The European Commission’s agreement to the Nord Stream 2 pipeline signals Russia’s conclusive victory in its protracted struggle to secure its position as Europe’s principal gas supplier whilst retaining control of its energy resources.
April 4, 2017
Confirmation that the EU Commission has dropped its opposition to Nord Stream 2 – the giant gas pipeline Russia is building through the Baltic to supply natural gas directly to Germany – effectively ends whatever doubts previously existed about the project.
More importantly, it also means Russia has won the energy war, which has been raging around the issue of Russian gas supplies to Europe over the last decade and a half.
Nord Stream 2 is the second undersea gas pipeline directly linking Russia to Germany. It comes after Nord Stream 1, which was laid down in the late 2000s and completed in 2011, coming on stream in 2012.
The story of the export by Russia of gas to Europe is extraordinarily tangled and is scarcely ever discussed properly. This is unfortunate because in my opinion it is the single most important reason for the collapse in relations between Russia and the West since Putin came to power in 1999.
Following the collapse of the USSR in 1991 there was a general assumption in the West that Russia would become the major source of oil and gas for the European economy.
This went together with an assumption that Russia’s vast oil and gas fields would be developed and exploited by Western energy companies in much the same way that those companies had developed oil and gas fields in other places.
This was the period of the so-called “dash for gas”, with Europe’s coal industry – highly polluting and with a notoriously truculent and politicised workforce – being deliberately closed down in anticipation of a vast flow to Europe of cheap Russian gas.
It never quite happened that way. Even during the Yeltsin era resistance in Russia to the country ‘opening up’ its oil and gas fields to unrestricted development and exploitation by Western energy companies proved sufficiently strong to prevent it happening.
Following the change of government in Russia in 1999, with Vladimir Putin emerging as Russia’s leader, first as Prime Minister and then as President, the possibility of Russia ‘opening up’ its oil and gas fields to unrestricted development and exploitation by Western energy companies was finally and conclusively ruled out.
Putin at the time of his appointment was already known as someone who believed in the importance of Russia retaining control of its energy resources. Indeed Putin had actually written a doctoral thesis on the subject (a partial translation can be found here), which since his emergence as Russia’s leader (and especially after the Yukos affair) has been the target of hostile commentary (see for example here). Almost certainly the fact Putin was known to believe that Russia should retain control of its energy resources was one of the most important reasons so many people within the Russian leadership in 1999 backed him for Russia’s President.
Though the bitter hostility of the West to Putin has many causes, the anger caused by his role in closing Russia’s vast oil and gas fields to unrestricted development and exploitation by Western energy companies is in my opinion unquestionably one of the most important, and one that consistently gets underestimated.
Suffice to say that all the allegations that Putin is corrupt and a billionaire have their origins in stories which circulated in the early 2000s that the “real” reason Putin wanted to prevent Western energy companies from exploiting Russia’s energy wealth was because he wanted to keep this wealth for himself. In this way action which Putin took for patriotic reasons could be misrepresented as done for selfish ones. It is no coincidence that some of the very earliest claims made about Putin and his billions centred on false allegations that he owns hidden shares in Gazprom, Russia’s giant gas monopoly exporter, and that he is its actual owner.
This is not to say that Putin opposes all investment by Western oil and gas companies in Russia’s energy sector. On the contrary he not only wants such investment but he actively encourages it. However Putin has always insisted that this investment be controlled and regulated by the Russian state, and his strong preference is that it happen through collaborative joint ventures with Russian companies, especially Rosneft.
This was not what Western governments and Western energy companies had had in mind. Their conception was for something closer to what happens in some countries in what was once called the Third World, where Western energy companies run the show, exploiting the energy wealth of these countries as they please in their own and the West’s interests. Not for nothing were some calling Russia before Putin became its leader “Nigeria with snow”.
Western oil and gas companies, as the hardheaded and pragmatic people that they are, have long since reconciled themselves to the new reality. Companies like BP, Total and Exxon have long shown a willingness to work with the Russians on Russia’s terms. Indeed they have developed a genuine respect for the tough way the Russians negotiate to protect their interests and then stick by any agreements they make.
The same however has not been true of the more ideological and geopolitically minded officials in the West’s governments. The US and UK governments and the European Commission in Brussels in particular have been implacably hostile, doing everything they can to bring the Russians to heel so as to force them, in the euphemistic language they like to use, to liberalise Russia’s energy industry ‘upstream’ so as to match the liberalisation that supposedly already exists in the West’s energy market ‘downstream’.
The result has been a festering energy war between the West and Russia which has gone on for years, with Gazprom – Russia’s majority state owned monopoly gas exporter – the primary target.
Gazprom is regularly accused in the West of manipulating Russia’s gas exports in order to achieve Russia’s political objectives, and recently it has been the subject of legal action brought against it by the European Commission amidst allegations that it has abused its monopoly position to gain unfair commercial advantages in the European energy market.
The agenda – obvious to all informed observers though never openly stated – is to force the Russians to privatise Gazprom and to break it up, ending its position as a monopoly exporter of Russian gas, and opening up Russia’s gas industry to exploitation and development by Western energy companies regulated by the European Commission in Brussels.
In reality there is no evidence the Russians have ever used their energy exports to gain political advantages in Europe or anywhere else, and it would be completely counter-productive for them to try. As for the accusations that Gazprom abuses its monopoly position in order to gain commercial advantages for itself, these ignore the fact that Gazprom acts at all times as the export arm of the Russian state, giving its energy supply contracts something of the quality of interstate agreements rather than mere commercial agreements.
The primary tool used by the European Commission for its attacks on Gazprom is the EU’s Third Energy Package, which seeks the liberalisation of Europe’s energy market and industry by opening it up to competition. The European Commission insists this means Gazprom cannot have exclusive control of any pipelines it builds or operates on EU territory since supposedly that would be contrary to the Third Energy Package since it would give Gazprom an over-dominant market position.
The Russian government signed the Third Energy Package but in the end refused to ratify it. Russia has since repeatedly made clear that it does not consider itself bound by the Third Energy Package. The reason is that the Russians understand that if they accept the Third Energy Package the European Commission will in time try to extend it to Russia itself by demanding that the Russians ‘liberalise’ their energy industry ‘upstream’ by privatising and breaking up Gazprom and by opening up Russia’s oil and gas fields to Western energy companies in order to conform to the European energy market liberalised by the Third Energy Package ‘downstream’.
Behind this move and counter-move was a Western miscalculation that the EU had the whip hand over Russia because of the EU’s supposedly dominant position as Russia’s primary energy customer. Since it was assumed that the whole existence of the Russian economy depended on Russia selling its oil and gas to Europe, the Europeans assumed the Russians would eventually be forced to accept the Third Energy Package so that they could continue to sell their gas to Europe.
In December 2014 however the Russians proved this to be completely wrong when they abruptly cancelled the South Stream pipeline, which was supposed to supply gas through southern and eastern Europe, after the European Commission insisted that the Third Energy Package applied to it. Moreover the Russians not only cancelled South Stream but announced that they would no longer seek to build or operate gas pipelines on EU territory, and that instead of South Stream they would build a pipeline to Turkey instead, which is not a member of the EU and whose territory is not EU territory.
This Russian move came as a complete shock, provoking furious recriminations across the EU whilst demonstrating that the whole assumption that Russia so depended on Europe for the sale of its gas that it would eventually be brought to heel was completely wrong. On the contrary it turned out that it was the Europeans who depended on Russia for their gas, and not the other way round.
At this point it is necessary to say something about European efforts to ‘diversify’ away from Russian gas and their failure, and about the role of Ukraine.
As the energy war between the EU and Russia heated up from the mid 2000s, demands – many of them originating in Washington and London, even though the US and UK are not significant importers of Russian gas – for the EU to ‘diversify’ its gas imports away from Russia so as to reduce the EU’s supposedly dangerous dependence on Russia steadily built up.
These led to various schemes to reduce the EU’s ‘dependence’ on Russian gas, including the importing of liquified natural gas from the Persian Gulf and the US, the building of the Nabucco pipeline across Turkey and the Caucasus to Azerbaijan, the importing of gas from the newly discovered gas fields in the eastern Mediterranean, and the importing of gas from north Africa.
These projects and the EU’s campaign against Gazprom were given further life by a succession of ‘gas wars’ fought between Russia and Ukraine in 2006 and 2009.
The background to these wars is that the existing pipeline network between Russia and the EU was largely built by the USSR from the 1960s to the 1980s, with many of the pipelines passing through Ukraine, which was of course at that time a constituent republic of the USSR.
After the USSR broke up the Russians for a time sought to keep Ukraine politically friendly to themselves by supplying Ukraine with cheap gas.
The result was that the Ukrainian budget benefitted from the transit fees Gazprom paid Ukraine for having gas destined for Europe pass through Ukraine’s pipelines, whilst Ukrainian oligarchs – like the oligarchs in Russia in the 1990s – made gigantic fortunes by buying cheap Russian gas domestically within Ukraine itself and then selling it at a high price to Europe.
After Putin became President this cozy arrangement came to an end. Russia began insisting that Ukraine pay the full market price for Russian gas, and in 2006 and 2009, as earlier gas supply contracts came to an end, Russia made it a condition for the supply of gas to Ukraine that it do so.
At the same time the Russians began to insist on prompt payment by Ukraine for gas already supplied, and demanded that Ukraine pay all outstanding arrears for gas supplied but not paid for.
In 2006 and 2009 Ukraine refused to pay the higher price demanded by the Russians, and failed to pay its arrears, causing Russia to cut Ukraine’s gas supply off. Ukraine retaliated on both occasions by siphoning off gas passing through its pipelines intended for Gazprom’s European customers. The result was gas shortages across central and eastern Europe.
On both occasions Ukraine eventually backed down, but the interruptions of gas supplies to Gazprom’s customers in central and eastern Europe were seized on by Gazprom’s and Russia’s critics who alleged that they proved that Russia was an unreliable supplier.
For their part the Russians and some of their European energy customers concluded that Ukraine was an unreliable transit state, causing the Russians to launch pipeline projects like South Stream, Nord Stream 1 and eventually Nord Stream 2 in order to bypass Ukraine.
By December 2014, when South Stream was cancelled, all these disputes and conflicts had come to a head.
The European projects to ‘diversify’ away from Russian gas had all failed.
The reason was that all these projects ran into the same problem: they did not provide enough gas to reduce Europe’s need for gas from Russia, and they made no economic sense because the gas they would have provided would have been significantly more expensive than the gas supplied by pipeline from Russia.
In the meantime the Ukrainians during fraught negotiations over gas supplies from Russia over the course of the summer of 2014 once more threatened to siphon off Russian gas passing through Ukrainian pipelines destined for Gazprom’s EU customers.
Meanwhile the Russians for their part were having far more success in diversifying their gas exports to non-European customers than the Europeans were having in reducing their need for imports of gas from Russia. Specifically in 2014 the Russians announced major projects to build two giant pipelines to supply gas to China. Though these pipelines have been derided by Western and Russian liberal critics as making no economic sense because the Chinese will pay less for the gas than Russia’s European customers, there is no doubt the Russians will make a profit from the sales, and the fact that they will soon be selling large amounts of gas to China means that they are no longer as dependent on the Europeans as their customers as they once were.
The European country which found itself most exposed was Germany, whose large industrial sector not only requires plentiful supplies of cheap gas but which has also become more gas dependent as Germany has been closing down its coal and nuclear industries.
The result is that despite the sanctions the EU imposed on Russia on German insistence in July 2014, in June 2015 – just a few months after the cancellation of South Stream in December 2014 – and with the full backing of the German government, a new pipeline project linking Germany to Russia across the Baltic was announced, which is Nord Stream 2. Moreover in order to ensure that this pipeline would be built the Germans agreed to Russia’s demand that it would not be subject to the EU’s Third Energy Package.
The new pipeline predictably provoked a sustained campaign of opposition from a coalition of opponents including those who claimed to be concerned about Europe’s ‘energy dependence’ on Russia, various eastern and central European states unhappy at the loss of transit fees caused by the direct supply of gas to Germany from Russia, other EU states such as Italy unhappy at the way Germany dealt directly with Russia in its own interests whilst simultaneously insisting that other EU states impose sanctions on Russia, and of course Ukraine, which risks being cut out completely as a transit state.
Opposition to Nord Stream 2 was led by the European Commission on the grounds that it was not compatible with the EU’s Third Energy Package and would increase Europe’s dependence on Russian gas. The Germans and the Russians countered, truthfully if somewhat disingenuously, that Nord Stream 2 is not subject to the Third Energy Package since it does not cross over EU territory as it passes under the Baltic Sea
The reality is that in today’s Europe if the Germans and the Russians agree on something it is going to happen irrespective of whatever others might think or say about it. The German government could have killed Nord Stream 2 at any time but it chose not to because that would have outraged German industry, already seething over the sanctions imposed on Russia. That in effect all but guaranteed that despite all the objections Nord Stream 2 would go ahead.
The EU Commission has now dropped its objections to Nord Stream 2 and said Nord Stream 2 is not covered by the Third Energy Package. This amounts to it raising the white flag, not just in relation to Nord Stream 2 but in respect of the whole energy war. Suffice to say that it is not a coincidence that at the same time the European Commission’s case against Gazprom seems to be fizzling out.
What this means is that following more than a decade and a half of struggle the Russians have finally and conclusively won the energy war.
Not only will Nord Stream 2 be built as the Russians want – without it being subject to the Third Energy Package – but there is nothing now to stop the Russians building Nord Stream 3 or Nord Stream 4 or as many other pipelines as they want under the Baltic on the same basis.
Not only does that secure Russia’s position as the predominant supplier of gas to Europe for the foreseeable future, but it means that Russia will go on supplying its gas to Europe whilst retaining full control over its own energy resources.
The Russians have paid a price for this war. Not only have they been forced to spend vast amounts of money building expensive pipelines to bypass Ukraine, but plans they once had for Gazprom to become a gas retailer within the European energy market have had to be abandoned.
Gazprom’s excessively low market valuation for a company of its size and resources undoubtedly also in part reflects the harm it has suffered because of this war.
The Russians will nonetheless consider all this an acceptable price to pay given the scale of their victory.