(Photo: tomtunguz.com)
Following the cancellation of South Stream, Nord
Stream 2 (NS2) represents Gazprom’s last opportunity to effectively bypass Ukraine
entirely for continental European deliveries, a troubling development in
Brussels. At the same time, it offers a direct line to western European markets
with declining indigenous production and an abundance of LNG regasification
capacity, representing Gazprom’s marginal competitor. If it is built, Gazprom
would be in a powerful position to negotiate the terms governing any future deliveries
through Ukraine after 2019 when the current transit agreement expires. In a
similar vein, NS2 immediately undermines the position of traditional Central
European (CE) transit states which will lose relevance and gas transit
revenues. Perhaps more consequently for the whole of Central and Southeast
Europe (CSEE), it would weaken gas security of supply and competition, the defense
of which is a key pillar of the European Commission’s Energy Union proposal.
CE transit states are already facing the inevitable
decline of their traditional positions, with gradual market integration opening
new trade flows that are redefining the modus operandi of transit and delivery
defined over the past 20 years by long term pipeline contracts with Gazprom. While
this represents progress towards a version of the single European market,
contracted gas subverting Ukraine via NS2 potentially overwhelms existing reverse
flow capacities, limiting available west-to-east spot trading.
CSEE countries would clearly benefit from an
intervention on the part of the European Commission that delays or blocks construction
of NS2, but its ability and appetite to do appears less and less likely as time
passes and Gazprom pushes ahead - in April it agreed to a pipe-laying contract
for the sub-sea cables and secured financing for 50% of the project from five
western European energy majors. As an external pipeline, NS2 sits outside the
jurisdiction of Europe’s energy laws and regulations, although its onshore
connection, EUGAL, would fall within this boundary. If the European Commission
decided to intervene, it would need to file a strong legal interpretation of
EUGAL’s (by extension NS2’s) adverse impact on the more vulnerable CSEE region,
for which there is a clear argument to be made, but no indications it will be
pursued. With such an impactful and divisive zero sum project the ultimate compromise,
tacit consent or objection on the part of the Commission will be heavily
influenced by political maneuvering between Brussels, Berlin and Kiev. This
article briefly summarizes the perspectives of Central European governments, the
Commission and Gazprom over NS2, which is expecting to reach a tipping point
this year.
First, what was at least on the surface collective regional
opposition to NS2 in 2016, highlighted by a March letter of opposition signed
by eight CSEE governments and sent to President of the European Commission Jean-Claude
Juncker, has become fragmented and somewhat demoralized. Outside of Poland,
governments appear resigned to the inevitability of NS2, opting to make independent
contingency arrangements rather than lobbying together in Brussels; behind the
scenes officials have quietly negotiated deals with Gazprom that provides
minimum transit guarantees in the event NS2 is built. For other countries in
the region not adversely affected by NS2, the signature itself represented the
extent of solidarity.
On the other hand, European solidarity towards Ukraine
has been elevated by geopolitical developments vis-à-vis Russia, and
undoubtedly NS2 is now more strongly associated with the Kremlin’s campaign to
isolate Ukraine than the merits of its impact on Europe’s gas network. Now the
EU is providing billions of euros in additional financing and aid to Ukraine,
leading to a more explicit interest in its state budget, like the 2 billion
euros annually - or 2% of GDP - that its gas transit receipts total.
Otherwise, the Commission’s core concern with respect
to Ukraine’s transit network is that it does not default due to
under-utilization. Since Nord Stream’s commissioning in 2011, annual transit of
Russian gas through Ukraine has fallen to what is now about 50% of capacity, and
if NS2 is built lower annual transit could put the network at risk, posing a
direct threat to Europe’s security of supply. Thus the idea floated by Germany’s
former Minster for Economic Affairs and Energy Sigmund Gabriel that Gazprom
could ensure capacity bookings at or slightly above this minimum threshold beyond
2019 is one form of compromise.
However, such a compromise still does not address the impact
of such a large portion of contracted volumes bypassing the Yamal and
Brotherhood trunk lines to reach CSEE final destinations via Germany. If
Gazprom’s primary intention is to reroute a majority of its CEE destined
volumes through NS2 and the proposed onshore EUGAL pipeline (a 51 bcm pipeline parallel
to Opal) rather than seeking greater market share in western European markets, this
would adversely affect CSEE by limiting competition and weakening regional security
of supply.
As it stands, the bidirectional upgrades that have
been implemented since 2009 to better integrate the continent and open CEE to trade
would instead facilitate Gazprom’s contractual obligations. Allowing contracted
gas to absorb these west-to-east capacities effectively limits CEE access to
Western markets and makes the region more susceptible to winter cold snaps or
N-1 scenarios if the largest infrastructure was to go offline.
In turn this massive realignment, effectively
transferring CEE’s onward delivery center from Ukraine to Germany, creates new
congestion points and additional need for infrastructure investment that
otherwise would not be necessary from a net social welfare perspective. A
number of these projects are eligible for grants (e.g. Connecting Europe
Facility, European Energy Program for Recovery, European Regional Development
Plan) that ultimately fall squarely on the European taxpayer. In this regard,
NS2 is a pathway that weakens the resiliency of Europe’s existing transmission
system and requires additional reinforcement and/or guarantees for
compensation.
Outside of this scope, the Commission is under no
obligation to protect member state transit status. With or without NS2, the internal
gas market is evolving away from long term sales and transit commitments.
Transmission service operators (TSOs) are already adapting to this reality by
meeting the new short-term demands of traders. In Slovakia, TSO Eustream can
continue to provide reverse flow for Ukraine and promote the Eastring project
in an effort to salvage its existing transit system, but the country’s transit
role has likely peaked. For transit countries like Slovakia, Poland or Hungary,
long time beneficiaries of their geography for a sizable and predictable
revenue stream, Nord Stream weakened their position and market integration will
continue this trend. As the bulk of long term contracts expire over the next
five years, renegotiations leveraged by access to western markets also dictate
new delivery conditions.
While acknowledging the real financial losses that the
region faces, it is important not to get lost in the sensationalism of geopolitics
when it comes to the actual risks of energy supply as they currently stand. CEE
member states are not as vulnerable as they were seven or eight years ago; by
the end of the decade Polish and Croatian LNG (pending final investment
decision) should be accessible in Hungary and Slovakia and new infrastructure
(Interconnector Bulgaria-Serbia, Interconnector Greece-Bulgaria pending final
investment decisions) will to help to physically open southeast European
markets like Bulgaria and Serbia to Caspian gas and Greek LNG. In this manner
the region is finally investing the necessary political and financial capital
(with enormous EU support) to complete these long discussed bit projects so
that a crisis on the scale of 2009 cannot repeat itself. For example, the Opal
decision that Poland has appealed is more a symbolic, precedent setting legal
discrepancy than something that materially threatens Poland’s security of
supply. Poland now has an LNG facility on its coast which it plans to expand
and will be connected to the Baltic network and Slovakia by the end of the
decade.
Finally, as a gas exporter Gazprom has reasons for attempting
to bypass Ukraine to avoid transit risk. Ukraine has struggled with corruption
across its gas sector while reform efforts have only recently shown signs of
progress, and Naftogaz has held firm negotiating tariffs. This is not to deny
Russia’s geopolitical strategy of weakening Ukraine, but to admit that there is
also a logic for Gazprom: avoiding transit disputes that affect deliveries to
Europe; the relocation of its production base to Yamal; and the fact that its
largest customers with greatest market share opportunities are in western Europe.
Perhaps deservedly so, this rationale tends to be lost in the polarizing
dispute over Ukraine and general distrust of Gazprom’s intentions amongst
Central Europeans.
Absent the ongoing proxy war in eastern Ukraine some European
voices might not be as loud for protecting its transit status out of solidarity.
Despite CEE transit states’ legitimate opposition to NS2 on the grounds that it
is detrimental to security of supply and competition, German interests remain
well represented in Brussels and the Commission has remained guarded. While VP of
the Energy Union Maroš Šefčovič
has openly questioned the commercial legitimacy of NS2, there have yet to be
any official statements to slow the project’s momentum. Thus without further
objection, Gazprom is likely to push forward towards a final investment
decision later this year, revealing the Commission’s position one way or the
other. Regardless, it is time for traditional Central European transit states
to look ahead and prepare for changing gas market fundamentals.
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