EU divisions and US sanctions to delay Nord Stream 2

EU divisions and US sanctions to delay Nord Stream 2

A new proposal from the EU Commission to amend gas market regulations will affect Russia’s Nord Stream 2 pipeline. Completion of the project, scheduled for 2020, will likely be delayed. It’s also coming under pressure from US sanctions, new legislation in Denmark, and weakening support in Germany.

Russia’s divisive pipeline

Since its conception, Nord Stream 2 (NS2) has been controversial. Russia’s intention to bring more gas to the EU market, which would concentrate 80% of Russian gas imports on one route, has damaged the solidarity of EU member states.

The countries involved in the project – Germany, Austria, France, the UK, and the Netherlands – have faced security concerns expressed by Poland, the Baltic states, Denmark and Sweden. This endangered the EU member states´ unity on how to deal with Russia and how to diversify the Union´s energy routes.

In particular, the pipeline created diplomatic tensions between Germany, which supports the energy project, and Poland, which adamantly opposes it. Over the course of last year, another even more significant rift appeared – this time between Germany and the EU Commission itself.

Since late 2016, the EU Commission has also voiced criticism of the pipeline project. Vice President for Energy Union Maros Sefcovic has said that “creating a well-diversified and competitive gas market is a priority of the EU’s energy security and Energy Union strategy…NS2 does not contribute to the Energy Union’s objectives. If the pipeline is nevertheless built, the least we have to do is to make sure that it will be operated transparently and in line with the main EU energy market rules”.

Under growing pressure against the pipeline among some member states, the Commission questioned the project’s compliance with the Energy Union’s principles. It asked Bundesnetzagentur, the German regulatory authority, to apply EU energy rules to the offshore pipeline. The Germans declined, referring to their own interpretation of the EU energy rules and to existing import pipelines such as Nord Stream 1.

EU Commission amends the Gas Directive

In June 2017, referring to a “legal void”, the Commission asked the Council for a mandate to start negotiations on an Intergovernmental Agreement with Russia which would regulate import pipelines. In November 2017, the Commission proposed the amendments to the Gas Market Directive (2009/73/EC), a regulatory framework for the EU natural gas market. The proposal aims to unify regulatory regimes of gas pipelines to and from third countries and avoid a “conflict of laws” in all existing and future pipelines. With these amendments, the Commission forces the equal application of the Third Energy Package’s rules to all pipelines, including NS2:

  • ownership unbundling (requiring pipelines not be owned directly by gas suppliers),
  • non-discriminatory tariffs,
  • transparent operations,
  • and access to third parties.

NS2, which is entirely owned by Gazprom, violates the key principles of the Third Energy Package in terms of energy security, diversification of energy supplies and competition on the energy market. However, the proposal enables EU member states to grant derogations to existing projects. In 2012, Germany used the derogation mechanism to build Nord Stream 1. This could be used by Germany as a potential loophole during the negotiations with Gazprom.

Denmark drafts new bill

In Denmark, a new draft bill might affect NS2 route as the pipeline is passing through Danish territorial waters, near Bornholm island. The new bill proposes that the country’s future energy infrastructure projects will be assessed through the lens of foreign, defence and security policies. If successful, it would be effective as of January 2018.

Nord Stream Route

The bill has cross-party support – both Lars Christian Lilleholt, the Danish energy minister, and Nick Haekkerup, a spokesman for the opposition Social Democrat party, spoke about changing political conditions. Although Nord Stream 1 was placed in Danish territorial waters without any concerns, since Russia´s recent aggressive behaviour in Ukraine the twin pipeline became geopolitical.

It is unlikely that the bill will block the pipeline, as it could be re-routed into its Exclusive Economic Zone. However, it will affect the pipeline´s timeline and will highly likely postpone its completion to late 2020. As a result, it could potentially strengthen Ukraine’s position in negotiating a new gas transit contract with Russia. The current contract expires at the end of 2019.

US Sanctions watered down

In August 2017, the US Senate voted for unprecedented sanctions against energy companies which have an ownership share of more than 33%. The new sanctions put severe limitations on capital, which potentially jeopardises the pipeline’s funding. At first it looked like they would affect the position of participating EU firms, including Austria’s OMV. Rainer Seele, the CEO of Austrian firm OMV, expressed the opinion that the US sanctions are making the financing of such large infrastructure projects almost impossible.

However, after legal clarification issued by the US Department of State in late October, the funding of NS2 was not at risk. The guidance watered down the original strictness of sanctions and clarified that investments in energy pipelines made prior to 2 August 2017 will not be subjected to the new US sanctions. It means that NS2 will be immune to the capital restrictions. “From the legal side and after clarifications from the US Secretary of State, we feel that OMV’s position is confirmed and strengthened,” Reinhard Florey, OMV´s CFO, said. NS2 already got €324 million cash from the five European companies. Overall, each party has committed itself to invest €950 million.

Weaker support in Germany

Since the Social Democrats´ defeat at the last Bundestag elections, German support for NS2 has started to weaken too. Having moved to the opposition, SPD, the most equivocal supporter of the pipeline, lost its strong lobbying position.

Unofficially, however, the German Social Democrats still have a channel via its former chancellor, Gerhard Schröder, who is also chairman of the pipeline.

With the new coalition government, the position of Germany on NS2 will likely change. The Greens and Liberals are highly critical of the Russian-backed project. Both parties raised their economic, security and ecological concerns together with concerns about solidarity within the EU. This puts more pressure on Angela Merkel, German chancellor, to reject the pipeline. In contrast, the German industrial lobby is pushing her to support it.

Construction will be delayed – but financial impact will still be felt in Ukraine

Currently, no legal basis exists to block the project. The latest developments could, however, significantly delay construction beyond the scheduled completion date in 2020. The European Commission proposal does not target the pipeline directly, but trying to negotiate with Russia on the application of EU rules will be time-consuming and problematic.

The Commission´s proposal needs to be presented to the European Parliament and the Council for approval. If the new rules are approved, the Commission will have to negotiate an agreement with Russia, as the Union’s regulations do not apply on a third country’s territory. In case the Commission does agree on a draft mandate from member states, it will be up to the EU countries involved – highly likely Germany as the main beneficiary – to agree with Russia to apply the rules.

The catch is that Russia has previously refused to proceed with South Stream for exactly the same reasons. Having rejected the EU requirements, Russia scrapped the project altogether. It is also unlikely that Russia will agree with EU rules in the NS2 case.

The new US sanctions, Denmark´s environmental bill and a new coalition in Germany will not stop Russia from building the pipeline. However, the political mood is changing in favour of the pipeline’s opponents, which makes it difficult for the investors to find funding.

Regardless of construction plans – delayed or scheduled, the pipeline will deprive Ukraine of Russian gas transit fees, which will cost the country $2.2 billion in annual revenue, roughly 10% of its GDP. By bypassing Ukraine, NS2 will put the country under further financial strain.

About Author

Maria Shagina

Dr. Maria Shagina specializes in European and post-Soviet politics with a particular focus on Eastern Partnership and Russia. She was previously a visiting fellow at the Centre for Russian, European and Eurasian Studies, University of Birmingham and is currently affiliated with the Geneva International Sanctions Network. She holds a double PhD degree from the University of Lucerne and University of Zurich and a M.A. from the University of Dusseldorf.