U.S. – EUROPE WORKING PAPER August 18, 2016

A Tale of Two Countries: , Germany, and Russian Gas Giovanna De Maio

Introduction significance for broader European energy dynamics and geopolitics. Italy and Germany are locked in a struggle over access to Russian gas supplies and the Italy has only recently re-emerged as a major construction of the controversial 2 player in the EU after more than a decade of pipeline. That struggle threatens not only to political retreat, and it is exploring both the complicate their bilateral relationship and their limits and opportunities of a new leadership respective relationships with , but also to role. Italy has been willing to challenge thwart (EU) efforts to Germany on a number of issues, including the consolidate a common approach to energy economic austerity measures that Berlin security and to create a formal energy union. insisted on in response to the Eurozone crisis as In the wake of the United Kingdom’s (U.K.) a condition for financial assistance to ailing historic June 23, 2016 (“Brexit”) referendum to national banks and economies within the leave the EU, the negative impact of this countries that adopted the Euro. Italy has also dispute on EU energy and trade issues could moved to oppose the German private sector- become heightened. The U.K., with its backed decision by a consortium of German liberalized energy market, will no longer play a companies to finance and construct Nord direct role in EU energy policy. Clashes over Stream 2 and has accused the European Nord Stream 2 and relations with Russia could Commission of adopting double standards in exacerbate the EU’s cleavages, exactly at a time when the remaining EU member Giovanna De Maio is an Italian Ph.D. countries––especially Italy and Germany, student in International Studies at the which were two of the original six founding University of Naples L’Orientale. Her countries of the European customs union and research deals with Russian politics in single market––need to pull together. Eastern Europe and perceptions of following the events of 2013-2014 This paper examines the factors that have Euromaidan unrest. De Maio was a special contributed to the German-Italian dispute over Guest at the Center on the U.S. and Europe Nord Stream 2, including their respective at Brookings in 2016. relations with Russia. It also analyzes their

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not blocking the project. Germany has pushed transit revenues for Ukraine at a juncture of back on both fronts. Meanwhile Russia, for its acute economic crisis, following Russia’s part, has tried to find ways to take advantage annexation of in March 2014 and the of the disagreement between Italy and subsequent war in Ukraine’s Donbas region.2 Germany and consolidate its position as the primary supplier to Europe. Benefits to the EU energy market

Nord Stream 2: The project Analysts who question the long-term commercial viability and energy security Nord Stream 2 is a project proposed by a benefits of Nord Stream 2 usually point out that consortium of companies led by Russia’s gas Europe’s gas demand has been depressed monopoly, , which holds a 50 percent since the 2008 economic crisis. However, the stake in the venture. The other 50 percent is core goal of Nord Stream 2 is to replace equally divided among Germany’s BASF. and declining volumes of European domestic fossil E.ON, France’s Engie, ’s OMV, and Royal fuel production, and to meet new, albeit Dutch Shell. The project would expand and limited, demand for gas that will be generated complement the Nord Stream 1 pipeline that is by Germany and some other EU member already in operation transporting natural gas states phasing out nuclear power.3 The from Russia directly to Germany across the majority of EU member states are projected, Baltic Sea. Like Nord Stream 1, the second under most scenarios, to remain dependent on pipeline would bypass the longstanding gas significant imports of Russian gas until at least transit systems of Ukraine, the Czech Republic, 2030.4 Moreover, absent drastic changes in and Slovakia, and pump 55 billion cubic energy consumption, the European gas supply meters (bcm) of Russian gas to Germany.1 The mix—which includes a significant share of two main points of contention at the EU level Russian gas—is not expected to change have been the prospect that Nord Stream 2 will much.5 increase rather than reduce EU countries’ dependence on Russian gas and the loss of

4 See Ralf Dickel, Elham Hassanzadeh, James Henderson, 1 Severin Fisher, “Nord Stream 2: Europe’s lack of Trust in Anouk Honoré, Laura El-Katiri, Simon Pirani, Howard its market model,” Policy perspectives Vol. 4/4, CSS ETH Rogers, Jonathan Stern & Katja Yafimava, “Reducing Zurich, March 2016. European Dependence on Russian Gas: Distinguishing 2 For further readings on the debate about Nord Stream 2 Natural Gas Security from Geopolitics,” OIES Paper 93. see Andreas Goldthau: “Assessing Nord Stream 2: Oxford: Oxford Institute for Energy Studies, 2014, regulation, geopolitics & energy security in the EU, https://www.oxfordenergy.org/wpcms/wp- Central Eastern Europe & the UK,” Strategy Paper 10, content/uploads/2014/10/NG-92.pdf. Department of War Studies & King’s Russia Institute, 5 Tim Boersma, Tatiana Mitrova, Geert Greving, Anna 2016. Galkina, “The Impact of the Crisis in Ukraine on the 3 Tim Boersma, “Further reduction of Dutch natural gas European Gas Market,” Policy Brief, October 2014, production: The end of an era?,” Brookings Up Front, http://www.brookings.edu/research/papers/2014/10/eu June 2015, http://www.brookings.edu/blogs/up- ropean-gas-market-import-dependence. front/posts/2015/06/26-dutch-natural-gas-production- boersma.

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Nord Stream 2’s utility is also questioned in light Stream 1 pipeline by the EU Commission. The of the fact that the full capacity of the Nord Commission’s legal service has since issued Stream 1 pipeline has not been fully-utilized, opinions in defense of Nord Stream 2 that since the consortium has only secured access suggest EU energy market rules also do not to 50 percent of the OPAL pipeline that apply in the case of the second pipeline–– connects Nord Stream 1 to onshore gas transit raising the prospect of another official and distribution networks. This is, however, due exemption from the EU .8 to anti-monopoly limitations imposed by the EU’s Third Energy Package. In accordance with Bypassing Ukraine these provisions, the companies in the Nord Stream 1 consortium are precluded from using Since the crisis in Ukraine, many EU member the pipeline’s full capacity and must make the states—not just Italy––have pointed out the additional 50 percent available to other gas political incoherence of building a new suppliers.6 pipeline that clearly benefits Russia’s energy sector at a time when Russia is subject to EU Compliance with the EU Third Energy and other international sanctions after the Package regulation annexation of Crimea. The EU has also expressed economic as well as political The Third Energy Package is a set of directives support for Ukraine given that the proximate adopted by the EU in 2009 to integrate cause of the crisis and ensuing war in Donbas national gas markets.7 The package represents was Ukrainian and EU efforts in 2013 to the toughest hurdle for Gazprom’s investments conclude an association agreement and a in Europe because it stipulates that gas deep and comprehensive trade agreement production and transmission must be (DCFTA). The construction of Nord Stream 2 managed by two different entities. In addition, would create a permanent alternative gas third-party access to pipeline networks must be export route from Russia to Europe that would provided to competing gas suppliers. In 2011- eclipse the existing pipeline network across 2012, Gazprom was granted an exemption Ukraine. As a result, Kiev would lose over $2 from the application of the Third Energy billion annually in transit revenues.9 After the Package for the construction of the Nord construction of Nord Stream 1, Poland had a similar experience in 2014.10 Ukraine would also

6 Vladimir Socor, “Gazprom Required to De-Monopolize other major pipeline projects, including Nord Stream 1 Access to German OPAL and NEL Pipelines,” Eurasia Daily and TAP, exemptions have been granted. That also raises Monitor, Volume 9, Issue 56, March 2012. questions on how these cases compare to Nord Stream 2 7 The EU energy liberalization agenda started in 2009. For and about the effectiveness of the EU law—in the sense more background see Tim Boersma “Energy Security and that it should not be influenced by politics. For more Natural Gas Markets in Europe Lessons from the EU and details in this issue, see Sijbren De Jong, “Why Europe the United States,” Routledge 2015. should fight Nord Stream II,” EUobserver, February 2016 https://www.routledge.com/Energy-Security-and- http://europa.eu/rapid/press-release_IP-14-585_en.htm. Natural-Gas-Markets-in-Europe-Lessons-from-the- 9 Ukraine EU/Boersma/p/book/9781138795129. http://en.interfax.com.ua/news/economic/289356.html. 8 This is a major gray area, and lawyers will have to figure 10 Strzelecki M., Martewicz M., “Gazprom Limits Polish out whether or not the consortium will be exempted. For Gas Supplies as Reverse Flows Halt,” Bloomberg,

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likely find itself cut off from Russian gas supplies transit country for Russian gas will be reduced for its own domestic consumption. Even if to zero.12 destination clauses that prevent the buyer from reselling the natural gas were dropped, Security reasons Gazprom would not export enough gas to allow European countries like Germany to Beyond Ukraine, eight EU member states, all resell excess domestic supply to Ukraine.11 Central or Eastern European countries, signed a petition against Nord Stream 2 citing security Since 2006, Ukrainian-Russian disputes over gas concerns. The Czech Republic, , prices have been the source of major gas Poland, the Slovak Republic, Romania, Estonia, supply disruptions in Europe. Prior to the Latvia, Lithuania, and Croatia are the construction of Nord Stream 1, most of Russian European countries most dependent on gas to Europe had been exported through Russian natural gas. The signatories pointed out Cold War-era pipeline networks across Ukraine that Nord Stream 2 poses “risks for energy and Poland. Ukraine used the same pipelines security in the region of Central and Eastern both for domestic gas distribution and for gas Europe, which is still highly dependent on a transit to Europe. Consequently, when Russia single source of energy.”13 In the view of some cut gas supplies to Ukraine in 2006, 2009, and energy analysts, after the construction of Nord 2014, it cut off supplies for Europe as well. For Stream 2, Russia could cut off gas supplies to this reason, Russia has long tried to find these countries without affecting access to its alternative ways to reach the EU energy main Western European market. The countries, market—with the goal of completely cutting could therefore all be simultaneously exposed off Ukraine in 2019, when its current gas to a loss in transit revenues and a shortage in purchase contract with Gazprom expires. In gas supplies. 14 December 2014, Gazprom’s CEO stated unequivocally that the role of Ukraine as a

September 2014 13 Alan Riley, “Nord Stream 2: Too Many Obstacles, Legal, http://www.bloomberg.com/news/articles/2014-09- Economic, and Political to be Delivered?,” Issue Brief, 10/poland-says-gazprom-cut-gas-supplies-via-belarus- Atlantic Council, November 2015 ukraine. http://www.atlanticcouncil.org/publications/issue- 11 PGNiG (Polskie Górnictwo Naftowe i Gazownictwo SA), briefs/nordstream-2-too-many-obstacles-legal-economic- Poland’s main gas importer, was forced to use its traders and-political-to-be-delivered. in the German market to purchase the missing gas 14 A counter argument could be that since destination volumes. Such situations create market volatility and clauses are prohibited, CEE countries would be granted show that Gazprom treats clients in the CEE and Western reverse flows. Last year, over 32 bcm of gas was re- Europe differently. See exported from Germany, partly to the CEE. See http://en.pgnig.pl/documents/18252/359153/Company+ http://www.naturalgaseurope.com/german-exports- Overview_EN_December+2014/b70516b7-6ae9-4c10- topped-30-bcm-in-2015-28791, However, as I explain 85e0-9cdae9a031d9 later, it could also happen that Gazprom would not pump 12 Karel Beckman, “Gazprom CEO Alexei Miller: This is the enough gas volume to allow Germany to re-sell it. beginning of the end of Gazprom’s business model in Europe,” December 2014, www.energypost.eu.

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Italy, Germany, and Russia: Different other countries are seen to take shortcuts or to perspectives avoid compliance. The success of the euro- skeptic Alternative for Germany (AfD) Party in Italy has very different concerns about Nord recent local elections underscores the current Stream 2, which are all closely related to the pressures facing German Chancellor Angela new role Italy wants to play within the Merkel in maintaining Germany’s governing European Union. After the controversial tenure coalition, especially against the backdrop of of as prime minister, it was hard the European refugee crisis. for Italy to rebuild international credibility and trust. In the EU, Italy was blamed, especially by Italy’s aspirations to play a bigger role in Germany, for not respecting the parameters of Europe have put it in political rivalry with the Maastricht Treaty and the Fiscal Compact. Germany. In 2014, Prime Minister Renzi pushed After four years of difficult reforms aimed at for stronger Italian representation in the EU in recovering from the economic crisis and order to counterbalance what considers preventing further damage, Italy wants to to be Germany’s over-representation. Renzi, rehabilitate its foreign policy image. Since for example, lobbied for Italian Foreign Minister Prime Minister Matteo Renzi came to power, Federica Mogherini to become the EU High there have been three leitmotivs in the Italian Representative for Foreign Affairs and Security approach towards the EU: 1) challenging Policy, ultimately overcoming the opposition of austerity in economic policy; 2) appealing to some EU member states who considered her the EU for assistance in managing the refugee “pro-Russian.” crisis in the Mediterranean; and 3) seeking a leading role in European foreign policy. Relations with Russia and EU energy policy have both become part of this Italian-German In contrast to Italy, Germany has long rivalry, at a time after Brexit when three of the occupied a dominant position in the EU as the original six founding members of the EU–– strongest European economy. After the 2014 France, Germany, and Italy––will play larger European parliamentary elections and the roles than before in shaping the future of creation of a new Commission, Germans hold Europe. A political and economic clash key positions in every institution of the EU. between Italy and Germany over Nord Stream Among others, Uwe Corsepius is the General 2 and Russian energy could have broader Secretary of the European Council, Klaus Welle political ramifications for the EU, especially as is the Secretary General of the European France does not have a particular stake in this Parliament, Martin Schulz is the president of the issue. , and Klaus Regling is the director of the European Stability Mechanism. Berlin has traditionally adopted an Germany has always acted in total accommodating political approach towards compliance with EU treaties, but it has also , but the Russian-German relationship made clear that the EU cannot make a has become more challenging. Despite decision without Germany’s approval. This has significant commercial ties, the German created frictions within Germany and degrees government has adopted a very tough of resentment toward the EU, especially when approach towards Russia since the beginning

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of the Ukraine crisis in late 2013. German The South Stream pipeline was an initiative led Chancellor Merkel has been one of the by Gazprom designed to connect Russia with staunchest advocates of EU sanctions. Russia across the , bypassing has retaliated by trying to exploit the divisions Ukraine like Nord Stream, but also bypassing within German society toward the EU, , where Russia constructed an earlier including by financing euro-skeptic parties like undersea gas pipeline, . Moscow’s the National Democratic Party and Pegida and Gazprom’s goals since the early 2000s Movement.15 In addition, Russia has promoted have been to ensure multiple direct pipeline and encouraged a pan-European anti- routes to Europe to mitigate the transit risks to fracking campaign aimed at preventing Russian interests and to maximize Russia’s Germany (and other countries) from export options and leverage. The Italian firm diversifying domestic energy sources and held a 20 percent share in the South Stream producing non-conventional gas and oil. venture, while its subsidy secured a $3 Given the war in Ukraine’s Donbas region and billion contract to build the undersea section.16 the overall crisis in Russian-Ukrainian relations, The EU Commission expressed vocal opposition completing Nord Stream 2 is a top priority for to the construction of this particular pipeline Moscow and Gazprom to secure its export and, in contrast to Nord Stream 1, found South routes to the European market, and head off Stream non-compliant with the EU Third Energy the prospect of EU member states turning to Package. LNG instead of pipeline gas from Russia. Many energy experts consider South Stream a South Stream as political leverage geopolitical rather than an economic project for Russia. The fact that Bulgaria was selected In addition to Nord Steams 1 and 2 across the as the first EU country to receive gas from South Baltic Sea, Russia has also pursued the Stream was viewed as telling. Bulgaria is a development of a new gas export pipeline peripheral country for the European energy across the Black Sea—South Stream, which is market and not a natural hub for gas part of a “pincers strategy” of pipeline redistribution. It is also a traditional Soviet-era networks aimed at binding Europe northwards bridgehead in Europe. Bulgaria and Russia and southwards to Gazprom and other Russian have established strong business connections producers. Italy has been heavily involved in since the collapse of the USSR, with significant the development of the South Stream project, Russian investments in the Bulgarian energy which is one factor in its opposition to Nord and utilities sectors. South Stream would Stream 2. require new connecting pipelines across the Balkans and Adriatic to Italy and onward to

15 Tony Paterson, “Putin’s far-right ambition: Think-tank Also see Mathew McDonald, “Putin and Pegida,” The reveals how Russian President is wooing – and funding – American Interest, January 2015 http://www.the- populist parties across Europe to gain influence in the american-interest.com/2015/01/13/putin-and-pegida/. EU,” The Independent, November 2014, 16 Emanuele Scimia, “South Stream’s Demise Shakes up http://www.independent.co.uk/news/world/europe/puti Italian-Russian Relations,” December 2014 n-s-far-right-ambition-think-tank-reveals-how-russian- http://oilprice.com/Energy/Natural-Gas/South-Streams- president-is-wooing-and-funding-populist-9883052.html. Demise-Shakes-up-Italian-Russian-Relations.html,

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other EU markets that would also be in through Gazprom’s access point in Slovakia.19 competition with new pipeline networks from Furthermore, the Italian government’s most Azerbaijan and Turkey favored by the EU, vocal complaints about economic losses including the Southern Gas Corridor and TAP.17 came just as Nord Stream 2 was launched. Rome criticized EU double standards in pushing Under EU pressure, the South Stream project to suspend South Stream and called on the was ultimately suspended in 2014 to loud Commission to deal with Nord Stream 2 in the Italian complaints about the economic losses same way. Between the lines, Rome was for its energy industry. The details of the deal clearly demanding that the EU treat Italy and and the structure of ENI’s participation in South Germany as equal powers with equal rights to Stream reveal a more complex story. Italy’s have their own signature gas pipeline projects energy giant, ENI, is a unique European with Russia. company that, like Russia’s Gazprom, deals with all stages of the oil and gas business— Nord Stream 2’s threat to Italy’s role as an upstream, midstream, and downstream—and energy hub handles all operations from extraction to distribution through its own infrastructure. In the Energy has always been an issue for Italy given case of South Stream, ENI was not responsible its significant dependence on gas and oil for gas extraction, so the profitability of the imports, and due to a strong environmental project would have been more limited than in bias in its energy policies. The use of nuclear other ENI ventures in the Middle East and North energy was rejected in 1987, and there have Africa. In addition, when the project was been several efforts to prohibit drilling within 12 suspended in 2014, ENI had not spent much miles of the Italian coast, including through a money, while Gazprom eventually decided to referendum in April 2016. Italy is the EU’s pay $1 billion in compensation to the second largest importer of Russian gas. Natural consortium to cover their stakes.18 gas accounts for nearly a half the total value of Italy’s imported goods and is mainly used in There was, in fact, no real loss for ENI— electricity generation for manufacturing especially as ultimately, once the pipeline was plants.20 built, the infrastructure construction costs would fall on the end gas consumers. ENI has To date, most of Italy’s gas imports from Russia also retained a broader deal with Gazprom for have come through Ukraine. If Gazprom gas supplies. Absent gas deliveries through succeeds in cutting off its exports through South Stream, these exports are brought Ukraine in 2019, which might be the case if

17 Interview with Edward Chow, senior fellow in the wants ENI to pay the price established in their agreement Energy and National Security Program at CSIS, April 2016. eight years ago, while ENI wants the market price. Thus, 18 “Gazprom pays $1bn for EU partner shares in South ENI is likely taking Gazprom into arbitration. Stream,” Russia Today, March 2015 20 Nicolò Sartori, “Rotta di collisione su Nord Stream 2,” https://www.rt.com/business/245621-gazprom-partners- Affar Internazionali, December 2015 debt-shares/. http://www.affarinternazionali.it/articolo.asp?ID=3263. 19 However, ENI and Gazprom still disagree on the gas price, which is normally linked to the oil price: Gazprom

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Nord Stream 2 is completed, then all Italian gas along with the infrastructure group SNAM, and imports would transit through Germany. Italy SAIPEM (ENI’s subsidy), as well as another would then pay higher gas prices along with Italian oil and gas contractor, MICOPERI.22 the transit fees as the costs for building the new distribution infrastructure would be amortized These projects have intensified Italy’s through an increase in the consumer price of cooperation with Azerbaijan, which became the gas. the largest oil supplier to the Italian market in 2013 and 2014. In the first eleven months of In addition to raising gas prices for Italian 2015, Azerbaijan covered 17.9 percent of consumers, Nord Stream 2 threatens to Italian crude oil requirements.23 TAP will carry 10 undercut Italy’s role as a EU energy hub in the bcm of Azerbaijani offshore gas to Europe by Mediterranean, and one of the key elements 2020, with the prospect of doubling future in the proposed framework for the European supplies through the Ionian Adriatic Pipeline Energy Union.21 Since the suspension of South and the Interconnector Greece-Bulgaria. Stream, the Italian government has focused on Relations between Moscow and Rome remain supporting the development of the Southern strong and Italy’s energy partnership with Gas Corridor (SGC). This is a threefold system of Azerbaijan is not conceived as being anti- pipelines aimed at reducing Europe’s Russian. Although Russia’s energy exports to dependence on Russian gas: 1) the South Italy have decreased in the last two years due Caucasus Pipeline (SCP), bringing Azerbaijani to a fall in demand, Russia nonetheless remains gas from the Caspian Sea to the Georgian- Italy’s main supplier of natural gas. 24 Moscow Turkish border; 2) the Trans-Adriatic Pipeline has so far given no indication that it sees the (TAP), now in the initial stages of construction, Italian energy market as a zero-sum-game field which will transport gas directly to Italy; and 3) and has expressed any public concern about the Trans-Anatolia Natural Gas Pipeline the SGC as a competitor to South Stream or (TANAP), which is under construction and will other energy projects. Azerbaijan cannot connect the other two pipelines by 2018. This match the 147 bcm of gas that Gazprom project is being carried out by the Italian- provided to Europe in 2014; and Gazprom has based engineering company, Nuovo Pignone, even stated its willingness to also transit some

21 This is a project launched by the Junker EU Commission Eurasia Daily Monitor, Volume 12, Issue 145 aimed at diversifying energy sources and implementing http://www.jamestown.org/programs/edm/single/?tx_tt European initiatives on the Southern shore of the news%5Btt_news%5D=44248&cHash=7a7fb0b186b7a58 Mediterranean. It was developed following the crisis in d38a711a3b2089cc1#.VzngYJPhBsM. Ukraine, which endangered EU energy supplies; its five 23 “Importazioni di greggio per paese di provenienza,” July priority actions are: 1) energy security, trust, and 2015 www.unionepetrolifera.it. solidarity; 2) full integration of the EU energy market; 3) 24 Emanuele Scimia, “For Now, Italy’s Relations With energy efficiency to contain demand; 4) de-carbonization Azerbaijan Do Not Upset Russia,” Eurasia Daily Monitor, of the economy; and 5) research and innovation. Italy was Volume 13, Issue 35, February 2016 supposed to be a key transit country for Northern Europe http://www.jamestown.org/programs/edm/single/?tx_tt and bolster the energy interconnections between EU news%5BbackPid%5D=27&tx_ttnews%5Btt_news%5D=45 member states. 121#.VznhR5PhDR0. 22 Emanuele Scimia, “Southern Gas Corridor’s Advance Cool off Energy Cooperation Between Italy and Russia,”

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of its own gas, along with Azerbaijani gas, in Russia is also a key strategic partner for Italy, the SGC. which has longstanding national interests in Libya. The Libyan crisis, the growing terrorist Compared to other competing pipeline threat from the Islamic State in Libya, and all projects, the construction of Nord Stream 2 is a the difficulties related to harboring refugees major threat to Italy’s role as energy hub. attempting to reach Italy from the Libyan Transferring the fulcrum of EU energy supply coast have been a major political and north towards Germany would reduce the economic (as well as security) preoccupation benefits of the SGC development, and for the Italian government. Libyan instability undercut central Italy’s role in redistributing has severely affected the Italian energy Caspian gas to the rest of the EU market. If market. Before the current crisis, Italy imported Russian gas is exported exclusively through 20 percent of its oil and 10 percent of its natural Germany, then the Azerbaijani gas transferred gas from Libya. The Italian government seeks to Italy through TAP will barely fulfill 1 percent Russia’s support at the United Nations level to of European gas demand. Russian gas help establish and agree on a long-term currently accounts for more than 20 percent. strategy for dealing with Libya and ensuring its Germany would become the dominant long-term stability. Rome sees close energy European and EU gas hub. relations with Moscow as a key factor in encouraging broader political cooperation. Italy’s response to Nord Stream 2 In the meantime, as in other areas of Italian- Italy is thus less concerned about economic Russian relations, Italy has adopted a dual- losses to its companies from the suspension of track strategy in response to Nord Stream 2. On South Stream and more worried about losing its the one hand, Rome complains about the competitive advantage in the European project’s non-compliance with the Third energy sector to Germany. Italy opposes Nord Energy Package and denounces the Stream 2 because of the threat this poses to Commission’s double standard, insisting that Italy’s position as Europe’s Mediterranean the EU should properly review Nord Stream 2 energy hub. Relations with Russia are also a key before the project can proceed. Renzi has also element in Italy’s reaction to Nord Stream 2. stressed it is inconsistent for the EU to prolong its Italy is Russia’s fifth-largest foreign trade economic sanctions on Russia and insist on the partner. Russia exports 15 percent of its oil to suspension of South Stream if the Commission Italy and 30 percent of its gas, in addition to simply allows Nord Stream to go ahead. 25 ferrous and nonferrous metals and timber. On the other hand, Italy delivers manufactured At the same time, Italy has also sought bilateral goods, textile fabrics, machinery, chemical agreements with Russia, including even products, and consumer durables to Russia. securing a role for Italian companies in the Almost 500 Italian firms have offices in Russia. Nord Stream 2 construction. Russia’s Gazprom- owned newspaper, Kommersant.ru, for

25 Beda Romano, “Renzi critica Merkel: non raccontateci 18/il-bilancio-premier-2015-italia-segnale-svolta-- che date il sangue per l’Europa,” Il Sole 24ore, December 140737.shtml?uuid=AClcm2vB. 2015 http://www.ilsole24ore.com/art/notizie/2015-12-

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example, reported that SAIPEM is the most Nord Stream 2, the pipeline would bypass likely candidate to acquire the $4 billion Ukraine. If the EU Commission allows the contract for constructing the two underwater construction of Nord Stream 2, Italian analysts branches of North Stream 2 across the Baltic believe it would be hard for the Commission to Sea. The scale of the construction is huge––the then justify blocking this pipeline project. pipelines would extend 25,000 km with a capacity 55 bcm per year. The Russian Italy and Russia have no significant history of newspaper reported that SAIPEM has a good competition or conflict, in spite of Italy’s role in chance of winning the contract because of its World War II. Since the 2000s, Italy has aspired previous construction work with Gazprom for to be “the” European leader in relations with North Stream 1. Some Italian experts are Russia, or at least equal to Germany in making skeptical that Italian companies would gain decisions over broader EU relations with Russia. any advantage from joining the Nord Stream 2 Italy certainly wants to make sure that German consortium.26 ENI’s primary revenues come interests do not supersede those of Italy and do from gas extraction, and as Nord Stream 2 not interfere with Italy’s economic, trade, and does not offer this option, ENI’s profit margin security strategies. Thus, Italy always attempts would be low. Only SAIPEM, which focuses on to position itself at the forefront when it comes pipeline infrastructure would stand to benefit; to the EU’s interactions with Russia. Prime and any profits from ENI’s participation in Nord Minister Matteo Renzi was the only Stream 2 would still be eclipsed by the losses representative of EU member states to attend related to Italy losing its position as an energy the St. Petersburg Economic Forum in June hub to Germany. 2016 together with EU President Jean-Claude Juncker. He has also made it clear that he will Italy has other cards to play with Moscow. In use Nord Stream and the dispute with early 2016, Russia’s Gazprom, Italy’s Edison, Germany as political leverage within the EU if it and Greece’s DEPA signed a Memorandum of will advance Italy’s interests. Understanding for a project resembling a scaled down version of South Stream.27 Instead Germany’s perspective on Nord Stream 2 of 63 bcm, this project envisages the construction of a pipeline with a capacity of 16 Like Italy, Germany sees its energy security as bcm that would run in parallel with the closely linked to Russia—partly because Southern Gas Corridor to Bulgaria. From there Germany is dismantling its nuclear plants and the pipeline would be extended to Greece, EU energy production is declining, but also joining the Interconnector Turkey-Greece-Italy because Germany wants to play a key role in (ITGI), which is still waiting final completion. If determining European gas prices. In 2013, realized, this project could bring significant German imports of Russian gas amounted to volumes of Russian gas directly to Italy. Like 39 percent of Germany’s total imports, and

26 Interview Nicolò Sartori, Senior Fellow in the Energy http://www.repubblica.it/economia/finanza/2016/02/24 Program at the Institute of International Affairs, Rome, /news/edison-gazprom- Italy, March 2016. depa_accordo_per_il_gasdotto_italia-grecia-134164530/. 27 “Edison-Gazprom-Depa: accordo per il gasdotto Italia- Grecia,” La Repubblica, February 2016

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there is no immediate substitute for Russian gas trade interests in Russia have generated in Germany. A new deal between Gazprom considerable domestic pressure to construct and German gas companies in September Nord Stream 2. At the same time, the views of 2015 strengthened the already close supply the German business community about lifting connections.28 The combination of Nord sanctions on Russia are more diverse. Some Stream 1 and 2 could increase the total flow of business groups like the Ost-Ausschuss would Russian gas to Germany to 110 bcm annually. like to see sanctions lifted, but they are the minority. The bulk of German industry and German officials have made some commerce has adopted an almost unanimous reassurances not only to Ukraine but also to position in supporting the government's Poland and Belarus about the impact of Nord choices. The chairmen of other two big Stream 2 on their interests.29 According to business associations like the Bundesverband Gernot Erler, the German government’s der Deutschen Industrie (BDI) and the special coordinator for Russian policy, the Osteuropaverein der Deutschen Wirtschaft “additional capacities will result in better have openly stated that they “adhere to the energy security in Europe.” This is partially true, principle of the primacy of politics.” 31 but how real these reassurances will be over the long term is difficult to say. In 2015, for In Germany, the balance of power between example, Gazprom reduced its total natural politics and economics leans towards the gas flows to Poland specifically to prevent EU former—state interest takes precedence. Thus, member states from then supplying Ukraine via the Nord Stream 2 project is moving ahead not reverse flows through the existing Ukrainian- simply because of lobbying by the German European pipeline network.30 Gazprom could business community. German ruling elites also easily do this again. Also, if gas demand rises support building the Nord Stream 2 pipeline. again in the EU, there may not be sufficient gas Although it can be argued that Nord Stream 2 to supply Ukraine as well as other Central enjoys multilevel consensus, Germany’s European countries would be supplied through attitude towards the project has not always Nord Stream 2 gas. been clear. There are two key factors to consider: Germany’s relations with Russia in Nord Stream 2 is clearly more than just a light of the Ukraine crisis, and disagreements commercial project for Germany. Germany’s within the German political elite and parties on dependence on Russian gas, as well as the this issue. German business community’s financial and

28 Hannes Adomeit, “Germany, EU and Russia: The 30 Marek Strzelecki, Maciej Martewicz, “Gazprom Limits conflict over Nord Stream 2,” Policy Brief series Centre for Polish Gas Supplies as Reverse Flows Halt,” Bloomberg European Studies/EU Centre of Excellence of Carleton September 2014 University Ottawa. http://www.bloomberg.com/news/articles/2014-09- 29 “Germany seeks to overcome opposition to Nord 10/poland-says-gazprom-cut-gas-supplies-via-belarus- Stream 2,” February 2016 ukraine. http://www.euractiv.com/section/energy/news/germany 31 Hannes Adomeit, “Germany’s Russia Policy: From -seeks-to-overcome-opposition-to-nord-stream-2/. Sanctions to Nord Stream 2? “Transatlantic Academy 2015-16 Paper Series, No.3 March 2016.

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Germany’s Ambivalence on Russia and met with the four largest German business Nord Stream 2 associations in Munich for high-level talks about trade between Russia and Germany Russia is a very sensitive issue in German and the implications of the crisis. society. There are two main groups: 1) the supporters of ostpolitik who wish to engage Despite her assertive attitude towards the Russia cooperatively and whose pro-Russian Russian Federation, Merkel has seemed to sentiment is also tinged with anti-Americanism; support the Nord Stream 2 project. In and 2) those who grew up in Eastern Germany, December 2015, she stated: “I made clear, like Chancellor Merkel, who are more critical of along with others, that this is a commercial the Russian political system and its poor human project; there are private investors.”33 rights record. There are around 4 million Russian However, her defense of Nord Stream 2 is speakers in Germany, divided among ethnic closely linked to other trends in Germany’s Russians, Russian descendants from German political landscape. Germany’s Vice migrants to the Russian and Soviet empires, Chancellor and Economic Minister, Sigmar and Russian Jews.32 Gabriel, is one of the main supporters of the Nord Stream 2 deal. He personally travelled to During the Ukraine crisis, Chancellor Merkel Russia to conclude the deal with Putin in the acted as the leading stateswoman of the EU. Kremlin. Gabriel has asserted that Brussels and She adopted a strong position on sanctions the EU should have limited involvement with and urged reluctant countries like Italy and the project.34 He has also presented both smaller eastern European countries with close Germany’s leverage in the EU and the Nord relations with Russia, like Slovakia, the Czech Stream 2 as a means of improving relations Republic, Hungary, and Cyprus, to support between Germany and Russia to address the them. At the same time, Merkel never closed Syria crisis, which has sent millions of refugees the door to dialogue and always bore German into Europe and Germany. national interests in mind. Chancellor Merkel has talked to Putin more frequently than any The Bavarian “sister party” of the CDU, the other world leader. She made 35 phone calls in Christian Social Union (CSU) is particularly the first eight months of 2015, for example. critical of the EU sanctions against Russia, Germany has more trade with Russia than any which it sees as an obstacle to securing other European state. Germany’s eastward- Moscow’s assistance in resolving the civil war in oriented business sector is a powerful lobby, Syria. The CSU has openly criticized Merkel’s including specifically within Merkel’s own choices related to the refugee crisis and has Christian Democratic Union (CDU). In March stressed that cooperation with Russia is an 2014, at the peak of the Crimea crisis, Merkel important way of also coping with this issue.

32 Interview with Angela Stent, Senior Fellow at the 34 Albrecht Meier, “Putin and Gabriel team up on Nord Transatlantic Academy and the German Marshall Fund, Stream 2 against Brussels,” November 2015 April 2016. http://www.euractiv.com/section/energy/news/putin- 33 “Merkel defends Nord Stream-2 pipeline,” Russia and-gabriel-team-up-on-nord-stream-2-against-brussels/. Today, December 2015 https://www.rt.com/business/326440- merkel-gas-nord-stream2/.

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Similarly, the German Foreign Minister Frank- Conclusion Walter Steinmeier, who is the leader of the German Social Democratic Party (SPD) seems This analysis has examined Italian and German to support dialogue and compromise with perspectives on energy security, relations with Russia, in spite of his open skepticism that lifting Russia and EU foreign policy, through the lens sanctions will result in a constructive Russian of Nord Stream 2. For Italy, Nord Stream 2 role in Syria. Steinmeier insists that threatens its role as an energy hub in the implementing the German and French- Mediterranean and its competitive position vis- backed Minsk II plan for the war in Ukraine is à-vis Germany within the European Union. indispensable for achieving a rapprochement Nord Stream 2 means an Italian loss in political with Moscow. The current EU sanctions are terms to Germany, including accepting the closely linked to the implementation of Minsk II. reality of an EU double standard when it comes to endorsing large German energy projects. Despite the explicit support of the Green Party, Rome has adopted a dual-track strategy in which opposes accommodation with Russia, response to Nord Stream 2, challenging the EU Chancellor Merkel clearly cannot just ignore to rule against the project, and seeking to the stances of other prominent German engage Moscow directly and bilaterally. For politicians, who are instrumental in her Germany, Nord Stream 2 is a matter of securing coalition government. She needs to signal economic advantage. It allows Germany a flexibility towards Russia on Nord Stream 2, greater role in determining European gas even though she has acknowledged the prices and reduces transit risks from the Ukraine potential damage Nord Stream 2 could do to crisis. Germany’s political ambivalence toward European energy independence and to the this project is related to the complexity of its credibility of European foreign policy. From a coalition politics and the need for the market perspective, a national government Chancellor to balance different interests within pressuring its companies to dump a pipeline the government and in German society, project would seem very outdated and anti- including in the business community. Italy and free market.35According to some analysts, Germany have a shared interest in maintaining Chancellor Merkel may be encouraging the EU good relations—or at least economic Commission behind the scenes to review the cooperation—with Russia at both the national Nord Stream 2 project for its non-compliance and European level. So far, they are pursuing with the EU Third Energy Package. If the selective cooperation in the critical energy Commission does not grant Nord Stream 2 the market. same exemption as Nord Stream 1, Merkel could avoid all of the negative consequences Russia has ample opportunity to take of having to intervene herself, and could advantage of the Italian-German present the decision as a more coherent disagreements over Nord Stream 2 in order to choice for the EU in general. gain leverage in EU foreign policy and ultimately discourage Europe from diversifying

35 Severin Fisher, “Nord Stream 2: Europe’s lack of Trust in its market model,” Policy perspectives Vol. 4/4 March 2016., CSS ETH Zurich.

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its energy supplies and seeking other sources of gas, including LNG. Against the backdrop of the crisis in Ukraine and the imposition of EU sanctions, as well as the recent decision by the UK to leave the EU, the clash between Italy and Germany could complicate the EU’s ability to forge a common strategy for managing the relationship with Russia. The dispute over Nord Stream 2 has already complicated the ongoing EU efforts to create an energy union, by undermining the Commission’s role in setting the frame for energy policy and being seen to act as an impartial arbiter.

To resolve this problem, the EU will either have to devise a legal framework that ensures clarity and predictability for reviewing and approving projects like Nord Stream 2, or formulate a more coherent political strategy within the Commission to cope with this issue. Given all the current risks to the European project, the EU, together with Italy and Germany, needs to find ways to resolve this dispute and to reach a common perspective on Nord Stream 2 that reduces the sense of political competition and contention. Without a clear energy strategy and a clear approach towards Russia, Europe’s ambiguity in managing high profile projects like Nord Stream 2 will undermine the coherence of the EU foreign policy.

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List of Acronyms Acknowledgements

ADF Alternative für Deutschland Alternative This paper would have never come to light for Germany without the support of Dr. Fiona Hill and Andrew Moffatt, who gave me the chance to BDI Bundesverband der Deutschen Industrie conduct my research at the Brookings Federal Association of German Industry Institution. I am extremely thankful to Tim Boersma, Edward Chow, Nicolò Sartori, and CDU Christian Democratic Union of Germany other experts I interviewed for their comments and helpful suggestions. I would like to thank CEE Central and Eastern Europe Anna Newby for editing.

CEO Chief Executive Officer

CSU Christian Social Union in Bavaria

EU European Union

ITGI Interconnector Turkey-Greece-Italy

LNG Liquefied Natural Gas

Med-REG Mediterranean Energy Regulators ABOUT CUSE: The Center on the United States and Europe Med-TSO Mediterranean Transmission System (CUSE) fosters high-level U.S.-European Operators dialogue on the changes in Europe and the global challenges that affect transatlantic relations. The Center offers independent OPAL Ostsee-Pipeline-Anbindungsleitung research and recommendations for U.S. and Baltic Sea Pipeline European officials and policymakers, and it convenes seminars and public forums on policy-relevant issues. SCP South Caucasus Pipeline

The Brookings Institution SGC Southern Gas Corridor Center on the United States and Europe

1775 Massachusetts Avenue, NW TANAP Trans-Anatolian Pipeline Washington, DC 20036 www.brookings.edu/cuse TAP

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