Nord Stream 2. Strictly business or wider threat?
Ukraine’s gas transmission system is one of the most extensive networks of gas pipelines in the world. The role of the Ukrainian system, in the functioning of the pan-European gas transit infrastructure, is extremely important in the strategic economic and energy security contexts of life in Europe.
When we talk about Nord Stream and Nord Stream 2, we cannot consider these large-scale projects in economic terms alone. What is more, from the point of view of financial and technical indicators, they are not justified. The capacity of the Ukrainian gas transmission system (GTS) at the entrance is 281 billion cubic meters per year with an output of 146 billion m3 per year. Almost 50 per cent of natural gas from Russia to European countries until 2019 was transported via the Ukrainian GTS. Today, unfortunately, the situation is not the same.
Starting in 2020 the Ukrainian GTS delivered about 30 per cent of natural gas to Europe, and this year it will decrease to about 20 per cent.
Russia has invested tens of billions of US dollars to build an inexpedient and unnecessary alternative to the Ukrainian GTS. Comparing the above indicators of output capacity of the Ukrainian system and the real volume of transit, one can conclude that Russia aims to neutralise the Ukrainian GTS as an integral part of European energy security. The reason is because the Kremlin broke its imperialist teeth on the rocky strength of Ukrainian sovereignty and national dignity.
Gas transit agreements 2020-2024
Three agreements between Ukraine and Russia on gas transit were signed on December 31st 2019. They were based on the protocol of the December 19-20 2019 meetings in Berlin and Minsk. According to these agreements, Russia has agreed to extend the transit of gas through Ukraine for a period of five years with a possible extension another 10 years. Ukraine has agreed to cede some of its demands to Gazprom through arbitration and antitrust investigations. The agreements have fixed the minimum volume of gas transit. In 2020 it was 178.1 million m3 per day (or 65 billion m3 per year); for 2021-2024 will decrease to 109.6 million m3 per day (or 40 billion m3 per year).
It should be noted that this contract allows Ukraine’s gas transmission system to operate for the next five years (up to 2024 inclusive) and to earn a profit. The logical question is, thus, what is next? One of the options is that if the Russian side does not want to use the Ukrainian gas infrastructure, European companies/traders can independently book the capacity of the Ukrainian system and purchase Russian gas at the Ukraine-Russia border and, accordingly, transport it to Europe via Ukraine. In this case, one can assume that the Russians will try to apply dumping mechanisms and make their gas supply through the Nord Stream and Nord Stream 2 pipelines cheaper than the Ukrainians could offer to European counterparties.
Unfortunately, the position of EU member states is not unanimous regarding the intentions and threats of Nord Stream 2. When I recently asked Mykhailo Gonchar, president of the Ukrainian think tank Centre for Global Studies “Strategy 21”, how he evaluates the EU’s attitude to the pipeline, he said: “Germany and Austria openly support the implementation of the Nord Stream 2 gas pipeline project. The position of France, the Netherlands and Belgium looks more passive.”
Poland and the Baltic states, including Lithuania, are among the countries that openly oppose the construction of the NS2 gas pipeline. Romania is also opposed to it on the basis of solidarity with Poland. It was at the request of Poland when Romania, during its presidency of the Council of the European Union in the first half of 2019, initiated amendments to the EU Gas Directive, which provide the dissemination of EU energy legislation on offshore pipelines. As a result, gas cannot be supplied through an offshore pipeline by the same company that owns the gas, produces it or sells it. Third-party companies must have access to offshore pipelines. Therefore, de jure, Nord Stream 2 must operate at 50 per cent of its capacity.
Unfortunately, there is an exception mechanism that Germany has lobbied for in regards to Russia. However, any decision by the Germans can always be influenced by the European Commission, up to its cancellation. If we assume, hypothetically, that the Nord Stream 2 pipeline will work, then the consequence for the Ukrainian system could mean zero transit, which would lead to the forced decommissioning of approximately two-thirds of gas compressor stations in Ukraine.
As Gonchar noted, article 274 of the Association Agreement between the European Union and Ukraine addresses gas transmission via Ukraine. It reads that: “The Parties shall endeavour to facilitate the use of gas transmission infrastructure and gas storage facilities and shall consult or coordinate, as appropriate, with each other on infrastructure developments. The parties shall co-operate on matters related to trade in natural gas, sustainability and security of supply. With a view to further integrate markets of energy goods, each Party shall take into account the energy networks and capacities of the other Party when developing policy documents regarding demand and supply scenarios, interconnections, energy strategies and infrastructure development plans).” This article comprehensively protects the Ukrainian GTS and guarantees the importance of its operation for the whole of Europe. The current position of each EU member state should be based primarily on this article of the Association Agreement.
Naftogaz, Ukraine’s national oil and gas company, estimates that the operation of the Turkish Stream pipeline has reduced gas transit through Ukraine by 15 billion m3 in 2020. According to the official gas transmission system operator of Ukraine, the country is receiving 450 million US dollars less annually from the transportation of gas, which it previously transited to countries in southern Europe and is now transited through the Turkish Stream. Here is evidence that Russia’s goal is not to do damage to the Ukrainian budget or to block about 2.5 billion US dollars of budget revenues, but to make Ukraine a weak energy supplier – to depreciate its energy, in particular its gas transportation potential. In early April, Ukraine’s gas transmission system operator announced that Russia has been gradually reducing transit through Ukraine. The transit to Turkey, Greece and Bulgaria has now been completely transferred from Ukraine via the new Turkish gas pipelines. From April 1st, gas deliveries to Romania are fully provided from Bulgaria via the Turkish Stream 2. Currently, transit via the southern route through Ukraine is provided only for Moldovan consumers.
It is important to also mention the Trans-Balkan pipeline, which Ukraine, Moldova and Romania lost significant revenue from. Sergiy Makogon, head of the gas transmission system of Ukraine, stated that “the strategic asset with a transit capacity of 27 billion m3 per year, the Trans-Balkan pipeline gas corridor can and should be a warranty of energy security for Southeast Europe. If there are interruptions or maintenance works on Turkish Stream, gas flows can still be assured. Furthermore, for the first time, on August 26th 2020, Ukraine’s transmission system carried out a transmission request from south to north. This request was placed by a local commodity trader shipping natural gas up the Trans-Balkan Pipeline from Greece through Bulgaria and Romania to Ukraine. The above-mentioned transaction helped to demonstrate the technical viability of this route, even if it is not yet commercially viable.”
Gas transit after 2024
It is difficult to accurately forecast gas transit by the Ukrainian gas transmission system after 2024. It will largely depend on the needs of the EU market. On the one hand, sources of gas supply are becoming more diversified and producers of liquefied natural gas (LNG) are developing dynamically. The EU seeks LNG as a reliable commodity in both price and security. On the other hand, the EU is actively restructuring its industry to meet tighter green standards. Accordingly, with the reduction of coal production and coal-fired power generation, the consumption of natural gas will increase. In general, the EU is the largest importer of natural gas in the world – in 2020 consumption amounted to 394 billion m3.
The EU expects to diversify its source of natural gas supply, but, understanding the risks and identifying aspects of energy security, it also takes a formal position. According to the European Commission Directorate-General for Energy, “Nord Stream remained the most important supply route of Russian gas to the EU. Fifty-two billion m3 of gas was transited through Nord Stream while around 38 billion m3 gas was transited through Ukraine with an EU destination in 2020”.
It should be added that by the end of 2019, approximately 85-94 billion m3 of natural gas transited each year was through the Ukrainian GTS. It generated approximately three billion US dollar in revenue for the country. Naftogaz spends about 2.4 billion US dollars on natural gas imports. Hence, it has been an opportunity for generating significant profit. Last year profits fell by 30 per cent and this year is expected to fall by almost 60 per cent. Income from transit will no longer be sufficient to cover the costs of importing natural gas. The management structure of the newly created Joint Stock Company “Mahistralni Gazoprovody Ukrainy” and the Gas Transmission System Operator of Ukraine LLC is professional and ambitious. The Ukrainian public has expectations that the system will be functional and profitable after 2024.
Integration or support
The Ukraine transmission system operator is not a member of the European Network of Transmission System Operators for Gas (ENTSOG) since Ukraine is not a member of the European Union. The road to full EU integration is comprehensive, but a few good steps have been taken. For instance, the Ukrainian company has become an observer in ENTSOG. It sends the data of network operation to the transparency platform on a daily basis. ENTSOG provides Ukraine’s dispatching centres with the tools for operational communication, monitoring and joint response in crisis and emergency situations. During the last two years, Ukraine and its transmission system operator has been working on the harmonisation of legislation and procedures as well as on transparency and security of supply.
There is one more point to Ukraine’s integration into the European regional gas network. In February 2015, the European Commission launched the Central and South Eastern Europe Gas Connectivity Initiative (CESEC). Austria, Bulgaria, Croatia, Greece, Hungary, Italy, Romania, Slovakia and Slovenia and the EU set up a High Level Working Group. The six energy community contracting parties – Ukraine, Moldova, Serbia, North Macedonia, Albania and Bosnia and Herzegovina – signed a memorandum of understanding and were joined to the CESEC. This initiative works to accelerate the integration of the central, eastern and south eastern European gas markets. The goals are to coordinate efforts to facilitate the swift completion of cross-border and trans-European projects that diversify gas supplies to the region and to develop regional gas markets and implement harmonised EU rules to ensure the optimal functioning of the energy infrastructure.
Hence, despite Russia’s approach to negatively affect Ukraine’s gas transit system, and hurt its revenue raising potential, there are still opportunities for Ukraine to develop. In the end, it is for the reader to decide whether the forecasted scenario of the Ukrainian gas transit system is optimistic or pessimistic.
Mykola Voytiv is the head of energy projects at the Kyiv-based NGO, New Generation Management.