Rising EU demand for Russian natural gas is making a case for keeping the Ukrainian transit route open even after Russia's controversial 55 Bcm/year Nord Stream 2 pipeline to Germany comes online.
Russia wants Nord Stream 2 flowing gas by end- 2019, when its transit contract with Ukraine expires. But Nord Stream 2 is facing multiple challenges which could cause delays, including regulatory uncertainties under EU law, a US sanctions risk that could deter investors, and planning issues that could force route changes.
Meanwhile, Russian gas flows via Ukraine reached a six-year high in 2017, and Russia could have to cap exports to Europe after 2019 if it dropped the Ukrainian route entirely. S&P Global Platts editors Siobhan Hall and Stuart Elliott discuss EU gas demand, transit capacities and regulation, as well as the outlook for EU, Russian and Ukrainian gas relations.
SH: Hello, and welcome to S&P Global Platts Commodity Pulse. I’m Siobhan Hall. The race is on for Russia to complete its controversial Nord Stream 2 pipeline to Germany before its transit contract with Ukraine expires at the end of 2019, which is less than two years away.
The challenges include EU proposals to regulate gas import pipelines, a risk – however small -- of US sanctions which could impact financing, and possible changes to local planning rules that could force route changes and delays. Joining me to discuss what this means for European gas supplies is our senior writer for European gas, Stuart Elliott.
So, Stuart, we know that Russia wants to move away from using Ukraine as a gas transit route to Europe, and we also know that flows through Ukraine dropped after Russia opened its Nord Stream 1 pipeline back in 2011, so how much gas is Russia flowing through Ukraine now?
SE: Well actually, last year, Russia sent more gas through Ukraine than it has done for six years -- a total of 94 Bcm, so it just goes to show that actually Russia does still need Ukraine as a transit route, at least in the near term. And Russian supplies to Europe and Turkey overall were an all time high as well last year – 194 Bcm. So clearly, Europe and Turkey both need Russia as much as ever, and the current evidence suggests that they need Ukraine as well as a transit country.
SH: Right, so, you mentioned there record demand from the European side. Is that likely to be the new norm and does that mean Russia will struggle without the Ukraine route even if it wanted to move away from it?
SE: That’s right, European gas demand has really recovered in the past few years, and it’s pretty buoyant at the moment, especially for power generation, and there’s no evidence to suggest that that level of gas demand is going to fall, in which case Russia will remain the dominant supplier to the European market. The problem Russia has, as you said, is it wants to diversify away from Ukraine, and it has stated that it wants to eliminate the Ukrainian route completely, at least in theory, but the problem is that the current Russian supplies to Europe of 194 Bcm – let’s say that becomes the normal level for the coming years, because of course EU gas production is falling – so let’s say 200 Bcm of Russian gas per year is required. If you take away the Ukrainian route, and you add in Nord Stream 2 and the Turk Stream pipeline, you’re actually only about 192 Bcm of export capacity to Europe and Turkey, so it’s very tight.
SH: (off camera) Very tight!
SH: I mean, it sounds like you would actually be slightly short. But even if it were the same number, you know pipelines need maintenance, there’s always outages and so on, it sounds like it would be – it creates a bit of a supply issue from the Russian side, that they wouldn’t be able to supply as much as they could or wanted to.
SE: That’s right, so I mean the thing we need to look out for is post-2019, with Nord Stream 2 and TurkStream online, they would still need theoretically a chunk of Ukrainian transit and in which case of course they need a contract for that.
SH: Yes, and on that point on it being so tight, I mean, that is one of the reasons the EU is particularly pushing Russia to keep that Ukrainian route open, because it wants to be able to buy as much Russian gas as the market needs. And the interesting thing, that’s why they’ve come with these proposals to regulate pipelines like Nord Stream 2, offshore gas pipelines, because they really want to encourage still sending gas through the Ukrainian route.
SE: And what would the impact be, Siobhan, if the EU does approve these new legislation points?
SH: The main impact if these proposal were approved – and let’s be clear, it’s unlikely that they will be approved as they have been written, but if we assume that they are approved as they are written now, then the main impact that I would see is that the regulators would be required to either set or approve tariff costs on pipelines. And the interesting thing there is that that means that the German regulator, for example for Nord Stream 2, would be setting tariffs and that would give the rest of the market information about how much it costs to use Nord Stream 2, which would allow Ukraine, perhaps, to offer lower tariffs to encourage people to use its route if customers have a choice of which pipeline they take their gas through.
SE: Would the German regulator then set the tariffs for the whole pipeline?
SH: Well, that’s a very interesting point, because EU law only applies up to the limit of EU territorial waters, so potentially you could have a situation where the EU local regulator has applied the rules on half the pipeline, and the regulator on the other side of the pipeline is applying different rules. And the only way that you would be able to have the same rules for the whole pipeline would be to have an intergovernmental agreement.
SE: So it wouldn’t be until that intergovernmental agreement was in place that we’d know what the rules would be?
SH: Yes, so if there was any divergence on the views on either side. That’s one of the things about this EU proposal, it really does create a lot of uncertainty for the people who actually use the pipeline, so the shippers and the customers and so on, about what rules the pipeline would be using. Another important point is that this EU proposal – it doesn’t stop the pipeline – any of the pipelines – being built. It would just – it would influence how they are operated. So on that point, I mean, how far along are Gazprom in building this pipeline?
SE: Yeah, well, that’s a good point, as you said at the beginning, we’re only two years away from first gas through Nord Stream 2, and they are working busily on this pipeline. They’ve ordered the pipes, some of them have been delivered, they’re working actively on the permitting process. That’s one area actually where there could be a delay, which is that Denmark last year passed a law which allowed it to takes its foreign policy objectives into account when approving infrastructure that passes through its waters. That’s a clear signal to Nord Stream 2 that it could, if it wanted to, and it hasn’t yet, force the pipeline into its exclusive economic zone, so out of its territorial waters and into the EEZ, which would cost more and would require a re-routing. Now, you know, it’s not a big deal and Gazprom said it could easily do that, but any kind of delay could be important to the way that this all pans out.
SH: Yes, because as we said before, we’ve got this very important cut-off point, you know, at the end of 2019, which I’ll come back to, but another thing there that might be an issue with the construction is that we have this risk – it’s a very small risk -- but there is this risk that the US now has the power to sanction people who invest in Nord Stream 2, and that may have an impact this year because the project company is going to the banks to seek financing, for up to 70% of the cost, and so it will be really interesting to see whether the banks are willing to finance a project that potentially could be sanctioned by the US.
SE: Yeah, I mean, as I understand it, from what I’ve been told, is that the companies that have already invested in Nord Stream 2, there’s five of them, Shell, Uniper, Wintershall, OMV and Engie, the French company, and they’ve given signals that they are not so fazed about this prospect of sanctions from the US. And of course in the meantime, Gazprom can probably afford it, just about, it’s only an Eur8 billion project, which might sound a lot to some people but for Gazprom it’s peanuts really. So for them, I think they would push ahead anyway and build this. It’s got so much strategic value to the company, and you know, for Europe as well, the northwest European countries certainly, are engaged in this pipeline, they want it built, the likes of Germany of course, but also the Netherlands, countries that are losing their domestic production, see it as a valuable economic project.
SH: Right, so, I think if we assume then that the pipeline is going to be built, so then the really interesting question is – when will it start and will Russia continue to use the Ukrainian route after it does?
SE: Yes, so the key thing is really what happens between now and then. So at the end of 2019 Gazprom doesn’t have an export contract with Ukraine anymore, but they are going to need one, because there’s a likelihood that Nord Stream 2 may be delayed, even if it’s a few months, they’re going to need to transit through Ukraine in the first months of 2020 because they have customer obligations to satisfy. In that case, Gazprom needs to be negotiating now with Naftogaz or whichever company in Ukraine is operating the transmission network at that point, and of course, we’ve also got this outstanding arbitration case between Gazprom and Naftogaz for transit, which is going to be ruled on I think at the end of February. And at that point we should get some more clarity on whether or not Gazprom and Naftogaz can actually come to some kind of better deal where they can agree on something around transit because there could still be the need for five to ten Bcm transit post-2019 even with Nord Stream 2 and TurkStream. So really the arbitration ruling could give us a better idea of how the two companies are going to sort things out between themselves.
SH: Yes, that arbitration ruling, I mean, it’s possible that might resolve all the conflict between Russia and Ukraine -- on gas issues, anyway. So that’s going to be a really interesting ruling to watch out for.
SE: It is.
SH: So, we have the arbitration ruling coming at the end of February, we have the project company going for financing this year, and it will be interesting to see how that turns out, we have these EU proposals that are going through and actually affect other pipelines as well but most people are interested in Nord Stream 2, so there’s a lot happening in the next few months on this area. So thank you so much Stuart for all your insights. This is something we’ll be following very closely at S&P Global Platts. Thank you for watching, and join us for the next edition of S&P Global Platts Commodity Pulse.