North Stream-2: Consequences for Ukraine and the EU – the Ukrainian Perspective

After the Revolution of Dignity in 2014, Ukraine implemented EU energy legislation and started reforming the energy sector. The ultimate goal of these reforms is sectoral integration into the EU’s energy markets: gas and electricity. This objective has been recognized by the European Parliament and the European Commission. After the signing of the EU-Ukraine Association Agreement in 2014 and a half-year gas blockade by the monopoly supplier, Russian Gazprom, the gas market reform process has significantly speeded up. Both Ukraine and the EU are closely linked to each other by gas infrastructure. Natural gas moves both from Ukraine to the EU (transit of Siberian gas), and in the opposite direction (reverse supplies by European companies to Ukraine through Poland, Slovakia and Hungary).

The Association Agreement contains the important Article 274 “Cooperation on infrastructure:“The Parties shall endeavour to facilitate the use of gas transmission infrastructure and gas storage facilities and shall consult or coordinate, as appropriate, with each other on infrastructure developments. The Parties shall cooperate on matters related to trade in natural gas, sustainability and security of supply. For further integration of energy markets each Party should consider energy grids and other Party’s capacities while working out program documents on demand and delivery plans, interrelations, energy strategies and infrastructure development plans”.

The key point is to take into account the capacities of the Parties (EU and Ukraine) in terms of demand for gas in Europe and the available capacity for its transportation. When Russia proposed the idea of the Nord Stream-2 (NS2) project in 2015, and a number of companies and governments of EU member states supported it, this naturally raised the question in Kyiv whether this project was in line with the EU’s interests and the Association Agreement.

It also raised moral and political questions – whether the leading European countries should implement a strategic project in cooperation with a country that had brutally violated international law, resorted to aggression against a neighboring country, by occupying and annexing part of its territory. In addition, it happens under the circumstances when the EU imposed sanctions on Russia for aggression against Ukraine. Moreover, there have been alternative supplies globally, there is not only Russia: for instance, the gas from Caspian Sea, Central Asia, the Eastern Mediterranean, or LNG.

We must pay tribute to the European Parliament, which has always opposed the implementation of this anti-European project. EU Energy Union program documents clearly state: “The EU will strive for diversity of its energy sources, routes and suppliers, in particular in the gas sector”. Considering that the gas originates in Russia, is extracted and dispatched by the Russian state-owned company Gazprom, and the pipeline is being built by Gazprom, the Nord Stream-2 project does not contribute to the desired diversification.

Many EU member states were against this project, in total 10 countries from Central and Eastern Europe, headed by Poland, which has become a leader of resistance within the EU. Nord Stream-2 had an unconditional support in Germany, Austria, France and the Netherlands. Paraphrasing Orwell, in the EU all member states are equal, but some are “more equal”. So the project is being realized under pressure of the largest European player – Germany.

Not just a commercial project

Why do Ukraine – outside the EU – and Poland – within the EU – strongly oppose Russian gas flows, while the Russian Federation and Germany consider this project to be purely commercial? Because Ukraine and Poland have experienced themselves (and understand) that these large-scale gas supply projects are not just commercial. Russia is not Norway. For Russia, large-scale gas transportation projects are part of a geopolitical strategy aimed at splitting the transatlantic community of Western countries and binding Europe to Russia by abuse of energy dependency. Few people in the West paid attention to the words in the first edition of the Russian Federation Energy Strategy, which was adopted in the “early Putin” age: “Russia has significant reserves of energy resources, and a powerful fuel and energy complex, which is the basis for economic development and a tool for conducting domestic and foreign policy”. So, according to this paragraph, it is easy to conclude that gas is not just a commodity for Russia, it is also a foreign policy tool. No wonder the former Polish Foreign Minister Radoslaw Sikorski called the first “Nord Stream” a new Molotov–Ribbentrop Pact. The story of his twin project confirms Sikorsky’s words. The gas pipeline has not been completed yet, but it has already caused a split between the US and Europe, and within Europe itself. This is one of the goals of Putin’s regime – to divide and conquer. An idea of ​​ of Russia’s gas strategy can be gained from the following diagram, which illustrates the Kremlin’s real intentions, which go far beyond the commercial boundaries.

Russia intends to outflank all transit countries with its “Nord Stream” gas pipelines in the Baltic Sea and the “Turkish Stream” pipeline in the Black Sea, and to retain the monopoly of gas supplies to the EU from the East. It also does everything possible to prevent the emergence of competitive gas flows in the European market from the Caspian region, the Eastern Mediterranean, West Africa, and of LNG from the USA.

“North Stream-2”: lobbyism versus rights

It is known that any new infrastructural project should not impact the existing reliable infrastructure. Such projects require an agreement with the parties whose interests are concerned – this is a requirement of EU law. The project must respect the principles of the European gas market. Does NS2 fit into the EU-Ukraine Association Agreement on cooperation and coordination when it comes to the construction of new gas infrastructure? Of course, it does not. The gas transportation system of Ukraine has available capacities which can be effectively used. In total Ukraine’s Gas Transport System (GTS) is capable of transporting 142 billion cubic meters of gas to Europe and Turkey per year. Currently, the untapped capacity is about 60 billion cubic meters, which almost equals the capacity of NS2. Thus, on the basis of Article 274 of the Association Agreement, initially, the EU should have suggested to the NS2 project initiators to use the available capacity of the Ukrainian gas supply route.

Although the European Commission has never been committed to NS2, it did not take an active position when it ignored Article 274 as an important argument against the project. It is clear that this was a result of NS2 supporting lobby, led by the former German Chancellor. Moreover, in October 2016, the European Commission allowed the German regulator to lift restrictions on the use of the OPAL pipeline – a branch of the existing Nord Stream – which allowed Gazprom to use it not at 50 percent capacity, as required by the EU’s Third Energy Package, but at  full capacity. Despite Poland’s efforts to temporarily suspend the entry into force of the European Commission’s decision on OPAL for several months, the restrictions were lifted and the Nord Stream became fully operational. Gazprom was proudly stated that in 2018 it pumped 57 billion cubic meters of gas to Germany while the project’s pipeline capacity was 55 billion cubic meters). This story made Russia confident that the same could be achieved with NS2 (see Scheme 3) in case EU restrictions were also imposed on it.

Gazprom became even more confident after the conclusion of the EU antitrust case. In 2012 the European Commission initiated an investigation about Gazprom’s anticompetitive behaviour, accusing it of abuse of dominant position, by disrupting gas supply in Central and Eastern Europe markets, in breach of Article 102 of the Treaty on the Functioning of the European Union. In 2015, the European Commission informed that “Gazprom” was preventing competition in gas supply markets in eight Member States: Poland, Czech Republic, Slovakia, Hungary, Bulgaria, Estonia, Latvia, Lithuania. Gazprom was accused of implementing a strategy of abuse in these markets, consisting in particular in territorial restrictions and unfair pricing policy. Gas deliveries were made dependent upon investments in Russian gas pipeline projects, or upon the acquisition or strengthening of Gazprom’s control over the gas infrastructure of those Member States. On May 24, 2018, a set of commitments was adopted by “Gazprom” to ensure the free flow of gas at competitive prices in Central and Eastern Europe markets for the benefit of consumers and businesses. However, at the same time, “Gazprom” managed to avoid a multibillion-dollar fine, which seemed to be inevitable…

The European Commission’s case on “Gazprom’s” violations in eight member states could be supplemented by theUkrainian case. In Ukraine, Gazprom’s behavior was even more brutal, having resorted to blackmail, corruption schemes (Eural Trans Gaz, RosUkrEnergo), suspension of gas supplies in 2006 and 2009, imposition of asymmetric price formulas with discounts conditional upon political requirements. For example, in order to obtain a discount on the price of gas in 2010, Ukraine was forced to agree to prolong the Russian Black Sea Fleet’s stay in the Ukrainian base of Sevastopol until 2042, while, under the Ukraine-Russia agreement of 1997, Russia would have had to leave this base in 2017.

One should take into account the fact that dealing with Gazprom means risking not only dealing with a counterparty failing to fulfill its obligations, but also keen on ignoring arbitral decisions. For example, “Naftogaz of Ukraine” took legal actions against Gazprom and applied to the Stockholm Arbitration, as stipulated under the transit contract with Gazprom, and won the case in 2018. However, Gazprom ignored its obligation to pay “Naftogaz” the amount of nearly $ 2.65 billion. Moreover, it insists “Naftogaz” should drop its claim which, so far, has grown to $ 2.8 billion including penalties. This case should make European gas consumers consider how “Gazprom” can be expected to behave, if it succeeds in strengthening its gas supply monopoly by implementing NS2 and TurkStream and by controlling gas route to the EU via Belarus.

Factors of uncertainty

Russia was already very close to the total success on the gas front earlier this year. Yet Poland’s persistence and Ukraine’s resistance, along with the joint support of the United States, Romania’s EU presidency in the first half of 2019, gave its results. In spring of 2019, the European institutions modified the EU Gas Directive and extended its scope to offshore gas pipelines similar to the Nord Stream-2. This means that this pipeline cannot be used at 100 percent capacity, but only at 50 percent. In September, the European Court of Justice ruled on a joint complaint by Poland, Lithuania and Latvia against the decision of the European Commission on the OPAL gas pipeline. Based on Article 194 “Treaty on the Functioning of the European Union” the Court reversed this decision. Although this applies to the existing Nord Stream system – OPAL, it also has an impact on Nord Stream-2, as its EUGAL pipeline is an analogue to OPAL.

“Gazprom” is currently resisting the implementation of the modified EU Gas Directive, and it is attempting to appeal the ECJ ruling on OPAL. Nevertheless, all this makes the perspective of NS2 even more uncertain, despite Gazprom’s reports of miles of pipes being installed on the bottom of the Baltic sea and the Denmark’s permission to construct a pipeline in its exclusive maritime zone. On the night of November 8, Russia and its lobbyists in Berlin had a desperate attempt to change German legislation in Bundestag, to make the legislation draft beyond the modified EU Gas Directive.

Thus, the fight around the NS2 continues. The threat of US sanctions against contracting companies is the Damocles’ sword for this project, as the project can’t be completed without their participation and “Gazprom” does not have the technology to build deep-water pipelines on its own. There is still a probability to appeal the Danish Agency’s decision on permission to construct the pipeline. But even if Russia manages to complete the pipeline, its exploitation will be complicated by both EU restrictions and increasing competition on the gas European market.

In addition to everything mentioned above about NS2, there are some other aspects to take into account. One issue relates to Russia’s tendency to use civilian infrastructure to expand its military presence by protecting it from malicious acts. Russia’s construction of a bridge from Crimea to Taman across the Kerch Strait, and the construction of «TurkStream» at the bottom of the Black Sea were accompanied by the increase of Russian military forces in the Black and Azov seas, which led to a dangerous incident: the Russian attack on Ukrainian ships on November 25, 2018. This serves as a confirmation of the risks of Russia’s military expansion going step by step with its energy plans.

Now let’s make a projection on the Baltic Sea, where there is one Nord Stream and another one is under construction, but Poland wants to build an alternative (Norwegian gas transferred via a Baltic Pipe). Russia will follow the same pattern in the Baltic Sea as in the Black Sea. Under the claim of protecting strategically important four pipeline threads for Russia and Germany!

Russia is gradually strengthening the Baltic Fleet as part of a rearmament program by 2020. The Russian media recently reported that the Baltic Fleet continued to receive new warships and security vessels. It is reported that 20 new ships have arrived, but for the period from 2010 to 2019 it was 56 units. Thus, the dynamics of the Russian built up of the Baltic Fleet are quite obvious and one must have no illusions about the Kremlin’s further intentions and actions.

Mykhailo Gonchar, Igor Stukalenko, CGS Strategy XXI, Kyiv, Ukraine

Article from the 1st edition of the Journal Brussels Ukraїna Review