SWP Research Paper Stiftung Wissenschaft und Politik German Institute for International and Security Affairs Kai-Olaf Lang and Kirsten Westphal Nord Stream 2 – A Political and Economic Contextualisation RP 3 March 2017 Berlin All rights reserved. © Stiftung Wissenschaft und Politik, 2017 SWP Research Papers are peer reviewed by senior researchers and the execu- tive board of the Institute. They reflect the views of the author(s). SWP Stiftung Wissenschaft und Politik German Institute for International and Security Affairs Ludwigkirchplatz 3­4 10719 Berlin Germany Phone +49 30 880 07-0 Fax +49 30 880 07-100 www.swp-berlin.org [email protected] ISSN 1863-1053 Translation by Meredith Dale (Updated English version of SWP-Studie 21/2016) The translation of this paper was funded by the German Foreign Office. Table of Contents 5 Issues and Recommendations 7 Nord Stream 2 – A Commercial Project with Political Dimensions 9 Nord Stream 2 as a Business Project 9 The commercial logic of Nord Stream 2 AG from the Western business perspective 9 Gazprom’s calculation 12 Nord Stream 2 and Regulation in the EU’s Internal Market 12 The legal framework in the internal market 12 Nord Stream 2 – Legal approaches and contested issues 17 The connecting pipelines for Nord Stream 2 19 Market Trends, Market (Power) Relations and Security of Supply 19 Nord Stream 2 and the gas supply in north- western Europe 19 Nord Stream 2: Price trends and liquidity 20 Transit through Ukraine and unresolved problems 22 The gas markets in central eastern Europe 24 Nord Stream and changing gas flows in eastern Europe 26 Nord Stream 2 – The Political Dimension 26 Nord Stream 2 and the strategic energy triangle 27 Nord Stream 2 in the context of climate and environmental considerations 28 Criticisms from central eastern and south-eastern Europe 29 Interests of individual member states 35 Summary and Outlook 38 Recommendations for Germany and the European Union 39 Abbreviations Dr. Kai-Olaf Lang is Senior Fellow in SWP’s EU / Europe Division Dr. Kirsten Westphal is Senior Associate in SWP’s Global Issues Division Issues and Recommendations Nord Stream 2 – A Political and Economic Contextualisation The plans to add another pair of pipes to the Nord Stream facility under the Baltic Sea have created waves within the European Union. While the Russian energy giant Gazprom and the project’s European supporters argue that Nord Stream 2 and its new direct connections between Russian gas fields and the EU energy markets will improve Europe’s energy security, the Commission and certain member states are sceptical. Their worries include further expansion of Gazprom’s dominant position in the EU markets and a weakening of the current transit countries, which could potentially completely lose their function of conveying Russian gas to central and western Europe. Above all in the eastern parts of the EU, there are also concerns that the project could negatively impact the region’s own security of supply and have political repercussions in the form of a revitalisation of Ger- man-Russian cooperation, with European and foreign policy reverberations well beyond the energy sector. One major point to be emphasised is that setting the planning and construction process in motion on the basis of a commercial venture entails a clear and given application and permission procedure based on law and regulation. Nevertheless, the pipeline is a politically highly charged issue. Notwithstanding, the subsequent legal processes should not be intermingled with the political dimension. The intense debates over the pipeline project unfold in a multi-dimensional context. For the EU, the Nord Stream 2 discussion raises the question whether – assuming the pipeline is built – it will be able to pass a three-fold consistency and coherence test: firstly in connection with the rules for the internal energy mar- ket, which should be neither watered down nor bent for political reasons; secondly in terms of its foreign policy and security objectives, concretely towards Ukraine, which should not be undermined by energy policy decisions; and thirdly, in relation to its internal cohesion, which Nord Stream 2 could erode: politically if the rifts between member states over policy on Russia and energy widen, and economically because the pipeline project could lead member states to con- centrate more strongly on national energy policy and above all energy security policy, thus exacerbating market fragmentation. SWP Berlin Nord Stream 2 March 2017 5 Issues and Recommendations On the one hand, Nord Stream 2 could serve to scrutiny, even if it were framed as a “Nord Stream 2 restore space and prospects for shared interests after exit deal”. They would also revise their to date largely the dramatic worsening of EU-Russia relations caused positive perception of the role of the European by the crisis over Ukraine in 2014. On the other, one Commission. cannot ignore the geopolitical dimensions of the proj- If Nord Stream 2 does not come into operation as ect, which is designed to obviate the need for transit planned, the problem of east-west transit and the through Ukraine. Moreover, the idea of building an- question of the security and reliability of the Ukrain- other pipeline through the Baltic is a political live ian transport corridor remains pressing. The resusci- wire. Opponents argue that the project makes a tation of TurkStream also has implications for tran- mockery of the Energy Union and contradicts all its sit volumes. A reconciliation of interests between objectives. So the pipeline plan involves significant the EU and Russia should be trilateral, including political costs whether it fails or succeeds. Nord Stream Ukraine, and be negotiated with the participation is a commercial venture, but its impacts transcend of the affected member states. A compromise its commercial and energy implications. Without a should be sought that permits Russia and north- question, the project represents a challenge for energy western Europe to expand their direct gas links diplomacy both internal and external. through the Baltic, but at the same time preserves While the German government rightly emphasises transit of a defined gas volume through Ukraine the project’s commercial character, it has also backed as a flexibility option. Only on the basis of such a it for reasons of gas supply security. Germany is the minimum consensus can an attractive business landfall state in terms of existing law and regulation. model for the Ukrainian transit corridor be found. From a German perspective it is particularly impor- In any case the EU and its member states should tant to argue the benefits for the European gas market continue their efforts to encourage stabilisation as a whole and to dispel myths. Concerns that a bi- in Ukraine’s energy policy and supply (above and lateral monopoly could emerge are unfounded, as beyond the gas sector) in the scope of the Energy the German gas market is fully liberalised with open Community. competition. Germany must foster confidence (among The argument that Nord Stream 2 will divide the its neighbours) in its competition authorities and markets is misleading, as the EU gas markets are scrupulously monitor shifts in markets and market already divided due to an uneven implementation power. At the same time, the potential costs for Euro- of the third internal market package. The energy pean and bilateral relations must be closely observed supply situation and market conditions in central and where possible reduced. To that end Germany eastern and south-eastern Europe need rapid mar- could conduct a structured multilateral energy dia- ket reforms and improvement. Alongside full im- logue with its central eastern European neighbours, plementation of the third internal market package, with the aim of reconciling the different interests in this would include calculating the consequences the process of developing the Energy Union. The sym- of possible changes in Russian gas routing for states bolic nature of the project should not be stacked any in this region and supporting the affected countries higher, but its political implications reflected and in making the necessary adjustments to their trans- accommodated in the Energy Union framework, in port infrastructure. order to avoid rifts with EU partners. None of the sides should have any interest in delay- Additionally, the aforementioned potentially ing the approval and construction process, as that divisive effects of the Nord Stream 2 project should would only prolong the uncertainty. Russia is keep- be reduced and inconsistencies avoided: ing its options open with TurkStream (and South The onshore connecting pipelines for Nord Stream Stream). These imponderables create particular dif- are subject to regulation under EU law. But the ficulties for network planning in central and south- offshore sections are currently a grey area, to the eastern Europe countries, whose energy systems are extent that Germany, the EU and Russia disagree extremely vulnerable. over which “regime” to apply. That also opens up opportunities for a broader settlement of conten- tious bilateral issues. The “Gazprom-sceptical” EU member states will certainly subject any compro- mise granting concessions to Gazprom to close SWP Berlin Nord Stream 2 March 2017 6 Nord Stream 2 – A Commercial Project with Political Dimensions The construction costs for adding two additional lines To comprehend the European dimensions of the to the Nord Stream pipeline system – increasing total project, one must trace the long routes followed by annual capacity by 55 billion cubic metres – are esti- Russian gas into the EU. It is no accident that OMV, mated at €8 to 10 billion. Realising the pipeline is the Shell and Engie have joined Uniper and Wintershall in explicit object of a project company set up in Septem- backing the project. Currently, gas from Nord Stream 1 ber 2015 in St Petersburg.