- Nord Stream II will take on an important role in Gazprom's strategy for Europe, which is focusing on increasing export capacity to undercut potential supply alternatives in Germany, Eastern Europe and Central Europe.
- Knowing that Gazprom must carry out its strategy in accordance with European law, the Russian natural gas firm likely will comply fully with EU regulations and do its best to secure onshore extensions either directly, through negotiations with Brussels, or indirectly, via other companies' investments.
- Nord Stream II has support from both Germany and Russia, unlike other massive pipeline projects such as TurkStream. Germany's backing likely means that Nord Stream II will get built, as long as it remains an economical project, but as with Nord Stream I the process could be lengthy.
Stratfor closely monitors the ebbs and flows of world energy. Aside from production, the transportation of crude oil, natural gas and petroleum products is of paramount concern for oil-producing nations. For energy consumers, transit routes are indispensible lifelines. A huge amount of the world's energy is transited through pipelines, across the Eurasian landmass in particular. In this periodic series we will examine some of the most geopolitically significant pipelines running through Europe and Asia. In this installment, Stratfor examines Gazprom's motivations for building the proposed Nord Stream II pipeline.
Gazprom's proposed Nord Stream II pipeline — along with TurkStream, possible capitulation to Energy Union Package regulations and Gazprom's ongoing debate with Europe's antitrust regulators — is part of the Russian natural gas firm's new European strategy. Previously, Gazprom pursued a divide-and-conquer strategy that involved reaching bilateral agreements with individual countries. Gazprom's new strategy appears to focus on flexibility in supply routes, markets and possibly even pricing; on dealing with the European energy market as a whole instead of piecemeal; and on leaving natural gas on Europe's doorstep to be transported to market through internal European pipelines.
Nord Stream II's Strategic Ambitions
It could be argued that Nord Stream II is another case of Germany and Russia increasing energy cooperation despite the political tension between them, but the situation is more nuanced. Nord Stream II will increase Gazprom's direct export capacity to 110 billion cubic meters, far greater than Germany's annual demand of about 80 bcm (of which Gazprom supplies approximately half). Gazprom certainly is looking beyond Germany with the project to both Western and Eastern Europe.
Western Europe's natural gas supplies from the North Sea, particularly from the United Kingdom, are in decline and could fall by at least 50 bcm over the next 20 years. By building an export pipeline to Western Europe, Gazprom can send more natural gas directly, avoiding the hefty transit fees that come with sending natural gas through multiple countries. Considering the decline in North Sea production, Gazprom has even considered building a pipeline spur to the United Kingdom. The lack of transit fees and the shorter route from Russia's natural gas fields to Gazprom's customers would put the company in a position to undercut more expensive remote offshore fields in the Norwegian and Barents seas, unconventional natural gas development in the United Kingdom and emerging liquefied natural gas exporters such as the United States. Even if Russian natural gas were uncompetitive, the state-owned Gazprom could still flood the market for political reasons as a way to discourage Western companies' investment in other energy projects in and around Europe.
In Eastern Europe, Gazprom's challenges are more complex. The company's attempt to divide European natural gas markets was most effective in the east, thanks to Soviet-era infrastructure and cheap natural gas. Interconnectors in Eastern Europe are minimal, limiting the state-to-state trade of natural gas beyond Gazprom's control, and some of Gazprom's contractual terms forbid such trade outright.
In Eastern Europe, Gazprom's challenges are more complex. The company's attempt to divide European natural gas markets was most effective in the east, thanks to Soviet-era infrastructure and cheap natural gas. Interconnectors in Eastern Europe are minimal, limiting the state-to-state trade of natural gas beyond Gazprom's control, and some of Gazprom's contractual terms forbid such trade outright. The European Union's Third Energy Package and Brussels have considerably limited the extent to which Gazprom can control the trade and movement of natural gas. Nevertheless, Gazprom's goal in Eastern Europe is to limit challenges to its market share, and its main mechanism has been price.
Gazprom has also said it wants to move away from Ukraine as a transit state by 2019 — a date that is looking increasingly improbable. Gazprom wants to end Ukraine's monopoly over the transit of Russian natural gas to Europe through the Urengoy-Pomary-Uzhgorod pipeline system, which can carry more than 100 bcm of natural gas. If fully developed, TurkStream and Nord Stream II together would remove the need to transit natural gas through Ukraine entirely. However, completing the pipelines and the needed internal European natural gas infrastructure by 2019 is impossible. Moreover, most of Gazprom's contracts are long-term contracts with specific delivery points (such as the Ukraine-Slovakia border) that would need to be adjusted if Russia moves away from trans-Ukrainian export routes. Gazprom is well aware of this and will not simply turn off natural gas supplies transiting Ukraine in four years.
Instead, Russia will use Gazprom's stated goal as a negotiating tool and as a way of building a coalition of potential investors around TurkStream and Nord Stream II. Even if TurkStream and Nord Stream II are built, Ukraine will still be an important transit state and would allow Russia to keep the Ukraine-Slovakia border as an anchor point for natural gas imports to the edge of the European natural gas market (with TurkStream anchored to the Turkey-Greece border in the south and Nord Stream II anchored to the German coastline in the north). Ukraine also would give Russia better delivery flexibility. All of this would support Gazprom's new strategy of leaving natural gas on Europe's doorstep and gaining the flexibility to send natural gas where it wants based on markets or politics.
Justifying Nord Stream II
If Gazprom wants to leave natural gas at the European border, the company needs relevant pipelines inside Europe's borders to move the natural gas to market. This is where the political disputes between Russia and Europe have most noticeably spilled over into the energy sector. To justify the construction of Nord Stream II, Gazprom must first navigate the internal pipeline politics that limit its use of the Nord Stream I pipeline. Gazprom's access to the combined 55 bcm of capacity in the Northern European Pipeline (NEL) and Ostsee-Pipeline-Anbindungsleitung (OPAL), which connect Nord Stream to West Germany and the Czech Republic, respectively, is limited by Europe's Third Energy Package third-party access requirements.
Under these requirements, European pipeline operators must offer 100 percent of their pipelines' capacity to third parties, unless the European Commission and the relevant national regulator (in this case, Germany's Bundesnetzagentur) provide exemptions to the operator. Both of these pipelines are partially owned by Gazprom, meaning that Gazprom needs exemptions to send its own natural gas through the pipeline.
In 2009, Gazprom received a 22-year exemption for 50 percent of OPAL's capacity. Under that ruling, Gazprom's access to OPAL could increase to 100 percent if it organized an annual 3 bcm natural gas release program. Gazprom hoped to avoid that requirement, but despite approval by the Bundesnetzagentur, Gazprom failed to get the European Commission's blessing to increase the exemption for OPAL to 100 percent and remove the strings attached to it.
On Jan. 28, the European Commission and Gazprom agreed to a workaround deal where Gazprom would auction OPAL's unreserved capacity under Europe's natural gas capacity auction mechanism and be allowed to bid for the capacity itself, effectively granting Gazprom 100 percent of the capacity. The European Commission had a deadline of March 10, 2014, to finalize the decision. Then, after Russia invaded and annexed Crimea, the European Commission delayed its decision, and on Dec. 23 halted proceedings altogether. Gazprom then canceled the expansion of Nord Stream beyond 55 bcm.
It was in this context that the Nord Stream II pipeline was proposed in June 2015 with a new consortium that included Royal Dutch/Shell, E.On and OMV. Gazprom followed the Nord Stream II agreement with the announcement of a 3 bcm auction — its first ever — in July. The auction was held the week of Sept. 14, and although the auction would have allowed Gazprom to gain 100 percent of OPAL's capacity, both the European Commission and Germany's regulator have said the auction is unrelated. Since then, Gazprom has said that for the European winter of 2016-2017, as much as 10 percent of natural gas sales could take place via auctions.
Either way, Moscow is exploring all options to get around this restriction. One possible option is Russia's elimination of Gazprom's monopoly on natural gas exports on a timeline that overlaps with the Nord Stream II project. This would allow other Russian companies, such as Novatek or Rosneft, access to the European natural gas market through existing infrastructure. In the longer term, Moscow could use this to avoid some of Brussels' most powerful enforcement tools, such as the restrictions governing access to OPAL.
Nevertheless, Gazprom is still negotiating with the European Commission under Jean-Claude Juncker to gain full access to OPAL. However, the commission has taken a hard stance against Russia over Ukraine and is unlikely to undermine Ukraine's status as a transit state unless Russia significantly backtracks in Ukraine. Although Gazprom has begun forming a new export strategy that places TurkStream and Nord Stream II as cornerstones, Russia's timetable is optimistic. As Nord Stream I's inception showed, these politically divisive pipelines can take more than a decade to come into being — and the first Nord Stream did not have the Ukraine crisis monopolizing Brussels and Moscow's political discourse and complicating energy agreements.