– Paul Taylor is a Reuters columnist. The opinions expressed are his own –

PARIS, April 20 (Reuters) - The European Union’s antitrust czar is struggling to stop governments bending EU rules on state aid to business when they rescue banks with taxpayers’ money.

But Neelie Kroes’ threat to force some banks to the wall unless they offer viable restructuring plans within six months of receiving state cash was economically unwise and politically inept. It could fuel political pressure to suspend the rules and weaken the European Commission’s crucial watchdog powers.

EU regulators in charge of policing state aid have given fast-track approval to more than 50 rescue schemes since last October, when the full force of the financial crisis hit Europe after the collapse of Lehman Brothers in the United States.

Kroes told Reuters in an April 7 interview that time was running out for some banks to propose restructuring plans that in most cases would mean slimming down and selling off assets to avoid distortions in competition.
“Brussels will not rubber-stamp such schemes and may even let banks go bankrupt if those plans do not satisfy the Commission,” the EU Competition Commissioner said.
She is very unlikely to make good on her threat because of the depth of the crisis and fierce political pressure from big member states to go easy on the banks.
Brussels would do better to give banks and governments more time to get over the worst of the crisis before restructuring or repaying aid, rather than making banks divest now at fire-sale prices that would cause bigger losses for taxpayers.

Kroes implicitly acknowledged as much on April 15 when she approved a request from Britain to extend recapitalisation and credit guarantees for its banking sector, approved last October.

A Commission statement said “the circumstances on the financial markets justify the extension which aims at underpinning lending to the UK real economy”.

The EU watchdog has bared its teeth at some other state rescues resulting from the crisis. Kroes has had a tug-of-war with Berlin over the conditions for state rescues of Commerzbank <CBKG.DE>, Germany’s second largest bank, and regional lenders WestLB [WDLG.UL] and BayernLB [BAYLB.UL].

Brussels is demanding Commerzbank spin off mortgage lending in return for an 18 billion euro government bailout. It is also insisting on deadlines for the sale of all or parts of WestLB in return for last year’s rescue and pressing state-aided BayernLB to sell foreign units.

German Finance Minister Peer Steinbrueck has charged that EU foot-dragging is undermining confidence in a systemically critical part of the financial sector.

Kroes may have issued her warning to rebut such pressure and concentrate member states’ minds on the need for an exit strategy from bankrolling banks. Commission figures show EU governments have provided 3 trillion euros in guarantees, risk shields and recapitalisation since the crisis began.

But it makes no sense for the EU executive to force the break-up of banks in the midst of the worst recession since the Great Depression. It would force banks to take further losses by disposing of assets at a time when there was no market for them.

The Commission’s authority over state aid is not comparable with its direct power to veto mergers. It can order governments to recover aid deemed illegal and haul them before the European Court of Justice if they fail to comply, but that process often takes years.

If pressed by Kroes, governments would probably tough it out and hope that by the time the Commission acted, the market would have recovered sufficiently for the banks to repay them — or for the state to sell on shares it has purchased.

Politically, it would be dangerous for Brussels to start down that road against any of the big EU states, especially at a time when Commission President Jose Manuel Barroso is seeking re-appointment this year. French President Nicolas Sarkozy may be the most outspoken in his criticism of EU competition “dogma”, but many other governments have been irritated by the Commission forcing them to change national rescue measures.

Many of the bank rescues were approved under an EU treaty article that allows state aid “to remedy a serious disturbance in the economy of a Member State”. That emergency situation is unlikely to end in the near future.

If Kroes did decide to make an example of a bank, the risk is that member states could reach for the nuclear option and seek to suspend the state aid regulations completely in the financial sector, or use their power to override a Commission decision unanimously. So if the Commission overplays its hand it risks seeing its key economic powers emasculated.
(editing by David Evans)

– Paul Taylor is a Reuters columnist. The opinions expressed are his own –

The United States is fighting a fire in the world economy, but Germany and some other European countries fear a flood of inflation as a result.

That clash of cultures is at the heart of transatlantic debate over whether Europe should spend more and ease monetary policy to revive growth, with a deep economic contraction certain this year and an end to the recession not yet in sight.

The perception gap could cause lingering resentment among Americans and Germans on the way out of the crisis.

World Bank President Robert Zoellick sees concern on both sides of the Atlantic, not just in Europe, at the risk of inflation down the road from the massive additional liquidity created by the U.S. Federal Reserve and soaring public debt.

The current gush of liquidity made the glut after the bursting of the Internet bubble in 2001 look like a desert, he told the weekend Brussels Forum, a conference of North American and European policymakers, business and opinion leaders.

The dollar’s sharp fall and the jump in the price of gold after the Fed’s announcement of a giant purchase of long Treasury bonds reflected fears that the United States will try to inflate its way out of the crisis.

“What some political leaders say when you bring this up is: “Well gee, when we’re putting out the fire, can you really worry about the water damage?” In a way, you really do have to worry about both,” Zoellick said, advocating a timely pathway back to fiscal and monetary discipline.

The European Central Bank has provided unlimited liquidity for banks to unfreeze credit markets and is weighing following the Fed into unconventional measures such as buying bonds to provide an extra monetary stimulus. But Germans are especially wary due to their traumatic history of hyperinflation in the 1920s, something that contributed to the rise of Hitler.

“I can promise you the European response to this crisis will not be inflationary. That’s why guys like me exist,” German Bundesbank President Axel Weber, a member of the ECB’s Governing Council, told the Brussels Forum. “I can promise you once it starts looking inflationary we will tidy up the mess.”

European Union leaders agreed at a summit last week they had taken enough fiscal stimulus measures for now and rejected pressure from the Obama administration to do more.

German leaders were particularly dismissive of calls to throw more money at the crisis when two stimulus packages adopted in the last five months are still being implemented.

European Commission President Jose Manuel Barroso made clear EU countries would review their stimulus efforts if the economy continues to deteriorate. European Economic and Monetary Affairs Commissioner Joaquin Almunia said the high debt levels of many states before the crisis were a constraint on further deficit spending.

“We are concerned by countries whose public debt is increasing very, very fast,” Almunia told the forum. “We cannot afford to spend the next two decades absorbing the debt we have created to tackle this very deep recession.”

The dispute about how to fight the crisis may have longer term negative consequences on both sides of the Atlantic — fuelling pressure in the United States for trade protectionism and stoking opposition in Germany to helping European partners.

Germans feel they made tough choices in the good times to balance their budget and cut unit labor costs to improve their competitiveness. Now many feel they are being expected to pay for the fiscal recklessness of other European countries.

Americans are raging at the greed and irresponsibility of bankers and corporate moguls. But if Main Street resents bailing out Wall Street, it will be even more resistant to paying to revive European or emerging economies through imports.

Lord Mark Malloch-Brown, the British minister in charge of preparing next week’s London crisis summit of G20 nations, said there was a big risk if Americans felt other countries were not pulling their weight in reviving the global economy.

“The most dangerous idea out there is that the world is somehow going to expect the American consumer to ride to he rescue,” the former senior U.N. official said. “If that idea is left out there, it’s going to lead to protectionism in America.”

– Paul Taylor is a Reuters columnist. The opinions expressed are his own –

The gas dispute between Russia and Ukraine that has left hundreds of thousands of Europeans shivering in the winter cold is bound to accelerate plodding European Union efforts to build a common energy policy.

The cut-off of Russian gas supplies to Europe via Ukraine highlighted how little progress the 27-nation EU has made in connecting national energy networks and diversifying supplies since the first such crisis three years ago.

“A similar situation occurred in 2006 and we Europeans now feel guilty about not having done what we said we would do,” said an EU energy official, who declined to be identified because of the sensitivity of his position.

Unlike 2006, when the Europeans broadly sided with Ukraine’s pro-Western, democratic government, the EU has remained strictly neutral this time in what it regards as mostly a commercial dispute over gas pricing and unpaid bills.

Both sides broke undertakings to Brussels on continuity of supply. The lack of transparency on contracts, the role of murky intermediaries and coalition feuding in Kiev all made it harder to sympathise with Ukraine this time, the EU official said.

“The Russians were having a good gas war until they overreacted by cutting supplies to the EU. As in the war with Georgia last year, they could not resist the urge to teach former Soviet republics a lesson,” he said.

Russian giant Gazprom’s demand for Ukraine to pay market prices is not unreasonable, but television images of Prime Minister Vladimir Putin ordering the company to turn off the taps to Europe belies talk of a purely commercial issue.

Several EU states have increased gas stocks since 2006 and avoided major disruption. But Bulgaria, the poorest EU newcomer, and western Balkans states Croatia and Bosnia were caught with no stocks at all. Supplies to 18 countries have been affected.

That prompted the EU to intervene. Czech Prime Minister Mirek Topolanek, the EU presidency holder, persuaded Moscow and Kiev to sign a deal allowing EU monitors to check the transit of gas across Ukraine to get supplies to Europe flowing again.

MUTUAL MISTRUST

Progress on integrating the European gas market by linking up national pipeline systems has been very slow, partly due to mutual mistrust among EU nations, as well as divergent business interests and political differences on relations with Moscow.

Member states still do not share information with each other about the price their energy companies pay Gazprom for gas. The executive European Commission and the EU Council secretariat have been struggling to collate such data since 2006.

“We preach transparency but we do not practice it among ourselves,” the EU energy official said.
Poland has led a chorus of new members from central and eastern Europe calling for energy “solidarity” within the EU to reduce the former Soviet satellites’ dependency on Moscow, which provides a quarter of the EU’s gas.

But Germany, Europe’s biggest gas consumer, opposes any emergency EU pooling arrangement for gas stocks, arguing that this is a commercial matter for utility companies.

Berlin is keen to manage its energy relationship with Russia without the involvement of Brussels. It resisted any EU involvement in the Ukraine dispute until the leaders of Bulgaria and Croatia appealed personally to Chancellor Angela Merkel.

EU officials say the crisis should spur European leaders at a March summit to put political momentum and public money behind plans to build cross-border energy interconnectors in Europe.

They may also agree on minimum requirements for gas storage as the EU has for national oil stocks.
And they will likely give higher priority to diversifying gas suppliers, supply routes and delivery mechanisms in particular to develop liquefied natural gas (LNG) facilities.

Among suppliers, the EU is eyeing Qatar and Nigeria for LNG as well as Algeria, Norway, Azerbaijan, Iraq and Central Asian countries for piped gas.

Russia is using the crisis to underline the cost for its NordStream and South Stream projects to carry Russian gas directly to European consumers via pipelines under the Baltic and Black seas, bypassing Ukraine, Belarus and Poland.

The dispute will also add political weight to the Nabucco project, backed by both the EU and the United States, to pipe Caspian and Middle East gas to central Europe via Turkey, but there are doubts about finding enough gas to fill the pipeline.

None of these projects offers an early solution, given the long lead times and high cost. EU officials say they are not an “either/or”. There will be enough demand and enough gas to justify all three extra pipelines, they say.

In the shorter term, the capacity of existing pipelines can be expanded. But the main quick gains for European gas security would come from linking national networks into a single market and improving energy efficiency, especially in central Europe.

For previous columns by Paul Taylor, click here.

– Paul Taylor is a Reuters columnist. The opinions expressed are his own –

The European Union is entering a lame duck year just as new challenges are mounting from Israel’s assault on Gaza, Russia’s gas cut-off to Ukraine and the impending inauguration of U.S. President Barack Obama.

The EU’s active crisis management in the Georgia war and the global financial meltdown last year under the energetic leadership of French President Nicolas Sarkozy was an exception, not the dawn of a new, more effective Union.

Europe now faces 12 months of stasis with two peripheral small countries - the Czech Republic and Sweden — holding the six-month rotating presidency, EU legislation on hold because of European Parliament elections in June, and the European Commission winding down to the end of its term in November.

Domestic politics in key member states will also constrain EU initiatives. Germany, the biggest member state, has a general election in September in which the two major parties in its ungainly grand coalition will be fighting each other.

That seems to preclude agreement on bold economic stimulus measures or foreign policy risk-taking.
Europe will also be held in check for most of the year by a second Irish referendum, expected in October or November, on the EU’s Lisbon treaty on institutional reform designed to give the bloc stronger leadership and a fairer decision-making system.

EU leaders will be careful not to do or say anything that could jeopardize the chances of reversing last year’s “No” vote.

LACK OF LEVERAGE

The first few days of the year have highlighted the EU’s divisions and lack of leverage in dealing with Israel, the Palestinians, Russia and Ukraine.

The Europeans exposed themselves to ridicule with two separate diplomatic missions touring the Middle East - an official EU delegation led by Czech Foreign Minister Karel Schwarzenberg and a French one led by Sarkozy, behaving as if he were still president of the Union.

The dual missions also reflected policy differences. While France, Britain and EU foreign policy chief Javier Solana demanded an immediate ceasefire, the Czechs and Germans blamed the Palestinian militant group Hamas squarely for the fighting and showed more sympathy towards Israel.

The EU has little leverage with either side, since the Israelis consider the United States to be the sole power broker in the region, and the Europeans will not talk officially to Hamas, which they have declared a terrorist organization.

The one card Europe can play is the possibility of deploying European monitors to help secure Gaza’s southern border with Egypt and prevent arms smuggling into the Palestinian area.

The offer of an EU monitoring presence helped achieve a ceasefire between Russia and Georgia last August.

France and Turkey have offered monitors to support an Egyptian ceasefire plan put forward by President Hosni Mubarak after talks with Sarkozy.

But there are snags: Israel does not trust the Europeans to enforce an arms embargo, Egypt does not want European forces on its soil, and Hamas does not want its hands tied by Europe.

If the monitors do go in, they could end up caught in the crossfire between Palestinian militants and Israeli troops.

European forces already run that risk in southern Lebanon, where they deployed in a buffer zone in 2006 to help end a conflict between Hezbollah fighters and the Israeli border.

WRONG-FOOTED

The EU has also been wrong-footed by Russia’s gas cut-off to Ukraine, which has now led to severe reductions in gas supplies to EU member states in central and southeastern Europe.

The European Commission and the Czech presidency have so far scrupulously avoided taking sides in what they describe as a commercial dispute.

But Czech Prime Minister Mirek Topolanek said if supplies to Europe were not restored by Thursday, the talks should be escalated to the top political level and the EU would intervene.

While many European governments, especially in former communist central Europe, suspect Moscow is playing with the gas taps to intimidate Ukraine’s pro-western government and send a message to other European countries dependent on Russian supplies, the EU has no common position.

The German election is a factor here too. Foreign Minister Frank-Walter Steinmeier, the Social Democratic candidate for chancellor, is widely seen as sympathetic to Russia, while Christian Democratic Chancellor Angela Merkel is more critical.

The same paralyzing factors may make it difficult for the EU to respond to challenges it is likely to receive from Obama.

Germany seems set to resist joining any massive fiscal stimulus of the kind the U.S. president-elect is planning.

Germany, Italy and Austria, with strong commercial interests in Iran, are unlikely to accept much tougher sanctions against Tehran’s nuclear program, especially without U.N. approval.
Berlin has also made clear it will not send more troops to Afghanistan or commit its forces to frontline combat missions.

The one issue on which a lame-duck Europe will be an eager partner for Obama is in fighting climate change. But EU hopes that the new U.S. leader may join an international agreement on curbing greenhouse gas emissions in Copenhagen at the end of this year may be over-optimistic.

For previous columns by Paul Taylor, click here.

– Paul Taylor is a Reuters columnist. The opinions expressed are his own –

He wasn’t present and he isn’t even in office yet, but Barack Obama was the elephant in the room at last week’s European Union summit on economic recovery and climate change.

The 27 EU leaders knew they needed strong agreements to reduce greenhouse gas emissions and give their recession-hit economies a big fiscal stimulus to make themselves credible partners for the U.S. president-elect.

Europe’s green deal had to be bigger, bolder and more ambitious to avoid being dwarfed when Obama announces his own clean energy program at his inauguration next month.

After the EU agreed on rules to cut carbon dioxide emissions by 20 percent by 2020, draw 20 percent of its energy from renewable sources and reduce energy consumption by 20 percent, European Commission President Jose Manuel Barroso adapted Obama’s campaign slogan to drive home the point.

“Our message to our global partners is ‘yes, you can’,” he declared. “Yes, you can do what we are doing … especially to our American partners.”

“We are asking him (Obama) to join Europe and with us lead the world.”

French President Nicolas Sarkozy, climaxing an energetic six-month presidency of the EU, proclaimed: “No other continent in the world is setting itself such binding limits as the measures we have just adopted.”

Behind their hubris lay worries that the charismatic new U.S. president could grab the mantle of green leadership from Europe, even though the goals he has outlined so far are more modest — to stabilize U.S. carbon emissions by 2020.

“The risk is that the Europeans could be upstaged by Obama acting more radically than Europe,” says Antonio Missiroli of the European Policy Center think-tank.

There is also the perennial fear that Europe may not figure very high on the new American leader’s radar screen, and that he may care more about relations with Asia’s emerging economic powerhouses than with the slow but steady EU.

“For Obama’s agenda, Euorpe is neither very relevant nor an obstruction. It doesn’t tip the balance,” Missiroli said.

Sarkozy warned more reluctant EU leaders that Europe would make itself look ridiculous if it abandoned its green ambitions just when the United States had finally elected a president who made climate change his priority.

Brussels officials are talking enthusiastically of linking the European emissions trading scheme with a future U.S. system to lay the foundation for a global carbon market.

They may be in for a cold shower, given likely resistance in the U.S. Congress to any binding cuts in carbon emissions.

Indeed, EU and U.S. officials are pessimistic about the chances of an international agreement in December 2009 at United Nations talks on a climate pact to replace the Kyoto Protocol, which Washington never ratified.

Some European leaders argued that the EU had to take the lead precisely because of the problems Obama will face at home.

“An EU agreement will support President Obama, who will have great difficulty getting an agreement on a system of emissions trading,” German Chancellor Angela Merkel told fellow leaders behind closed doors, according to an official record.

On the economy too, Barroso argued that Europe and the United States should coordinate their recovery programs.

Yet the main European powers remain divided on the correct response to the recession, despite agreeing on paper on a European Commission programme calling for a stimulus of about 1.5 percentage points of Gross Domestic Product.

Obama has indicated he is considering a far bigger fiscal jolt to the economy, given the scale of the U.S. recession.

Germany’s finance minister has branded Britain’s sweeping cut in sales tax “crass Keynesianism”. All other EU countries rejected any across-the-board cut in Value Added Tax.

France has focused its recovery measures on public infrastructure investment, plus a short-term cash incentive to trade in old cars for new ones.

Merkel has resisted pressure from Berlin’s EU partners to do more to stimulate Europe’s biggest economy, but she now faces domestic calls too for tax cuts and spending on public works.

On both climate change and the economy, Europe hopes to find a more cooperative partner in Obama, but perhaps with a degree of self-delusion about his interest in European solutions.

For previous columns by Paul Taylor, please click here.

– Paul Taylor is a Reuters columnist. The opinions expressed are his own –

European Union leaders this week face a crucial credibility test of their ambition to lead the world in fighting climate change, just as President-elect Barack Obama is making it a top priority for the United States.

Will the EU give real teeth to its pledge to cut greenhouse gas emissions by at least 20 percent by 2020, draw 20 percent of their energy from renewable sources and cut energy consumption by 20 percent over the same period, or will it fall short?

The omens for the Dec. 11-12 summit are not too encouraging.

Europe’s climate goals were agreed in March 2007 in sunnier economic days. The financial crisis and looming recession have fueled pressure from heavy industry and some governments to go easy on implementation measures.

The EU will almost certainly reach a deal by the early hours of Saturday, which French President Nicolas Sarkozy will no doubt declare a triumph for his presidency of the bloc.

Yet the draft legislation has already been watered down to assuage industrial lobbies led by Germany, and more concessions will have to be made to placate coal-dependent Poland.

European Commission President Jose Manuel Barroso says he is confident the essentials of the EU executive’s proposal to turn Europe’s climate objectives into reality will remain intact.

But green campaigners say the result will be a toothless package that falls far short of the EU’s leadership boast.

“The glass is three-quarters empty. The emperor is standing there with no clothes,” says Stephan Singer, head of the European Climate Change and Energy Unit at pressure group WWF.

FEAR OF COSTS

He and other environmentalists argue that the EU should be aiming to cut emissions by 30 percent in the light of impending “regime change” in the White House, Australia’s ratification of the Kyoto Protocol on climate change, and sigs of progress by China, India, Brazil, Indonesia and the Philippines.

Singer says the 27-nation EU will probably achieve its so-called 20-20-20 objectives, since European emissions are already almost 9 percent down on the 1990 starting point, leaving just 11 percent to cut in the next decade.

Moreover, EU states can make half those reductions far from home through a Clean Development Mechanism, which gives them carbon credits for funding emissions cuts in developing nations.

The emerging EU deal may not be tough enough to galvanize other nations into an agreement at U.N. climate negotiations in Copenhagen in December 2009 to save the planet from potentially catastrophic ecological consequences of global warming.

Fear of high initial costs for business and consumers has made many European governments wary of unilateral EU action, despite warnings from economists such as Britain’s Sir Nicholas Stern that the price of inaction will eventually be far higher.

Auto manufacturers have been given an additional three years till 2015 to meet a binding limit on carbon emissions from cars, and fines for non-compliance have been tapered in a way that may encourage some producers to overstep the mark.

INDUSTRIAL LOBBYING

The main climbdowns have been on the European Emissions Trading Scheme (ETS), which caps overall output of carbon dioxide, the main greenhouse gas, and makes companies buy and sell permits to emit CO2 according to their needs.

The Commission proposed requiring industry to buy all or most ETS allowances at auction from 2013. Power companies would have to buy 100 percent of their permits from the outset.

However, energy-intensive sectors such as steel, glass, chemicals, aluminum, ceramics and cement, which threatened to relocate outside Europe if forced to pay for pollution permits, will now be granted free allowances — at least initially — unless there is an international agreement.

The criteria proposed by the French presidency to determine which industries are exposed to international competition and are hence deemed unable to pass on auctioning costs to customers seem particularly generous to business.

This is a victory for German Chancellor Angela Merkel, whose green credentials have been tarnished by industrial lobbying since she presided over the 20-20-20 accord last year.

Merkel is determined not to jeopardize jobs in Germany, Europe’s biggest industrial economy, in an election year.

Exempting many companies from having to buy permits will reduce the incentive to use energy efficiently and shrink the proceeds from auctioning earmarked to fund clean energy projects in poorer EU states and developing countries.

Even electricity generators may now get some free carbon allowances in countries that are highly dependent on coal.

This is a sop to Poland and other central European states that are heavily reliant on coal and do not want to become more dependent on Russia by switching to less polluting gas.

PARTNER FOR OBAMA

A summit deal may hinge on Germany and Britain agreeing to earmark more EU money for next-generation clean coal power stations, cross-border electricity grid interconnectors and perhaps new nuclear plants for Poland and its Baltic neighbors.

On the plus side, European countries have made significant progress on legislation to promote renewable energy sources such as wind, wave, tidal and solar power.

And they are well set to reap big energy efficiency gains through better building design, insulation, lighting, heating and cooling.

So the EU’s green credibility may just about survive the inevitable compromises and delays necessary to get a deal at the Brussels summit, although environmental campaigners are bound to denounce a sell-out.

“In the end, we will achieve 80 to 90 percent of our objectives and the critics will scream about the other 10 or 20 percent,” sighed an EU official involved in the climate drive.

“But Obama will look at what Europe is doing and see he has a partner in the fight against climate change.”

– Paul Taylor is a Reuters columnist. The opinions expressed are his own –

The global financial crisis has been a stark reality check for the European Union, exposing divergences over economic policy and highlighting the European Commission’s growing difficulty in enforcing common rules.

The European response to the turmoil shows that most real power still resides with member states, not in Brussels. Even after 50 years of integration, governments instinctively reach for national solutions at the risk of harming EU partners.

The 27 EU leaders, especially the big three of Germany, France and Britain, need to take a deep breath before next week’s summit and measure how much damage they could inflict on future prosperity and on Europe’s credibility in the world if they continue down this path.

The EU united briefly in October behind a plan to avert a meltdown of the financial system and a call for a global summit to reform financial supervision, incorporating the emerging economies of Asia, Africa and Latin America.

But since then, forces pushing towards a re-nationalization of EU economic, fiscal and competition policy seem to have gained the upper hand over forces working to unite and coordinate Europe’s response to the crisis.

“It may be that measures taken nationally will break community rules and we will not recover,” said Tommaso Padoa-Schioppa, former Italian finance minister and president of the Notre Europe foundation.

“What we observe now is that both forces are at work — an extraordinary effort at coordination and a strong diversity of measures taken at national level.”

SMOKE AND MIRRORS

In two months, countries such as Ireland, Britain and now France, have cast aside the EU’s budget discipline rules in favor of massive deficit spending.

Who seriously believes that the deficits which those countries will run next year, way in excess of the EU’s limit of 3 percent of Gross Domestic Product, will be brought back into line within a year or two, as Brussels says it expects?

Likewise, the 200 billion euro ($252.8 billion) economic recovery program proposed by the executive European Commission last week was largely an exercise in smoke and mirrors, aimed at creating at least a facade of unity.

It totted up money already spent, or about to be spent, by national governments, with just 30 billion euros in proposed EU funds, some of which finance ministers blocked this week.

That may be inevitable since the EU budget is a mere 1 percent of the bloc’s combined GDP, while national budgets average about 40 percent of GDP.

The Commission hoisted a European flag of convenience over often divergent measures that member states were taking anyway, in the hope of dissuading them from making more unorthodox, protectionist or beggar-thy-neighbor moves.

But it cannot mask the fact that the three biggest EU economies are heading in separate directions.
Britain has thrown fiscal caution to the wind and cut sales taxes, France is on the brink of announcing a big boost in public spending but orthodox Germany, Europe’s biggest economy, is holding out against a bigger stimulus for now.

EACH FOR HIMSELF

EU restrictions on state aid to banks have been eased, with a further softening in the pipeline as Brussels faces pressure to be ever more indulgent. Even pro-market Sweden’s finance minister this week urged the Commission “to call off these legions of state aid bureaucrats”.

The single market at the heart of Europe’s economic success is starting to fray as a result.
“Each country is acting for itself, also in the impact of bank rescues,” said Daniel Gros, director of the Center for European Policy Studies.

“There are different conditions on help to the banks, different interest rates on state loans to banks, different governance arrangements, different conditions on lending.”

An earlier free-for-all over guaranteeing bank deposits led some savers to withdraw money from solvent institutions and place it in troubled ones such as Britain’s Northern Rock or Irish banks that had an unlimited state guarantee.

Now France is fighting Brussels to be allowed to pump money into healthy banks in return for commitments to lend more to the “real economy”, while the Commission demands that ailing banks reduce their activity as a condition for state aid.

EU officials are worried that the each-for-himself mentality will weaken the European position in global climate change negotiations, the latest round of which began this week.

EU leaders are due to adopt ambitious plans next week to make good on their pledge to cut greenhouse gas emissions by 20 percent by 2020, reduce energy consumption by 20 percent and draw 20 percent of energy from renewable sources.

But a fierce battle is under way to water down or delay implementing measures because of the financial crisis. That would weaken the EU’s green leadership ambition just as a more climate-conscious U.S. president takes office.

GOLF CART BLUES

Historically, European integration advances through crises. The 1970s oil price shock led to the creation of the European Monetary System. The 1989 fall of the Berlin Wall made possible the establishment of the euro single currency.

And the Sept. 11, 2001 attacks on the United States hastened the adoption of a European arrest warrant, replacing centuries of cumbersome extradition proceedings for criminal suspects.

The financial crisis may yet spur another leap forward for the EU, perhaps convincing Irish voters next year to reverse their rejection of the Lisbon Treaty and allow a reform of the bloc’s creaking institutions.

But this crisis could also deal Europe an enduring setback. If budget discipline and competition rules fray further, it will be hard to get the toothpaste back into the tube when it’s over.

One image from the last few weeks summed up the EU’s uncertain state as it struggles to find a common path.

At crisis talks in Camp David with U.S. President George W. Bush in late October, French President Nicolas Sarkozy, the rotating president of the EU member states, rode in the front of a golf cart with Bush, while European Commission President Jose Manuel Barroso sat glumly in the back, facing the wrong way.

Diplomats said Barroso was offered a seat in the second cart alongside Secretary of State Condoleezza Rice, but he was determined to stay in the front cart, even if that meant taking a back seat.

For more columns by Paul Taylor, click here.

Want to debate? Send in your written submissions to debate@thomsonreuters.com.

– John Kemp is a Reuters columnist. The views expressed are his own –

Even by the standards of a deep-cyclical industry, the “golden age” of oil refining has proved remarkably brief, lasting no more than three years, before giving way to a new dark age.

Particularly in the United States, refiners have returned to the state of chronic unprofitability that plagued the industry before 2005.

U.S. refiners now have too much capacity and produce the wrong products (gasoline) in a fuel economy increasingly dominated by ethanol and diesel. Capacity cuts of as much as 0.5-1.0 million bpd (equivalent to 4-8 average refineries) and expensive investment to reconfigure the system to increase the diesel yield seem inevitable.

EVAPORATING PROFIT MARGINS

In May 2007, U.S. refiners paid an average of about $64 a barrel to acquire high quality West Texas Intermediate (WTI) crude (less for other grades) and sold gasoline for $97 per barrel - a margin of $33 per barrel or 52 percent.

By November 2008, U.S. refiners were paying $62 to acquire WTI but selling gasoline at a loss for just $52 - a negative margin of $10 or 16 percent.

Other outputs are still profitable (notably diesel and heating oil) and many refineries will have acquired lower-quality crudes for less than the WTI price. The overall gross margin was still (just) positive.

But the NYMEX benchmark 3-2-1 crude oil-gasoline-heating oil has shrunk from $30 per barrel to just $3. Once operating costs (including natural gas, electricity, water and catalysts) as well as capital expenditures (building, maintaining and upgrading refineries) are taken into account, the industry is making little or no profit.

DEMAND DESTRUCTION

Demand for gasoline and other refined products has been falling for more than a year, initially in response to high prices and now as a result of a weakening economy, leaving refiners with a huge overhang of unused capacity.

The total volume of refined products supplied to the domestic market averaged just 19.2 million barrels per day (bpd) in the four weeks ending Nov. 21, down 1.7 million bpd (8 percent) from 20.9 million bpd in the same period last year. The volume of motor gasoline supplied (9.0 million bpd) was down 300,000 bpd (3.3 percent) compared with last year (9.3 million bpd).

Refiners have responded with run cuts and record exports of both gasoline and distillates to avoid flooding the domestic market and collapsing prices further.

Operating rates have been below year-ago levels since the start of 2008 (https://customers.reuters.com/d/graphics/US_RFRT1208.gif).

Refineries processed 15.2 million bpd of crude and other inputs in the week ending Nov. 21 - using just 86.2 percent of their 17.6 million bpd maximum capacity, and leaving more than 2 million bpd of crude distillation capacity idle.

Refiners also sent increasing volumes of refined products abroad to avoid flooding the domestic market. Refiners and merchants ramped up gasoline exports from 38 million barrels in Jan-Sep 2007 to 50 million in Jan-Sep 2008 (+32 percent) and distillate exports from 52 million barrels to 146 million (a massive increase of +182 percent).

It has not been enough. By Nov. 21, reported gasoline inventories stood at 200 million barrels (22.3 days of supply) up from 197 million barrels (21.2 days cover) in 2007.

ETHANOL DISPLACEMENT

Refinery gasoline is increasingly squeezed out by ethanol. U.S. ethanol production has tripled from 260,000 bpd in Sep 2005 to 640,000 bpd in Sep 2008, with another 80,000 bpd of ethanol imported. As a result, ethanol is cutting almost 750,000 bpd of demand for fossil-fuel refinery-derived gasoline (https://customers.reuters.com/d/graphics/US_GSETH1208.gif).

In Sep 2005, some 8.9 million bpd of gasoline was supplied to the domestic market, of which 8.7 million bpd came from refineries and just 0.3 million bpd was sourced from ethanol distilleries.

Three years later, in Sep 2008, the volume of gasoline supplied had fallen 400,000 bpd to 8.5 million bpd. But while the volume of ethanol sourced from distilleries had risen by 0.5 million bpd to 0.7 million bpd, the volume of gasoline sourced from refineries was down by a massive 1 million bpd to 7.7 million bpd.

Roughly half the refinery demand lost over the last three years is due to increased ethanol (500,000 bpd), while the remainder is due to cyclical factors (400,000 bpd).

The displacement of refinery gasoline is an explicit objective of federal policy to reduce U.S. oil imports. It has been accelerated by the surge in crude oil prices during 2007-2008, encouraging widespread voluntary blending of cheaper ethanol into the domestic fuel supply.

But increased blending volumes threaten to strand many U.S. oil refineries as white elephants with no long-term future. Refinery utilisation rates have been trending down since the start of the decade, but the loss of demand has accelerated notably since widespread ethanol blending commenced in 2005 (https://customers.reuters.com/d/graphics/US_RFRTA1208.gif).

As a result, there is an increasingly wide gap between system capacity and actual throughput. More than 2.0 million bpd of crude distillation capacity is sitting idle. The last time the refining system had more than 1 million bpd of spare capacity was in the early 1990s, when refiners responded by mothballing facilities and closing plants, cutting capacity by more than 500,000 bpd between 1992 and 1994 (https://customers.reuters.com/d/graphics/US_RFRTB1208.gif).

Even with refinery shutdowns, the long-term outlook is bleak. The Energy Information Administration (EIA) projects gasoline consumption will increase from around 142 billion gallons in 2006 to 151 billion gallons in 2030 (based on an increasing population and rising car use, partly offset by improved fuel efficiency).

But the fossil-fuel content of that gasoline is scheduled to drop from 136 billion gallons to just 125 billion gallons as the ethanol content rises from 5.5 billion gallons to 25.8 billion gallons to comply with Renewable Fuel Standard (RFS) targets.

GASOLINE-DIESEL MIX

As if falling demand and the increasing challenge for ethanol were not enough, U.S. refiners face a deeper structural problem.

Most of the world relies on diesel rather than gasoline for transportation fuel and heating demand. According to the International Energy Agency (IEA) the world consumed just 0.75 gallons of gasoline for every gallon of diesel in 2005, and the refinery system was configured to produce the two fuels in roughly the same proportion (https://customers.reuters.com/d/graphics/FL_CNSP1208.gif).

The U.S. petroleum economy is highly unusual in that it is tilted towards consumption and production of gasoline. The United States consumes almost two gallons of gasoline (1.97) for every gallon of diesel; the European Union consumes only 0.40 gallons and China consumes 0.48 gallons.

Until recently, that led to a mutually beneficial trade, with the United States exporting surplus diesel, while Europe and China exported surplus gasoline (https://customers.reuters.com/d/graphics/REFINEPRDS1208.htm).

But U.S. refiners now face the problem that in the fastest-growing parts of the petroleum economy (China, Asia, the Middle East and Africa) the marginal demand is for diesel, while their marginal supply is gasoline, for which demand is stagnating.

The global economy now faces a structural surplus of gasoline and a structural shortfall of diesel. By implication, the world has too much capacity for producing gasoline (much of it concentrated in the United States) and not enough capacity for producing diesel (especially in Asia).

As a result, U.S. refiners face increased competition in their domestic market from imported gasoline, while they struggle to produce enough diesel to sell abroad. This mismatch explains why U.S. diesel exports have risen much faster in the past year than gasoline, even though it is the domestic gasoline market which is most oversupplied.

The United States now has too many refineries for its increasingly ethanol-based economy, and they produce the wrong product mix for a dieselised global economy.

U.S. refiners have begun to reduce gasoline production (https://customers.reuters.com/d/graphics/EIA_REFGS1208.gif) and prioritise distillates (https://customers.reuters.com/d/graphics/EIA_REF1208.gif). But yield changes have been marginal (1-2 percentage points), reflecting the technical limitations of the existing refinery units.

In the short to medium term (12-24 months), it seems virtually certain U.S. refiners will have to cut total capacity sharply, perhaps as much as 0.5-1.0 million bpd, 4-8 average refineries. In the longer term, they have no choice but to undertake substantial capital expenditures to shift the system towards more diesel.