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June 29, 2020

Nord Stream II: A battle the US can lose

By Market Line

A new round of US sanctions on the Nord Stream II was proposed in early June in the effort of the US administration to prevent increased Europe’s energy dependence on Russia

The US views Europe’s increasing energy reliance on Russia as a threat to regional security and the Nato alliance. However, for Germany and other EU countries, North Stream II is seen as a vital project that will secure energy needs.

The US administration may have stopped the construction of the North Stream II a few months before the project was due to be completed, but the German Government, under the coalition of the EU, has declared ready to defend against new sanctions that could kill it off.

Germany and EU countries cannot abandon Nord Stream II

There is no doubt about the significance of the Nord Stream II pipeline for Germany and the rest of the EU countries, which are reliant on imports of natural gas. Nearly 75% of their consumption is covered by imports with the Netherlands being the only significant net exporter of gas within the EU.

While demand for natural gas in Europe is set to increase, domestic production in the EU, as well as in EU’s primary supply partner Norway will continue to decline as reserves deplete and transition to renewable energy sources increases.

It is especially a problem for Germany, where domestic production can only fulfil 7% of demand. Meanwhile, Germany’s need for natural gas will continue to increase by the growth of its industrial output and the replacement of its coal-fired power plants. These demand and supply conditions are projected to create an energy shortage of at least 30%.

An increase in gas supply from Russia to the EU through the Nord Stream II pipeline is the most economically efficient solution to fill this gap, unlike rival gas supply through liquefied natural gas (LNG) imports from the US and Qatar.

What the new EU Gas Directive means: More leverage for Germany and the EU

In May 2020, Germany denied a waiver to Gazprom over amendments to the EU Gas Directive that require separate ownership of gas supply from pipeline transmission (unbundling) even for non-EU entities exporting gas to its jurisdiction. This regulatory change implemented a year ago is controversial for Gazprom given that only 4% of the pipeline is located in the EU territory, hence, it was interpreted as an effort to conform with the demands of the US administration.

However, the amendments of the EU Gas Directive did not aim to cancel the project, but only to increase the bargaining power of Germany and the EU against Russia. Without regulation amendments, Gazprom would be the sole owner, operator and gas supplier of the pipeline. But now it will have to split its operations by either giving up the control of the infrastructure or the monopoly over supply. Since it is Gazprom’s gas that can only be transmitted through this pipeline as the company has de facto and de jure monopoly on Russian gas exports, Gazprom will most likely be forced to sell or transfer the control of the pipeline to another (local) operator.

A win-win for EU and Russia that defies US sanctions

Gazprom has already appealed against the non-waiver decision of the German regulator. Although the basis of its claim over a discriminating policy is valid – given that in similar cases such as Sonatrach and the Trans-Mediterranean Pipeline – there has been no compliance – Gazprom is expected to accept these terms.

The threat of US sanctions that could kill off this project serves as a weapon for Germany, exerting pressure to Russia to accept new terms, which might be less beneficial, but still better than abandoning the project.

Ultimately, this is a win-win situation both for Russia and Germany. Russia gains a valuable stream of income to stabilise its economy, while Germany and the EU make the most out of the situation, securing its energy sufficiency and safety.

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