The Endgame In European Natural Gas

The construction of Nord Stream 2 is nearing its logical conclusion - a grand standoff, in the first move of which the Council of the European Union adopted the amended EU Gas Directive. Brussels never really hid the fact that its only detectable target was to get pipelines which are constructed, owned and filled by Gazprom under its control. Thus came about the "gas triad" which will regulate Russian gas supplies to Europe from now on - the unbundling of transportation from supply, full predictability and transparency of pipeline tariffs and provision of third-party access. As of today, the contours of the future modus operandi are getting increasingly discernible, so we will try to disentangle some of the most complicated (and often incorrectly defined) issues surrounding Nord Stream 2.

The hurry with which the EU Gas Directive adjustments were made brings some light to the emotional background of Brussels technocrats: fast-tracking the approval process (so that instead of June it was April 15 that the CEU passed them), cutting back the transposition period from 12 months to 9 months (leaving the EC discontent as it was pushing for a largely unprecedented 3-month period). The European Commission simply needed to have it done before Gazprom can claim any further successes with the construction of Nord Stream 2. Apart from EC members directly alleging to keep the aim in view, Brussels' only pipeline that is currently under construction and was only half-covered by the current legislation is Nord Stream 2.

First let's look at what was missing in the initial version of the Gas Directive, issued in 2009. The three main tenets of EU's gas policy were already stipulated there, however back in 2009 when the construction of SouthStream (what will eventually transform itself into NordStream) was still a possible scenario, the EU mostly focused on the legal status of gas pipelines that are built by a third-party (read Russia) on European territory. This aim was met with the initial set of policy guidelines, yet there remained one grey area which eventually turned out to be of some importance - international waters. How can the EU promote its agenda over the Baltic Sea (or perhaps at some point in the future the Black Sea, too) if it is already regulated by UNCLOS, you ask? Here is what the EU's gas policy amendment has left us with.

Issue I: Pipeline Unbundling

No matter how hard Brussels would try, right up until the German exclusive economic zone Nord Stream 2 would be regulated by UNCLOS, which basically means under Russian, i.e. Gazprom's control. From the German EEZ onwards towards the continent, Nord Stream 2 would already be subject to the tenets of the EU Gas Policy, thus constraining Gazprom in owning and operating the entire pipeline. Gazprom has a whole plethora of options on how to have Nord Stream 2 cleared from the unbundling point of view, yet the most likely one entails the creation of a separate operator company, either Russian or a joint Russo-German one (representing the exit and entry points of the pipeline).

Granting the operatorship rights to a Russian company might face further administrative obstructions, absent a sudden and all-encompassing thaw in relations between Russia and the EU. So it would make much more sense to involve the German gas pipeline transmission system operator GASCADE - by creating a joint venture between one of Gazprom's transportation-focused subsidiaries (i.e. not a supply side company) and GASCADE, NordStream 2 can circumvent the EU's policy novelties and concurrently back up its bid by the support of German business. Unlike the option of operating it alone and asking for an exemption from EU gas policy rules (sure to be delayed or denied) this solution would not require the involvement of the European Commission.

Issue II: Denmark

Amidst the great legal battles between Brussels and Moscow, Denmark remains the one last operative roadblock that separates Gazprom from a clear picture of how Nord Stream 2 would look like. The Danish pipelaying issue stems down to Denmark's not granting a permit for the construction of the pipeline, even though Gazprom has been waiting for it since April 2017, an unprecedentedly long time (all the more so as Denmark was the first to grant Nord Stream I a construction permit back in the day). Yet Copenhagen cannot refuse to grant Gazprom the permit as the pipeline's environmental assessment went smoothly - hence, Denmark waits until it is inescapably compelled to do so.

(Click to enlarge)

Source: NordStream 2.

The date mentioned above is August 2019 when Danish authorities ought to give a verdict on the northern route, a new pipeline route bid that was filed by Gazprom in August 2018. In a way, Gazprom is responsible for the situation it has found itself in - the first permit it applied for crosses Denmark's territorial sea, whilst the second and third bids are passing through its exclusive economic zone. The difference is of some importance as Danish legislation that permits via the nation's EEZ be sorted within 12 months, whilst it does not place any time constraints on how swiftly should it proceed bids via territorial seas. Denmark's current stance is obstructionism at its finest, yet even this has its organic limits.

Issue III: When Would Nord Stream 2 be Launched

The 2.5-year wait for the Danish construction permit leads us to one of the key questions - when Nord Stream 2 would be ready to be put into operation. Gazprom certainly did not count on Denmark's foot-dragging when it set December 2019 as the official starting date - if Copenhagen does indeed wait until August 2019 for the required regulatory nod, the pipeline might be already out of timeline even though more than 1000km of it were already laid. Moreover, the European Union would desperately try to delay the NS2 startup date so that the pipeline starts up after Russia and Ukraine sort out a new (ultimately even short-term might do) gas transit modus operandi. Hence, February-March 2020 seems a plausible estimate.

Issue IV: Who Is to Supply the Gas

The extent of regulatory antagonism vis-à-vis Nord Stream 2 to a large extent depends on geopolitical developments, centered around the Russia-Ukraine link. Europe generally has a problem in finding new sources of supply - NordStream 2 only amplifies this scarcity of choice as Northern and Western Europe are largely running out of available gas supply. The politically subtler version of pressurizing Gazprom would be to obligate the pipeline operator to let in other Russian producers, too - a potential boon for Rosneft and LUKOIL. Yet this seems a far cry for the current establishment in Brussels where increasing any Russian company's footprint in Europe is seen as a moral outrage.

As for NordStream2, the EC might be tempted to push Gazprom out of the pipeline by means of mandated quotas yet would have a very hard time succeeding in it. EUGAL, the German pipeline connecting onto NordStream 2 and taking the incoming gas deeper into German territory, has already seen its pipeline capacity booked - the operator held the relevant capacity auction in March 2017, resulting in 20-year long-term binding contracts that even the European Commission cannot alter. Only 10 percent of short-term and 10 percent of mid-term volumes are not booked and even those can only be filled with Russian gas simply because there is no other supplier around.

Coming back to the world of politics, recent geopolitical shifts might provide for a very elegant solution - Gazprom started buying Turkmen gas again this week. Technically, this is not Russian gas, moreover Europe has been courting Ashgabat for decades already in a largely unsuccessful bid to establish a direct line of supply to the Central Asian gas producer. Turkmen gas is now predominantly used to supply Balkan countries and Italy so they already fulfill the aim of diversifying gas sources (even though the trader - Gazprom - remains the same). Turkmenistan itself would welcome this as it needs at least 10-15 BCm per year transported via Uzbekistan and Kazakhstan to render these supplies profitable.