The Nord Stream 2 gas pipeline project, which Russia has proposed as a way to increase Europe’s energy security, continues to be dogged by a number of contentious issues, not the least of which is the unresolved status of the Ukraine crisis.

A worker during the construction of the Nord Stream 2 gas pipeline. Photo: TASS

The debate over the Nord Stream 2 project, the proposed gas pipeline that will run through Finland, Denmark, Sweden and Germany to connect Russia and the EU, has been reinvigorated. After it initially appeared that the EU might attempt to block Russia’s new pipeline project, there are now tentative signs that opposition to it may be softening.

As Jens Mueller, a spokesperson for the Nord Stream project, pointed out on July 6, "We do not see the European Union’s pressure on the four countries – Germany, Sweden, Denmark and Finland, whose exclusive economic zones will be used for the installation of the pipeline. “We know that it is necessary to fulfil all the requirements of EU legislation. We do not feel the EU Commission’s intention to block the project, [we just see] its intention to make it [the project] comply with the relevant EU laws."

The debate over the Nord Stream 2 pipeline has its origins in the evolution of Russia’s gas export strategy over the past decade. Since 2006, when the first interruption of Russian gas transiting Ukraine occurred and provoked the gas war between Russia and Ukraine, Russian President Vladimir Putin has been adamant that avoidance of any transit interruptions should be a key plank of Gazprom’s strategy in Europe.

This view was confirmed in 2009, when the most serious interruption of supply to date occurred as a result of a second dispute with Ukraine over gas prices and supply, and this event catalyzed the construction of the Nord Stream 1 pipeline. The European Commission and EU member states gave a cautious welcome to the extra 55 billion cubic meters (bcm) of pipeline capacity through the Baltic Sea, as it provided additional security of supply in the event of transit disruptions elsewhere.

However, from a Russian perspective, it was clearly not the ultimate answer, as some reliance on Ukraine remained. Total pipeline export capacity to Europe from Russia amounts to around 240 bcm, with 120 bcm passing through Ukraine. With Gazprom exports averaging 150-160 bcm, it is clear that at least 30-40 bcm of this must use the Ukrainian system.

In response to this problem, Gazprom therefore planned a second direct pipeline route, South Stream, via the Black Sea to Bulgaria. With 63 bcm of capacity, this pipeline could have allowed Gazprom to avoid Ukraine altogether, completely changing the dynamics of its trade with Europe. However, in December 2014 the South Stream pipeline was cancelled after tensions related to the Ukraine crisis.

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The political dynamics of Russian export pipelines

Even in 2011, though, when the South Stream plan was officially launched, the interwoven commercial and political aspects of Russia’s gas relationship with Europe, which are now affecting Nord Stream 2, were clear.

Gazprom used straightforward business logic to argue that Europe’s gas supply was best secured via an additional pipe without transit risk, but Russia’s tense relationship with Ukraine throughout the post-Soviet era and the perception that the South Stream was part of an attempt to undermine the Ukrainian economy and political system following the Orange Revolution added an inevitable element of politics to the debate.

On the other side, the European Commission offered valid commercial arguments for its concern over the South Stream, namely that it should not be seen to flout the EU’s emerging gas market rules, as set out in the Third Energy Package, and also that it should not completely undermine Ukrainian transit, which by its very presence does provide an alternative route for Russian gas and therefore contributes to security of supply. It would certainly not make sense from the EU perspective to see Ukraine completely removed from the Russian gas export equation.

The political dynamics involved in the Russian export pipeline debate were of course magnified by the annexation of Crimea in early 2014 and the subsequent military conflict in Eastern Ukraine. At this point, EU support for the Ukrainian authorities and increased concerns over dependence on Russian gas in Europe took a much more prominent position in any discussions over the construction of new pipelines.

However, what has also been obvious is that the EU has been reluctant to link political sentiment directly with commercial decisions; instead, it has used its regulatory powers to undermine pipeline proposals. This was very clear with South Stream, when strong application of Third Energy Package rules, including an insistence on third-party access to onshore sections of the pipe, effectively forced Gazprom to cancel the project.

It has also been seen in the debate over the OPAL pipeline, which connects Nord Stream 1 to the European market, with the EU remaining insistent that 50 percent of the capacity should be made available to non-Gazprom stakeholders despite the fact that no alternative users of the pipeline have emerged. Agreement on a compromise solution appeared to have been reached at the beginning of 2014, but was then undermined by the start of the Ukraine crisis and put on indefinite hold.

Similar political dynamics, combined with some commercial logic and regulatory procedures, have affected the Nord Stream 2 project. From a Russian perspective, the idea to double the capacity of Nord Stream emerged from the failure of Gazprom’s Black Sea strategy, where the plan was to replace South Stream with an alternative involving Turkey. The Turkish Stream gas project collapsed due to price negotiations and, more importantly, to a dramatic deterioration in political relations following the shooting down of a Russian military jet by Turkish forces in 2015.

However, despite this overtly political catalyst, which saw an agreement signed between Gazprom and various European partners to form the Nord Stream 2 consortium in June 2015, an expanded Baltic pipeline does also have some commercial logic.

The majority of Gazprom’s largest customers can be found in, or accessed through, northwest Europe, while the need for imports there is growing due in particular to the recent sharp declines in output from the Groningen field in the Netherlands.

Over the longer term, supply from the UK, and perhaps even Norway, will also fall, leaving an import gap that can be filled at least in part by more Russian gas. This logic would appear to be recognized not only by the European companies involved (Shell, E.ON, BASF, Engie and OMV) but also by a number of European countries, in particular, Germany.

In addition, Gazprom has highlighted the risk of rising Ukraine transit costs as an additional commercial issue, in particular following the recent threat by the Ukrainian authorities to double the transit fee.

How the Ukraine crisis impacts Nord Stream 2

However, there is a clear alternative commercial and political logic that can and is also being advocated. Again, it centers on the EU’s support for Ukraine and its concern over security of supply. As far as Ukraine is concerned, a number of EU leaders have called any support for Nord Stream 2 a betrayal, but less dramatically, worries over a loss of around $2-3 billion of annual transit revenue, with its implications for the already strained Ukrainian budget, have also been expressed.

The underlying agenda, of course, is political backing for Kiev in its conflict with the Kremlin, but the commercial logic of wanting to maintain a multitude of transit routes and not to become overly reliant on one through the Baltic Sea is also very valid.

Furthermore, it is also true that the Ukraine transit route is vital for countries in southeast Europe, providing a shorter and more practical source of Russian gas than Nord Stream 2, which has limited interconnection with markets in the south.

The main problem with these arguments, though, is that they have forced EU leaders to champion Ukraine as a secure transit route, which it demonstrably is not. Political and military concerns aside, the pipeline system itself is in a poor state of repair and needs significant investment ($3-4 billion) to maintain and upgrade it, and this is unlikely to be forthcoming given the state of the Ukrainian economy.

Given the strength of feeling, and also the logic of the arguments, on both sides, it would seem that the Nord Stream 2 debate could continue for some time. Certainly the EU has the regulatory tools to extend the uncertainty for potential investors in the pipeline, making a final investment decision and real cash investment a risky proposition any time soon.

Not only must a decision be made about the application of the Third Energy Package for onshore pipelines such as OPAL (and, by inference, any onshore pipeline related to Nord Stream 2), but the status of the offshore element of Nord Stream 2 is also being challenged, as opponents are arguing that it should also be subject to third-party access rules.

Whatever the validity of this claim (and there are strong advocates on both sides), the mere exercise of debating the issue will cause a practical delay. Furthermore, there is a clear division between EU countries over support for a new pipeline. While Germany seems intrinsically positive, Italy is opposed, as it is still annoyed about the cancellation of South Stream, which could have resulted in it developing a gas hub in southern Europe.

Meanwhile, the increasing proximity of 2019, when the current Russia-Ukraine gas sales and gas transit agreements come to an end, is sharpening the focus of the debate. Interestingly, though, the issue of contract renegotiations may point to a potential outcome for Nord Stream 2.

Initially Gazprom announced that “the moon would replace the sun” before it would sign a new transit contract with Ukraine for post-2019 deliveries, but its attempt to force the case for Nord Stream 2 in fact hardened EU opposition to it and increased support for the Ukraine route.

The Kremlin has since forced Gazprom to back down, and the likelihood now is that new, shorter-term deals will be signed for gas transit, and could be brokered by the EU in the same way as recent “winter packages” for gas sales to Ukraine have been negotiated. In other words, compromise could well be reached which could also involve the construction of Nord Stream 2, in whole or part, as part of an overall gas supply strategy.

Gazprom could acknowledge EU concerns over supply to southeast Europe by guaranteeing to maintain a certain level of gas transit through Ukraine, but could also increase its access to northwest Europe through an expanded Baltic Sea route. However, any compromise solution will inevitably depend upon how the politics around Ukraine and EU sanctions on Russia develop.

A frozen conflict in Eastern Ukraine and a continued EU refusal to lift sanctions could also imply extended regulatory tactics to undermine any hope of a new Russian gas pipeline to Europe. 

The opinion of the author may not necessarily reflect the position of Russia Direct or its staff.