institutions.

Therefore, the region should keep focusing on intensification of infrastructure development efforts enabling access of other than Russian gas to the region as the key precondition for functional regional market. The region should also do more to offer transparent and competitive gas storage services. Moreover, the countries should gradually withdraw from gas market distortion measures such as regulation of gas prices. This in the long run will bring new market actors and new investments, thus translating into higher energy security levels.

As far as electricity markets are concerned, the region should create attractive conditions to invest in generation capacities, as well as transmission and distribution lines. The priority task is an active involvement in a current debate over new electricity market design, along with new renewables and efficiency measures proposed in the winter package.

[Tweet "The region should speak with a strong and common voice in order to keep to the technology neutrality principle"]The region should speak with a strong and common voice in order to keep to the technology neutrality principle, and further the establishment of a level playing field for all generation technologies.

Declining wholesale electricity prices questions the viability of the majority of existing conventional power plants, whilst they do not provide for the stability of electricity generation based on RES. The coal based generation faces mounting pressure (EU climate policy obligations) in Poland and the Czech Republic. Nuclear energy might face the same fate, if negative political attitudes prevail. Gas based electricity generation is apparent in Hungary. Taking the above-mentioned factors into consideration, we can observe a serious lack of generation capacity that is stable enough and can efficiently back-up the growing volume of intermittent RES.

Therefore, finding the right balance between short-term financial and market considerations on the one side, and a long-term vision for building a truly integrated and diversified region on the other, seems to be the key challenge to keep pace with infrastructural development.

[1] Gross inland consumption of primary products in 2013: Ukraine* - 115.9 mtoe, Poland - 92.8 mtoe, Czech Republic – 42.2 mtoe, Hungary - 22.7 mtoe, Slovakia - 17.3 mtoe. Source: Eurostat, *Energy Community

[2] Calculations based on IEA data: https://www.iea.org/statistics/statisticssearch/report/?country=Ukraine&product=balances

3 Energy import as a share of domestic consumption (overall import dependency) in 2014: Poland – 28.6% , the Czech Republic – 30.4%, Slovakia – 60.9%, Hungary – 61.7% , EU average – 53.5%.

4  Calculations based on IEA data, https://www.iea.org/statistics/statisticssearch/report/?country=Ukraine&product=balances

[5]  See more: GAZ-SYSTEM, Development plan for satisfying the current and future transmission demand for natural gas for 2016-2025. Excerpt, Warsaw April 2016.

[6] http://www.pse.pl/uploads/pliki/Unplanned_flows_in_the_CEE_region.pdf