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Russia-German Pipeline May Break Europe’s Energy Union

In March, nine Central and Eastern Europe (CEE) European Union member states sent a letter to European Commission President Jean-Claude Juncker objecting to the construction of the Nord Stream 2 gas pipeline from Russia to Germany.

Russia-German Pipeline May Break Europe’s Energy Union

In March 2016, nine Central and Eastern Europe (CEE) European Union member states sent a letter to European Commission President Jean-Claude Juncker objecting to the construction of the Nord Stream 2 gas pipeline from Russia to Germany.

The letter, signed by the Czech Republic, Estonia, Hungary, Latvia, Poland, Slovakia, Romania, Lithuania, and Croatia, noted that development of the pipeline would perpetuate a dependence on Russian energy already acute amongst the CEE states. This continued dependence is in contravention of the European Energy Union's goal of diversity of energy suppliers to alleviate national security concerns.

This letter illustrates a growing divide between Eastern and Western Europe over the purpose and value of a cohesive Energy Union. Chief among states supporting the construction of Nord Stream 2 is Germany, which contends that the new pipeline holds commercial viability and better secures gas inflow into Europe by reducing dependence upon Ukrainian transit routes. Germany also asserts that, should Russia seek to use its control over energy flows into Europe as a tool of its foreign policy, existing gas could be reverse-flowed back through Nord Stream to maintain continuity of supply.

Germany's interest in the success of this project may extends beyond its belief in Nord Stream 2's role in ensuring European energy supply. There is a belief in Berlin that the route to improved EU-Russian relations will be paved with stronger economic ties, and the development of Nord Stream 2 may be a key to overcoming an increasingly icy relationship with Moscow.

The divide between Eastern and Western Europe has proved especially troubling for the European Commission, which has placed a high priority on the deepening of the Energy Union. While legal and jurisdictional questions about Nord Stream 2 remain, Juncker responded to the objection letter with what seemed a measured show of support.

Last week, Mr. Juncker conceded that Nord Stream 2's impact on EU gas markets goes "beyond the legal," and could further Russia's energy "dominance to the detriment of competitors and consumers." Juncker's sentiments add even greater weight to earlier comments by Miguel Arias Cañete, Commissioner of Climate Action and Energy, who said there were serious doubts whether Nord Stream 2 was compatible with the EU's goal of security of supply.

This is likely the Commission's attempt to regain control of a situation proving that is proving to be as political as it is a commercial endeavor. Former Polish Prime Minister Jerzy Buzek-the current chair of the European Parliament's ITRE (Industry, Research, and Energy) Committee-even went as far as to comment that "Nord Stream 2 and the Energy Union cannot coexist."

On June 16, German Chancellor Angela Merkel met with Slovak Prime Minister Fico whose country begins its 6 month tenure as President of the European Council to discuss the growing tension. While Berlin has begun to feel the pressure this project places on pan-European cooperation on energy policy, the consortium of 6 companies responsible for the pipeline's development and operation believes that the Commission may not have standing to prevent construction.

Legal questions surround Nord Stream 2

The point of legal dispute is whether Nord Stream 2 would be subject to regulations under the EU's Third Energy Package, which requires that the owners of major gas pipelines also not be the providers of the upstream gas. As Gazprom is both the gas provider and the sole owner of all of Nord Stream 2's capacity, the project would fail regulatory oversight.

The Nord Stream 2 stakeholder consortium - including Gazprom, E. ON, Wintershall, Shell, OMV, and Engie - contends that since the intended pipeline location runs offshore rather than over land, it is not subject to Third Energy Package requirements, but rather its development is at the individual discretion of the countries whose territorial waters are impacted. These countries include Russia, Finland, Sweden, Denmark, and Germany.

The Commission continues to deliberate this legal challenge - but should it fail to exercise regulatory control preventing the pipeline's development, it may cause a political rift in the Energy Union.

Economic Impact

There are significant economic implications for each side of the Nord Stream 2 debate, with each claiming cost savings and efficiencies favor their preferred outcome. At the June 16 St. Petersburg International Economic Forum, Gazprom Chairman Alexey Miller detailed that gas transit via Ukraine is 20 percent more expensive than similar transit using the Nord Stream 2 pipeline due to substantially lower operating costs on the northern corridor than the central corridor.

This analysis conflicts with the assessment of Ukraine's Naftogaz that the current route is more cost effective than the proposed Nord Stream 2 pipeline. In a recent statement, Naftogaz explained, "If capacity is booked at the present level of 110 bcm the delivery [Ukraine] will be four times cheaper than via Nord Stream 2."

With Nord Stream 1 operating at approximately half of its 55 bcm capacity currently, the commercial viability of doubling this capacity with Nord Stream 2 has come under considerable question.

From Russia's perspective, this excess capacity would be more than sufficient to render the Ukraine route obsolete thereby depriving both Ukraine and Slovakia critical and lucrative transit fees. Ukraine currently transits roughly 40 percent of total Russian gas pipeline exports. In the case of the already destabilized Kiev, such a drop in revenue would further impair economic development.

While these CEE states would be deprived of critical gas transit fees, they would realize increased dependence upon Russia as a majority, if not sole, energy supplier. The new recipients of this lucrative revenue stream would be the other 5 members of the Nord Stream 2 consortium: E. ON, Wintershall, Shell, OMV, and Engie. The first two of these five key stakeholders, E. ON and Wintershall, are German companies heightening Germany's interest in seeing the development of the pipeline - regardless of existing capacity and source diversification concerns.

Casting further doubt over the near-term need for significantly expanded gas transit capacity from Russia is the 10 year outlook on global gas. The International Energy Agency (IEA) sees the current glut of global gas continuing through 2020, but this market saturation has also led to a pull-back in upstream investment. This upstream development slowdown should realize reduced transit need in the coming decade.

Author: By Jon Lang, Globalriskinsights