Lord Crickhowell: Can I pick you up on Norway. You have spelt out a strategy which is a Europe-wide, top-down approach, grids and gas storage. You have talked about Norway, and I understand perfectly well that Norway’s population is four and a half million and not a great incentive to sell its gas and it has got political interests that make it want to talk to Russia, but you do not say anything about the desirability of Europe - you referred to the UK - talking to Norway, which David Howell puts a good deal of emphasis on. Should not the Europeans, as top-down and working together, be talking pretty seriously to Norway?Professor Helm: Yes. Norway has got other interests. Recently they had to abandon all their rigs because of the Russian military activity in their area. There are all sorts of changes in what is going on on their north coast with regard to Russian military forces. There is a whole series of arguments about the ownership of land which is going to become ice-free to the north of them. There are Arctic Councils to agree about, the issue about shipping rights, the role of Iceland. Once you look at the world from the Arctic down and you imagine it icefree and you look where the strategic places are and work out that maybe 30-40 per cent of the world’s undiscovered oil and gas may lay up there, and you look at what the Russians and Canadians are doing, et cetera, you suddenly realise that countries like Iceland may become strategically incredibly important, and certainly Norway, and in an historical context they must consider their independence, their political status and how they fit together. I agree entirely that it makes enormous sense to build on what are already fantastically good relations, as I understand it, between the European Community in the widest sense and particularly Britain and Norway in a narrower sense. Yes, I agree with that.
Lord Crickhowell: Storage is an aspect here because perhaps some of those North Sea facilities may be the place where storage can be provided.Professor Helm: It is much more than storage when it comes to the North Sea. This is the natural carbon deposit for carbon sequestration. There is a whole host of relationships to form. Storage is a complex area. The oil companies absolutely loathe the idea that there will be strategic storage in gas. Why? Because if you want security of supply you have to have excess supply and if you have excess supply and you do not pay for it you depress the price. We do not have a proper price force for capacity in electricity, we have this very short-termist market in NETA, and in gas from the oil companies’ point of view it is not economically very attractive for the Commission to run a regime in which there is spare supply. My view is that has to be paid for and there is a serious argument about what it costs and what term structure that storage is on, but the fundamental question is whether the good to the whole, the benefit to all of us, of the security and bargaining power that comes from that is much greater than the sum of the individual parts.
Chairman: Lord Hamilton, I think the question you were going to ask has probably been covered.Professor Helm: Sorry, you mistake me completely. I am not saying the oil companies have any objection to carbon sequestration, this is about strategic gas storage. Sorry if I misled you.
Lord Hamilton of Epsom: I think it has, my Lord Chairman.
Lord Hannay of Chiswick: I just wanted to question slightly what you said about the oil companies hating the idea of storage and sequestration. They too are having to look to a post-Kyoto world where certain obligations may be imposed internationally on ---
Lord Hannay of Chiswick: No, I completely misunderstood.Professor Helm: On the contrary, the oil companies appear to me to be leading the game in terms of thinking about how the North Sea will develop for carbon sequestration.
Lord Hannay of Chiswick: Sorry, I completely misunderstood you. Could I ask you about the regulatory negotiated framework for, above all, gas but also other energy issues between the European Union and Russia which has come to a grinding halt with the non-ratification of the Energy Charter and in particular its Transit Protocol and the clear indication, and I imagine you would confirm the thrust of your answers, that the Russians are not going to buy into ratification particularly of the Transit Protocol. What can be saved from this shipwreck is the question I would like to put to you. Is it sensible to, as it were, recognise that the Energy Charter is never going to enter into force between Russia and the European Union? If so, is it sensible to try to find a more modest regulatory framework within which, above all, the gas relationship will continue to be operated and which will seek to balance the European interests not only in Russian gas but also in other people’s gas that transits Russia and the Russian interest in downstream? Can that be fitted into an agreement in which there is equality, reciprocity and so on? I think from your extremely useful paper of last September I know roughly where you will come down but I think it would be very useful for the Committee to hear your views on that.Professor Helm: There were two things going on in the Energy Charter and Transit Protocol discussions. One view, which was the view in the 1990s in the Yeltsin period when the oil prices were low, was that Russia, which at that stage was about the size of Mexico in terms of economic significance despite its vast size, was basically on its way to a liberal democracy, and one way of expressing that was that it would arrive in a position where its laws and structures would look like the EU. It was almost as if it was a candidate member but was never going to be allowed to be a member. In the same way that Bulgaria, Romania and eastern European countries, had to converge on European ways of doing things, so it was thought the Russians would do that. The Energy Charter and the Transit Protocol at that stage were deemed to be essentially the application of what I would call a kind of bastardised British model of how to run an energy system applied to Russia and at the core of that idea was they should open up all their pipelines and electricity systems to third party access on even terms. The other view about the Energy Charter which has developed subsequently is the notion it is basically a contract resolutions or arbitration body which can sort out disputes between players, and I will come back to that in a moment. The first view was not only falsified by the sharp rise of oil prices, Russia was no longer beholden to Europe, it was no longer in a bankrupt state, but it was utterly absurd for Gazprom to ever accept the idea that third party access should be allowed to its pipes because what that does is minimise its monopoly power. It is the absolute opposite of what you would want to do. For the Europeans to believe that they could bash the Russians into that position could only be based on the idea that Russia was so weak and compliant to European needs because its economy was in such trouble and after the bankruptcy it would need resources into the future, or the Europeans believed the thesis that a liberal capitalist democracy was at the end of the history and we were all going to go there anyway, which you can understand people believed after the collapse of the Berlin Wall. I think that was utterly hopeless and an enormous amount of effort and time was spent on something which clearly was not going to happen, and it is not going to happen going forward. If the Russians sign and ratify it through it will only be in a sense in which it will not be applied. The other idea that there should be an international body which is responsible for helping parties to resolve disputes seems to me to be an excellent idea but one has to be very careful that it does not have a British or necessarily European label upon it. I will not say it is necessarily a UN function but it is a kind of WTOtype function and it seems to me in the framework of negotiation with Russia to join the WTO this should be part and parcel of that framework. Going down that route is the sensible thing to do. Going down the former route is both hopeless and just creates trouble because every time there is a serious interchange between the EU and Russia, the EU says, “Ratify the Energy Charter, ratify the Transit Protocol” and the Russians say, “No, go away” and that does not help get us anywhere. That is why I think it has been misconceived.
Lord Hannay of Chiswick: Can I just be clear, if you will forgive me for saying so, I think your concept that at this very late stage this could somehow be incorporated into the WTO accession negotiations is not terribly realistic.Professor Helm: That may be right.
Lord Hannay of Chiswick: Are you saying that the idea of an EU-Russia regulatory framework building on the four spaces or a new agreement with Russia is too narrow for basing what you see as desirable, which is a regulatory framework that could give both sides a degree of predictability, rule of law, et cetera?Professor Helm: If you look at the pillars in the EU-Russian energy dialogue and the PCA framework what I am really saying is not that that engagement cannot be taken forward but in the energy component of that dialogue one needs to have a harder and more realistic approach to negotiations which start from a clear understanding of the objectives of both parties. Basically the energy pillar in those negotiations has been anchored in the Energy Charter and third party access. I wish it was not true from a European perspective, but all I am saying is it is utterly hopeless to imagine that political and diplomatic capital should be used and expanded on the idea that we will persuade the Russians to admit third party access to their gas network. This will not happen, it is not in their interests, and we are wasting a great deal of time and effort to no net benefit.
Chairman: Thank you very much indeed. That, to some extent, links to the next question from Lord Truscott.Professor Helm: There are two bundles of EU policy relevant to the energy sector. There is the bundle from last year, a group of directives, initiatives, around the idea of unbundling competitive markets, and then there is the package for 23 January this year which is the environmental side. I will start with the unbundling. I cannot get myself terribly exercised that forcible ownership unbundling in the energy market we now have in Europe is going to do much per se to increase competition. It probably will do a bit but if you want competition you have to have some competitors. If you are on a football pitch and you have got two Frenchmen and a German, or two Germans and a Frenchman, as we have in the UK, plus a Spaniard, you have not got enough to make a really competitive market stick. The big mistake in the internal market in Europe was to allow these mergers and acquisitions which created this market power which means that you are not going to have this idealised market, which was the objective in the first place. It is an interesting question of whether you want to get to that market, but if you did want to do it you should not have allowed these mergers but we are where we are now. However, where unbundling is extremely helpful is unbundling detaches grids and if the grids can then co-operate to think on a European level to help construct the European grid this is an excellent thing to happen. I turn out to be in favour of unbundling not primarily for the competition argument but because I think it will help to get this European grid built. The greatest asset in trying to increase competition is interconnection. Competition comes through wires and pipes, that is why incumbents do not connect and that is why it has to be imposed upon them. It had to be imposed before the Second World War in the UK, after the Second World War in France, by central government in Japan and by Germany through forced collusion. You do not get natural grids developing out of the interests of the players. For that reason I am in favour of the unbundling provided it goes with a package on the grid side. You need a physical market before you can have the actual competition. On the issue of the environmental security of supply measures, it is true that the market will not produce optimal diversity and the market will not produce security of supply through individual decisions. That is contrary to British energy policy for the last 15-20 years in repeated White Papers and statements and it is a matter of fact which even this government now accepts by having to earmark particular technologies. There would be no wind power in the UK but for government policy, the market would never build a windmill, or hardly any windmills. The question is how far should the intervention be and of what sort. In this context it is fashionable for people to argue that environmental measures, like renewables and energy efficiency, are the best way of increasing security of supply. Unfortunately, the best way of increasing security of supply is coal and coal is the growing fuel around the world and it has many sources, it is extremely cheap and is fantastically damaging to the environment. People who argue that pursuing environmental policy and security of supply are necessarily linked, that is not true. If you look at the particular technologies, energy efficiency does reduce demand and in the short-term a lower level of demand might lead to a higher level of security in the short run, but not in the long run. On renewables, most of the renewables policies very unfortunately reduce security of supply, particularly when the renewables penetration goes to high levels. At the extreme you could have a system in which if the wind was blowing nothing else would be needed and, therefore, nothing else would earn any money but if the wind does not blow everything else is needed and it has to earn enormous returns to provide that facility. Hopefully in ten or 15 years’ time it will have some batteries and then wind will be base load and this thing will be transformed, but not in the short run.
Lord Truscott: Thank you, my Lord Chairman. Professor Helm, what is your view of the Commission’s Third Energy Package and the alleged discrimination that Russia might face? Would you also comment on the EU’s other efforts to avoid dependency and enhance accessibility to supply and the European idea of boosting renewables, enhancing efficiency and some Member States going down the nuclear road, like the UK? We were talking about dependency earlier but the percentage of gas supplied by Russia to the EU will go down in percentage terms over the coming years although not in absolute terms.
Lord Boyce: I wonder if you would say something about the anti-monopoly powers. I rather get the impression from what you have been saying that Gazprom would like to have a dominant position in the European gas market. Do you think the European Union existing anti-monopoly powers could prevent that? That is the theory, but in practice do you think the European Union will want to exercise those powers because individual states may not want them to be exercised because it will upset their bilateral relationships?Professor Helm: I think the European Union should insist that any company that operates within its boundaries should abide by European law and by the rules of the European Community laid down for its markets. I think Gazprom should be treated like any other state driven company that wished to invest in the European Union and because its motives are not purely the maximisation of profits, they are political and wider ranging, there should be a greater burden of proof applied than if a normal commercial quoted company with transparent accounts wished to acquire assets. Transparency of accounts should be demanded. I have no idea where the money goes in Gazprom. I have never seen any accounts which lead me to understand that. Given the strategy that Gazprom is pursuing, given it has upstream market power, the Commission should ask serious questions to have a look at a competition inquiry into its activities across the market and apply the full force of competition law. Will it do so? No, probably not. Does it have the powers to do these kinds of competition investigations? I am not sure. Part and parcel of a more realistic policy towards Gazprom is to say, “We understand you are trying to maximise your position, we understand your strategy to extract the maximum returns for your resources, why shouldn’t you, but you have to understand that within the EU we want to protect our position too and we are interested in a competitive market, not a political market, and just as we should be concerned about sovereign wealth funds we should be extremely concerned about particular acquisitions which have this broader market power rationale behind them”. I would argue for a much sharper application of competition policy and the rules of the European Union within its boundaries.
Lord Anderson of Swansea: You argue for quite a substantial new agenda for the Commission. Have you been brought in by the Commission as an adviser at all? I notice from your CV that most of your work has been with the British Government, but are you an adviser to the Commission?Professor Helm: I have no formal post or role in respect of the European Commission but I spend a great deal of time talking to people there and a lot of time in Brussels.
Lord Crickhowell: I suppose your central recommendation about how the Europeans should deal with the situation is that they should get together and act as a European whole, and you have given some pretty compelling reasons as to why the Germans seem to be unlikely to go down this road, the French with their nuclear dominance are not likely to go down the road and the British for political and other reasons are reluctant to go down this road. In preliminary conversation before this meeting with Lord Hannay he said, “Yes, but Europe under threat sometimes is prepared to come together and act as Europe”. How far do you think it is likely that we can get together and act on a European basis? It is a central recommendation but it may be the most difficult one to achieve.Professor Helm: My first observation is that nothing substantive seems to happen in the EU unless the Germans, the French and the British agree. That may be too strong a statement and monetary union might be the exception to that, but it seems to me when it comes to the energy debate the question is how are those three countries going to co-operate. So far the British have been banging on against the French and the Germans on the competition agenda and the unbundling. The British energy position could not be more in your face vis-à-vis French energy policy and German energy policy. On a regular basis British officials attack European companies for being bundled and argue they should be broken up and their governments tacitly or explicitly do not want that to happen. The question comes, if fundamentally we disagree with the position that these two other countries wish to take in terms of the structure of their own energy markets, how can we expect them to co-operate with us to protect us, those who now have had to join the European club. The great difference between British energy policy and everybody else for the last 40/50 years has been, “We’ve got plenty of energy and they haven’t”. Germany in the end had to manufacture synthetic fuels in the Second World War. France built its nuclear programme because it does not have natural resources. Suddenly we do not because we have pursued this strategy of depleting the North Sea as fast as possible and it turns out historically at the lowest possible prices too. Suddenly we are terribly exposed. My own view is it will take another few winters before the British Government discovers that actually the exposure to a volatile spot market without much storage and without the long-term contracts that our European partners have is a big disadvantage. It is already true that British prices on the electricity market are moving above the European average and in the coming decade I expect them to be at the top of the European market but very much extremely volatile in that context. My view is you need quite a lot of pain for people to understand they need to change their political policies and there is a long lag that leads with it. Given that, the understanding between France and Germany, between Merkel who is somewhat more distant than Schroeder was to the relationship, and with Sarkozy who clearly has views about how France will join this club, that gives some grounds for hope that a Franco-German common view on energy policy will gradually emerge. I think it will take time and my real fear is that we are on the cusp of a decade in which any nuclear power will not be there because that is 2020 and beyond, the AGRs here are in a pretty weakened state and could fail, as they do on a regular basis, we have a dramatic increase in our need to import gas and we have no long-term contracts and that is a terribly exposed position. All of my work on energy policy has led me to the conclusion that energy policy changes after a crisis and not before. My view is at the moment we have the makings of a crisis but the bad news is that it is not anything like big enough yet to force the British to come to an understanding that they will have to agree with the French and the Germans a common energy position. In the meantime, why should the Germans share the benefits they have got of their storage and the long-term take or pay contracts and their relationships with us who told them this is the worst way to organise their market and they should break them up immediately to our benefit. This is an extraordinary position to get to.
Lord Anderson of Swansea: Can you see any conceivable German interest in a European grid?Professor Helm: Yes. Germany is geographically surrounded by links with other players and, of course, as France expands its nuclear position and Germany does not that is important to it, but there are big links between Germany and the Netherlands, Denmark, all round its frame. The question is not whether it has an interest in a European grid as opposed to more bilateral links that suit its own purposes. No incumbent oligopolistic firm will ever want the system optimal outcome; they will want to control the linkages. What Europe is in a network sense is a series of bilateral links between major dominant players, that is why we have such an inferior grid. It is very, very important on the grid position to realise it is not just about security of supply, it is fantastically important for the competitiveness of the European economy because interconnection creates a portfolio effect which means the amount of power stations you need to secure supply at any point is much less, that is why we built national grids and broke up the local ones. The Americans are going through the same problem. This is a competitive battle to see who can get the greatest efficiency out of their electricity systems in addition to the security of supply problem.
Lord Hannay of Chiswick: I just wanted to ask you on what you said about Nabucco and about the European grid. Does this lead you to the conclusion that a European policy ought to be prepared to pay a premium in public funds to get those two sorts of ideas going and not just leave them to the market? After all, the whole of energy policy around the world has been filled with interventions by governments to in a way distort the power of the market in particular circumstances where their security might be strengthened by it. Are you suggesting that the EU as such should, for example, put some EU budget money behind constructing a grid that is less bilateral and national than the individual companies might do?Professor Helm: The first thing to say is there are no free markets in energy in a perfect textbook sense. Governments are always involved in energy, they are always intervening, the question is what is the balance, which bits should they go for and which bits should they not. No pipeline like Nabucco can be anything other than political and no company can possibly want to invest in such things without a political framework around it. The first thing the European Union should do is decide which bits of infrastructure matter and put the weight of the European political framework behind it, and that includes the big players talking with one voice about them. There is no doubt in my mind whatsoever if the Europeans were minded they could say to Turkey and other countries affected by the Nabucco framework, “We want this as a priority European project and we are going to put political support behind it”. The second thing is the cost of pipelines is mostly about the cost of capital. Private risk would make these things extremely capital expensive and government guarantees would reduce those costs of capital considerably. The difference between Russia and Europe is in Russia if they want to do something they may not have the technical skills to do it but an authoritarian capital state can make sure infrastructure is built. What we have got to do is find how a liberal democracy can ensure that vital infrastructure, roads, rail as well as energy infrastructure, gets built and I would much rather we spent the money on that than paying for the Common Agricultural Policy.
Lord Selkirk of Douglas: May I ask a general question about Kyoto. What are the possibilities for the European Union working with Russia on post-Kyoto negotiations on climate change? Perhaps in general you can comment on the prospects for co-operation between Russia and the European Union in the present political climate?Professor Helm: On climate change, as I tried to say in the note, I cannot see what interest the Russian elite have got in halting climate change. This is a terribly depressing thought, but if you were to say that the Russian elite political system is essentially managing its carbon assets, the faster global warming the better for the northern sea routes and the expectation of new resources in Siberia. Of course there will be offsetting effects but I cannot see that the Russians have much interest in an international agreement. However, if someone wants to pay them to do it, as is the negotiation over hot gas and buying gas into the EU-ETS et cetera, I am sure that they will accept the cheque. That is a rather cynical view but we have to be realistic. We are not going to persuade Putin and his Kremlin colleagues that it is in Russia’s interest to have a sharp reduction in carbon emissions and carbon taxes and things that go with that.
Lord Selkirk of Douglas: Is your general message to us that there should be a greater degree of realism injected into our foreign policy?Professor Helm: Absolutely. If I could summarise the most important point I want to make, it is that we should understand and take as given what Russian objectives are and what Russian interests are and we should spend less effort trying to persuade them to change their objectives and more effort in thinking about what to do as they pursue those objectives to strengthen our own position. There are an enormous number of things we can do both on security of supply and on climate change to improve our position, but of the main things that need to be done these things are not easily done at a nation state level, they are European, and this involves the British understanding that nearly having run out of our own natural resources we are now in the same position as the French and the Germans and we have to actively cooperate to produce an outcome between the big powers in Europe at the EU level and this will be a rather challenging problem for British political culture but as an economist, and as someone looking at the energy sector, if we do not do that then we are going to have a serious energy problem and in the UK this will be reflected in high and volatile prices and a lot less security.
Chairman: Professor Helm, we have kept you for longer than we originally talked about but we are extremely grateful. I think we have had an extraordinary morning. You might be surprised, you might find some of us queuing up to listen to your lectures in future because this has really been extremely helpful for us in challenging some of our ideas and also giving us a framework to look at this question which is obviously a central part of the report which we will be preparing. We are extremely grateful. We will be sending you the transcript and we very much look forward to your comments and including them in our report. Thank you very much indeed.