European Commission throws book at Russia's Nord Stream 2 natural gas link

The European Commission, watchdog of the EU treaties, is throwing everything it has at Russia's planned 55 Bcm/year Nord Stream 2 pipeline across the Baltic Sea to Germany in its efforts to keep Russian natural gas transit flows to the EU through Ukraine a viable option.

It plans to propose in November revised legislation that aims to apply the EU's internal energy market rules — known as the third energy package — to offshore gas pipelines to the EU. These rules include allowing third-party access to pipelines, unbundling pipeline operators from parent energy supply companies, setting non-discriminatory tariffs and requiring more transparent operations.

But speculation over whether forcing Nord Stream 2 to apply third-party access rules would prompt an end to Russian state-owned Gazprom's export monopoly, for example, is probably wishful thinking. Gazprom's Russian rival Rosneft may be ready and waiting, but it's difficult to see the benefit for the Russian state of two Russian companies competing with each other for European customers.

The EC has said it wants the new rules for offshore gas pipelines to be in force by end-2018, in plenty of time to capture Nord Stream 2, which is due online by end-2019. That timetable would require the European Parliament and the EU Council, representing the EU's 28 national governments, to fast-track their debate and approval of the proposals — and neither the speed nor the approvals are guaranteed.

The Nord Stream 2 project company is 100% owned by Gazprom, but supported financially by five European energy companies: Austria's OMV, France's Engie, Germany's Uniper and Wintershall, and Anglo-Dutch Shell. These five together have already provided Eur1.43 billion in total in 2017, and committed to fund up to 10% each of the total estimated Eur9.5 billion ($11.2 billion) cost if needed.

That means that five EU countries — including big hitters France, Germany and the UK (which is still a full member until March 2019 at least) — are likely to reject anything that would cause the project difficulties. That means the EC's proposal would likely be watered down considerably or even blocked, as these five countries have enough votes in the council to form a blocking minority.

The EC has already requested a mandate from the council to negotiate an EU intergovernmental agreement with Russia on operating rules for the pipeline. A commission official said the mandate could work by itself if through it Russia agreed to apply the third package rules. But there is no guarantee the council will give the EC this mandate.

If the EU legislation is changed to apply to offshore pipelines but the EC does not get a mandate for talks with Russia it would be the responsibility of the EU countries involved to negotiate with Russia to apply the new rules.

And there is the real difficulty for the commission. Applying EU third energy package rules depends on Russia's cooperation. And there is no obvious reason for Russia to give this. Russia has already formally complained to the World Trade Organization that the EU's third energy package and related infrastructure rules discriminate against Russian projects. The WTO plans to rule on that complaint by the end of this year.

The EU has several other outstanding energy disputes with Russia. These include an ongoing antitrust case over Gazprom's activities in central and eastern Europe, and legal challenges from Poland at the EU's General Court in Luxembourg against the EC's decision to allow Gazprom to bid for more capacity in the OPAL gas pipeline. OPAL carries gas from Russia's 55 Bcm/year Nord Stream 1 pipeline, online since 2011, across Germany to the Czech border.

The latest on all these disputes, including the EU's sanctions against Russian oil companies over Russia's role in destabilizing Ukraine, are set out in the S&P Global Platts Guide to EU-Russian Energy Relations.

One area where EU-Russian energy relations continue to thrive, however, is in Russian gas sales to the EU. These were up 7.68 Bcm or 9.5% to 80.67 Bcm in the first half of 2017, compared with the first half of 2016. Nearly half of that increase — 3.61 Bcm — went to Germany.

One of the main reasons the EC is so critical of Nord Stream 2 is that it thinks Russia will use the new route to replace the Ukrainian gas transit route, allowing up to 80% of Russian gas flows to the EU to go via the Baltic Sea to Germany. This would mean Gazprom could supply countries in central and eastern Europe from the west rather than via Ukraine.

This is particularly galling for the EC, which has pushed to enable west-east flows on the European gas grid specifically to give these countries access to non-Gazprom (but possibly still physically Russian) gas from the west. The aim was to improve their supply security through access to western gas hubs, and give them leverage to negotiate better deals on their Gazprom gas from the east.

Even if third package rules are eventually applied to Nord Stream 2, this would not resolve the EC's concerns about the expected shift in Russian transit gas flows from Ukraine to the Baltic Sea. What the EC's proposals can do is extend uncertainty about Nord Stream 2's final regulatory conditions for another year or so. How much investors care about this will soon become clear — the project company is planning to go to banks for financing up to 70% of the cost early next year.