Diversification of gas supply sources and routes in the EU: How not to saw off the bough on which one is sitting?
When discussing design of EU natural gas market one of the major initial questions which arises is - what are the forecasted needs of the EU forthis commodity? On the one hand there is a long-term political aim of decarbonization, constantly proclaimed by the EU against a backdrop of the recent surge in coal consumption,on the other hand, there are factors which objectively support increasing role of EU gas import in theEU gas balance. Even if gas demand in the EU stagnates, import is likely to increase due to sharp decline in the domestic production. It is well known that both leading international energy analytical centers and the European Commission conceptually agree that by 2030-2035 the EU will need additional imported gas. It is also clear that in order to bring that additional gas to the market, relevant import capacity – be it pipelines or regasification terminals – shall be timely in place.
Since 2009 after the second Ukrainian gas transit crisis, the EU amended its energy policy by giving clear priority to the infrastructure projects aimed at diversification of gas supply sources. The main priority was given to the Southern gas corridor projects and to LNG projects. In 2010 the Commission proclaimed that by 2020 the Southern corridor shall bring gas covering 10-20% of the EU overall demand. Various Southern corridor and LNG projects were labeled “projects of common interest”, received regulatory and financial support from the EU and state aid from separate Member States. However these diversification efforts have not met the planned objectives. The Southern gas corridor in its current configuration, if successful, will bring only 10 bcm. of gas in 2020 (around 2% of EU demand, i.e. 5 times less than the planned objective) . As regards LNG receiving terminals – many were built but they still stay heavily underutilized; price of new LNG imported by certain Member States resulted higher than price of pipeline gas while volumes and commercial terms of LNG from new sources are not fully clear. At the same time there are well-known problems with production and supply of gas from such traditional partners of the EU as Norway, Algeria, Libya and Egypt.
Therefore, a role of Russian supplies in satisfaction of European gas needs would remain important and at least in midterm-perspective the overall share of Russian gas in the EU mix is not likely to decrease.
Due to Ukrainian transit crisis in 2009 the Russian supplier suffered huge damages because during almost two weeks in the middle of the winter it was not able to fulfill its gas supply obligations to the EU customers. In order to be able to cover the gas demand according to the contract obligations and to compete amongst others for additional import needs of the EU, the Russian gas supplier since 2009 has been persistent in continuing itsefforts to build new gas pipeline routesbypassing Ukraine and directed both at South-Eastand North-Westof Europe.As such, Nord Stream-1 was put into operation in 2011-2012. South Stream was completely ready for construction by 2014: final investment decisions were taken and all necessary contracts concluded. Nord Stream-2 was initiated in 2015 by signing the shareholders agreement.
All new Russian pipeline projects share a number of common features.They have a secured long-term access to vast Russian gas resources which the Russian sponsor is eager to monetize. They are aimed at shortening distance of transportation to the market. They are supported by major European energy companies which participate asshareholders in the project companies. They are based on project financing which means that they are purely commercial because this sort of financing is not available to non-commercial projects. Last but not least they cost “zero” to the EU gas customers because their costs are not “socialized” compared to what can be currently witnessed at the European infrastructure market.
Against this background common sense would justify at least tolerable if not privileged attitude of the EU institutions towards these new Russian projects. However when big politics comes into play common senseappears to be not the main argument.
Since at least 2011 the Commission officially promotes the idea on the need to maintain Ukrainian transit route for Russian gas supplies to the EU. Initially the Commission recognized that maintaining Ukrainian transit role depends on establishing trilateral mechanism among the EU, Ukraine and Russia to control transit flows.
However since 2014 when after Ukrainian coup d’etat and reunification of Crimea with Russia relations between the EU and Russia worsened and the Commission’s rhetoric has changed. It now defends role of Ukraine as an “important transit state” without linking this role to the trilateral mechanism.
In other words political desire of the Commission is to force the Russian supplier to transit gas through Ukraine after the end of 2019, when the current transit contract between Gazprom and Naftogazends.
This political stance of the Commission is difficult to explain by security of supply considerations because since 2009 risks associated with transit of gas through Ukraine have significantly increased, which is illustrated by the following facts:
- Physical security of the transit system may not meet a “stress-test” of increased utilization. Huge investments are needed to repair and maintain Ukrainian transit system (as of 2011 the report of Mott MacDonald showed the figure of around 8 bln. USD for 7-10 years) – and such investments are absent.
- Political unpredictability and “frozen” military operations in the country.
- Enactment of Law authorizing Ukrainian Security Council to cease at its discretion transit of Russian gas through Ukraine.
- Multibillion arbitration cases between Gazprom and Naftogaz on supply and transit issues.
- Administrative acts of Ukraine to unilaterally (outside arbitration) increase gas transit tariff 1,5 times as compared to contractually agreed tariff.
- Imposition by Ukrainian antimonopoly committee of 3,4bln. USD fine on Gazprom for alleged abuse of dominance on “Ukrainian market of gas transit services” (which Gazprom has never rendered but only received).
- Last but not least, lack of trust between the parties which hinders prospects of mutually acceptable decision by the end of 2019.
The Commission’s non-supportive attitude to the Russian projects seems to be the opposite side of its political will to maintain the Ukrainian transit role. Although the Commission has limited legal instruments to hinder the projects, it combines them with various political means.
In 2009 the Commissionrestricted the Russian supplier’s right to use more than 50% of OPAL - Nord Stream-1 onshore prolongation. This restriction could be lifted only if Gazprom performed a gas release of 3 bcm. per year during 22 years at conditions imposed by the regulator. The rigidity, volume and term of this gas release became unprecedented in the EU practice and finally it was reviewed in 2013 in the course of EU-Russia Energy Dialogue. However the whole 2014 the Commission delayed approval of this solution due to political reasons and finally stopped the approval process. Therefore Nord Stream - 1 and its onshore prolongation remains half underutilized.
In 2011 and 2012 the Commission blocked the Russian initiative to conclude EU-Russia international agreement on cross-border energy infrastructure which could serve as a set of commonly agreed rules. Two drafts of the agreement delivered by Russia to the Commission received no positive response.
In 2014 the Commission triggered suspension of the South Stream Project.Initially it claimed that intergovernmental agreements on the project were not in line with the Third Energy Package but pretext for suspension was different – alleged breach of public procurement rules. In its non-binding letter opening the infringement procedure against Bulgaria the Commission asked Bulgaria to suspend the project while the procedure was ongoing. Before sending the letter the President of the Commission visited Sofia where he advised Bulgarians to be “cautios with Russian projects” and reminded about “Russian agents” active in Bulgaria. The Bulgarian Prime-Minister announced its consent with the Commission’s request immediately after meeting with U.S. senators. In fact this decision meant that the schedule of the project becamе completely unpredictable because the infringement procedure has no fixed time limits (they are determined by the Commission). In such environment it was not possible to maintain resources dedicated for the project and the Russian side announced its termination.
In respect of Nord Stream-2 project the Commission stated in 2015 that the EU attitude towards this project shall depend not only on its compliance with the legislation, but also on its compliance with “key principles of the Energy Union”.
This statement is tricky due to a number of reasons. First, neither principles nor objectives of the Energy Union are clearly defined (the paper outlining strategy of the Energy Union uses a word “dimensions” but does not set principles or objectives). Second, even if they were defined the Commission has no powers to conduct assessment of compliance with such principles. Third, the consequences of assessment are not clear: what happens if the project is compliant with law but not compliant with the “key principles”?
Nevertheless, the Vice-President of the Commission has already openly concluded that Nord Stream-2 is not compliant with “the Energy Union objectives”. He also mentioned that pipeline projects aimed at exclusion of Ukraine as a transit state “will not be acceptable for the EU”. Although these are personal views of one of the officials, they demonstrate quite an alarming trend of excess of administrative powers.
Negative political statements of high-ranked Commission’s officials in respect of the commercial project pose risks for its impartial legal assessment. As it recently became clear from the press, the Commission’s Directorate for Energy pushes its own – quite“innovative” – viewon applicability of the Third Energy Package to the off-shore pipelines, which appears to be different from the Commission’s Legal Service’s opinion. It is reported that the DG Energy tries to extend EU energy acquis over Nord Stream-2. It can only be explained by the political will to hamper the project. The reason for this is that neither the text of the Gas Directive, nor practice of its application supports its extension over offshore import pipelines coming from third (i.e. non-EU, non-EEA, non-Energy Community) states. No single offshore pipeline running from North Africa through Mediterranean seato the EU shore has been required to comply withthe Gas Directive. The international law on seas confers to coastal states strictly limited rights toregulate pipelines in the exclusive economic zones/ continental shelfs, and these rights do not include such type of regulation as the Gas Directive. Logic and common sense also advocates against operation of third party access principle in the maritime zones.
It is clear that administrative practice which aims at or results in hindering particular commercial projects may raise concerns as regards compatibility with certain basic legal principles among which are equal treatment, legal certainty, protection of legitimate expectations, reasonable administration, freedom of commercial activity, proportionality and subsidiarity.
In the EU context the latter principle is crucially important. Though the Commission persistently tries to extend its energy competences within the Energy Union initiative (including by recently published “security of supply package”), these intentions have natural limits. Under Treaty on the Functioning of the EU Member States retain exclusive powers over their national energy mixes and structures of energy supply. Security of energy supply is not defined in the EU law and Member States retain large degree of freedom to define it at national level choosing those projects which in their view are better for this purpose.Ultimately Member States remain responsible for secure supplies to their companies and citizens.
In conclusion let’s try toanswer the question formulated in the Russian proverb mentioned in the titleof thisarticle byusing the following metaphor. Imagine, the EUis a living house composed of twenty eight flats where different inhabitants live. The Commission is a guard in this house. The Russian supplier as well as suppliers from other countries isa guest-visitor to this house. If a guest comes under an invitation from one or several inhabitants and the guardtells him “I do not like you, go away, because I prefer another guest”, there is an issue. If however the guard readily opens the door to all the guests who have invitations, he does his job right. In such case the bough from the proverb will not be cut and one will not be exposed to a risk of falling down from the tree.
Associate professor at MGIMO-University
The views expressed in this article represent personal views of the author and do not reflect official position of any entity or organization. This article is prepared on the basis of the author’s report to the Global Gas Center Meeting (Paris, March, 10, 2016).
 Communication from the Commission to the European Parliament and the Council.European Energy Security Strategy.Brussels, 28.05.2014.COM(2014) 330 final. P. 15.
 Communication from the Commission to the European Parliament, the Council, the European Economic and Social Committee and the Committee of the Regions “Energy Infrastructure priorities for 2020 and beyond — A Blueprint for an integrated European energy network”. Brussels. COM (2010) 677/4.P. 32.
 R.Dickel, E.Hassanzadeh, J.Henderson, A.Honoré, L.El-Katiri, S.Pirani, H.Rogers, J.Stern, K.Yafimava.Reducing European Dependence on Russian Gas: distinguish-ing natural gas security from geopolitics.OIES Paper: NG 92, October 2014. P.1.
 Communication from the Commission to the European Parliament, the Council, the European Economic and Social Committee and the Committee of the Regions on Security of Energy Supply and International Cooperation – “The EU Energy Policy: Engaging with Partners beyond Our Borders”. Brussels, 7,9,2011. COM (2011) 539 final.P.5.
 COMMUNICATION FROM THE COMMISSION TO THE EUROPEANPARLIAMENT, THE COUNCIL, THE EUROPEAN ECONOMIC AND SOCIALCOMMITTEE, THE COMMITTEE OF THE REGIONS AND THE EUROPEANINVESTMENT BANK - State of the Energy Union 2015 Brussels, 18.11.2015COM(2015) 572 final p.10.
 S.Pirani, K.Yafimava Russian Gas Transit Across Ukraine Post-2019: pipeline scenarios, gas flow consequences, and regulatory constraints. OIESPAPER: NG 105, February 2016.
 Жозе Баррозу: «Южный поток» не приоритет для ЕС. Русская Болгария. 07.04.2014 // http://rus.bg/ekonomika/100-ekonomika/8637-zhoze-barrozu-juzhnyj-potok-ne-prioritet-dlja-es
 COMMUNICATION FROM THE COMMISSION TO THE EUROPEANPARLIAMENT, THE COUNCIL, THE EUROPEAN ECONOMIC AND SOCIALCOMMITTEE, THE COMMITTEE OF THE REGIONS AND THE EUROPEANINVESTMENT BANKState of the Energy Union 2015 Brussels, 18.11.2015COM(2015) 572 finalP.11.
 Sefcovic: Nord Stream is not in conformity with the Energy Union’s goals. 11.02.2016 // https://www.euractiv.com/section/europe-s-east/interview/sefcovic-nord-stream-is-not-in-conformity-with-the-energy-union-s-goals/
 Брюссель задул в украинские трубы. Еврокомиссия против новых проектов "Газпрома" // Коммерсант. 16.07.2015.
 A.Gurzu Legal opinion undermines EU's ability to block Nord Stream pipeline. 07.02.2016 Politico Krukowska Russian Gas Link Extension May Face EU Law Compliance Risk. 04.02. 2016 BloombergBusiness // http://www.bloomberg.com/news/articles/2016-02-04/russian-nord-stream-2-gas-link-may-face-eu-law-compliance-risk