The Nord Stream 2 project to transport natural gas directly from Russia to Germany through the Baltic Sea has been granted a construction permit from Denmark, overcoming its final hurdle. But for Ukraine, Nord Stream 2 will prove a “painful” blow to its economy, as Russia will divert gas around the country and no longer pay its neighbour billions of dollars in transit fees each year. Maddy White reports.
Denmark’s Energy Agency approved a permit for the construction of a 147km section of the Nord Stream 2 twin pipeline system south-east of Danish island Bornholm at the end of October, in doing so defeating the last obstacle facing Russia’s Nord Stream 2 project. As it stands now, the pipeline will become operational in mid-2020.
Nord Stream 2 AG, based in Zug, Switzerland, was established in 2015 for the planning, construction and operation of Nord Stream 2, a 1,230km natural gas pipeline through the Baltic Sea. Nord Stream 2 is owned by Russian state-owned energy company Gazprom, which is the largest supplier of natural gas in the world, holding 16% of global natural gas reserves and 71% of Russian reserves.
The €9.5bn project has been a source of controversy: Ukraine, some European countries and the US have taken aim at Nord Stream 2, as they say it will tighten Russia’s already firm grip on the European gas market – Russia supplies around 40% of Europe’s natural gas. Meanwhile, other European markets hail it as a key way to ensure Europe’s future energy security. Half of the funding for the project comes from European energy companies, including Germany’s Uniper and BASF subsidiary Wintershall, the Anglo-Dutch Shell, Austria’s OMV and France’s Engie Energy. Each company will fund up to €950mn of the project, with the remaining €4.75bn financed by Gazprom.
The pipeline will mean an extra 55 billion cubic metres (bcm) of gas is pumped every year from Ust-Luga, Russia to the EU for at least 50 years – enough energy to supply more than 26 million businesses and homes – says Nord Stream 2.
Nord Stream 2 follows the first Nord Stream project, in which Gazprom holds a 51% share. This saw a twin pipeline system built by Nord Stream AG, established in 2005, to transport gas from Vyborg, Russia to Greifswald, Germany through the Baltic Sea. The first string was completed in 2011 and the second in 2012; it also has an annual capacity of 55bcm of gas. Nord Stream 2 will largely run parallel to the first Nord Stream system.
Get rid of the gatekeeper
Ukraine acts as the gatekeeper in the transfer of natural gas from Russia to Europe, but the completion of Nord Stream 2 will enable Russia to go through the Baltic Sea, bypassing Ukrainian land and the accompanying US$2-3bn-worth of transit fees every year. In 2018, Gazprom supplied Europe with more than 200bcm of gas, of which 87bcm went through Ukraine. The Nord Stream 2 route crosses the Exclusive Economic Zones or territorial waters of Russia, Finland, Sweden, Denmark and Germany instead of going via Ukraine like many Russian gas pipelines currently do.
Evghenia Sleptsova, senior economist at Oxford Economics, tells GTR: “On the one hand, the Nord Stream 2 pipeline allows Russia to ensure a more undisrupted trouble-free supply stream to Europe and on the other, it is hurting Ukraine economically. It is a two birds with one stone situation. It will be painful for Ukraine to stop seeing transit flows through its territory.”
The operational date for the pipeline also coincides with the expiry of the 10-year transit contract between Ukrainian and Russian-owned energy giants, Naftogaz and Gazprom, meaning there is no contractual agreement binding Gazprom to transit a minimum volume of gas through Ukraine. However, Gazprom says: “Nord Stream 2 alone will not be able to meet all demand for gas, let alone replace existing transit capacity in Ukraine, which will continue to play a role.”
Last year, Maros Sefcovic, vice-president of the European Commission for energy, floated a proposal for a new 10-year contract between the companies that guarantees a minimum annual transit volume of 60bcm of gas, with flexibility for an additional 30bcm. But Russia is yet to agree, and if a new deal is not decided, the loss of transit fees would hit Ukraine’s economy hard – in 2017, the country earned around 3% of GDP from Russian gas transit fees. “This is not only a matter of energy security, it is a geopolitical issue,” Ukraine’s President Volodymyr Zelensky said of the pipeline at a press conference in Kiev in October after the Danish permit was granted.
In November, Sweden’s Court of Appeal upheld the March 2018 ruling by the Stockholm Arbitration Court that ordered Gazprom to pay more than US$2.5bn to Naftogaz over a contractual dispute involving the supply and transit of gas. Sleptsova says that this ruling will no doubt have angered Russian authorities and added more fuel to the current situation; Gazprom has said it will only sign a new transit deal if the fine is waivered by Ukraine.
Pipelaying operations began in the Baltic Sea for Nord Stream 2 in September 2018, but despite plans to complete construction in 2019, it remains unfinished because of push-back from the EU.
Increasing concern regarding the environmental impact has also hindered the project. In 2017, Greenpeace Russia filed a lawsuit in the Supreme Court to challenge the regulatory procedure of projects like Nord Stream 2. It wrote on its site at the time: “As if fossil fuels weren’t bad enough already. Now Gazprom wants to build the Nord Stream 2 gas pipeline through the unique Kurgalsky Nature Reserve. We can’t let that happen.” Any further delays benefit Ukraine as Russia is forced to negotiate a transit deal to get gas to European customers. “This is a crucial time, it really is whether Ukraine and Russia can negotiate. The earliest Nord Stream 2 can be finished is mid-2020 and that is an optimistic scenario,” Sleptsova adds.
It is no secret that the tension between Russia and Ukraine runs deeper than gas. Since 2014, Ukraine has been in a bloody battle with Russia over Crimea and parts of the east of the country, which has killed 13,000 people and displaced millions, according to the UN. “Russia has had conflicts with Ukraine and gas has sometimes been used as a lever to achieve political goals. Pipelines often become heavily wrapped up in geopolitics,” she says.
Using gas as a political tool in this way has resulted in disrupted supply. In 2006, friction over gas prices between the two countries led to Europe being cut off from gas because Russia reduced supply through Ukraine after it accused the country of withholding gas destined for Europe. Several similar disputes have occurred since.
Another new gas pipeline threatening Ukraine is TurkStream, which stretches from Russia to Turkey through the Black Sea. Turkey is an important market for Russian gas, and it is the second biggest importer of Gazprom gas in Europe, behind Germany. The first and second strings of TurkStream will each have the capacity to transport 15.75bcm of gas a year.
Financing Nord Stream 1 and 2
In terms of funding, it has been reported that Paul Corcoran, chief financial officer of Nord Stream 2, has been in discussions with export credit agencies (ECAs) to cover a portion of the financing. However, a spokesperson for the €9.5bn project tells GTR that this is not the case and that “approximately 85% of the financing requirement has already been provided by the shareholder and financial investors. The existing long-term financial agreements provide the necessary framework for the project implementation.”
A different approach was taken to fund the first Nord Stream project, which cost €7.4bn. Nord Stream’s shareholders provided 30% of the project costs through equity contributions proportionate to their shares and the remaining 70% came through project financing via banks and ECAs. Gazprom holds a majority stake (51%) in the Nord Stream 1 project, German energy companies Wintershall and PEG Infrastruktur, a subsidiary of Uniper hold 15.5% each, and the Dutch firm NV Nederlandse Gasunie, along with French energy provider Engie, have a 9% stake.
Nord Stream closed a €3.9bn debt financing for phase one of the pipeline project in March 2010. Italy’s ECA Sace provided a loan guarantee on a €500mn tranche, while Euler Hermes covered a €1.6bn portion. A further €1bn tranche was guaranteed by the German government’s untied loan guarantee programme, known as UFK. The uncovered portion of the deal totalled €800mn, carrying a tenor of 10 years.
In March 2011, Nord Stream revealed it had secured a further €2.5bn for the second phase of the project. The funding saw participation from 24 banks. ECAs Euler Hermes and Sace, with support also coming from UFK, provided €1.75bn in cover for the deal. RBS, Commerzbank and Société Générale acted as financial advisors.
Since the start of operations in 2011, Nord Stream has steadily increased the volume of gas transported year by year, reaching pipeline capacity in 2018. In August 2019, the project hit a major milestone: more than 300bcm of natural gas delivered from Russia to the EU through the Baltic Sea.
Parties in favour of Nord Stream 2
Germany is the largest buyer of Russian natural gas and it bought more than 50% of Gazprom’s gas exports to Europe in 2018. Second to Germany was Turkey at 24% and the third largest importer was Italy at 22%. Germany is in favour of Nord Stream 2 as it is in the country’s economic interest for the project to be operational. “Germany has practical considerations: the pipeline would go through the Baltic Sea directly into Germany, powering its manufacturing sector. It also gives the country more control of European gas. They could sell part of that Russian gas to other European countries,” explains Evghenia Sleptsova, senior economist at Oxford Economics. However, the German government has said Nord Stream 2 will only go ahead if Gazprom also continues to transit gas through Ukraine.
European businesses have invested in the pipeline and view it as a key enabler of securing future energy as the pipeline’s route through the Baltic Sea is the most direct link between gas reserves in Russia and the EU. The project has been designated as being of “European interest” by the European Parliament and Council.
Parties in opposition to Nord Stream 2
EU countries say the pipeline will make the bloc more dependent on Russian gas and decrease energy security, with member states previously considering taking action to axe the project. They have now agreed to bring the pipeline under tighter legislation.
Poland’s anti-monopoly regulatory body UOKiK says it has fined France’s Engie, one of the firms financing the pipeline, US$44mn as part of action against Gazprom. The government agency says Engie has refused to provide it with documents about the deals it signed with the Russian gas supplier, and is concerned about Russia’s dominance on the market.
“There are other countries in Europe which don’t want to see European dependence on Russia increase: Poland, Slovakia, all of the Eastern European countries, apart from the southern countries like Romania and Hungary,” says Sleptsova. “The Eastern European countries see it as political, and they are concerned about how it might turn out in the future. High dependency on Russia can be problematic and painful. There has been pressure within the EU to either not allow it or delay it. But it is a project that is too advanced to be stopped.”
The US believes the pipeline will tighten Russia’s grasp over the region’s energy supply and reduce its own share of the European market for American liquefied natural gas (LNG). US President Donald Trump says the pipeline could turn Germany into a “hostage” of Russia. Sleptsova says: “Certainly it would allow Europe to buy less of American LNG, which is more expensive, so that is another economic consideration for Europe.” The US has been trying to impose sanctions on providers that are involved in Nord Stream 2. However, whoever they attempt to sanction has arrangements in place for the pipeline to be finished, she says.