MS Risk Blog

Nord Storm 2 Pipeline Creates Divisions Within Europe

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Finalising the construction of the Nord Stream 2 pipeline has become a hotly contested issue that has put all sides in a ‘lose-lose’ situation. The German government is acting as though the pipeline were a vital national interest and the US, Baltic States, Poland and Ukraine fear that it will make Europe overly dependent on Russia.

An objective security analysis suggests that the fears have a kernel of truth, nevertheless Ukraine is not necessarily in a detrimental position.

One might see that Ukraine’s fear over the project as a major security threat is justified. Following this perspective, indeed from a purely geostrategic sense, the Nord Stream 2 threatens Ukraine, and not just with the loss of billions of euros in fees for the transit of Russian gas to Europe. Once Russia stops the gas transit, it would not hold back on damaging Ukrainian gas pipelines, and this would mean that the threat of war for Kyiv would increase considerably. The situation could also impact on how quickly Ukraine integrated into NATO and the EU and that the country would need both military aid and financial assistance in the form of low-interest European loans and funds to compensate. Therefore some analyst concluded that if the physical flow of Russia gas through Ukraine stops, the risk of full-scale military aggression by Russia could go up substantially.

In Poland, too, the US-German deal prompted strong condemnation. Poland Government emphasized from the very beginning that Nord Stream 2 is a geopolitical project that destabilizes the political situation in central and eastern European. The Polish Government announced it was ‘surprised’ by the German-American agreement and that Germany was “unfortunately pursuing Russia’s interests,”. Moreover, there has been no adequate response from the EU. At the same time, Poland’s relations with the US and Germany are likely to cool further. The fear remains that the Kremlin will perceive the concessions from the US which could encourage them to pursue an even more aggressive policy with regard to Ukraine and the whole central and eastern European region.

Nevertheless, one needs to keep in mind that a pipeline creates a bilateral dependence: Russia depends on the EU remaining a reliable customer. The bilateral economic link is much more important for Russia since earnings from gas exports make up a significant portion of Russia’s overall export earnings (and the revenues of the Russian government) – but are only a tiny fraction of the European economy. Furthermore, Europe already has an alternative source of supply in the form of free capacity for LNG imports. This means that Russia depends much more on the EU as a customer than the other way round. To achieve its own ‘gas market independence’ from Europe, Russia would need to construct a costly capacity to export LNG from facilities closer to fields near the Arctic Circle. With Nord Stream 2 it has less of an incentive to do so.

This being considered the fact that a large part of its gas exports go through Ukraine did not deter Russia from annexing Crimea and creating a frozen conflict in Donbas. It is thus not clear why a further drop in gas transit should negatively affect Ukrainian national security. Despite their mutual hostility, the two countries still managed to reach an agreement whereby Gazprom will pay transit fees between of $1.5 and $5 billion per annum until 2024. Many US and European observers assume that the transit fees benefit ‘Ukraine’. In reality, these fees found their way into the pockets of oligarchs who siphoned off profits via shell companies and associated local companies. Some recent reforms, which began even before the election of President Zelensky, have improved the situation, as recognised in a report by the OECD. But the transit fees will remain a potential source of corruption, which remains engrained in the country’s energy sector, as noted by the Ukrainian anti-corruption agency. The country as a whole still ranks at the bottom of all indicators of good governance and corruption.

In terms of the goal of bringing Ukraine closer to Europe, and of reducing corruption, the loss of Gazprom transit revenues should be counted as a plus. Ukraine no longer imports gas directly from Russia. The energy security of Ukraine is ensured by reverse flows from Western Europe towards Ukraine. But most of this gas (delivered from Slovakia to Ukraine) is actually Russian gas. Today, this gas arrives first through the Ukrainian transit pipeline into the EU and then returns. With Nord Stream 2 completed the flow would be somewhat more complicated (first to Germany, then through intra-EU Central European interconnectors and then back to Ukraine), but the substance would not change.

Analysing this, the geostrategic point raised initially, loses its linchpin assumption, namely that Ukraine stands to be negatively affected by the new gas pipeline. The discussion in its essence should revolved on how Germany, as the main gas beneficiary, could use its leverage point against Russia and not the other way around.