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Ross McCracken

Ross McCracken

Ross is an energy analyst, writer and consultant who was previously the Managing Editor of Platts Energy Economist

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The Great Power Politics Behind Nord Stream II

Pipeline

Nord Stream II is proving to be one of the most politically contentious pipelines of all time. The project is making gradual progress, but remains vulnerable to the fragile state of the EU-Russian energy relationship. This took another body blow November 25 with the Russian seizure of two Ukrainian gunboats and a tug boat by force in the Kerch Strait, which links the Black and Azov Seas.

The significance of Nord Stream II goes far beyond the volumes of gas it will carry. By forming a critical element of Russia’s ambitious plans to bypass the Soviet-built Ukrainian Gas Transmission System (GTS), it will potentially leave a power vacuum in the heart of central Europe, and nature, as the saying goes, abhors a vacuum.

US President Donald Trump has waded into the debate, arguing that Nord Stream II will make Europe, and Germany in particular, ever more dependent on Russian gas. Trump advocates US LNG as an alternative.

Pipeline economics

However, both Russia’s ability to circumvent the Ukrainian GTS and Trump’s ambitions for US LNG may be over-stated.

In Europe, LNG provides a price ceiling for, rather than competition to, Russian pipeline imports. Volumes of the latter have risen in the last two years to record levels at peak demand times. In contrast, Europe’s LNG terminals saw utilisation rates of just 27% on average in 2017, up from 25% in 2016.

So unimpressed is Germany with LNG that it has yet to construct its first LNG terminal. Where competition exists, compared with Russian pipeline gas, LNG economics simply don’t stack up.

However, neither do Russia’s Ukrainian bypass ambitions. According to the Oxford Institute for Energy Studies, Russian gas export capacity at peak winter flows early this year hit 92.4% to 99.0% utilisation.

The combined addition of Nord Stream II (55 Bcm a year) and TurkStream (31.5 Bcm/yr) would add 86.5 Bcm, considerably less than the rated capacity of the Ukrainian GTS, which is estimated at 132.3 Bcm/yr by the International Energy Agency and 120.1 Bcm/yr by Entsog, the European Network of Transmission Operators for Gas.

This implies that Russia cannot avoid continued usage of the Ukrainian GTS post-2019, at least during critical peak European demand periods, even if both its new northern and southern pipelines are completed.

Moreover, Germany’s need for gas imports is likely to rise. The EU’s own gas production has been falling since 2001 and has recently come under additional pressure from the premature decline of the giant Groningen gas field in the Netherlands. Germany is phasing out its nuclear reactors, and is expected to then embark on a gradual reduction of its coal-fired power plants to reduce greenhouse gas emissions. More gas burn, as well as renewable energy, will be required.

Nord Stream II makes good economic sense for Germany, and the likely continuance of some flows through Ukraine appears to undermine the European Commission’s concern that a bypass will reduce the number of entry points to the EU for Russian gas.

However, the politics of Nord Stream II are another story. The naval incident in the Kerch Strait has set alarm bells ringing from Tallinn to Warsaw, prompting calls for further sanctions to be imposed on Russia.

Russian expansion

In 2014, Russia annexed the Ukrainian territory of Crimea, itself gifted to Ukraine by Russia in 1954. Following the annexation, Russia built a bridge across the Kerch Strait, providing it with a land route to Crimea and the major naval port of Sevastopol, where the Russian Black Sea fleet is stationed.

The annexation meant that Russia held both sides of the Kerch strait, allowing it to squeeze Ukrainian trade from its Sea of Azov ports such as Mariupol, which has also been a target of the Russian-backed separatists fighting in the eastern Ukrainian provinces of Donetsk and Luhansk.

The latest action was an exercise of Russia’s already dominant control of the Azov Sea, despite both Ukraine and Russia having rights of passage under a bilateral agreement reached in 2003. That agreement did not draw demarcation lines and referred to the Sea of Azov historically as an inland sea of Ukraine and Russia, which in turn implies that the International Law of the Sea does not apply.

Naval control of the Black Sea, into which the Azov Sea flows, is critical for Russia. From the Black Sea, Russia can access the Mediterranean, but only through the confines of the narrow Bosporus Straits, which are controlled by Turkey and governed by the 1936 Montreaux Convention. This allows free passage of merchant shipping in peace time, but places restrictions on large warships.

Open access to the Mediterranean has been a long-standing Russian ambition, and even here Moscow has made gains via its support for the al-Assad regime in Syria. Russia’s naval facility at Tartus on Syria’s coast is its only overseas naval base, the expansion of which has already been agreed with Damascus. This will give Russia a real presence in the Mediterranean.

Puppet states

While these events may seem somewhat remote from northern Europe, any escalation of Russian-Ukrainian tensions immediately raises the hackles of the EU’s eastern European states, particularly Lithuania, Latvia and Estonia, all of which have significant Russian-speaking populations.

They note that in addition to its annexation of Crimea and support for the Ukrainian separatists, Russia has created a number of puppet states, largely unrecognised in diplomatic terms -- Transnistria on Ukraine’s western border and Abkhazia and South Ossetia in the Caucasus -- based around the Russian diasporas in these areas.

They argue that Russia hopes to weaken Ukraine economically and destabilise it politically. Nord Stream II is part of this strategy as its construction would reduce Russia’s own dependence on the Ukrainian GTS, lessen the economic importance of Ukraine to the EU and cement Germany’s dependence on Russian gas imports. This, the eastern EU states fear, will weaken EU opposition to Russia’s extension of its sphere of influence westward into Ukraine.

The Ukrainian-Russian naval incident does not create any new opponents to Nord Stream II, but it does reinforce the east European line that Nord Stream II is anything but ordinary. Although the project developers have been careful to play by the EU rule book, Nord Stream II is not immune from political interference. From the US perspective, Trump is certainly right in one respect; if the pipeline is not built, Europe will need more LNG, and it may well come from the US.





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