ENERGY WATCH #2 - August 7, 2018
As Germany corners EU gas market, will anyone be building new gas pipelines to Europe in future?
by Karel Beckman
In a new paper – Nord Stream 2: Inconvenient Questions – written for PISM, the Polish Institute of International Affairs, analysts Aleksandra Gawlikowska-Fyk, Marcin Terlikowski, Bartosz Wiśniewski and Szymon Zaręba claim they “identify new questions around NS2 that have not been addressed and yet are crucially important”.
“The task of resolving the issues these questions raise will belong to the supporters of NS2”, they add.
The problem is that the paper does not identify any new questions but instead repeats the arguments of the critics of Nord Stream 2 that have been going round in the debate for a long time now. And it mostly ignores the counterarguments the supporters have been advancing.
The Polish analysts “revisit” six arguments in favour of NS2, in the form of six questions, which they try to demolish one by one, but not very successfully.
For example: “Isn’t Europe in need of cheap, clean natural gas, which Russia happens to have in abundance”, ask the supporters of NS2?
Yes, gas consumption is rising, say the authors, “but it it is somewhat astonishing that the public discussion has focused on the NS2 solution while overlooking at least three alternatives.” What are those three alternatives?
First, “Russia already has sufficient capacity at its disposal to supply its European customers”, i.e., it can transport through its existing pipelines. Well, yes, but there is a little problem with Ukraine, remember, which the Russians want to go around.
Second, “The European market is able to absorb significant volumes of liquified natural gas (LNG) from other exporters”, i.e. we can use LNG as alternative. Again, yes, true, so? Isn’t that good news? Doesn’t that mean that the Russians may be taking a big risk with NS2?
Third, “More generally, the question is whether the role of gas is overestimated?”, i.e. do we need more gas in future? Once again, yes, good question, but again, isn’t that good news? What is the problem of Gazprom building a gas pipeline that might become a stranded asset?
The authors also have a lot to say about the supposed negative effects of NS2 on Eastern European gas markets, but they ignore all the arguments supporters have put forward showing that the EU gas market has been successfully liberalized.
“The expansion of pipeline capacity from Russia directly to Germany … along with either existing or planned onshore infrastructure, would allow Gazprom to effectively halt deliveries via transit countries unless they agree to pay a premium for their gas or to otherwise secure Gazprom’s position”, they write. “This would work similar to Gazprom’s prohibited destination clauses, which the European Commission, using its prerogatives as competition policy watchdog, banned.”
This argument is patently false. Gazprom cannot in the current market framework “halt deliveries” to countries in Eastern Europe. These countries will now be able to import gas from Germany, which is subject to the EU market rules.
The authors also completely ignore the outcome of the EU antitrust case against Gazprom on 24 May, when the European Commission announced the following measures:
- No more contractual barriers to the free flow of gas: Gazprom has to remove any restrictions placed on customers to re-sell gas cross-border.
- Obligation to facilitate gas flows to and from isolated markets: Gazprom will enable gas flows to and from parts of Central and Eastern Europe that are still isolated from other Member States due to the lack of interconnectors, namely the Baltic States and Bulgaria.
- Structured process to ensure competitive gas prices: Relevant Gazprom customers are given an effective tool to make sure their gas price reflects the price level in competitive Western European gas markets, especially at liquid gas hubs.
- No leveraging of dominance in gas supply: Gazprom cannot act on any advantages concerning gas infrastructure, which it may have obtained from customers by having leveraged its market position in gas supply.
None of this is even referred to in the paper.
With regard to Russia’s motivation for building NS2, the authors write that “the Russian strategy is as political as it gets.” Well, yes and no. I don’t think anyone denies that when it comes to gas (and oil) for Russia politics and economics are tied at the hip. The Russian leadership no doubt views NS2 as a geopolitical as well as economic instrument. In this approach, they are hardly alone. The U.S. government looks at its LNG exports in exactly the same way.
So the question is not so much whether Russia has political considerations, of course it does, but whether or not these present a danger to Europe. The answer depends to a large extent whether one sees Russia as an aggressive power that aims to dominate or even conquer (parts of) Europe, or whether one believes Russia is not a direct threat to Europe, even if it is not an “ally”. In the former case, anything that the Russians do to sell more oil or gas to Europe (not just NS2) is by definition a threat. In the latter case, the reverse is probably true: by selling more oil and gas, the mutual dependence between Russia and Europe will be reinforced.
Let’s not forget that Russia has a weak economy that depends to a strong extent on its gas and oil sales to its most important trading partner, which is Europe. Moscow can ill afford to jeopardize that position. Of course if Russia is the aggressive power its critics believe it is, that won’t make any difference in the end, that’s the big uncertainty.
One legitimate point that the analysts of PISM raise is the increasingly dominant position of Germany in the European gas market after NS2 will be built.
They note that “Further expansion of Nord Stream will have a negative impact on [Central and Eastern Europe] but Germany will benefit from the doubling of direct supplies from Russia, its increased role as a hub, and tailored gas prices. Already now, both its physical capacity and the size of the domestic market makes Germany the largest gas consumer in Europe (92 bcm) and, at the same time, the largest importer of Russian gas (53.44 bcm). With NS2 doubling the 55 bcm per year of NS1, which has been operating at close to full capacity, as much as 110 bcm per year of natural gas will be pumped to Germany through the northern route. This will mean that nearly one third of EU 2017’s imports of natural gas, amounting to around 360 bcm/year, will be supplied directly through that country. At the same time, about 80% of the Russian gas supplied to Europe will flow through Germany. That puts Germany, where the onshore part of Nord Stream 2 terminates, in the position of middle man, especially to Central European countries.”
Already, the role of Germany in the European market is growing: “In 2017, whilst Germany increased its gas imports by 11.5%, exports grew by as much as 29%. Add to that the loss of British National Balancing Point (the most important gas hub in the EU) after Brexit and the expected merger of two German hubs (NetConnect Germany and Gaspool) in 2022 and one cannot miss what is at stake for the German gas market. As a result, Germany, already one of the most important gas hubs in the EU, will become even stronger.”
It is not unreasonable from a Polish perspective to worry about this new Russian-German gas axis – though it should be noted that Poland does not use much gas at all and Eastern European countries would do well to diversify their energy mix. Incidentally, the reasons some of them have not been doing this has a lot do with domestic interests that profit from the gas trade with Russia, which almost never get mentioned in the NS2 debate.
Even if Germany may have the best of intentions, other EU member states, not just Poland, may have a problem with the increasingly dominant German position in the European gas market.
In fact, as the well-known analyst Thierry Bros writes in a recent analysis on Natural Gas World – NS2, Germany & the EU Solidarity Mechanism – an argument could be made that Germany will be in violation of the recommendations made by the Agency for the Co-Operation of Energy Regulators (ACER) in its Gas Target Model. These recommendations state that EU member states should:
- have at least three distinct origin sources (defined as gas-producing countries or countries hosting a liquid hub from where gas is purchased);
- have a market concentration, as measured by the Herfindahl-Hirschman Index (HHI), lower than 2,000;
- have the capacity to meet yearly demand without their largest upstream supplier.
At this moment, Bros shows, the dependency of EU member states on Russian gas looks as follows:
Bros then assumes the following fictional scenario for 2021 when NS2 would be in operation:
- Gazprom fully uses Nord Stream 2 (55bn m³/yr) as it is already doing for Nord Stream 1
- Gazprom agrees to keep 50bn m³/yr volumes transiting via Ukraine (compared with 77bn m³ in 2017) to please the EU Commission which might otherwise have the power to stop flows in Nord Stream 2 (as it did in capping the flows in the early part of Nord Stream 1).
- Gazprom maximises its revenues by:
- Rerouting 27bn m³/yr away from Ukraine for its Austrian, Dutch, French and German partners.
- Selling the additional 28bn m³/yr in Germany to avoid transport fees inside the EU
The result, writes Bros, will look like this:
According to Bros, this means Germany would be in highly dependent situation, which could undermine the solidarity principle introduced in 2017 in the EU”s new Security of Gas Supply Regulation. After all, he writes, if Germany makes itself so dependent on Russian supplies, “would it be fair for other EU citizens to reduce their gas consumption if an unexpected event was impacting Nord Stream?”
Good question. “To allow Nord Stream 2 to go ahead, on top of a minimum amount of Ukrainian transit that the EU wants, the existing EU rules must be fully enforced and the Gas Target Model must be fully implemented”, writes Bros.
How exactly this should be done, he does not say – but it’s a question German and European policymakers would do well to start thinking about.
You may wonder, where exactly does ACER’s Gas Target Model fit in here? How does it relate the Security of Gas Supply Regulation? And to the Third Energy Directive? How do all these EU regulations affect the gas pipeline sector in Europe?
Good questions. And very likely no one really has the answer.
Katja Yafimava, Senior Research Fellow at the Oxford Institute for Energy Studies (OIES), has just written a detailed analysis (191 pages!) of the evolution of EU pipeline legislation over the last ten years: Building New Gas Transportation Infrastructure in the EU – what are the rules of the game? As Professor Jonathan Stern of OIES notes in the Preface of this paper, gas pipeline regulation has become “extremely complex”.
Stern pointedly notes that “Calls over the past decade for gas pipeline promoters to ‘respect EU rules’ have tended to ignore the fact that these rules had either not been established or were not clear, requiring forensic examination and interpretation of the language of, and potential contradictions between, EU Directives and Regulations.”
Yafimava in her paper tries to provide, as Stern puts it, “a guide to the different regimes for incremental (new) pipeline capacity which have evolved over the past decade. By disaggregating this ‘messy’ evolution, the paper not only sets out the different regimes and the projects to which they apply, but also shows how this rather unsatisfactory situation became increasingly politicized post-2014 in respect of all Russian pipelines, but especially Nord Stream 2.”
Stern goes even further: “The paper also discusses the impact of the new security and governance regulations, and the possible amendment of the Third Gas Directive to include offshore pipelines and specifically Nord Stream 2. Over a period of nearly 30 years, enormous effort has been expended in creating a regulatory regime for EU gas pipelines. The result seems likely to be that complexity and politicization will persuade those wishing to bring additional gas to EU countries to do so as LNG, rather than as pipeline gas. It is not clear whether this is a desirable outcome, and important that all stakeholders understand both the reasons why it has resulted and their potential consequences.”
A very clear warning from OIES.
Yafimava takes a unequivocal stand against the European Commission’s controversial proposal to amend the Third Gas Directive to make it apply to “import pipelines” such as Nord Stream 2. Such a move would “increase the (already significant) uncertainty in respect of regulatory treatment of incremental capacity in the EU”, she writes. (For more on this see here and here on Energy Post. See also this article by Severin Fischer: Lost in regulation: the EU and Nord Stream 2).
Here we can only summarize some of the main findings of the paper from the Executive Summary. Yafimava finds that:
- “The process of developing a legally binding regulatory framework for the creation of incremental pipeline capacity in the EU and hence for the construction of new gas pipelines has been uneven and slow.
- Eight years after the TEP [Third Energy Package] was adopted in March 2009, and more than five years after it entered into force in September 2011, the CAM NC [Capacity Allocation Mechanism Network Code] was finally established in March 2017. However, it did not fully resolve all the problematic issues in respect of the regulatory treatment of incremental capacity.
- The passage of time meant that many new pipelines, which were initiated around the time of the TEP’s adoption and entry into force, developed under a patchwork of TEP exemptions, OS [open season] procedures, and IGAs [intergovernmental agreements]. This meant that incremental capacity was allocated and contracted under different regulatory regimes which – while not dissimilar – were not identical to the regulatory framework established by the CAM NC.
- In addition, although the CAM NC established a legally binding regulatory framework for conducting an incremental capacity process, it left important regulatory specificities, particularly in respect of capacity allocation methods, for the TSOs [transmission system operators] and NRAs [national regulatory authorities] to decide. This meant that the latter have been able to develop capacity allocation methods which differ across the EU.
- As a result, there are differences in the regulatory treatment of incremental capacity both between the CAM NC and the previous frameworks (exemptions, OS procedures, and IGAs) as well as within the CAM NC itself. Thus, the problem of the regulatory treatment of incremental capacity – created under diverse frameworks with varying degrees of consistency – has not been fully resolved at the EU level and uncertainty remains in respect of its future treatment.
- These problems have been made more difficult by the ongoing politicization of EU gas regulation, particularly in respect of Russian gas, and this adds further uncertainty in respect of the regulatory treatment of new EU pipelines, connected with Russian export pipelines. Signs of such politicization started to appear even before the sharp deterioration in the EU–Russia political relationship in the aftermath of the 2014 Ukraine crisis. For example, the cap imposed in 2009 by the EC on the utilization by Gazprom of OPAL (and hence Nord Stream) capacity was not justifiable on regulatory grounds.
- Such signs became even more evident post-2014, when the EU started to develop its new policy initiatives, which aimed de facto at reducing EU dependence on Russian gas and placing artificial constraints on Russia’s Europe-bound export pipeline capacity, in order to inter alia preserve significant transit of Russian gas across Ukraine.
- As the EC exhausted its ability to control capacity in Nord Stream 2 on the basis of the existing acquis, it launched several legislative initiatives – most importantly, the proposal to amend the Third Gas Directive.
- If adopted, the amended Directive would enable the EC to control the degree of utilization of capacity in pipelines coming to the EU from third countries and hence the degree of utilization of capacity in the EU’s internal connected pipelines (irrespective of whether the latter are regulated). This would increase the (already significant) uncertainty in respect of regulatory treatment of incremental capacity in the EU (including the projects that have been initiated prior to adoption of the amended Directive).
- At the time of writing, lack of political agreement among member states means that it is uncertain whether such regulatory action will succeed. To the extent that it does succeed, it will politicize – and ultimately undermine – an EU regulatory framework that has been painstakingly constructed over several decades.
- This paper concludes that, given the uncertainty and complexity associated with the regulatory treatment of incremental capacity, the projects that have been initiated prior to the CAM NC’s entry into force should proceed under the rules which were in place at the time of their initiation. Although the EC and the regulatory authorities might be tempted to request some changes in respect of their regulatory treatment – particularly where this differs from what would have been required under the CAM NC – this temptation should be resisted, as further changes would unnecessarily increase uncertainty and complexity.
- Overall, the complexity and the lack of clarity associated with the regulatory framework for incremental capacity in the EU (resulting from the way in which regulation has developed, as well from its subsequent politicization) suggests that very few major new pipelines will be built in the EU in the future, apart from those under construction or foreseen in this paper (including TAP, EUGAL, and the Baltic Pipe) and possibly also those pipelines needed for connecting the second string of Turkish Stream with European markets. This is because it will be much easier for those wishing to bring additional gas to Europe to do so via LNG import terminals.”
So what about the idea of the “Southern Gas Corridor” which is supposed to reduce Europe’s dependence on Russian gas by bringing in gas from Azerbaijan initially and later maybe Turkmenistan and Iran?
Well, “don’t hold your breath”, is the message of Simon Pirani of the Oxford Institute for Energy Studies (OIES) in a new study: Let’s not exaggerate – Southern Gas Corridor prospects to 2030.
Pirani notes that “a new round of political activity to promote the Southern Gas Corridor from the Caspian to Europe has begun. In February, European energy ministers and supplier nation officials met in Baku. In June, first gas entered the Trans Anatolian Pipeline (TANAP) across Turkey, and the first substantial source of supply for the Southern Corridor, the Shah Deniz II project in Azerbaijan, started producing. Shah Deniz II will ramp up to peak output of 16 bcm/year by 2021-22.”
This may sound hopeful, but as Pirani notes, “Europe will then receive around 10 bcm, no more than 2 per cent of its overall demand, via the Southern Corridor, compared to the 10-20 per cent that had been envisaged in Brussels.”
“While political leaders continue to paint the corridor’s prospects in very bright colours, the market dynamics, in the Caspian region itself, in the Caucasus and Turkey, and in Europe – are less promising”, warns Pirani. “Commercial conditions for the Southern Corridor’s success have deteriorated as political support for it has grown.”
He argues that “up to 2030, the corridor will most likely remain an insubstantial contributor to Europe’s gas balance. At best, there may be sufficient gas for a second string of TANAP, but only at the end of the 2020s.”