ALACO DISPATCHES: Russian pipeline dispute escalates as US enters the fray

ALACO DISPATCHES: Russian pipeline dispute escalates as US enters the fray
The Senate proposed new sanctions on companies investing in or supporting the construction of Russian energy export pipelines such as Nordstream 2.
By Yigal Chazan of Alaco June 26, 2017

Brussels is attempting to mediate in a European dispute over Russia’s Nordstream 2 pipeline, just as the US considers new sanctions against Moscow that could threaten the controversial $10.6bn project.

European Union countries are deeply divided about plans by Russian state-owned energy behemoth Gazprom to lay a second gas pipeline under the Baltic Sea connecting Russia with Germany.  Nord Stream 2 – with half its cost financed by five European energy firms – will potentially allow Moscow to considerably increase its stake in the EU gas market. 

Baltic and Central European member states are concerned that the EU is becoming far too dependent on Russia – which already supplies a third of its gas – and should seek to diversify energy sources. Poland has already attempted to stymie the project by blocking a move to fund it through a joint venture between Gazprom and its European energy partners. Western European states, especially Germany, meanwhile argue that the 1,200 kilometre pipeline, scheduled to be operational in 2019, will provide Europe with cheap gas.

The European Commission (EC), which shares the new member states’ concerns about Russian dominance in the region’s energy market, is nonetheless looking to mediate in the dispute by offering to negotiate an agreement with Moscow on the operation of Nordstream 2. But just as the EC seeks to do so, the US has entered the fray, potentially threatening European companies involved in the project.

In mid June the US Senate passed legislation imposing tougher sanctions on Russia for its alleged interference in the US elections, support for the Syrian regime and the annexation of Crimea. The bill, expected to be passed by the House of Representatives, includes measures that could penalise companies investing in or supporting the construction of Russian energy export pipelines.  It also puts existing sanctions against Russia into law, making it harder for President Donald Trump to ease them in the event of a rapprochement with Moscow. 

The Senate vote drew an angry response from Germany and Austria. In a joint statement, Sigmar Gabriel, the German foreign minister, and Christian Kern, the Austrian chancellor, said they could not accept the threat of "illegal and extraterritorial sanctions" against European companies. They declared the move had brought a “new and very negative quality in European-American relations”. 

The US is keen to export Liquefied Natural Gas (LNG) to Europe and Gabriel and Kern said the new sanctions were aimed at "squeezing out Russian natural gas from the European market" in favour of American LNG. The first two US shipments of LNG to northern Europe arrived in Poland and the Netherlands this month.

A concern shared by many in the dispute over Nord Stream 2, which would double Russia’s capacity to supply gas to Germany under the Baltic Sea, is its possibly damaging impact on Ukraine, already destabilised by Russia’s annexation of Crimea and its intervention in the Donbas. Moscow conceived the pipeline, along with the Turkish Stream pipeline, to lessen its use of Ukraine for the transit of gas to European markets.

Brussels is keen to see Russian gas flow through Ukraine, which earns $2bn annually in transit tax revenues, beyond 2019, when Kiev’s contract with Gazprom expires. Andriy Kobolyev, the CEO of Naftogaz of Ukraine, the state-owned energy company, believes the new pipeline may strangle his country financially. Brussels is also worried that it would reduce transit revenues for other Eastern and Central European countries.

In a sign of the heightened concern within the EU over the economic consequences of the pipeline, Donald Tusk, president of the European Council, reportedly wrote to the EC earlier this month warning that Nord Stream 2 would make the region more dependent on Russian gas supplies and allow Moscow to close down the transit route through Ukraine. His remarks came as the EC began the process of seeking a mandate from member states to negotiate a pipeline operation agreement with Moscow, which would address European reservations, in particular the question of transit revenues. 

Gazprom says it hopes Trump will reject the proposed new US sanctions, but some industry commentators have suggested that the company would likely go ahead with Nord Stream 2 even if the US restrictions prevent its energy partners from investing in the project. Of probably greater concern for Gazprom is European opposition. With Tusk indicating that he wants the EC’s mandate to be as demanding as possible, negotiations with Russia look set to be protracted.

Yigal Chazan is an Associate at Alaco. Alaco Dispatches is the business intelligence consultancy’s take on events and developments shaping the CIS region.