Ben Aris in Berlin -

The gas row between Russia and Ukraine has given new impetus to the Nord Stream pipeline project, which will bring Russian gas to the German coast in 2011. But as the first new pipeline to be built between Russia and Europe since the fall of communism, Nord Stream can only meet rising demand and won't provide an alternative to gas transit through Ukraine.

Millions of European homes were freezing in the middle of January as gas supplies dropped off to nothing during a nasty cold snap and accusations traded between the two combatants became ever more nasty.

The Kremlin and the EU have been calling for a "diversification of energy supplies," but the truth is that rising energy consumption in Europe means the new routes on the table will struggle to simply meet rising demand, let alone create alternative supply routes to existing pipelines.

In the latest instalment of what is turning into an annual circus, Russia is over a barrel as the state-owned gas monopolist Gazprom has almost no alternatives to sending its gas via Ukraine. The volumes of gas routed via Beltransgas pipelines that pass through Belarus were quickly increased to a maximum in January, but as 80% of Russia gas goes through the "friendship" pipeline in Ukraine, the increases to the Belarusian route made little difference.

Nord Stream will be the first new pipeline of significant capacity to provide Russian gas to western Europe when it is planned to start operating in October 2011, running from Russian gas fields in northwest Russia under the Baltic Sea to terminals on Germany's Baltic coast.

There have been reports that this year's row with Ukraine will push Russia to get Nord Stream online more quickly and others that the international financial crisis has endangered its chances of raising billions of dollars in finance needed to complete the project. Both are wrong. "All the agreements are in place and the environmental assessments are done. We are going to submit them in the coming months and expect them to be accepted," says Maud Hanitzsch, spokesperson for Nord Stream.

Countries like Poland and the Baltic states have complained loudly about being bypassed by the sub-sea route and have thrown up objections based on environmental grounds. However, Nord Stream says the company is confident these problems can be solved. "It will happen, as this project has been given a priority by the EU and the current political environment can only serve to push it forward," says Hanitzsch. "The situation [on the financial markets] could be easier, but this is a long-term energy project and there is real interest by the banks.

Demand driven

Russia's run-in with Ukraine has refocused everyone's attention on gas pipes, but the crisis itself will make little difference to plans to build new pipelines. "The current crisis confirms that there is a need for a true diversification of the ways to deliver our energy resources to the main consumers in Europe," Russian Prime Minister Vladimir Putin said at a joint news conference with Czech Prime Minister Mirek Topolanek in Moscow in January.

But comments like these are so much hot air. When finished, Nord Stream will deliver 55bn cubic meters (cm/y) of gas to Germany a year (27.5bn cm in each of the two pipelines). However, the EU estimates that as soon as 2025 there will be a shortfall of 200bn cm/y of gas between what Russia is delivering and Europe is consuming.

Some analysts have suggested the Russians are happy with the Ukrainian row, as it supports the development of Nord Stream, but this is to miss the point: the EU's own insatiable appetite for gas is all the support the pipeline needs. "Nord Stream will cover a quarter of this shortfall, but the rest will have to be made up by other projects like the Nabucco pipeline or liquified natural gas (LNG) projects," says Nord Stream's CFO Paul Cororan.

Putin also highlighted the need to build the less-advanced South Stream gas pipeline across the Black Sea and southern Europe, as well moving ahead with plans to liquefy gas which can be transported by ships, not pipes, worldwide. Russia has one LNG facility in the Far East region and Gazprom has plans to build another LNG in Russia's northwest, but progress has been slow and the cost of these plants runs into the tens of billions of dollars so it could be several years before any facilities appear.

A matter of financing

Nord Stream is a joint project of four major companies: Gazprom with 51%, two German companies BASF/Wintershall and E.On Ruhrgas have 20% each and Dutch company Gasunie owns the remaining 9%. The total project cost is estimated to be €7.4bn. The shareholders have committed to contribute 30% of this as equity and already transferred €1.3bn in 2008. After the company receives another €300m this year - with Gazprom contributing half - all the shareholders' money will be in.

Construction will be in two phases, with construction of the first of two parallel pipes starting after the winter in 2010 with the first pipeline due to come on line in October 2011. The contractors for this work have already been chosen and orders are already placed. Work on the second pipe is slated to start in 2010 after the second round of financing has been put in place.

The remaining €5.2bn will be raised from the capital markets and comes as a pretty attractive package. The company is in the last stage of raising the financing, which Nord Stream says will be in place by the third quarter of this year. Pretty much all banks that consider themselves to be significant players in project finance - some 30 in all - are expected to present bids. If anything, the crisis has enhanced the project's chances of being financed, rather than damaging it. "In the past, the financing for a project such as this would have been underwritten by three-four major banks, but since the onset of the credit crunch the trend has increasingly moved towards club-style transactions involving a large group of banks acting at senior level," says Graham Lofts, who heads up the corporate and strategic finance unit at Dresdner Kleinwort.

Much of this money will be spent on the physical pipes. Germany's Europipe has already won a big chunk of the pipe deal and the half the financing needed to cover its costs will be guaranteed by the German export credit agency (ECA). Likewise, Italian companies will do a significant amount of the work and also have half their costs guaranteed by SACE, the Italian ECA. The contracts for the second pipeline haven't been decided yet.

Margins that banks add to a deal for the unsupported part of it have increased significantly, but the rise in costs has largely been compensated by the drastic fall in interest rates as central banks around the world slash rates to stimulate growth While banks have less money to invest, they still have some and in these tough times they are looking for solid, and more importantly safe, projects to invest into. "The liquidity for our project is there. Banks have less money, but there has been a flight to quality and the Nord Stream project is of the highest quality," says Cororan.

Dresdner Kleinwort, along with the Royal Bank of Scotland and Societe General, is advising Nord Stream on raising the money and confirms there is real appetite for the project. "This is one of the most bankable energy projects that is going to come onto the market in 2009," says Lofts. "It is essentially an infrastructure project, which means there is no market risk, no exposure to gas prices risk - only a nice steady and predictable revenue stream that depends on the booking of pipeline capacity. If this project doesn't get financing, it is hard to see what project could get financing this year."

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