May 15, 2020

Nord Stream 2: Preparing for the Bait & Switch

Allseas' deep sea pipe laying ship Solitaire lays pipes for Nord Stream 2 pipeline in the Baltic Sea September 13, 2019.
Allseas' deep sea pipe laying ship Solitaire lays pipes for Nord Stream 2 pipeline in the Baltic Sea September 13, 2019.

One should not interpret recent media reports to the effect that the Nord Stream 2 project is in peril. The German energy regulator the Bundesnetzagentur (BNetzA) it is reported may not grant Nord Stream 2 a derogation from EU energy liberalisation regime, contained in the gas directive 2009. Such a failure to obtain a derogation from the BNetzA, even if that is its final decision, is likely to prove far from fatal to Nord Stream 2.

It is more likely that we may be facing a change in direction in the regulatory argument pursued by Nord Stream 2 and its allies in order to successfully deliver the project. It may amount to a bait and switch. Instead of granting a derogation, which has been the focus of regulatory debate and discussion,  the German regulators may adopt a decision that purports (but does not actually) comply with EU law, and which in fact permits Gazprom full freedom to use the pipeline.

Russia is on the backfoot following its unforced error in taking on Saudi Arabia in an oil price war amid a pandemic. It has had to accept four times the level of cuts in the April 9th deal with OPEC than in the deal it refused on March 6th. Meanwhile, although the scale of OPEC and Russia cuts are huge, 10mbd, they are dwarfed by the demand destruction triggered by the virus, which is around 30mbd. Oil prices have plummeted toward $20 a barrel, and it now takes 75 roubles to buy one dollar. At the same time as the main source of budget revenues has collapsed Moscow is struggling like every other state with heavy costs of the pandemic.

In this context media reports that the BNetzA is likely to require that the Nord Stream 2 pipeline is fully subject to the EU’s gas directive, suggest that that Moscow may be about to give up on the pipeline. However on closer examination this is clearly not the case. No halt has been called to completing Nord Stream 2’s connecting land-based pipeline EUGAL. Nord Stream 2 is still in the process of ensuring a pipelaying vessel is in place later in the year to complete the pipeline in a way which will not infringe US sanctions. And the lobbying and advocacy for the pipeline continues at pace in the media and in Washington, Brussels and Berlin.

Hence despite the media reports one cannot discount the possibility that the BNetzA will still at the last moment, at the end of this month, rule that after all, Nord Stream 2 can receive a derogation from the application of the EU gas directive 2009. The argument that a derogation can be granted is legally absurd. The easier regulatory terms of the derogation procedure are only available for pipelines completed by May 23rd, 2019. On that date not only was only 40% of the pipeline completed but Nord Stream 2 did not even have a route permit for the Danish section of the proposed route. At that date in fact Nord Stream 2 had three outstanding proposed Danish routes under consideration by the Danish Energy Agency-it could not actually therefore give an account of the route that the whole pipeline would follow on May 23rd, 2019.

The only even mildly credible response from Nord Stream 2 has been to argue that it had a legitimate expectation that should mean it should be able to benefit from a derogation. It has sought to argue that because it had made a final investment decision prior to the coming into force of the gas directive the pipeline should be treated as a completed pipeline even though it was not actually complete. The difficulty with that argument is that responsible investors do not make final investment decisions and start constructing pipelines when they do not have all the route permits in place and cannot even identify the actual route that the whole pipeline will take. Irresponsible investors cannot claim that they have any legitimate expectation.

The weakness of the argument for a derogation does not necessarily mean that the BNetzA will not seek to grant a derogation. One has only to look at the German reaction to the OPAL case. In T-883/16 Poland v. Commission. In that case the EU General Court struck down a European Commission decision expanding Gazprom’s capacity to the OPAL pipeline, the connecting pipeline to Nord Stream 1. The EU General Court handed down a well-reasoned and principled ruling drawing upon Article 194(1) TFEU to argue that EU energy law contained a broad-based principle of solidarity. The Court argued that a Member State regulator and/or the European Commission when taking account of a major energy project had to take account the interests of all Member States and the Union as a whole. This ‘solidarity test’ had not taken place in the OPAL case (and if it had happened Gazprom would have been unlikely to have obtained a significant increase in its access to OPAL’s pipeline capacity given the damage to the interests of other EU states) and as a result the Commission decision was struck down.

The OPAL case is relevant in relation to the German approach to whether the derogation will be granted because of the subsequent differential reaction of the European Commission and the German government. In Brussels the reaction was to accept the ruling of the EU General Court and not seek to appeal the ruling to the EU supreme court, the Court of Justice of the European Union (CJEU). Not unreasonably the Commission took the view that a very principled based judgment which emphasised the need for solidarity amongst the Member States was unlikely to be overturned by the CJEU. However, in Berlin, Germany used its right as a privileged litigant in the EU legal order to appeal the ruling of the EU General Court. This is despite the fact that Berlin knows that it is likely to lose. This is also despite the fact that before a judgment is handed down by the CJEU, that one of the Court’s Advocate General’s will hand down a detailed opinion on the law, which is likely to further bind national energy regulators such as the BNetzA.

Why would Germany appeal when it knew that is was likely to lose and any loss would be likely further undermine the scope of action of its regulator? The underlying reason for the appeal it suggested here is to demonstrate to the German energy sector, the German energy firms backing Nord Stream 1 and 2 and to the Russian government, German commitment to the Nord Stream projects — even if the outcome is still likely to result in a defeat in Luxembourg. Equally therefore one can see why despite current media reports the BNetzA may well decide ultimately to grant a derogation for Nord Stream 2, despite the fact that there is no legal basis for such decision. And also despite the fact that any such decision will trigger infringement proceedings before the EU courts by the European Commission and several Member States, including Poland and at least some of the Baltic states.

However, what the recent media reports may indicate, that even for the German state and its energy regulator, granting a derogation may be a bridge too far. The danger for the BNetzA is that such an act is such a blatant infringement of EU law, the Commission may well be able to go to the CJEU and obtain an order immediately suspending the operation of the derogation. As a consequence there would be little value in making a decision that would be almost immediately reversed by the Luxembourg courts.

It is therefore possible that the entire focus on the derogation procedure over the last few months, and the media reports that the BNetzA does intend to adopt to grant a derogation to the pipeline is all part of a bait and switch operation. Emphasise over several months the prospect of a derogation being granted, at the last moment, pull the prospect of a derogation and instead take a decision that looks like compliance with EU law. In reality the new decision does not comply with Union law either but it is not a derogation decision. As a consequence although it also seeks to subvert Union law, it will not immediately bring down the full weight of the EU infringement procedure upon the BNetzA and the government in Berlin.

There are a number of options for Nord Stream 2 for something that looks like a measure that complies with EU law, but is really nothing of the sort. For example, last year before the discussion surrounding the derogation procedure took hold there was a discussion amongst advocates of the Nord Stream 2 pipeline that one option would be to focus application of EU law solely to the ‘stub’ of the pipeline. The stub is the 55km of pipeline solely in German territorial waters. The stub argument is essentially that EU law only applies to the pipeline in EU territory, the rest of the pipeline remains free of Union law and can be owned and controlled by Gazprom.

The stub would be fully compliant with EU energy liberalisation law and in particular the EU’s gas directive. There would even be no need for an exemption as that part of the pipeline will be subject to ownership unbundling. The pipeline would be owned by a EU owner unconnected with Nord Stream 2 and Gazprom. It would comply with third party access rules. However, no one but Gazprom would be able to access the stub from international waters and it would set a transparent tariff regime but conscious it would have only one source of supply from Gazprom.

Such a ‘stub’ project would be a legal sham. There is only one single pipeline running from Russian Federation territory to German territory. It was designed, planned and route permits were obtained on the basis of it being one pipeline. The majority of the pipeline outside German and EU territorial waters has no purpose or value save in relation to the physical connection with that part of its pipeline within EU territory. One can legitimately apply the territoriality principle in allocating jurisdiction in public international law as a consequence of the pipeline’s fixed connection to infrastructure in EU territory permitting the full application of Union law to the pipeline.

However, from a PR perspective opting for the stub approach has the merit of being more easily able to defend in the media. It is much easier for the German authorities to present the application of EU law to the stub as reasonable application of Union law, than participate in what would amount to an overt breach of Union law, by granting an unwarranted derogation to Nord Stream 2.

Applying EU law to the stub would create a legal framework to the pipeline which can then be defended over the next few years through the EU’s judicial hierarchy. In parallel, the pipeline can be completed and can be functioning. The facts on the ground will have been put in place with the aim of then minimising any subsequent application of Union law to an already functioning pipeline.

What we may be seeing put in place therefore is a bait and switch operation with the aim of completing the pipeline and get it up and running. Not by a long chalk should we believe that Nord Stream 2 is a dead project.