The risks of German unilateralism on Nord Stream 2

Gazprom CEO Alexei Miller with parts of the future Nord Stream 2 pipeline
Gazprom CEO Alexei Miller visits the Chelyabinsk pipe-rolling plant where components of the highly controversial Nord Stream 2 pipeline are being made (source: dpa)

There is no more controversial energy project in the European Union than the Nord Stream 2 gas pipeline. The initiative would put two new lines alongside the two in Nord Stream 1, which began operation in 2011. The dispute between supporters and opponents of the pipeline is intertwined with the EU’s relationship with Russia.

The project challenges the EU’s and Germany’s energy foreign policies, both among member states and externally. Germany still has not fully accepted its leadership role within the EU by defining European solidarity as an important element of its national interest. Its support of Nord Stream 2 could deepen the political rifts within the bloc, fueling a renationalization of energy policies in Central and Eastern Europe as countries in the region see that their energy security interests are not being defended by Brussels and Berlin.

Unilateral stance

The pipeline’s route runs from Russia’s Leningrad Oblast under the Baltic Sea to Greifswald in Germany. Its economic justification is based on exemptions to EU regulations granted for onshore pipelines connected to Nord Stream 1. However, the political and regulatory environment has changed considerably since work on Nord Stream 1 began. If the two additional pipelines with a capacity of 55 bcm are built, Russia could pump up to 70 percent of its total European gas exports through just one route, though its exports could rise further.

  • Total export capacity of Nord Stream 1 & 2: 110 bcm
  • Gazprom’s total gas exports to Europe and Turkey in 2015: 159 bcm

In this context, Germany’s energy and foreign policies regarding Russia seem contradictory. While Chancellor Angela Merkel has become the most important defender of the West’s sanctions against Russia, the German government has strongly supported Nord Stream 2, declaring it a “purely commercial” venture. Many eastern EU members, however, see the pipeline as a geopolitical project aimed at increasing Europe’s dependency on Russian gas. Germany, they say, is putting its energy ties with Russia above European solidarity.

Nord Stream 2 has strategic implications for the EU’s energy policy, as well as for its ability to speak with one voice toward Moscow. Given the fundamental disagreements between the pipeline’s supporters and opponents within the EU, the prospects for a compromise seem slim. However, there is one exception: they agree that Ukraine should remain a transit country for Russian gas beyond 2019, when Gazprom’s contract with Ukraine expires. But without addressing the concerns of the pipeline’s opponents, Germany and Brussels are taking the risk that eastern EU members will renationalize their energy policies, leading to greater market fragmentation and a collapse of the EU’s common foreign and security policies.

A map showing the routes of Nord Stream 1 & 2
Nord Stream 2 will follow almost the same route as Nord Stream 1, as Gazprom tries to take advantage of the same regulations that allowed the first pipeline (source: macpixxel for GIS)

In 2015, then German Economy and Energy Minister Sigmar Gabriel controversially said he favored special bilateral energy relations with Russia. He added that he hoped the legal and regulatory questions surrounding Nord Stream 2 would be resolved by the German authorities, so that “opportunities for external meddling will be limited” (in other words, so that Brussels would be kept at arm’s length). Even German observers have criticized this approach as putting the interests of energy companies ahead of European security and solidarity.

Many in the EU see the German government’s support for Nord Stream 2 as yet another indicator of its tendency to act unilaterally on energy matters that affect the entire bloc. Though it eventually involved other European gas companies, Nord Stream 1 was originally meant to be a solely Russian-German project – offering a striking contrast to Berlin’s support for a common energy policy when Germany held the presidency of the Council of the EU in 2007. In 2010, Germany initiated its “Energiewende” (“energy transition”) without consulting the European Commission or any neighboring countries. Some defend the country’s unilateralism, saying all other EU member states would also follow their own national interests.

Benefits and exemptions

Supporters of Nord Stream 2 point out that the project will increase the availability of gas in Germany’s fully liberalized market, reducing prices. The pipeline will help Gazprom directly supply Germany, its largest market, and reduce transit risks. It will make Germany a major hub for Russian gas supplies in Europe and enhance competition in the European gas market. Poland and even Ukraine will benefit from the new supplies and enhanced competition. Already, Ukraine has been able to import more gas from the EU (some of which is from Nord Stream 1) at cheaper prices than the gas it buys from Russia directly.

Supporters see no problem that Gazprom will be the sole shareholder of Nord Stream 2

Gazprom has begun revising its contracts and lowering prices to adapt to the new conditions of Europe’s already oversupplied market and consolidate market share. The European Commission and Gazprom recently reached a compromise on the long-standing antitrust dispute that allowed the Russian gas giant to avoid incurring a fine. It has promised to offer greater flexibility in its long-term contracts, allowing for renegotiation if prices diverge from benchmarks such as liquid hub prices.

Supporters see no problem that Gazprom will be the sole shareholder of Nord Stream 2, building and operating the pipeline on its own, after its European consortium partners withdrew in 2016 following objections from the Polish competition authority. That will make it the first direct gas import pipeline to the EU under Gazprom’s exclusive control. While opponents of Nord Stream 2 fear that it will make those imports dependent on the presumed goodwill of the Kremlin, supporters point out that Russia is also dependent on the European gas “buyers’ market” and that there is an overall “mutual interdependence” in the EU-Russian relationship.

According to EU legal experts, the offshore Nord Stream 2 pipeline does not fall under the Third Energy Package (TEP) and EU regulation, in contrast to the connecting onshore OPAL pipeline (capacity: 36.5 bcm). The latter, transporting gas from Nord Stream 1 on Germany’s coast to the Czech Republic, is required to grant access to third parties. Until the end of last year, Gazprom had an exemption that allowed it to give third parties access to only half of the pipeline’s capacity. In October 2016, the European Commission agreed to expand the exemption to more than 80 percent until 2033.

Following a complaint filed by Polish company PGNiG Supply and Trading with the European Court of Justice in December 2016, the Commission’s exemption has been suspended until a decision is issued, probably this summer. PGNiG also initiated legal action at the German Higher Regional Court in Dusseldorf. The European Commission now wants to negotiate a separate legal agreement with Russia on offshore energy infrastructure. But if Germany continues to dismiss other member states’ interests, it is unlikely to push the issue – and Russia has no interest in such negotiations.

A map showing the routes of the OPAL and EUGAL pipelines
The EU allows Gazprom to offer only 50% of the OPAL’s capacity to third parties. The Russian firm wants to expand the exemption to 80% (source: macpixxel for GIS)

Stunning contradiction

If OPAL does receive the larger exemption, a similar one can be expected for the EUGAL pipeline, running parallel to OPAL to the Czech Republic. That would raise the question of whether similar exemptions would be granted in Southeastern Europe for the recently revived TurkStream pipeline or for the South Stream pipeline. Though the South Stream project was abandoned in 2014, some are proposing that the project should be renewed. That would significantly undermine EU efforts to diversify imports, increase competition and liberalize markets in the region.

Because the EU and the European Commission are only as strong as the member states make them, Germany has a responsibility for the overall direction of the EU’s energy, foreign and security policies. Berlin still ignores the fact that it can have a huge impact on the EU if a small member state takes an anti-European stance because Germany – the EU’s largest and strongest member – fails to take the interests of weaker partners into account. It can hardly expect political solidarity from such partners in, say, refugee policy, when it deliberately ignores their energy security concerns.

Berlin’s idea of energy supply security is based on a belief in perfectly functioning liberalized energy markets

There is a stunning contradiction between Germany’s long-standing narrative that it favors multilateralism and its unilateral energy policy. Berlin’s idea of energy supply security is based on a belief in perfectly functioning liberalized energy markets that need no institutional supervisor. National energy supply security is left largely in the hands of private energy companies. But they are ultimately responsible to their shareholders – the security of the country’s energy supply is not their main concern, as they admit themselves. This business-focused approach has even come under criticism from members of Chancellor Merkel’s own Christian Democratic Union (CDU) party, for making both Germany and the EU more dependent on Russian gas imports.

It also weakens the states through which Russian gas currently transits. Countries like Ukraine question the “purely commercial” reasoning Germany has given for Nord Stream 2, since Russia itself has offered geopolitical justifications for building the pipeline. The Kremlin and Gazprom have always explained the building of Nord Stream 1 and 2, South Stream, and TurkStream in terms of their strategic objective of circumventing “unreliable” and “unstable” transit countries (especially Ukraine). These states would not only lose gas transit fees, but would also find themselves in a much weaker negotiating position with Russia. In any case, even “purely commercial” projects can still have significant implications for the energy security and economic competitiveness of other countries.

Questionable claims

Given the complex legal and regulatory questions, it is ironic that supporters of Nord Stream 2 accuse its opponents of politicizing the project. The EU regulations that promote diversifying gas imports away from Russia were adopted in light of supply disruptions in 2006 and 2009, when Russia cut off gas to Ukraine. The EU laws and regulations cannot be properly understood or interpreted without the historical context and political will behind TEP and the EU energy strategy of 2014.

Most European gas companies will not invest in modernizing Ukraine’s pipeline network

Russia has repeatedly made clear that even if it needs Ukraine’s gas pipelines for a few more years after 2019, it will certainly shut down all gas supplies to Europe via Ukraine eventually. Germany and the EU have declared that keeping gas flowing through the Ukrainian transit route (with at least 15-20 bcm per year) is a crucial goal. But this does not do anything to produce a business case for such an operation – most European gas companies, allied with and dependent on Gazprom, will not invest in modernizing Ukraine’s pipeline network. Rerouting Russian gas supplies around Ukraine and other transit states may result in fewer, not more, pipelines – contradicting Germany’s argument that it favors having as many pipeline routes as can be built and operated.

A graph showing EU gas consumption and indigenous production from 2010 to 2015
Between 2010 and 2015, EU gas consumption dropped, as did production. This raises the question of whether more gas supplies are even needed (source: macpixxel for GIS)

The economic basis for Nord Stream 2 is also questionable, since European gas consumption declined between 2010 and 2015. Forecasts for future import demand have been slashed dramatically. In 2010 it was expected to reach more than 525 bcm by 2035, now it is projected at less than 380 bcm by 2040. Russia is expanding both its gas pipeline and liquefied natural gas (LNG) export capacities (including two LNG terminals on the Baltic coast near St. Petersburg and Kaliningrad). More export capabilities with demand for gas in Europe could further decrease profitability.

Deepening rifts

Gazprom has received loans from its five original joint venture partners to cover 50 percent of the cost of Nord Stream 2’s construction. This makes it appear that the pipeline will indeed be built, with Gazprom as its sole shareholder. Neither the European Commission nor Germany has answered whether Nord Stream 2 and the exemptions granted for OPAL will undermine alternative import options. These include existing LNG terminals in Poland and Lithuania, as well as planned projects such as an LNG terminal in Croatia, Poland’s Norwegian Corridor pipeline and gas interconnector networks like the North-South Gas Corridor and Eastring. If these EU diversification projects lose commercial viability, it could deepen the political rifts within the bloc.

The European Commission’s original assessments of Nord Stream 2 assumed that Russia would not be able to implement its TurkStream gas pipeline project, with a planned capacity of 63 bcm. But in the summer of 2016, the pipeline project was revived, though with just one pipe (15.75 bcm annual capacity) to supply Turkey.

Gazprom and Russia have a strategic interest in maintaining market share and geopolitical influence in Southeastern Europe. With the precedent of the OPAL’s exemption from EU regulations, Russia, Bulgaria, Italy and others will push even harder for additional TurkStream pipelines (or a revived South Stream) and similar exemptions. The result could be the end of a single EU gas market and a common energy foreign policy.

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