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    Gazprom Soldiers on With Nord Stream II

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Summary

Five international giants in the natural gas industry pulled out of an agreement to join Gazprom in the Nord Stream II AG consortium. This could have serious consequences across Northern and Central Europe.

by: Stratfor

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Top Stories, Europe, Global Gas Perspectives, Corporate, Import/Export, Political, Regulation, Infrastructure, , Nord Stream 2

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Gazprom Soldiers on With Nord Stream II

Poland has achieved a significant victory in its battle against German and Russian energy collaboration. Daunted by Polish regulations, five international giants in the natural gas industry announced Aug. 12 that they had pulled out of an agreement to join Russian state-owned gas company Gazprom in the Nord Stream II AG consortium. The consortium, which Gazprom currently owns in its entirety, will oversee the construction and operation of the controversial Nord Stream II pipeline, set to enter service in 2019. The pullout leaves Gazprom to move forward with the 55 billion-cubic-meter natural gas pipeline project, estimated to cost between $8 billion and $11 billion, by itself, and it could have serious consequences across Northern and Central Europe. Even so, Gazprom will persevere.

Analysis

Germany has been one of the strongest supporters of the Nord Stream II project. The proposed pipeline would replace the transit agreement between Kiev and Gazprom, which expires in 2019, moving natural gas from Russia to Europe while skirting the aging infrastructure and politically delicate situation in Ukraine. To do this, it would traverse Germany to supply natural gas to the Austrian hub of Baumgarten.

For Poland, this is a problem. As it stands, Germany and Russia are Poland's only options for natural gas. A closer relationship between those two countries would give them greater leverage over Poland. Moreover, the country does not want Gazprom to be able to send more natural gas to Germany without it first passing through its borders, since otherwise, Gazprom could conceivably cut off natural gas supplies to or negotiate harder terms with Poland. Gazprom has argued that building new pipelines would be cheaper than rehabilitating and modernizing the Ukrainian route, a claim that many of Nord Stream II's opponents, including Poland, find suspect.

 
Though the consortium was registered outside Poland, it was nevertheless subject to the country's anti-competition rules, since the companies involved all do considerable business there. For months, Gazprom and its former partners have worked to get the approval for their consortium from Urzedu Ochrony Konkurencji i Konsumentow (UOKiK), the government body in charge of regulating competition in Poland. Originally scheduled to rule on the partnership agreement in June, UOKiK delayed the decision until Aug. 31 before issuing a statement of objections to the consortium's prospective members in July. According to the statement, UOKiK found that the agreement and resulting consortium would strengthen Gazprom's advantage in the Polish natural gas market and limit competition in the sector. UOKiK gave the partners four weeks (until Aug. 19) to respond to the objections, but the Western companies — Uniper, Engie, OMV, Royal Dutch/Shell and Wintershall — evidently felt they could not meet the regulators' demands under the current agreement and decided to pull out.
 

A Series of Hurdles

Despite the uncertainty surrounding the project, Gazprom has prioritized Nord Stream II, diverting money toward it even at the expense of other projects, such as the extension of the Power of Siberia pipeline into China. The company must now decide whether to proceed with the pipeline project on its own or try to build another consortium with a different structure to implement it. In the meantime, it has been moving forward, issuing tenders for pipe and discussing financing options internally and with the Kremlin. (Nord Stream II AG was likely planning to fund about 30 percent of the project by itself, borrowing the rest from financial institutions.)

Even if it does not find other partners quickly, Gazprom can afford to keep going with the project on its own for now. Though pipe deliveries are set to begin in September, construction on the two pipelines that will form Nord Stream II is not scheduled to start until 2018. By then, Gazprom's resolve to build Nord Stream II may have wavered, depending on whether it feels that other projects — for instance, the TurkStream pipeline — are more important. The recent reconciliation between Turkish President Recep Erdogan and Russian President Vladimir Putin has revived talks over TurkStream, which were derailed in late 2015 when Turkey downed a Russian fighter jet.

As big an obstacle as Poland's UOKiK has been for Gazprom, the company faces even greater obstacles. The European Commission is currently deciding whether offshore pipelines fall under the Third Energy Package regulations, which prohibit companies from owning the pipeline through which they transmit and sell their own natural gas. The German government, Gazprom and its former Western partners have all argued that the existing legislation does not apply to offshore pipelines, but the European Commission has no official position (it was supposed to make a ruling in July). If the commission decides that that the Third Energy Package regulations apply to Nord Stream II, the project will be even more difficult to advance. (Germany will likely continue to pressure the European Commission to avoid such an outcome.) Securing downstream infrastructure to support Nord Stream II will also pose a challenge. The Nord Stream I pipeline, which follows roughly the same route, is currently limited to roughly 75 percent capacity because of the Third Energy Package and similar regulations.

Risks Worth the Reward

These complications stand to stymie Russia's efforts in Northern and Central Europe. New supplies from global liquid natural gas markets, including Central Asia, and EU regulators' success in preventing monopolies from developing in any single country​ have made the European natural gas market more competitive. Facing growing competition, Gazprom is working to improve its capacity to deliver natural gas to Europe at a lower cost and with more flexibility than it has now with the Ukrainian pipeline. Much of Nord Stream II's intent was to supply Germany and its neighbors with natural gas using a more direct, and potentially cheaper, route than the one through Ukraine.

Beyond its economic benefits, the proposed pipeline has political implications, too. Now that Ukraine can source nearly all of its natural gas from European countries, Moscow no longer enjoys the power that it once had over Kiev (though, ultimately, the natural gas is still Russian). Russia does not want to do any favors for a Ukrainian government that is not under its influence. Unless Gazprom builds an alternative pipeline to Europe, Ukraine can use the existing route as leverage in negotiating with Russia. This is a political and financial vulnerability that neither Moscow nor Gazprom can afford.

Poland has fought long and hard against Nord Stream II. And though its competition regulations have driven Gazprom's Western partners out of the deal, it appears that progress on the pipeline will continue, for now. For Gazprom, the project's difficulties are just another in a series of challenges that it has faced in the past decade as it tries to shed its reputation as Moscow's political pawn in Europe.

Natural Gas Europe is pleased to provide this article in cooperation with Stratfor, a Natural Gas Europe Knowledge Partner.  For more visit www.stratfor.com Follow Stratfor: @stratfor on Twitter | Stratfor on Facebook 

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