- Gazprom and its European partners will be unable to bring the Nord Stream 2 pipeline online by 2019 as planned. As a result, Russia will be required to negotiate a new transit supply contract with Ukraine before the current agreement expires.
- The outlook for the new pipeline remains uncertain given shifting legal and political exigencies, but the most likely scenario for construction involves a deal between Russia and the European Commission that would see a commitment to maintain a level of transit via Ukraine.
- The European energy and regulatory market is likely to remain in flux, and by the time a deal on Nord Stream 2 is agreed, the commercial rationale for the project may have weakened, leading Gazprom or other players in the project to seek an alternative.
In September 2015, Gazprom and its five European partners – BASF, E.ON, Engie, OMV and Royal Dutch Shell – signed a deal to construct two new natural gas pipelines through the Baltic, committing to increase existing capacity from 55 bn cubic meters to 100 bn cubic meters. In a sign of confidence, the Nord Stream 2 consortium has ordered pipe and pressed ahead with survey work on the project, which is completely financed by its shareholders. However, while the Nord Stream 1 project was completed with EU backing, the pipeline’s expansion has left European powers divided, setting of a contentious and heavily politicised debate over Russian gas imports and European energy policy. Sanctions and competition remain serious impediments to Russia’s ongoing efforts to develop customers for its gas exports in Asia, increasing the importance of maintaining Gazprom’s market share in Europe. In the EU, the debate has coalesced around a series of key questions, with supporters and detractors of the project drawing different conclusions.
Is there a commercial rationale for Nord Stream 2?
In the short-to-medium term the project would represent excess capacity in Europe. Russian gas exports to Europe and Turkey were less than 159 bn cubic metres (bcm) in 2015 compared to available capacity of 307 bcm. There are legitimate concerns about the reliability of Ukraine’s ageing pipeline network, through which around 40 percent of European gas imports transit. However, the urgency of these concerns has been ameliorated by a fall in Ukrainian demand that has reduced pressure on the system, as well as European financing earmarked to improve the integrity of pipelines. After suggesting it would halt shipments via Ukraine entirely, Gazprom head Alexei Miller said in June that transit via Ukraine would fall to around a quarter of current volumes (10-15 bcm) once Nord Stream 2 comes online in 2019, the same year the current contract with Kiev expires.
Despite EU assertions Kiev is a reliable partner, the vulnerability of the Ukrainian transit corridor has been demonstrated by disputes with Russia in 2006 and 2009 that disrupted the flow of gas to Western European markets. However, the current consultative framework involving Brussels, Kiev and Moscow has greatly reduced the risk of supply disruption even as a poor relations look set to persist indefinitely. Moreover, a 2006 report prepared by a researcher at the Swedish Defence Research Agency found evidence that Russia cut supplies to markets in Eastern Europe and the Baltics more than 40 times between 1991 and 2004, raising questions about Russia’s reliability as a supplier at a time when the EU has prioritised efforts to diversify energy sources and suppliers.
Construction of Nord Stream 2 would strengthen the position and influence of Russia – which accounts for 39 percent of EU gas imports – even as it improves the security of supply to northwest Europe.
Thus, while there are commercial arguments for the project, the pipeline is still contrary to the EU’s wider energy and political strategy. However, it is unclear whether these grounds alone are sufficient to block a project funded by its stakeholders and backed by relevant transit countries.
Can the EC block construction of the pipeline?
In their public statements, senior EU officials have highlighted their concerns over Nord Stream 2 specifically and signalled their general opposition to Russian energy projects, but their ability to prevent its construction rests on the interpretation of EU law in several key areas, among them:
- Third Energy Package (TEP) – The TEP prevents a single company from owning both the pipeline and the gas being sent through it, and if applied to Nord Stream 2 would require Gazprom to ensure third-party access to the pipeline. Political tensions and concerns over supply security make it highly unlikely that Gazprom would be granted an exemption from the TEP, as it had been with one of the onshore streams of Nord Stream 1 (the OPAL pipeline).
- Offshore Pipelines – There has been some debate over whether the EU has oversight of offshore pipelines, which would allow it to apply the TEP and other regulations to the subsea portion of Nord Stream 2. However, EU legislation remains focused on the internal market, making it unlikely that the European Commission (EC) that the TEP would apply to offshore pipelines in the territorial waters of member states.
- Intergovernmental Agreements (IGAs) – In early 2016, the EU unveiled new powers that would enhance its ability to block future pipeline projects based on IGAs. The new legislation, contrary to previous rules, would not require the invitation or approval of a member state for the EC to determine compliance of IGAs with the TEP. Gazprom signed IGAs with seven countries for construction of the South Stream but abandoned that project in December 2014 under pressure from the EU, which said the pipeline was not compatible with the TEP and raised concerns about possible procurement violations in Bulgaria.
Notwithstanding the EU’s powers, it is unclear whether regulators have the desire to prevent construction of a privately financed project supported by major European companies. The Commission may enact barriers to the project, for example refusing exemptions to Third-Party Access, without actually vetoing it. In order to ensure its decision stands up to the scrutiny of any legal challenge, the EC must ensure that any conclusions it reaches on Nord Stream 2 are grounded in EU law and an assessment of its pipeline itself, rather than a reflection of the wider geopolitical tensions with Russia.
Beyond the EU, other regulatory bodies may also erect challenges that slow or deter the Nord Stream 2 project. This potential was most clearly demonstrated by a legal challenge from Poland’s UOKiK anti-monopoly regulator in August that blocked a joint venture of Gazprom and its European partners to build and operate the pipeline. Although the partners in the project said that they remained committed to the project, the move forced them to consider alternatives, including issuing loans to Gazprom at higher interest rates or reducing their stakes in the project to move it beyond the purview of Polish regulators, to advance the pipeline. The options under consideration show that even if alternative solutions to future regulatory challenges can be found, they are likely to result in higher costs and delay.
How will the political debate evolve?
The coalition opposing Nord Stream 2 is diverse, ranging from environmentalists who favour cleaner fuels to Central and Eastern Europe (CEE) powers concerned about the security of supply and potential loss of transit revenues. The US also opposes the project for geopolitical reasons and Italy, angered over the cancellation of South Stream, is against the expansion. Critically, there is strong backing for the project in parts of the German government although the Chancellor’s Office has not so far pledged support, and though there is evidence of wavering support for Western isolation of Moscow, Europe has signalled a long-term commitment to Ukraine and it cannot ignore the concerns of its CEE members at a time of serious questions about the viability of the European project post-Brexit.
Given the complex political realities, the most likely scenario for Nord Stream 2 to come online involves a compromise that would see Russia maintain transit via Ukraine, thus ensuring revenues and stable supply in southeastern Europe. In exchange, the EC would agree not to block the project, removing the largest source of risk and uncertainty. However, by the time such a deal is agreed and after changing market dynamics in the Europe are accounted for, it is unclear whether support for the project will be as robust as it now. The revival of a possible rival of Nord Stream 2, the Turkish Stream pipeline between Russia and Turkey, highlights the ever-shifting priorities of Gazprom and the potential for evolving geo-political realities to affect the prospects for any expansion of capacity into Germany. Moreover, acrimonious political relations between Moscow and the West will make it even more it difficult to resolve the impasse. Thus, Nord Stream 2, like many other pipelines proposed by Gazprom in recent years, may fail to materialise as political, commercial and regulatory challenges mount.