After years of mostly unrivaled gas market dominance and segmentation in Central and Eastern Europe (CEE), the energy relationship between Gazprom and the region is gradually equalizing thanks to successful market liberalization and integration in Europe. Greater diversification has exposed Gazprom to competition, forcing it to adjust its pricing mechanisms and revise its export strategy to maintain market share. Evidence of this can be found just last year, when Gazprom recorded its highest volume of exports to Europe ever. This was not because countries had no choice but to buy Russian gas, but because Russian gas was the cheapest.
With the settlement of three longstanding disputes at the heart of EU-Russia energy relations and a decision on Nord Stream 2 forthcoming, 2017 promises to be a watershed year of outcomes that will officially mark the beginning of the depoliticizing process of natural gas.
The management of energy relations between Brussels and Moscow has at times been counterproductive, but underneath the ebb and flow of inflammatory rhetoric lies a steady business-as-usual attitude borne of mutual interdependence. The adoption of the Third Energy Package in 2009 was going to radically reshape the market, but the process was accelerated (arguably helped) by the Euro crisis and an unanticipated collapse in natural gas demand that left European energy majors overburdened with take-or-pay obligations. The dysfunction motivated both sides to pursue constructive dialogue, leading to the establishment of the Gas Advisory Council (GAC) framework in 2011, laying out a series of intensive workshops that would serve as the basis for developing an EU-Russia roadmap until 2050. The program was a success, but the last of eight sessions was held in November 2013. Russia’s 2014 annexation of Crimea brought the process to a grinding halt and returned the energy relationship to its frosty but functional transactional core – not much talk but Russian gas keeps burning. Now Gazprom’s increasing European market share should not elicit panic but serve as affirmation that the market is working.
While Russia’s destabilizing aggression did not influence the Commission’s thinking on two important, longstanding issues, it did affect the timing. The outcome of both the Gazprom antitrust case and the Opal decision have been somewhat preordained, but the crisis in Ukraine made it politically untenable for Brussels to settle with or make any kind of concession to Moscow in its immediate aftermath. After two years with no political end to the crisis in sight, the Opal decision was rendered last October and the antitrust settlement is expected early in 2017. However, it is important to keep these outcomes in perspective.
At this point, the antitrust case and the arbitration are less impactful because market developments obviates their outcome. On the other hand, Opal and Nord Stream 2 will alter contracted gas flows in the short term to medium term and impact security of supply and competition in CEE.
Over the past year, Gazprom’s planned Nord Stream 2 pipeline has emerged as a controversial flashpoint, creating fresh divisions between Western and Eastern Europe - the winners and losers of the proposal – and particular acrimony between Germany and Poland. This should not come as a surprise: we are talking about the shifting of billions of transit euros from one state to another for decades to come, an extraordinarily positive sum game. And that is nothing to say of its implications for security of supply and competition in CEE, the topic of another article. At this point, it is not known if Nord Stream 2 will or will not be built, but, in all likelihood, the determination will be made this year. And either way this is great news for Europe simply because it will mark an end to the era of pipeline geopolitics, which has sewn division amongst member states since Gazprom signed an MOU with Eni for South Stream in June 2007.
Gazprom’s CEO Alexey Miller has repeatedly stated that Nord Stream 2 will be operational by 2019, not coincidentally when the company’s transit contract with Ukraine expires. While such statements don’t really mean anything, especially if you can imagine them as a leveraging tactic for negotiations on a new transit contract, the two-year construction lead time would require a final investment decision (FID) in 2017. In this sense, there is pressure for Germany and Gazprom to make the final legal and financial push this year to avoid revisiting the expiring transit contract with Ukraine at a disadvantage.
At the same time, there are several projects of common interest (PCIs) slated for FIDs in 2017 with expected commissioning in the 2019-2020 window that will greatly improve market integration in Central Europe, bringing to life the long-awaited North-South Corridor and opening Croatian, Greek and Polish liquefied natural gas (LNG) to the region. In its 2017 report, ENTSO-G confirmed that most of the 34 listed gas infrastructure PCIs are slated for completion by 2020. This will further erode Gazprom’s traditionally dominant market position and force the company into a market protection strategy of competitive pricing. It is already moving in this direction, having tested auctions with some of its sales in Germany and Lithuania.
Five years after the biggest antitrust raid in the EU’s history a settlement between the European Commission (EC) and Gazprom will be announced in 2017. This follows the Commission’s formal statement of objections in 2015 on three specific points of market abuse: restricting cross-border gas sales (destination clauses), unfair pricing policy (oil-indexation) and leveraging gas sales to gain control over downstream infrastructure. However, the settlement will be largely ceremonial since many of the alleged monopolistic practices have been withdrawn in response to improved market integration and diversification. It is simply impossible for Gazprom to do business this way anymore, particularly with an aim to retain a 30% market share in the EU.
In fact, Gazprom made the announcement that it would deliver its settlement proposal for the antitrust case on October 26th, the same day that the EC announced a major decision concerning the Opal pipeline, which is one of two onshore extensions of Nord Stream that travels from Griefswald, Germany to the Czech border. The decision allows Gazprom to use 80% of Opal capacity, which up to that point was limited to 50% and effectively capped Nord Stream’s utilization under 70%.
Poland has railed against both developments, expressing displeasure with the preliminary findings of the antitrust case and taking the Opal decision to court. The Polish government referred the EC decision on Opal to the European Court of Justice (ECJ) December 6th and German regulator BNetzA is now considering the case.
Lastly, the outcome of the high-stakes arbitration hearing in Stockholm between Naftogaz Ukrainy and Gazprom regarding their gas transit and supply contract is also expected at the beginning of the year. The heart of the dispute lies within the interpretation of the 2009 gas sales and purchase contract, specifically the ‘take or pay’ clause and the re-export ban which Naftogaz rejects as invalid because they are not market-based. These types of clauses are already prohibited in the EU under the Third Energy Package, which Ukraine is in the process of adopting as a contracting party of the Energy Community. In the case Naftogaz is claiming nearly 25 billion euros and Gazprom close to 30 billion euros, but aside from the incredible sum of money at stake, the resolution will not be precedent setting because Ukraine is already on a path of market liberalization and integration with Central European markets. Like the antitrust case, this decision is important for providing clarity and allowing all sides to finally move on but it does not portend to redefine the Ukrainian market one way or the other.
2017 will provide some needed closure in the EU-Russia energy relationship. Nord Stream 2 (and to a lesser extent Opal) is still a wild card, a complex and sensitive undertaking for the EC that has tremendous ramifications for the flow and utilization of Europe’s gas system in the short to medium-term. Outside of that, the other outcomes are revisionist and behind the market developments that have emerged during their long deliberations. Slow but steady implementation of the Third Energy Package has already forced considerable accommodation from Gazprom, even in CEE. While the endgame for Europe’s internal gas market needs to be reimagined and is far from complete, tangible gains have been made to preclude market dominance of a single supplier. Suffice it to say, the Nord Stream 2 decision in 2017 will be the last flashpoint in the decade long EU-Russia pipeline drama, which is good for everyone, but particularly Europe’s gas industry as it seeks to rebrand itself as a dependable source of energy for European consumers.