Nord Stream 2, the controversial Russian-German pipeline project, is generating fierce opposition in Central and Eastern Europe as well as from the European Parliament and the European Commission. But could the opponents of the pipeline, owned 50% by Gazprom and 50% by some of the largest Western European companies, stop the project? They may be able to follow a complex legal route that could place formidable obstacles in the way of the pipeline. There is also an even more complex political route that could result in a blocking of the project, but this would involve a high-stakes battle at the highest political level. Energy Post editor-in-chief Karel Beckman reports.
At a debate in the European Parliament on 6 April, the mood towards Nord Stream 2 could not have been more hostile. Petras Auštrevičius, MEP from Lithuania and Vice-Chair of the ALDE-faction (Alliance of Liberals and Democrats for Europe) in the European Parliament, called Nord Stream 2 a “killer project”, that “would kill much of what the Energy Union was intended to achieve”.
MEP (and former Polish Prime Minister) Jerzy Buzek of the European People’s Party (Christian-Democrats), and also Chair of the important ITRE Committee (Industry, Research and Energy) in the Parliament, said that “Nord Stream 2 and Energy Union cannot co-exist”. He also stressed that “the majority of the European Parliament opposes Nord Stream 2.”
By pitting Nord Stream 2 against “the Energy Union” the opponents have turned their opposition to the pipeline into a high-stakes game. The Energy Union is one of the top priorities of the current European Commission.
But their stance is not a surprise. Earlier, on 17 March, Prime Ministers and leaders of 9 EU member states (Czech Republic, Hungary, Poland, Slovak Republic, Romania, Estonia, Latvia, Lithuania, Croatia) had sent a letter to Jean-Claude Juncker, President of the European Commission, speaking out against Nord Stream 2. They pointed out, among other things, that Nord Stream 2 poses “risks for energy security in the region of Central and Eastern Europe, which is still highly dependent on a single source of energy”.
And the European Commission itself has also taken a highly critical stance towards Nord Stream 2. In a speech in October last year, Miguel Arias Cañete, Commissioner of Climate Action and Energy, said there were were “serious doubts” whether Nord Stream 2 was compatible with the EU’s “strategy of security of supply”. He said diversification of routes and sources is key to this strategy and “Nord Stream 2 does not follow this core policy objective. On the contrary, if constructed, it would not only increase Europe’s dependence on one supplier, but it will also increase Europe’s dependence on one route.”
At the event on 6 April in Brussels, Maros Šefčovič, who as Vice-President of the European Commission is in charge of the Energy Union project, voiced equally strong criticism
of Nord Stream 2. “Let me be very clear”, he said. “The impact of the Nord Stream 2 project goes clearly beyond the legal discussions. Nord Stream 2 could alter the landscape of the EU’s gas market while not giving access to a new source of supply or a new supplier, and further increasing excess capacity from Russia to the EU. This raises concerns, and I am pretty sure this will play a role in this debate.”
The European Parliament and European Commission seem bent on stopping the Nord Stream 2 project. But can they? The EU is not directly involved in the decision-making process around Nord Stream 2: it is the national permitting authorities of the countries whose waters the pipeline will cross that must grant approval for the project. In this case, these are the permitting authorities of Russia, Finland, Sweden, Denmark and Germany.
Currently, the Nord Stream 2 consortium is “communicating” with the permitting authorities in the five countries, says Ulrich Lissek, Head of Communications of the company. If they give approval, the pipeline can go ahead, according to Lissek: “There is an established approval process based on the rule of law that we are going through. The outcome does not depend on a political decision in Brussels.”
Lissek, who was one of the speakers at the debate in Brussels, said in a separate interview with Energy Post that, although he regarded the political debate in Brussels as “important”, “its outcome will not have a direct impact on the project”.
Nor does Nord Stream 2 wait on an FID (final investment decision), Lissek explained. In effect, the FID has already been taken: the shareholders agreement
that was signed in Vladivostok on 4 September last year was the start of the project, said Lissek. (At the time of the signing, Gazprom had a 51 per cent share in the joint project company, called New European Pipeline AG, while Eon, Shell, OMV and BASF/Wintershall each had 10 per cent and Engie 9 per cent. Later Gazprom’s share was reduced to 50 per cent and Engie’s increased to 10 per cent.)
Signing of shareholders agreement: Pierre Chareyre, Klaus Schaefer, Ben van Beurden, Alexey Miller, Kurt Bock, Rainer Seele
The implementation of the agreement requires a number of separate investment decisions, such as the selection of the pipeline supplier
, which took place last month, and getting the required permits from the authorities. Lissek said he does not expect problems with the environmental permits: after all, Nord Stream 1 was built in the same location and is already operational. Indeed, Nord Stream 1 also encountered a great deal of opposition, yet it has been fully approved and is functioning today. So, Lissek implied, why should Nord Stream 2 be treated differently?
Source: Nord Stream 2
Does this mean case closed, Nord Stream 2 will be built if the shareholders want it to? Well, not quite. As Alan Riley, professor at City Law School in London and nonresident senior fellow with the Atlantic Council, pointed out in Brussels: Nord Stream 2 may well face both legal and political obstacles that Nord Stream 1 did not encounter. (See also his in-depth article on Energy Post
.) “The world has changed since the first Nord Stream was launched in 2008”, he said.
Riley noted that firstly, EU energy law has progressed (the Third Energy Package and Third Gas Directive were adopted in 2009) and secondly, Ukraine was invaded by Russia in 2014 and is still in a state of war, which creates a new political context.
According to Riley, the European Commission and individual member states do have legal options to block Nord Stream 2. The key issue here is whether EU law – specifically, the Third Energy Package – applies to the pipeline or not. Under the Third Energy Package, the owners of major gas pipelines must be independent of the suppliers of gas, and they must allow equal access to all suppliers who want to make use of the pipeline. Nord Stream 2 clearly does not conform to these requirements: it is 50% owned by Gazprom, which is a supplier, and also partly by companies like Shell, OMV and Engie, also suppliers. If the Nord Stream 2 consortium were forced to submit to the unbundling and third party access rules of the Third Energy Package, it seems clear that the business case for the project would be destroyed.
However, the Nord Stream 2 consortium takes the view that since the pipeline runs offshore, the Third Energy Package does not apply to it. The rules of the Third Energy Package, says Lissek,do apply to the connecting parts of the pipeline inside Germany (owned by different companies), but not to Nord Stream itself, which runs offshore and is an “import pipeline”. He said there are ample precedents for this view: “The five gas pipelines in the Mediterranean that run from Africa to Europe are not subject to the Third Energy Package either. Nor is Nord Stream 1. So Nord Stream 2 cannot be treated differently.”
Riley disagrees. He says EU law applies to the territorial waters of the relevant member states (the 12-mile limits) and to their 200-mile Exclusive Economic Zones (EEZ). For Nord Stream 2 this means that “at least 100 kilometres of the offshore route fall under the Third Energy Package”.
If the Third Energy Package has not been applied to existing “import pipelines”, said Riley, it’s because it was not in force yet when they were built. Since it has come in force, there is no reason why it should not apply.
If he is right that would mean that the offshore pipe would need to be certified as TSO by the national regulators of the five countries involved. And under aticle 11 of the Third Gas Directive, the regulators must refuse to grant certification to a project if it does not a) comply with the “unbundling” and third-party access requirements of the Third Energy Package, and b) if the project puts at risk “the security of energy supply of the Member State and the European Union”.
possible route Nord Stream 2 according to company
Maros Šefčovič also alluded to this point in his speech in Brussels. “Let me underline again that EU law applies in principle also to off-shore infrastructure under the jurisdiction of Member States including their exclusive economic zones”, he said. But he added, “What exactly within EU sectorial legislation applies has to be assessed in regard to their specific provisions.” In other words, the Commission Vice-President is not entirely sure yet of the applicability of the Third Energy Package to Nord Stream 2.
A spokeswoman for the Commission did not want to make any further comments. She said “the Commission is in touch with the German Energy Regulator to find out more about the details of the project. On that basis the Commission will draw its conclusions on the extent to which EU law (internal energy market, environment, competition etc.) applies to the Nord Stream 2 project and the next steps to be taken by the Commission.”
On 19 November last year, the European Commission sought the advice of its Legal Service on this question. To the disappointment of the Commission, the Legal Service replied that the Gas Directive does not
apply to the part of the project running through the exclusive economic zones and territorial waters of the member states concerned. This was reported
on 7 February by the website Politico on the basis of an analysis of the Legal Service reply written by DG Energy, which Energy Post also has a copy of.
In this analysis, DG Energy concedes that “if the opinion of the Legal Service is applied, this would mean that the EU cannot claim any applicability of its energy legislation to any part of Nord Stream 2.”
However, the author of the analysis then goes on to present a contrary opinion, arguing, in a detailed Annex, why, according to DG Energy, the Legal Service opinion is wrong and EU law should apply to Nord Stream 2. Thus, the issue is not settled yet.
That’s as far as the Third Energy Package is concerned. But as Riley pointed out, the certification process by the national regulators also involves a “supply security test”, and he wondered, “how on earth can Nord Stream 2 ever pass such a test?”
The issue of “energy security” is a critical one in the debate around Nord Stream 2. The opponents invariably argue that the pipeline has an extremely negative impact on Europe’s energy security. This is enough reason, they say, for EU leaders to block the project. One of the critical strategical objectives of the EU’s Energy Union is after all “energy security, solidarity and trust”, as it was phrased by the European Commission when it launched the Energy Union
in 2014. This phrase also appears in the official Energy Union “package” that was published on 25 February 2015. Šefčovič repeated it in Brussels: “Energy security, solidarity and trust constitute a key dimension of our framework strategy of 25 February 2015”, he said.
But what exactly is “energy security”? And what is “solidarity”? From an economic perspective, energy security in the gas market is defined by the European Commission as “diversification of energy sources, suppliers and routes”. As Šefčovič put it: “diversification of energy sources, suppliers and routes are crucial for ensuring secure and resilient energy supplies to European citizens and companies.”
The critics of Nord Stream 2 have no doubt that the pipeline fails to meet the energy security test on these grounds. Šefčovič said: “Nord Stream 2 could alter the landscape of the EU gas market while not giving access to a new source of suply, and further increasing excess capacity from Russia to the EU.” He added that “Nord Stream 2 could lead to decreasing gas transportation corridors from three to two, abandoning the route through Ukraine. Also the Yamal route via Poland could be endangered.”
Buzek too said that “Nord Stream 2 is against the EU strategy of energy diversification. It would further strengthen the position of a dominant supplier who is already under investigation for abusing its position.”
Yet this argument seems debatable. Even if Nord Stream 2 does not bring additional supplies (the consortium says it will, opponents deny this), all it does is change the route by which Russian gas is transported to Europe. This may not increase suppliers or bring additional routes (since there already is a Nord Stream 1), but neither does it reduce the number of routes or supplies. So how can it reduce competition or energy security?
The answer is: from an EU perspective it clearly doesn’t. From an Eastern European perspective, however, things look rather different.
Once Nord Stream 2 becomes operational, Gazprom may close down its gas transit through Ukraine (this is not certain yet), and through countries like Poland and Slovakia, either completely or partially. This will lead to huge losses for these countries. Ukraine stands to lose $2 billion in annual transit fees, but a country like Slovakia also makes $800 million annually on its gas transit contract.
This puts the opposition from Central and East European countries in a somewhat different light. For many years they have made profits from their transit capabilities. Now they are afraid to be passed by. This is painful for them, but why would Russia and its Western European partners not be allowed to decide on a more profitable arrangement for themselves? Isn’t this the whole idea of the “well-functioning gas market” the EU has managed to create – against Russian opposition – over the last seven years, since the last supply crisis in 2009, when Gazprom cut off gas transit through Ukraine?
Péter Kaderják, Director of the Regional Centre for Energy Policy Research (REKK) in Budapest – an opponent of Nord Stream 2 – said in Brussels that the diversification strategy of the EU has worked very well so far. He pointed to the new LNG terminals being built or planned in Lithuania and Poland, the new interconnectors that have been built, and the reverse flow capabilities that have been created since 2009. As a result, he said, “supply security risk has significantly decreased” and Eastern European gas markets have increasingly integrated with the west.
The result of this diversification effort is that Eastern European countries have become much less dependent on Russia. They can now easily import gas from Western Europe. True, their market position will clearly worsen, once Nord Stream 2 is built. As Kaderják said, there will be “a widening price gap between West and East”. But one could argue that this is what competition is about. The market is not about “solidarity”.
It may also be noted that it is rather misleading to argue, as the 9 prime ministers do in their letter to Juncker, that Eastern European countries are “still highly dependent on a single source of energy”. They may still be “highly dependent” on Russia for their gas supplies, but gas is only part of their energy needs. Many countries in Eastern Europe, like Poland, Hungary and Bulgaria, actually do not use much gas in their energy mix at all. And they can choose to develop alternative sources of energy. There seems to be an element of choice involved when it comes to being “dependent on Russian gas”.
None of this is meant to imply that Russia does not have geopolitical motivations in building Nord Stream 2. No doubt for Moscow Nord Stream 2 is also seen as a weapon in its conflict with Ukraine. That is what makes the issue so complex. The EU will have to decide whether it should regard Nord Stream 2 as simply an economic project, or also as a geopolitical threat.
MEP Rebecca Harms, co-chair of the Group of the Greens in the European Parliament, had no doubts on this account. She said in Brussels that Ukraine is at war, and asked: “Why should we allow a further weakening of the country?”
The problem with this argument is that it could be applied to any project that affects the Ukrainian economy negatively. As Lissek of the Nord Stream 2 consortium said: ”Do we have to stop every economic exchange with Russia?” He complained: “Why is so much importance attached to this project? That’s not very fair.”
For Ukraine the ending of Russian gas transit would clearly be an economic blow. Yet the country also has itself to blame. For years it has allowed tremendous corruption
in the gas sector, thereby putting the energy security of Western European countries at risk. The Russian decision in 2006 and 2009 to cut gas transit through Ukraine had a lot do with that.
Opponents of Nord Stream 2 argue that this past is not relevant anymore: Ukraine has firmly started on a process of reform. Šefčovič said: “Ukraine continues to be a reliable gas partner and transit country….” He added that “The completion of energy sector reforms in Ukraine [is] of utmost importance and should be further implemented. There is no better reassurance for Ukraine to remain a transit country and to attract investors to its gas assets then by completing ownership unbundling of Naftogaz and setting up an independent energy regulator in line with the 3rd Energy Package. Ukraine has all our support to make these necessary game-changing steps.”
The question is, does the energy market reform in Ukraine imply that Nord Stream 2 should not be built and the EU should help the country retain its dominant position in Russian gas transit to Western Europe? Wouldn’t this be an incentive for the country not to pursue its market reforms?
In an article
published by the Atlantic Council in April, the well-known Russia expert Anders Åslund, a fierce critic of Nord Stream 2, writes that Ukraine has made tremendous progress in its energy reforms. One effect has been an “extraordinary” decline in gas consumption: “As late as 2011, consumption amounted to 59.3 billion cubic metres. In 2015, it had fallen to merely 36 bcm, of which Ukraine itself produced 20 bcm.” The expectation is that in 2016 gas consumption will fall to a mere 29 bcm, “of which Ukraine itself will produce 20 bcm”. In 2015, Ukraine imported a mere 6.1 bcm from Russia.
Åslund writes that “Energy is the linchpin of Ukraine’s independence on Russia”, and recommends that Ukraine should “stop buying gas from Russia altogether”, yet he wants Nord Stream 2 also to be stopped, as it is “instigated by Gazprom and certain German interests to weaken the EU and its energy policy to the disadvantage of Ukraine”. This does not seem consistent.
Åslund has a broader perspective, though, since he also wants Gazprom to be investigated as “a criminal organization”. He may have a point, but if Gazprom really is a criminal organization, then it seems reasonable to argue that this is what the debate in Europe should be about: not about Nord Stream 2 but about Gazprom. After all, Gazprom is dealing with Europe in many ways, supplying large amounts of gas through various channels.
In the end, a political process to halt Nord Stream 2 could be even more complicated than a legal process. The only way this could happen is if the European Commission and European Parliament received full support from the European Council. But that would require the agreement of Germany and other Western European member states, like The Netherlands and Austria, which stand to benefit from Nord Stream 2.
So far, the European Council has been fairly critical of the project. After a meeting in December 2015, its President Donald Tusk wrote: “Talking about the Energy Union, leaders had an exchange on the Nord Stream II project, some of them were very critical, and we also discussed the conditions that need to be met by major energy infrastructure projects. We reiterated that any new infrastructure should be fully in line with the Energy Union objectives. Not to mention the obvious obligation that all projects have to comply with all EU laws, including the third Energy Package. These are clear conditions for receiving support from the EU institutions or any Member State – political, legal or financial. Now the ball is in the court of the European Commission. But the political message of the European Council is clear and goes in a similar direction as the position expressed by the European Parliament.”
Petras Auštrevičius, Didier Seeuws and Andrey Kobolyev (CEO Naftogaz)
Didier Seeuws, Director of Transport, Telecommunications and Energy at the European Council, said in Brussels that the Council had “put forward not only legal but also political conditionality”. But Seeuws declined to speculate about what exactly a political decision from EU leaders to block Nord Stream 2 would look like. Any such move would run into one formidable problem: Russia would regard it as an extremely hostile act.
Perhaps Péter Kaderják had the wisest advice to offer at the event in Brussels. He said that if Nord Stream 2 gets built, “Regulatory measures should ensure that competition is maintained in the Central and South East European region even if Gazprom transits gas along new routes. The EU and local regulators should prevent Gazprom from blocking interconnection capacities and make it release significant gas volumes in Germany.”
This kind of compromise might be the most pragmatic outcome of the battle for Nord Stream 2. A similar solution is hinted at in the “analysis of the Legal Service reply” written by DG Energy, which refers to the possibility of a “case-specific regulatory framework for the project”. It is probably the maximum that the opponents of Nord Stream 2 will be able to achieve.
Why Nordstream 2 risks failure December 4, 2015 by Alan Riley 2 Comments
he Nordstream 2 gas pipeline that Gazprom and a number of major European energy companies, have agreed to build, faces formidable political, legal and economic obstacles that may make the project undeliverable, writes Alan Riley, professor at City Law School in London and nonresident Senior Fellow with the Atlantic Council’s Global Energy Center. According to Riley, the overarching problem Gazprom and its partners Shell, Engie, Wintershall, OMV and Eon, face is that the world has changed very much since the first Nordstream was launched in 2008. In this essay, courtesy of the Atlantic Council’s Global Energy Center, he explains in detail why the project risks failure.
There are a number of factors that make Nordstream 2 much more difficult to deliver than Nordstream 1. The two most significant factors are questions surrounding the financing of the project and its compliance with EU law.
Firstly, Gazprom is in a much weaker financial position than it was when Nordstream 1 was completed. Furthermore, financial institutions are likely to be far less willing to support this project, due to the sanctions imposed on Russia by the European Union and the United States.
Secondly, European Union (EU) energy-liberalisation law has progressed in the years since Nordstream 1 was launched. EU law now becomes a significant obstacle to completion of the project on the terms that Gazprom desires. EU regulatory requirements are likely to reduce Gazprom’s control over the pipelines, and reduce its access to the network’s full capacity.
The overarching problem that Gazprom and its commercial allies face is that the world has changed very much since the original Nordstream project was launched in 2008. The invasion, occupation, and annexation of Crimea—and the invasion and occupation of eastern Ukraine—by forces of or controlled by the Russian Federation have undermined the basis for cooperation between Brussels and Moscow.
Background: from Nordstream 1 to Nordstream 2
The first Nordstream pipeline project was conceived in the early 2000s as a means to avoid conflicts over Ukrainian transit of gas to Europe, and to bring gas to Russia’s most lucrative market, Germany. The project was conceived as having two pipelines—each with a carrying capacity of 27.5 billion cubic meters per year (bcm/y). They run under the Baltic Sea, from Vyborg on the Russian coast to Greifswald on the German coast, passing through the exclusive economic zones of Finland, Sweden, Estonia, Latvia, Lithuania, Denmark, and Germany (and the territorial seas of the latter two states).
The pipeline length is 1,224 kilometers, making it the world’s longest undersea gas pipeline. The majority of the permits were obtained in October 2009, while the first pipeline was completed and operations commenced in November 2011. The second pipeline was completed and operational from October 2012. The cost of the project was €7.4 billion, with 30 percent of equity injections from shareholders and 70 percent from financial institutions. The holding company is Nordstream AG, and the shareholders are: Gazprom, with 51 percent; E.ON, 15.5 percent; BASF/ Wintershall, 15.5 percent; Gasunie, 9 percent; and GDF Suez (now Engie), 9 percent.
In addition, a number of pipelines that connect to the Nordstream pipeline are substantially owned and controlled by Gazprom. These include the OPAL pipeline, which takes natural gas from the Nordstream pipeline into the German and Czech markets and has a capacity of 36 bcm/y, and NEL, which has a capacity of 20 bcm/y and takes gas into the markets of Germany and the Netherlands. Both pipelines, as discussed below, have been subject to the application of EU energy-liberalisation rules, which have limited Gazprom’s ability to make full use of the pipelines.
At the St. Petersburg International Economic Forum in June 2015, Gazprom CEO Alexey Miller announced that Nordstream 2 would proceed with the support of some of the existing partners, along with Shell and OMV. On September 4, at the Eastern Economic Forum in Vladivostok, Russia, a shareholders’ agreement was signed by Shell, OMV, BASF/Wintershall, Engie, and Eon. Gazprom took a 51-percent share, with all the other firms taking 10 percent—save Engie, which would take 9 percent.
The proposal would seem to involve taking the same route as Nordstream 1, and also constructing pipelines with the same carrying capacity, which would mean two lines of 27.5 bcm/y each. The combined total capacity of Nordstream 1 and 2 would therefore be 110 bcm/y, just short of the likely total for exports to the EU in 2015.
Financing the pipelines
Gazprom will need to find €5 billion for its share of the approximately €10 billion cost of the pipeline. This amount will be difficult to generate from internal funds. Not only does Gazprom have the new Nordstream project to contend with, but also the $55 billion Power of Siberia project, and Turkish Stream—even if Turkish Stream is scaled back to only one or two pipelines, instead of the originally conceived four pipelines.
The award against Russia in the Yukos case is in the process of being registered as a judgment under the New York Convention. Once that is done, it can potentially be enforced against any Russian state-owned assets not subject to sovereign immunity anywhere in the world
More fundamentally, the recent collapse in the company’s revenues makes it difficult to see how it can generate the capital required. Gazprom’s EU exports fell from a height of 163 bcm in 2013 to 139 bcm in 2014, and they are expected to be even lower in 2015. To make matters worse, the collapse in oil prices in late 2014 has seen a fall in gas prices linked to oil under Russian supply contracts—from approximately $350 per thousand cubic meters (mcm) in 2013 to an average price of $240 per mcm in 2015.
The Russian economy ministry estimates that prices could fall as low as $187 per mcm next year; it sees no recovery at least until 2018. Gazprom’s overall revenues are likely to be cut by one third over the next three years, and its EBIDTA (earnings before interest, taxes, depreciation, and amortisation) is likely to fall by 50 percent.
Worse still, under increasing competition from Rosneft and Novatek, Gazprom has lost approximately 90 bcm in sales from the domestic gas market since 2006, and domestic sales have declined in each of the last three years. The increasingly gloomy economic prospects for the Russian economy do not suggest that this market will recover, at least in the short term.
The Russian response to these figures is that this situation is temporary, and the market will recover. The principal sources of gas in the EU, from the Norway, the Netherlands and the UK are declining. In addition, the major alternative source of supply, North Africa—particularly, Algeria, Libya, and Egypt—is now replete with political risk, making it difficult to bring forward capital investment to develop the region’s resources.
Gas now carries an “energy security,” or “Gazprom,” charge. The effect of this Gazprom charge is that fears about supply security encourage states, energy companies, and utilities to use less gas—or, if they decide to use gas, not Russian gas
The difficulty with this argument is that it does not take account of additional alternative sources of natural gas, particularly liquefied natural gas (LNG). According to the International Energy Agency (IEA), an additional 175 bcm of supplies will come on stream between now and 2020, principally from Australia and Papua New Guinea, and also from the United States.
Given this increase in supply over the next few years, plus falling Chinese and Japanese demand, there is a real chance of LNG becoming a considerable source of alternative energy for the European market. Furthermore, marginal-cost LNG is competitive against Russian pipeline gas in the short run, unless Gazprom is prepared to absolutely cut its own margins to the bone.
Along with these challenges, the European gas market itself has been shrinking, from 577 bcm in 2008 to less than 500 bcm in 2014. There are a number of factors at play here: first, a stagnant Eurozone market; second, the growth of renewables across the European market, whose onward targets for 2030 will result in even greater deployment in the 2020s; and third, the dumping of cheap coal into the European market (in part, a result of US shale gas displacing US coal and forcing it onto international markets).
More fundamentally, the cost of renewables in the EU markets has made utility companies focus on the cheapest possible alternatives. Coal, rather than gas, is the cheapest possible alternative; as a result, even Germany is building 8 gigawatts of coal plants. This is partly a failure of the EU’s Emissions Trading Scheme (ETS), which was supposed to price coal out of the market. This would require a price of approximately €30 a tonne (currently, the price is around €8 a tonne).
Gazprom and its commercial allies are likely to face a much tougher regulatory environment than that faced by Nordstream 1
These factors, which shrink the size of the European gas market, will not be easy to change. Worse still, gas now carries an “energy security,” or “Gazprom,” charge. The effect of this Gazprom charge is that fears about supply security encourage states, energy companies, and utilities to use less gas—or, if they decide to use gas, not Russian gas.
If those factors do not raise serious questions in the minds of the investors, there are two other factors to ponder. The first is whether investors will consider the sanctions risk too great. Although Gazprom itself is not sanctioned by the current US and EU regime, there is a knock-on effect in the market. This makes investors wary that the project could be affected if sanctions are tightened. This problem has already impacted the Vladivostok LNG project, as Gazprom is finding it difficult to obtain long-term customers, because of fears that they might be affected by future sanctions.
A further consideration involves the award of $50 billion to the principal Yukos shareholders in the Energy Charter Treaty case against Russia, which was heard in The Hague in 2014. This case stemmed from the expropriation of the Yukos oil company by the Russian Federation in 2004. The award against Russia is in the process of being registered as a judgment under the New York Convention. Once that is done, it can potentially be enforced against any Russian state-owned assets not subject to sovereign immunity anywhere in the world.
Alexey Miller, CEO Gazprom (photo Gazprom)
Gazprom is controlled by the Russian government, and 51 percent of its shares are owned by the state. Gazprom, as a commercial gas company, would not be able to rely on any sovereign immunity claim if the pipeline became subject to a claim in the courts of EU member states. Investors would need at least some substantial assurances that the pipeline, or at least the shareholding of Gazprom, could not be seized by the Yukos shareholders.
Together, these factors cast a significant shadow on the prospect of external financing. These factors demonstrate that Gazprom is no longer in the fiscal and political environment of this century’s first decade, when its market capitalisation reached $367 billion in 2008. Today, its market capitalisation is approximately $50 billion, and Gazprom is under far greater pressure than when it launched Nordstream 1. This is not to say that it won’t ultimately be able to find the financing for the pipeline. It will, however, be very challenging to find the financing at a price Gazprom will want to pay.
Nordstream and EU energy-liberalisation Rules
One of the most formidable barriers to the full-capacity utilisation of Nordstream 2 will be the rules established by the European Union under the 2009 Gas Directive, and accompanying legislation known as the Third Energy Package (TEP).Under that directive, gas supply must be separated from the network over which it is carried.
A number of options are provided by the legislation, from full ownership unbundling to significant restrictions on the gas supplier’s control of the network. In addition, third-party access to the network must be provided to competing gas suppliers. Under Article 11 of the directive, there is also a requirement that any non-EU entity seeking substantial participation in, or control over, a network will be subject to the same unbundling requirements as an EU-based entity.
In particular, member states’ regulatory authorities must certify that the foreign owner complies with the unbundling requirements of EU law, and will not put at risk the security of either the member states’ or the EU’s energy supplies.
It is difficult to see how easily an exemption from unbundling and third-party access could be granted under Article 36. Nordstream 2 does not enhance competition. It merely alters the route of existing gas supplies
Nordstream can potentially seek an exemption from these requirements under Article 36 of the gas directive. However, several conditions have to be met, including that the investment will enhance competition in the supply of gas.
The liberalisation regime set out in the 2009 Gas Directive was still coming into being while Nordstream 1 was being permitted and constructed. Now it is fully in place, and the European Commission and its member states have some experience in operating it. In proposing to launch Nordstream 2, Gazprom and its commercial allies are likely to face a much tougher regulatory environment than that faced by Nordstream 1.
EU law and the connecting pipelines
As with Nordstream 1, the connecting pipelines to bring Nordstream 2’s gas into the European market will be subject to the full weight of the Gas Directive. The pipelines will have to be unbundled on one of the approved models, and third-party access will be required. If Gazprom is deemed to have control of those pipelines, they will likely need to be certified under Article 11 of the Gas Directive—to ensure that unbundling has occurred, and that Gazprom’s ownership does not threaten national and European supply security.
The difficulty for Gazprom is that constructing two extra pipelines into Germany does undermine the supply security of Central and Eastern European (CEE) member states. As a result of Russian gas transit across their territories, those states have access to natural gas. Furthermore, the fact that the gas transiting across their territories is heading for the lucrative Western European market provides the transit states with a degree of supply security; Gazprom cannot cut them off without threatening the supplies to Western Europe.
However, as the new pipelines would provide gas directly to Germany, they would represent a supply security threat for the Central and Eastern European states. Russia could cut off existing routes at will, without affecting access to its main Western European market. This would not only deprive those states of transit revenues, but also remove their underlying supply security.
It can be argued that this threat is overstated, because of the increasing capacity of EU states to reverse-flow gas from Germany to Central and Eastern Europe. This essentially involves taking Russian gas already sold into the European market via Nordstream, and reverse-flowing the gas using the now- greater range of bidirectional pipeline interconnectors to send gas eastward.
The difficulty with this argument is that Gazprom may well seek to undermine reverse-flow operations by restricting supply via its primary supply routes into the European market. There is already some precedent. In 2014 and 2015, Gazprom made it clear to several member states that it was displeased with the agreements to reverse-flow gas to Ukraine. There were clear instances of gas supplies being cut to states that were seeking to provide gas to Ukraine by reverse-flow.
Furthermore, relying on reverse-flows via Nordstream 2 not only means relying on Russia not to cut the level of gas flows westward via the new pipeline, but also relying on German cooperation to ensure that the gas does indeed flow eastward. CEE states may be willing to trust German Chancellor Angela Merkel; however, the German leadership might change. The CEE could well face a new Ostpolitik, if a new German chancellor takes an approach closer to that of former Chancellor Gerhard Schröder.
It could also be argued, in the alternative, that gas is going to flow solely via Nordstream, and that the Ukrainian transit route will not be utilised at all. This argument, however, does not assist the Gazprom position, as it further exposes how dependent the CEE states will be on Gazprom deciding not to manipulate the flows from Nordstream, and on German goodwill.
It is not only connecting pipelines that have to be considered under EU law; Nordstream 2 itself has to be considered. The fact that the pipeline is offshore does not, in and of itself, immunize the project from the application of EU law
It is also difficult to see how easily an exemption from unbundling and third-party access could be granted under Article 36. Nordstream 2 does not enhance competition. It merely alters the route of existing gas supplies, which currently transit via Ukraine and CEE states. Equally, by bringing gas via Germany, Nordstream will strengthen Gazprom’s already significant market dominance in the German market.
Gazprom will also gain market power by having more choices as to where to place gas markets across Europe, using the two sets of Nordstream pipelines, Yamal, Turkish Stream, and the Ukrainian transit route. A dominant market player holding the capacity to choose where supply should be directed significantly increases its market power.
Furthermore, the European Commission is currently undertaking an antitrust investigation into Gazprom, in which it is considering the impact of the exercise of Gazprom’s market power. At the very least, the Directorate-General (DG) for Energy is going to have to liaise with the Commission’s competition department running the case, DG Competition, in considering the competition issues under Article 36. The Commission will want to ensure a coordinated response to the increase in market power with respect to Nordstream, as well as any Article 36 conditions that may be imposed, and any commitments accepted by DG Competition with respect to the antitrust case.
The likelihood is that the connecting pipelines will be subject to intense scrutiny from both the European Commission and concerned member states. First, a national regulatory authority—probably for Germany, as this is from where the connecting pipelines will run—will have to make a draft decision on certification of the network operators in compliance with the Gas Directive, considering Article 11 and the application of Article 36. Only then would it be considered by the European Commission. At the very least, it is likely that the Commission will require that Gazprom can only access part of the capacity of any new connecting pipeline.
The application of EU energy law to the offshore pipeline
However, it is not only connecting pipelines that have to be considered under EU law; Nordstream 2 itself has to be considered. The fact that the pipeline is offshore does not, in and of itself, immunize the project from the application of EU law. For almost 100 kilometers, the pipeline goes through the territorial seas of both Denmark and Germany. It also goes through the exclusive economic zones of Denmark, Germany, Poland, Sweden, Finland, Estonia, Latvia, and Lithuania.
It is difficult to see how the rules of the Gas Directive and accompanying EU legislation do not apply to gas pipelines running through the territorial seas of the member states. The European Court of Justice in Commission v. United Kingdom, in discussing the application of the EU Habitats Directive, was clear that EU law applied with respect to territorial seas. The court also applied the Habitats Directive to the exclusive economic zone.
Minister Gabriel made it clear that Germany was prepared to avoid ‘external meddling’ presumably by the European Commission by ensuring that all the legal issues remained under the competence of the German authorities
One can argue that this extension was exceptional, as the Habitats Directive had objectives similar to those contained in the United Nations Law of the Sea Convention (UNCLOS), in terms of the protection of marine life. However, the court’s approach in that case was to argue that member states should apply EU law to the fullest extent of their sovereign rights. In fact, UNCLOS has nothing to say about the governance regime for pipeline structures through the economic zone.
Furthermore, one can make a compelling argument that an attempt to use the exclusive economic zone to run a pipeline from a foreign supplier to an EU country, rather than build a pipeline more cheaply on land through several EU states, is tantamount to an attempt to circumvent the application of the EU’s energy acquis. If the European Court of Justice (ECJ) takes this view of the use of the exclusive economic zone for the Nordstream pipelines, then it is likely it will be inclined to extend the application of the acquis to those zones.
possible route Nord Stream 2 according to company
At the very least, it is difficult to see how Nordstream 2 can avoid the full application of EU law when it enters the territorial seas of Denmark and Germany. There appears to be no legal difference between the application of EU liberalisation law to the Yamal Pipeline once it enters EU territory, and to Nordstream 2 once it enters the territorial seas of the member states. Currently, Polish regulatory authorities are seeking certification from the European Commission for their regulatory regime. The Commission has raised a number of questions regarding compliance with the full unbundling requirements of the Gas Directive and application of the supply security requirements of Article 11.
The initial view, with respect to Nordstream 2, is that it is likely to face formidable legal obstacles, both in terms of the main offshore pipelines and the onshore connecting pipelines. EU energy-liberalisation law is likely to apply to both, requiring compliance with both unbundling and third-party access rules. This will severely reduce the scope for the amount of gas that can be expected to pass through the pipeline.
Germany’s attempted subversion of EU Law in respect of Nordstream
However, one could take the view that as long as Nordstream 2 has powerful EU supporters, such as the German government, then EU law can be overcome. This view is supported by the transcript of the meeting on October 28 where the German Energy Minister Sigmar Gabriel met with President Putin outside Moscow (see the box with the relevant text of the transcript).
Extract of Transcript of Meeting between German Energy Minister Sigmar Gabriel and President Putin, October 28, 2015, Novo-Ogaryovo, Moscow Region
Sigmar Gabriel: Mr Miller and Mr Matthias Warnig will continue to pursue Nordstream 2 project. This is in our interests; but it is not just in Germany’s interests—it is a very interesting project even beyond Germany’s borders.
What’s most important as far as legal issues are concerned is that we strive to ensure that all this remains under the competence of the German authorities, if possible. So if we can do this, then opportunities for external meddling will be limited. And we are in a good negotiating position on this matter.
And in order to limit political meddling in these issues—you are, of course, aware, this is not just a formality—we need to settle the issue of Ukraine’s role as a transit nation after 2019. There are technical reasons for this: you know that Ukraine’s gas transportation system is not in very good state. And, of course, the financial and political role it will play for Ukraine, as will the backflow of gas.
As regards everything else, I believe we can handle it. What’s most important is for German agencies to maintain authority over settling these issues. And then, we will limit the possibility of political interference in this project. Source: Kremlin’s official website,http://en.kremlin.ru/events/president/news/50582.
Mr Gabriel, it should be noted, is also German Vice-Chancellor and Chairman of the SPD, the coalition partner in Chancellor Merkel’s coalition. At that meeting, Minister Gabriel made it clear that Germany was prepared to avoid ‘external meddling’ presumably by the European Commission by ensuring that all the legal issues remained under the competence of the German authorities.
It is however very difficult to see how Minister Gabriel will be able to so subvert EU law. Both the application of the so-called Gazprom clause in Article 11 of the Gas Directive, and the Article 36 exemption provision, require the involvement of the Commission. In addition, third parties may well seek review of any German decision ultimately in the EU courts.
One approach that the Russian and German governments may be seeking to take to evade the application of EU law is to suggest that Nordstream 2 is not really under the control of Gazprom. It is noticeable that two weeks after the meeting with the German Energy Minister, Engie, which had agreed to take a 9 percent shareholding in Nordstream 2, suddenly increased its stake to 10 percent, with Gazprom falling to 50 percent.
landfall of Nord Stream pipeline in Germany (photo Nord Stream)
However, the difficulty for the German and Russian governments is that the Gas Directive provides that the concept of control is governed by EU merger law. That law takes a much broader concept of control that is not limited to mere shareholdings. It looks at actual control and influence over an entity. Even a shareholding of 25 percent may be sufficient given the surrounding commercial relations and past history to give Gazprom control for the purposes of the Directive.
Although Germany is the single most powerful country in the European Union, it does not own the EU, or EU law. It is extremely difficult to see how the German government can exclude ‘external meddling’ from the European Commission seeking to ensure uniform application of EU law across the whole territory of the Union. It will also be difficult to reduce Gazprom’s shareholding in a way that will permit the company to escape the concept of control in EU law.
The Russian government may have sought in publicising the extent of German-Russian co-operation to push the German government to openly support Nordstream 2. It is likely that the actual effect of the transcript’s publication is the opposite. It has first alerted the European Commission to the extent of the willingness of the German government to subvert EU law, as well as the Central and Eastern European states. Secondly, the negative reaction to the publication of the transcript is likely to make German and corporate co-operation in evading EU law much more difficult to deliver.
The overarching problem with Nordstream 2 is that the political context is so utterly different than that in the first decade of the twenty-first century, when there was a more cooperative relationship between the Russian Federation and the European Union. It is difficult to see how, for instance, the EU can support Nordstream 2, which will strip Ukraine of at least $2 billion in revenue and undermine its role as a major shipper of gas to Europe, while the EU is also seeking to stave off Ukraine’s collapse.
The EU and the United States provided $17 billion in financing to Ukraine via the International Monetary Fund. Protecting Ukraine from collapse and promoting reform have become major objectives of the EU’s external policies. It is difficult to understand, therefore, why the EU should see any reason to support Nordstream 2, which has the effect—and, almost certainly, the intention—to undermine Ukraine.
No doubt, Moscow and its allies within the EU will lobby hard for Nordstream 2. However, on this occasion, they may have taken on a project that is undeliverable, or only deliverable on terms they do not want to finance and will not deliver the market access they are seeking
Equally, the European Union has committed itself, via the Energy Union program, to radically transform its energy markets. At the core of the Energy Union program is a commitment to reduce the supply dependency in the gas markets of member states that significantly depend on Gazprom. Nordstream also cuts across this objective. It seeks to undermine the supply security of states in Central and Eastern Europe, reducing their direct access to gas supplies and increasing their supply dependence on Gazprom. Again, it is difficult to see why the European Union should give any support to this project, given its negative impact on supply security.
One can also note that, whether or not falling foul of EU policy objectives is enough to make Nordstream undeliverable, the fiscal and legal obstacles will suffice to do so. It is open to question how easy Gazprom will find it to raise the financing for an expensive natural gas pipeline in a shrinking market—where new competition is expected to enter the market, where further shrinkage may well occur, and where there is a considerable aversion to the product within the customer base.
This is reinforced by the prospect of investors being deterred by the potential impact of sanctions and of Yukos claims. Brave investors, for a price, may ultimately be willing to provide funds to Gazprom. But at the very least, the cost of capital will not be cheap.
The legal problems also impact upon the obstacles to raising capital. If both the offshore and connecting pipelines are subject to the full application of EU energy law, it is difficult to see how more than half the capacity of the pipeline will be able to be utilised in the market. Investors will be faced with the prospect of investing in a 55-bcm/y pipeline project, only half of which will be utilised.
Nordstream 2 is likely to be subject to far greater scrutiny than Nordstream 1. Member states now have a greater understanding and experience of the rules than they did when Nordstream 1 was under construction, and can insist on full application. There is also the prospect that issues, such as application of the EU rules to the offshore pipeline network, may well be litigated all the way to the ECJ, further delaying the commencement of the project.
There is also a question as to whether some member states may ask the Commission for an investigation of Nordstream 1’s compliance with the current law. If the Polish section of the Yamal Pipeline had to be adapted to be in compliance with EU law, then surely Nordstream 1 also must be brought into full compliance with EU law as well.
The EU could also respond to Nordstream 2 in other ways. For instance, it could increase the capacity of the British and Spanish interconnectors, making it possible to make greater use of the 110 bcm/y of Anglo-Spanish gasification capacity. Greater capacity across the English Channel and the Pyrenees, combined with additional interconnectors to carry LNG-sourced gas into Central and Eastern Europe, could substantially offset the impact of Nordstream 2.
No doubt, Moscow and its allies within the EU will lobby hard for Nordstream 2. However, on this occasion, they may have taken on a project that is undeliverable, or only deliverable on terms they do not want to finance and will not deliver the market access they are seeking.
This is a slightly shortened version of an article first published by The Atlantic Council’s Global Energy Center and Dinu Patriciu Eurasia Center. The full and annotated version can be found here.
Alan Riley is a professor at City Law School in London. City University advises governments, EU institutions, NGO’s, and corporations on major strategic problems in relation to abuse of dominance, price-fixing, and merger cases concerning strategic problems in the global and European energy markets. Riley is also a Nonresident Senior Fellow with the Atlantic Council’s Global Energy Center. Additionally, he is an Associate Senior Research Fellow of the Institute for Statecraft and a regular guest columnist on competition and energy law issues with the Wall Street Journal, the New York Times, and the Financial Times.
The Atlantic Council Global Energy Center works to promote global access to affordable, reliable and sustainable energy. It devises creative responses to energy-related geopolitical conflicts, advances sustainable energy solutions, and identifes trends to help develop energy strategies and policies that ensure long-term prosperity and security.