Amid much shock and confusion, as of last Friday the EU appears to have decisively moved to put a stop to Gazprom’s long-running pipeline gambit—a series of moves designed to gain pricing leverage over Europe’s energy market while also isolating Ukraine. The Ukrainian element was not incidental, and the strategy had three goals: First, to stop Kyiv having any leverage over Gazprom and Moscow by removing it as major transit country for Russian gas. Second, to strip Kyiv of the accompanying transit fees that amount to approximately 2 percent of Ukrainian GDP. And Third, to make Kyiv, without its own transit leverage or transit fees, more dependent on the Russian Federation. To that end, the Russian state had come up with plans for endless pipeline development, many of which have failed to launch—see South Stream and the Yamal II pipeline—and some of which have succeeded, such as Nord Stream 1.
What Gazprom and the Kremlin feared was that at some point, the EU would bring its open market liberalization rules to bear. If that happened, Gazprom would lose control of the pipeline and be subject to significant regulatory audit and market pricing obligations. This past Friday, Gazprom’s worst fears appear to have been finally realized, when a proposed amendment to the EU’s 2009 Gas Directive passed through the European Council. If the European Parliament, which has already approved a similar proposal, agrees on the terms of the legislation, Gazprom’s entire external pipeline strategy, with Nord Stream 2 at its center, will come under significant pressure.
Nord Stream 2 is by far the most controversial element in Gazprom’s current pipeline strategy. The pipeline was initially proposed in June 2015 and involved placing two 27.5 bcm pipelines through the Baltic Sea to Germany. In this way, the pipelines would avoid the territory of Central and Eastern European (CEE) and Baltic States—all prickly due to being occupied by the Soviet Union—giving Gazprom a direct route to its largest customer, Germany. So much gas would flow via the Nord Stream 2 pipelines that the existing Ukrainian transit network—the so-called Brotherhood pipeline which has been the main conduit of Russian gas to the European Union up until now—would at best be left with extremely low or no gas at all.
In addition, because the existing Brotherhood network brought gas into Western Europe as well as supplying Central and Eastern European states, the CEE states retained a degree of transit security. To put it simply, Gazprom would find it difficult to cut off any CEE states it might want to bully without cutting off its customers in Western Europe. The building of Nord Stream 2 would allow the Kremlin a way around that, giving them more flexibility in targeting recalcitrant European member states.
The pipeline will also have the effect of dividing the EU’s single market in gas. The Nord Stream 2 pipes will land at Greifswald on the German coast. The connecting pipe, EUGAL, then will take most of the gas in a 55bcm capacity pipeline eastward to Poland and the Czech Republic. The West to East interconnectors would be flooded with Gazprom-controlled Russian gas. No one else’s gas would be able to easily enter CEE markets. In essence the EU will then have two gas markets: a liberalized and diversely supplied gas market in Western Europe, and a Gazprom-dominated and supplied market in Central and Eastern Europe. This is why Poland is busily seeking to increase its Liquid Natural Gas (LNG) gasification capacity, signing contracts with U.S. LNG exporters, and seeking a new Baltic Pipeline bringing non-Russian gas in from Norway. It is also why most EU member states, backed by the European Commission and supported by the United States, have opposed Nord Stream 2.
Notwithstanding all this opposition, Germany has backed Nord Stream 2. It has done so partly due to the Social Democrats (SPD) being in office (albeit in coalition with Angela Merkel’s CDU)—a party still in thrall to the Ostpolitik of former Chancellor Willy Brandt; partly because German industry views European Russia as a huge potential market; partly because the German energy industry has overlapping commercial interests with Gazprom; and partly the sense that direct fixed pipeline gas routes to the Russian market protect German supply security. Despite these interests, a considerable number of voters in Germany—both in the Green Party and within the CDU—question the value of Nord Stream 2 to Germany, and the damage it does to German interests across Europe.
Over the last 18 months, a proposed amendment to the 2009 Gas Directive has hovered over the debates over Nord Stream 2. This amendment has been making its way through the EU legislature, pushed by concerned CEE states and the European Commission. If enacted, it would apply EU energy law in full to all new import pipelines, including Nord Stream 2. Up until now, the amendment has been held up by a loose coalition of member states, including France, that had managed continue keep the amendment in limbo.
On Friday, it became clear that France had moved over to support Poland and the other CEE and Baltic States. In switching sides, France only conceded the most limited face-saving measures to the Germans.
The proposed amendments have only three points of any significance. First, they limit the application of the scope of EU energy law to the territorial sea, rather than the territorial sea and the broader exclusive economic zone. Theoretically the scope of EU jurisdiction is reduced significantly in a geographical sense. Practically, however, it makes no difference. Any offshore pipeline has to go through the territorial sea of a member state, and that section has to fully comply with EU law. If it does not comply with EU open market energy rules, then it cannot operate.
Second, the amendments accepted by France grant initial EU regulatory supervision for the whole pipeline to the member state where the pipeline lands. This means in the case of Nord Stream 2 that the German regulator is responsible for the supervision. Gazprom could take the view that the pipeline is in “safe hands” and the project can proceed. But it is in fact not. The German regulator is applying EU law, which is subject to supervision by the European Commission and the EU courts. In particular, any exemption from the EU liberalization rules is in the hands of the Commission. The German regulator makes the initial decision but it is the Commission that ultimately reviews any national decision and whose approval is vital to any exemption.
Third, the amendment would permit national regulators to seek an agreement with a third country on the operation of a pipeline. This could potentially provide the German regulator and Gazprom with a means to do a deal. However, the provision is again hedged round with obligations to comply with EU law and the need to obtain Commission authorization at every step. It is unlikely to provide a way for Gazprom to protect Nord Stream 2.
The conflicting amendments of the EU Council and the European Parliament will now enter into a reconciliation process known as the Trialogue (the European Commission participates as well). This could begin as soon as today. As the amendments proffered by the Council are only marginal, it is likely that the Parliament will broadly accept the new amendments. If so, the amended legislation is likely to be agreed soon, perhaps before the end of March.
If agreed, Nord Stream 2 will face a range of problems that will at the very least require a complete restructuring of its current business model by Gazprom. EU law requires that the owner and the supplier of gas must be separate. Under the current model, Gazprom will own the pipeline and supply the gas. Nor can Gazprom just hand over the pipeline to another state-controlled energy company. The EU’s concept of “control” for these purposes is very broad and taken from EU antitrust law. Gazprom would have to find an independent owner.
This is also underpinned by Article 11 of the 2009 Gas Directive. Article 11 requires that where there is a non-EU owner, the EU national regulator must make an assessment of whether the owner prejudices the supply security of the member state or the EU as a whole. For Gazprom or a connected company to own the pipeline in such circumstances would be problematic. In addition, Gazprom would have to provide a transparent tariff price regulation regime and be willing to automatically resell at least 10 percent of the gas supplied across the network.
At the very least Gazprom is going to face a very significant delay in restructuring the pipeline programme if the amendment is enacted. It may in fact find it very difficult to find an independent owner of the pipeline and also accept the European supervision of its commercial practices.
And there is likely to be a knock-on effect on any future pipelines. Gazprom will need to find independent owners of any new pipeline, and given the scale of European supervision, Gazprom may not be able to maintain sufficient commercial and political leverage to make the entire operation worthwhile. The issue is likely to affect the next major pipeline project, Turk Stream 2, which will run across the Black Sea with 15.75 bcm capacity to either Bulgaria or Greece, both EU member states. It will at least be quite difficult to sustain the pipeline politics games of old in a situation where all new import pipelines are subject to ownership unbundling and extensive regulatory supervision.
It may be that Germany launches one last furious attempt to block the amendment. As noted above, German economic interests alone are substantial, and even in the public sphere, a lingering sense of anti-Americanism and a desire to balance Russia’s way provides support for politicians who want to make a stink. And yet it’s this exact German domestic political dynamic that suggests a possible explanation for why France has decided to switch sides. After all, why now? The French energy company, Engie, is one of the corporate partners for the Nord Stream 2 project, and stands to lose out if the deal falls apart.
Some are speculating that Angela Merkel, who properly understands the geopolitical stakes underlying Russia’s Nord Stream 2 bid but who has always been stymied by her own domestic political constraints, finally sees an opening. Germans across the board don’t like it when the United States is dictating terms, but in general are more open to Brussels adopting legislation in the European interest, which appears to conflict with some German interests. With her own political career in the sunset phase, she may have decided that it was a good moment to spurn the more rigid pro-business members of her coalition and tacitly nudge the French to take these steps. It’s the right thing to do, and is more politically palatable if coming from the EU rather than the White House.
As for the French themselves, they probably needed little convincing. They were holding the line as a favor for Merkel, but have been concerned about the EU’s energy dependence on Russia for the better part of a decade. A nudge and a wink from the Chancellor may have been all that is necessary.
This story is, of course, far from over. But the plot has certainly taken an interesting new turn—for the much better.