5 challenges Nord Stream 2 faces in meeting EU regulations

The German network regulator denied the Russian pipeline owner’s request to not be covered by EU rules.

The Russia-backed Nord Stream 2 pipeline ran into an unexpected German roadblock on Friday.

German regulators rejected the €9.5 billion project’s request for a 10-year pass from new EU gas rules.

“When it is put into operation, therefore, Nord Stream 2 will be subject to German regulatory requirements and European rules on unbundling, network access and cost regulation,” said the Bundesnetzagentur.

That’s a problem, but Russian gas giant Gazprom — the company behind Nord Stream 2 — does have some possible solutions.

There are three main requirements the 1,200-kilometer pipeline will have to meet to legally deliver its gas once construction wraps. It must separate the operator of the pipe from the entities supplying the gas — known as unbundling. Any supplier wanting to ship gas through the pipeline must have the right and ability to do so — known as third party access. Finally, Nord Stream 2 would have to publish its tariff methodology for approval by the German regulator.

Here are five things to know about the impact on Nord Stream 2 now that its application has been turned down.

1. Keep building while lawsuits proceed

The first step is appealing the denial.

“We await receiving the official decision and will then evaluate it and consider further actions to preserve our rights, including appealing this decision in the German courts,” said Nord Stream 2 spokesperson Sebastian Sass. “The appeal is possible within one month following the decision.”

The company also has other legal options.

It filed a lawsuit in July at the Court of Justice of the EU seeking to undo the changes in the second amended Gas Directive on discrimination and other grounds. In September, it launched an arbitration against the EU under the Energy Charter Treaty.

The average CJEU case takes 20 months to reach judgment, which in this case would be March 2021 — around the same time Russian President Vladimir Putin says gas could flow if pipeline construction restarts and stays on schedule. For that suit to proceed on the merits, Nord Stream 2 must first pass the high bar of whether it has standing to sue.

The arbitration could take two to four years or longer. The Russian company wants a ruling that the Gas Directive amendments are discriminatory to Nord Stream 2’s investors and require correction, and it’s also hoping for compensation payments.

Those cases won’t stop the directive from taking effect in the meantime, but if Gazprom wins it could escape from the strictures of that regulation and get damages.

2. Relinquishing pipeline control

Under the EU directive, if Gazprom wants to ship its own gas through Nord Stream 2, it can’t also control the infrastructure. It is currently the project’s sole owner, operator and gas supplier.

A few options exist.

It could sell the pipeline off altogether, or it could retain ownership and just allow someone else to manage it.

In one approach, Gazprom could remain the owner but shift the operation of the whole pipeline to one of its subsidiaries, adding a layer of separation that technically would comply with the rules, said Katja Yafimava, senior research fellow at the Oxford Institute of Energy Studies.

Otherwise, it could remain the owner but form a new transmission system operator owned by a Gazprom subsidiary together with an existing European operator, she said.

Finally, Gazprom could remain the owner of the whole pipeline and operate the Russian section, but have a European transmission operator be responsible for the last 54 kilometers.

But ultimately the Bundesnetzagentur will decide whether these sorts of adjustments go far enough to certify compliance with the rules.

“If Gazprom remains the owner from the Russian shore to the entry point of the territorial waters in Germany and then they have a different company” own the last 54 kilometers, “this could be seen as a circumvention of the unbundling rules,” Deputy Director General for Energy Klaus-Dieter Borchardt warned in an interview with POLITICO last year.

3. Russia might have to rethink Gazprom’s role as a monopoly exporter

The challenge of mandated third-party access is that Gazprom has a monopoly on Russian gas exports.

Physically it also makes no sense for a European company to pay to ship its gas up north to only to send it back down again through Nord Stream 2.

That could prompt a change in Gazprom’s role.

Alternative gas producers have competed with Gazprom within Russia since 1998, and in 2014 the SPIMEX gas exchange was launched in St. Petersburg, not far from where Nord Stream 2 originates.

“If [Russia] were really to develop this place and allow other companies to compete with Gazprom [on exports], that could in future open up some possibilities,” said a senior EU regulatory official. “But that depends on the Russian side, which we cannot influence.”

Gazprom could also keep its export monopoly but auction off gas on the company’s electronic sales platform with the delivery point being the mouth of Nord Stream 2. Third parties could then request and pay for the right to use Nord Stream 2 to ship it down.

“It does complicate things, but they’re not complications that can’t be overcome,” said Kim Talus, professor of energy law at the University of Eastern Finland and the University of Helsinki.

4. Get ready for higher prices

Talus said if Russia has to conform to the EU directive, the likely result would be an increase in the cost of its gas.

Any supply contracts Gazprom negotiated in advance of the project would need to be adjusted accordingly.

“This exercise increases the cost of Gazprom gas, and that extra cost ultimately will be passed down to European consumers, but it might make other suppliers, like U.S. LNG, look more tempting,” Talus said. Whether that overall price increase is worth it to satisfy strategic aims, “or whether you should buy the cheapest gas to help your economy, is a different question,” he added.

German network tariffs would also increase, because the Bundesnetzagentur sets them based on the cost of all pipeline infrastructure in its jurisdiction, which would see the last 54 kilometers of Nord Stream 2 added.

These numbers have yet to be publicly crunched by the regulator, but a PwC analysis commissioned by Nord Stream 2 and reported by Handelsblatt calculated that the extra fees passed to German customers could end up being €50 million a year.

5. Beware the precedent set for other pipelines

Although the Gas Directive amendments were largely aimed at Nord Stream 2, the regulations do cover other pipelines running to the EU from third countries.

Both Italy and Spain have pipelines originating in Algeria, which, like Russia, has a state-owned gas export monopoly, Sonatrach. Neither country has met the February 24 deadline to transpose the amended Gas Directive into national law, EU data shows.

Without transposition, those pipelines haven’t been able to apply for derogations, which under the directive can only be granted until May 24. However, a Commission official said that “even if it’s late, this happens regularly and it doesn’t mean the whole thing falls apart; the Commission can be stricter or more lenient.”

But denying Nord Stream 2 a derogation for missing a construction deadline while granting derogation to other pipelines despite missing an application deadline could strengthen Nord Stream 2’s arguments on discrimination.

This article has been updated with the decision from the German regulator. It also corrects the owner and operator structure explained by Katja Yafimava.

This article is part of POLITICO’s premium policy service: Pro Energy and Climate. From climate change, emissions targets, alternative fuels and more, our specialized journalists keep you on top of the topics driving the Energy and Climate policy agenda. Email [email protected] for a complimentary trial.

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