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Home Archive September 2010 Issue Issue Content The Evolution of Energy Security in the Slovak Republic

The Evolution of Energy Security in the Slovak Republic

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The Slovak Republic is an excellent example of what can happen to a country when it doesn’t pay attention to its own energy security. Slovakia has historically been and remains one of the most vulnerable countries in Europe in terms of energy security. There are a number of reasons for this, including the timing of energy privatization and the general inability of government to transform its declarations into deeds with a prioritization on this issue. The fact that none of this nation's successive governments over the years have done much to change this situation is both puzzling and potentially interesting for other countries as well. In a nutshell, the country provides an example of political ignorance and negligence in the energy sphere that should not be repeated elsewhere.

After failing to secure its own energy supply (and especially natural gas) for years, Slovakia was one of the worst hit countries in Europe during the 2009 Russia-Ukraine gas crisis. According to some sources, Slovakia lost 100 million euros a day, or 1 billion euros over the duration of the entire crisis, and the gas-cut related recession led to a 1-1.5 percent decrease in GDP (Duleba 2009). National tax revenues in January 2009 dropped by 40 percent (due to both the gas crisis and the recession). Some Slovak companies, as part of their own contingency plans, which were to be invoked in the event of an energy crisis, even began to prepare to relocate parts of their production elsewhere. Some companies chose not to disclose an exact quantification of their losses (not even to the Ministry of Economy), so the real extent of the impact remains unknown. This is a real wake-up call of what happens when energy security is taken for granted.

Slovakia shared 75 years of history in common-state with the Czech Republic. The example of Czech Republic was analyzed in the previous issue of JES. In comparative terms, why is it that the level of energy security of Slovakia has floundered while that of the Czech Republic accelerated over time? It is argued that the two main reasons why Slovakia has not focused sufficiently on improving energy supply security or diversification strategies are (1) its actual as well as perceived role and importance as a transit country for Russian natural gas and oil, and (2) the timing and sequencing in the privatization of energy assets.

Energy security in the Slovak Republic
The primary aims of energy policy since 1993, when Slovakia seceded from the Czechoslovak federation, have been the establishment of a new legal framework for the energy sector, an expansion of its domestic gas distribution network, and an increase in its transit capacity. Market building and regulatory aspects of the energy reform took place, mainly due to complying with EU pre-accession pressures, but improving supply security and emergency preparedness lagged behind. Slovakia’s energy intensity compared with its immediate neighbors was, until 2006, the highest in the region (measured by the amount of energy required to produce one unit of output). Slovakia’s energy intensity was greater than that of the Czech Republic until roughly 2007. In contrast, Hungary uses its energy more efficiently, and Poland even less efficiently, measured in energy intensity terms. When measured on a per capita basis of energy intensity, Slovakia is less energy intensive than Poland and the Czech Republic but more energy intensive than Hungary.


An important fact is that Slovakia is a net importer of all of the fuels listed in the graph above. As one can see from the chart below, the country imports most of its oil and gas, and almost all of its primary coal energy sources. Slovakia also imports all of its nuclear fuel for electricity generation (54.65 percent in 2007).

Nonetheless, the alarming fact, which was demonstrated during the January 2009 gas crisis, is the lack of diversification in the sources and transit routes of Slovakia’s imports. All of Slovakia’s nuclear fuel comes from Russia. All of its pre-2009 gas imports came from Russia’s Gazprom, and about three quarters of its imported oil is from Russia in spite of the existence of the alternative oil pipeline Adria (from the Croatian Adriatic port of Omisalj). The worrying sign is that its imports depend on a single import route via Ukraine. This puts Slovakia in a very difficult position, not only with supply security risks, but also regarding the premium price customers in Slovakia are paying for their energy resources.

 

This lack diversification is demonstrated by the following illustrations. One chart demonstrates the Slovak Republic’s level of diversification relative to its supply security. The index of market concentration is calculated using the Herfindahl-Hirschman Index in the share of imports from different countries using the data from UN COMTRADE database, and multiplied by the share of imported gas or oil on the total gross domestic consumption from Eurostat. From this chart, it is clear that the import market concentration (by countries, not by companies, since this better represents the political rather than business risk) for both oil as well as gas to Slovakia is the highest compared with its neighbors.

 

From these charts it is clearly visible that the lack of diversification and overall higher concentration of imports from a single source put Slovakia in a bad position in terms of its supply security, and results in Slovak customers paying a higher price for their energy supplies than those in neighboring countries. Why is it then that succeeding Slovak governments and enterprises have not improved their supply security?

Role and importance of Slovakia as a transit country
The default explanation for not diversifying the supply routes for (mainly) gas throughout the history of Slovakia has been its importance and role as a major transit route for gas from Russia and via Ukraine to Western Europe. Slovakia has been the most important single transit country within the EU for Russian gas to Western Europe (via Austria and via Czech republic). In 2008, the Eustream gas transit company transported 76.2 bcm. The transit of oil is not of strategic importance.

Slovakia has been second only to Ukraine as a gas transit country, and, with its technical capacity of more than 90 bcm annually (transporting 2/3 of gas arriving to Europe via Ukraine), it is the largest natural gas transporter within the EU. Given this situation, Slovakia until 2009 (unlike the Czech Republic) ignored the fact that Russia was building new pipelines and export LNG terminals which create alternative routes from Russia to its major west European customers, bypassing not only Ukraine but Slovakia as well. The consequence of this is lower supply-security and a weakening in the bargaining position of Slovakia vis-à-vis its Russian partner. This lack of initiative, assertive economic diplomacy, and willingness to pay for improving the security of supply can also be illustrated by the results of plans to improve diversification of gas supplies to Slovakia. Before the 2009 crisis, there were two relevant plans that would have improved the supply security of Slovakia. These were a Norwegian-Polish-(Slovak-Hungarian) pipeline connector and an inter-system connector that was partially intended to forestall the Norwegian-Polish gas pipeline. Nonetheless, the way that the Slovak government failed to deal with these two developments illustrates the low priority that energy supply security has been traditionally given in Slovakia. The chances for diversification of gas supplies evaporated after the Slovak gas company (SPP) was privatized and the most important issue for the new owners (and holders of management rights) became immediate economic return rather than providing for the public good of energy security.

Timing and sequencing of privatization
The timing and sequencing of privatization of energy assets and development of diversified infrastructure is of paramount importance to any country’s energy security. It is easier to take diversification decisions when the energy infrastructure is solely owned by the state, as was the case of diversification in Czech Republic during the nineties. Nonetheless, if government pays sufficient attention to energy security, further diversification is possible even after the assets are privatized. This is what the Czech government has done.

The timing and sequencing of privatization in Slovakia was peculiar. Similar to other countries in the region, the Slovak gas sector was vertically integrated with the Slovak Gas Industry (SPP) and oil sector in Transpetrol. The state company NAFTA performed the underground storage of gas. The problem with the privatization of energy assets in Slovakia was that it occurred before any infrastructure or supply diversification plans were put in place. In light of the previously mentioned self-perception of the importance of Slovakia as transit to Western Europe, no real diversification was perceived as necessary, nor beneficial for the mid-term economic strategy of the new owners who exercised managerial control over the gas company.

The interesting peculiarity of Slovakia is that the transformation and privatization of energy assets started with gas storage. Already in April 1992 the state company NAFTA Gbely was transformed into a (state owned) shareholder’s company. Just a few days after this transformation, a new shareholder’s company POZAGAS a.s. was also created to develop and build underground storage (UGS) at Láb. In 1994, already one year into the existence of an independent Slovakia, Gaz de France acquired shares in Pozagas, and currently ownes 30 percent of shares. Nonetheless, the clearly political privatization of Slovak energy assets happened in 1996, when 45.9 percent of NAFTA a.s. shares were acquired by people within then Prime Minister Mečiar’s circles at one-sixth of their estimated value. This situation was reversed in 2000.

The wave of privatization that took place a decade ago was driven by a desire to maximize financial yield from sales to the detriment of public supply security. By the time the post-Mečiar (Dzurinda) government got into power in 1998, the government was forced to sell a large amount of state owned assets. The most important case of privatization in the Slovak gas sector took place in 2002, when 49 percent of shares, including full managerial control, were sold to Slovak Gas Holding B.V., a consortium of E.ON Ruhrgas and GDF Suez (Gazprom, an initial member of the consortium has not claimed its share and eventually stayed out). The remaining 51 percent were retained by the National Property Fund of the Slovak Republic (soon to be administratively merged into the Ministry of Finance). The legal unbundling of this vertically integrated company took place in July 2006, with distribution in Eustream and SPP. The privatization process, which resulted in managerial control being given to foreign shareholders, was often quoted as a reason for the government backing down on natural gas supply security. Nonetheless, in contrast the Czech Republic sold 97 percent of its gas company, but this has not translated into a decline in interest in continuous energy security.

During the Fico’s government (2007-2009) the government’s aims in the energy sector again ignored energy security and focused on subsidizing selected economic sectors through managed prices and building privileged relations with those in Russia’s higher economic and political echelons. The reality which remains is that “special” relations between Slovakia and Russia have no value if relations between Ukraine and Russia are not fully taken into account. How Russia understood this “special” relationship was illustrated by the January 2009 gas crisis. The result was that in the end it was Slovakia that paid a higher price for crisis-gas rather than Ukraine or even Germany.

Factors influencing change in Slovakia’s energy security posture
The Slovak government remains the majority shareholder in Slovakia’s largest energy enterprises, which, at least in the gas sector, provides it a sufficient tool for influencing the strategy of its natural gas holding company SPP. This state-shareholder majority (without managerial control) provides a sufficient basis for access to information and a possibility to influence gas sector development in an area considered a public good, which gas is.

On the EU level, activities aimed at the establishment of a single European market for gas and electricity are supportive of improving the energy security of Slovakia. However, there are real differences between how both commodities are treated; the single gas market represents a bigger challenge. Preconditions for the creation of a single gas market cover cross-border pipelines, gas-to-gas competition, connections to several gas source countries of origin, developed gas storages and the free movement of gas based on the commercial interests.

The current economic downturn has caused lower gas demand mainly from the industrial sector. Therefore, a surplus of natural gas exists which has led to a decrease in prices and supports the trading activities of gas hubs. Thanks to advanced infrastructure and its ability to supply the gas in several directions, customers in many of the older EU member states have been able to buy gas at lower prices compared to nations covered only by the long-term take-or-pay contracts. Russian gas prices reached their zenith over 2008 to 2010. Customers in a majority of the Central European countries like Slovakia have suffered from these centrifugal influences due to the lack of cross-border interconnections, the dependence on one gas source (Russia) and one gas transit route (Ukraine), and a delayed gas market infrastructure expansion and evolution.

Reaction to the January gas supply crisis
As mentioned above, there is limited opportunity for Slovakia to increase its energy security bilaterally. The last several years have been accompanied by the bilateral efforts to solve this problem. The most visible demonstration of this line of thinking was a post-January 2009 crisis evaluation carried out by the Fico government. The report blames the Ukraine directly for the crisis’ negative fallout on Slovakia, and contrary to reason the evaluation proposed that Slovak state authorities along with Gazprom construct new gas storage capacity in Slovakia. Yet this view has changed.

In Slovakia, policy alterations manifest in the three major components of Slovakia’s energy security: its legislative and regulatory framework, its diversification portfolio and the development of cross-border connectors, and the development of the natural gas storage capacity.

Newly adopted legislation in Slovakia has transferred the responsibility for the security of gas supplies (during periods of shortages) to gas suppliers. The supplier has two options on how to secure sufficient supply to its customers: through the utilization of domestic storage facilities or through an ability to guarantee necessary amounts of this commodity through the cross-border interconnectors with reverse flow ability.

The gas supply portfolio in Slovakia has been diversified by the country’s dominant gas company SPP, which signed three contracts with Germany’s E.ON Ruhrgas and VNG and with France’s Gaz de France. Up to 880 mcm annually can now be covered by these contracts, obviating gas from and through the Ukraine.

For a long period, cross-border pipeline development has not been taken to heart by successive Slovak political regimes. This changed after the January crisis and the introduction of the EEPR (European Energy Program for Recovery) EU budgetary allocation. The EEPR budget allocates significant financial resources to develop concrete energy projects—gas and electricity interconnectors, offshore wind projects, and carbon capture and storage sites (CCS). Some of these concern Slovakia directly.

Concrete project development
A first step on shoring-up Slovakia’s energy security is a technical upgrade of existing pipelines to reach reverse flow capability. Among concrete projects of this sort are a pipeline to the Czech Republic and a connection with Austrian Baumgarten hub, which currently operate only in one direction. The latter will be finished by the end of 2010. During the January 2009 crisis it was clear that the most vulnerable region within the Slovak territory is its eastern region, where no gas storage capacity exists. Therefore the reverse flow capability of the domestic pipeline system together with the development of gas storage in the eastern part of Slovakia is presently underway. A second pipeline project, a connection between Slovakia and Poland, has received EUR 20 million in financial support. But the current situation and the length of a possible route favor a more financially feasible connection to Poland through Czech Republic.

Among other selected projects, there is a new interconnector with Hungary. In 2009 the operators of the transmission pipelines in both countries, Slovak Eustream and Hungarian FGSZ, started talks and non-binding open season procedure to ascertain the market interest. An open season procedure is a kind of market survey, during which the capacity of a planned pipeline is offered to the gas traders. This ended at the end of 2009, and a binding season was opened and completed in July of this year. Altogether only 6 traders booked its capacity and participated in the procedure.

A planned Slovak-Hungarian pipeline is another long-term investment, and current low interest may be subject to change in the future.

Possible gas futures
In Slovakia several gas fired power projects are presently under discussion. The biggest project, a 430 MW plant in Malzenice, Slovak Republic is expected to be commissioned by the end of 2010, and the share of gas in Slovakia’s energy mix will increase with it. The security of gas supplies will then have a direct impact on the security of the supply of electricity and on the whole economy of the country. Therefore, from a security of supply standpoint, it is highly questionable whether the construction of gas-fired power plants should receive a green light in Slovakia given the risk of supply disruptions.

Regulatory conditions of the Slovak-Hungarian pipeline need to take into account several factors. In order to stimulate market interest, pipeline conditions have to be competitive. On one hand tariffs should reflect the cost of new investment, while concurrently they should be comparable with the tariffs for existing pipelines.

The Slovak-Hungarian interconnector is a piece of a wider north-south corridor that will connect Poland, Czech Republic, Slovakia, Hungary and Croatia, and is a crucial building block for an integrated gas market in Eastern Europe. Political support for this project was obtained in 2010. This pipeline corridor will connect currently unconnected pipeline systems and will interconnect the planned LNG terminals in northern Poland with southern Croatia. The corridor will also have reverse flow capability. The connection to Austria’s Baumgarten hub is important as well. In addition to new LNG capacity in Poland, there are plans for new pipeline capacity—Nabucco and South Stream. Both will terminate in Baumgarten, and the Slovak-Hungarian connection will allow gas to be supplied directly to Slovakia. With this expected constellation—cross-border pipelines, LNG regasification capacity and a new pipeline coming from the southeast, the energy security of the Central European region should be significantly increased.

Conclusions
During the January 2009 gas supply crisis, Slovakia was the second most affected country within the EU, after Bulgaria. This “wake-up call” finally ignited the interest of Slovakia’s political elites to the topic of energy security. The era in which energy security for Slovakia was based solely on the important role of the country as a transit state is over. Besides the development of cross-border pipelines, another challenge will be the pressure to change pricing formulas in existing long-term contracts with Russia. With a decreasing level of gas transport in Slovakia, it will be essential to find an alternative utilization of its transmission grid’s spare capacity. Moreover, the gas title transfer taking place at the Slovak/Ukrainian border (entry point Veľké Kapušany) requires a formal framework agreement. Slovakia can serve as a virtual trading point in a first country position where the price of the Russian gas is set. After the integration of the Central European markets, and with connections to new gas sources, gas trading should become commercially competitive.

The coming years offer ample opportunities for regional and European cooperation on energy security. During the last regional V4 summit in July 2010, representatives stressed the issue’s importance and proposed common meetings before the EU summits. Next year, Hungary and Poland will hold the Presidencies of the Council of the European Union, with the opportunity to put gas market integration in Central Europe on the EU agenda. Energy security can be neither reached on a unilateral, nor on a bilateral basis, as illustrated by the case of Slovakia. Slovakia remains the country that has most to gain from cross-border cooperation in energy security. Whether it will be able to move from political rhetoric and declarations to deeds remains to be seen in the months and years ahead.

Contributor Andrej Nosko is a Researcher on energy security at the Central European University in Hungary, and Peter Ševce is member of Energy Security Institute in Slovakia

 

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