September 21, 2015

Nord Stream Two in Ukrainian Perspective

AFP/Scanpix
View of the Nordstream gas pipeline terminal prior to an inaugural ceremony for the first of Nord Stream's twin 1,224 kilometre gas pipeline through the baltic sea, in Lubmin November 8, 2011. When fully operational in late 2012, Nord Stream's two lines will have the capacity to transport 55 billion cubic metres of Russian gas a year to the EU for at least 50 years.
View of the Nordstream gas pipeline terminal prior to an inaugural ceremony for the first of Nord Stream's twin 1,224 kilometre gas pipeline through the baltic sea, in Lubmin November 8, 2011. When fully operational in late 2012, Nord Stream's two lines will have the capacity to transport 55 billion cubic metres of Russian gas a year to the EU for at least 50 years.

At Russia’s initiative, the Nord Stream Two natural gas pipeline project has advanced from agreements of intent to a binding agreement; and Gazprom has formed the project consortium with several major European energy companies. Planned to connect Russia with Germany through the Baltic Sea by 2019, Nord Stream Two would double the Nord Stream system’s overall capacity to 110 billion cubic meters (bcm) of Russian gas per year, potentially replacing Ukraine as the main transit route for Russian gas to Europe.

This project is inseparable from the context of Russia’s efforts to undermine Ukraine, through instruments ranging from military aggression to economic exhaustion. Specifically, Nord Stream aims to eliminate Ukraine from European energy transit systems (strategic goal), and in so doing, to deprive Ukraine of transit revenue (collateral Russian goal). The Kremlin’s even more ambitious goal, however, is to replace the Ukrainian transit route, which is free from Gazprom’s control, with a route to Europe fully controlled by Gazprom. Indeed, in Nord Stream, Gazprom is the majority stakeholder (its 51 percent stake is intangible), the sole authorized user of Nord Stream pipelines’ capacities, and the only authorized seller of gas at destination points in Europe. The project’s board chairman and the CEO, Gerhard Schroeder and Matthias Warnig, respectively, are (formally) Gazprom’s and (slightly less formally) the Kremlin’s nominees.

Thus, Nord Stream must be evaluated not only for its fiscal or other impacts on Ukraine but, more broadly, for its impact on the energy supply security of a number of European countries, and the challenges it poses to the European Union’s laws and common policies.

The target date for completing Nord Stream Two, 2019, coincides with the expiry of the Russia-Ukraine gas supply and transit agreement. As regards the transit, Moscow’s public statements indicate that it will seek an entirely new agreement, reducing the transit flow through Ukraine, perhaps dramatically, if Nord Stream construction work advances as planned.

Russian gas transit volumes through Ukraine have steadily declined, from 110 bcm annually a decade ago (representing some 80 percent of Russia’s total gas exports to Europe) down to 85 bcm in 2013 (slightly more than 50 percent of Russia’s total) and 62 bcm in 2014 (some 40 percent of Russia’s total), and an anticipated 51 bcm for 2015 (about one third of Russia’s anticipated total figure) (Gazprom.com, accessed September 17; UNIAN, September 3). The slump in European demand has been the main cause, but the operation of Nord Stream One since 2011 became an additional factor reducing Gazprom’s use of Ukrainian transit pipelines. Gazprom anticipates European demand to recover by 2019 and thereafter.

Ukraine’s transit revenue has declined correspondingly with the volume decline. Ukraine earned some $4 billion for transit services in 2013, some $3 billion in 2014, and expects some $2 billion for 2015 in transit fees. These revenue losses are potentially destabilizing to Ukraine’s already precarious fiscal position. Ukraine proposes to negotiate an increase in transit fees as part of the current negotiations on the price of Russian gas supplies for 2016. Raising the transit fees is normal practice in situations when the transit volume declines. At the current level of transit fees, Ukraine’s transit system is expected to turn loss-making if the transit volume drops below 40 bcm per year.

The current transit fee is apparently set at $2.88 per one thousand cubic meters of Russian gas per 100 kilometers of Ukrainian pipeline. According to some reports, Kyiv proposes to raise that fee to a range of $3.70–$5.50 per one thousand cubic meters per 100 kilometers of pipeline, apparently depending on the transit volume to be agreed (Interfax-Ukraine, June 26, September 18; Ukrinform, September 10; Bloomberg, September 11; UNIAN, September 18).

Whether Nord Stream Two materializes as planned is still far from certain, given the project’s unresolved financial and legal issues. The signed agreement, however, in and of itself will discourage other Western companies from investing in the upgrade of Ukraine’s transit system, as long as the bypass threat hangs over that system.

For its part, the European Commission insists that Ukraine must remain a major transit route for Russian gas to Europe. The Commission encourages discussions about an international consortium that would buy into, and upgrade, Ukraine’s gas transit system, once Ukraine will have reformed its natural gas sector. Last year, the Ukrainian parliament authorized the formation of such an international consortium; and on April 15, 2015, the parliament approved the law on breaking up the Naftohaz Ukrainy state monopoly, with a view to separating the gas transit system from it, effective October 1, 2015 (Interfax-Ukraine, September 18).

If and when the construction of Nord Stream Two is completed (target date 2019) and then brought to full operating capacity (presumably within two years of completion), Gazprom will not abandon Ukraine’s transit system immediately on the agreement’s expiry (also 2019). Russian government and Gazprom officials indicate that they would negotiate a new transit agreement with Ukraine, albeit for low transit volumes for the years after 2019. This is because Gazprom’s long-term supply contracts in Europe, including those expiring well after 2019, stipulate specific points of delivery for the gas supplied. Presumably, Gazprom would have to adjust those points in order to switch those deliveries from the Ukrainian transit system into Nord Stream.

RUSSIA’S likely objective is to see Ukraine’s transit system disused for the most part, but still handling Russian gas deliveries to the Balkan region. GAZPROM WAS PLANNING to supply that region through South Stream or Turkish Stream, bypassing Ukraine; but those plans have failed conclusively. Hence, Gazprom will still have to use elements of Ukraine’s transit system in order to supply the Transnistria protectorate, Moldova itself (where Gazprom controls Moldovagaz), and farther downstream Bulgaria, Greece and Turkey’s westernmost provinces.

All those intentions presuppose the successful completion of Nord Stream Two. And that, in turn, may depend on special arrangements on the overland pipelines in Germany that feed from Nord Stream. While Russia has decided to turn Germany into a privileged transit country, those special arrangements have yet to be reconciled with the EU’s energy market legislation; and that will be difficult.

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