Liquidity first, diversify later…

Home/Special Reports/Liquidity first, diversify later…

Liquidity first, diversify later…

EU natural gas policy in the view of Nord Stream 2, Brexit, and Germany’s effect.

Anwar Al Taqi – Esam Aziz

The long-standing energy relation between the EU and Russia is expecting to follow a new path. Considering the prospects of EU energy ties under the Angela Merkel’s firm leadership amplified by the underlying effects of Brexit on the balance of power among EU-27 members.  Merkel plans put forward forming a competitive gas hub in Germany and a bigger role in EU gas supplies. Counting on low-cost gas supplies and Long standing energy relations with Russia as the right tools to re-engage with Moscow. Yet, there is little chance for project’s local opponents to revoke construction permit, as Merkel is backing the project internally, and widely advocating its economic rationale behind it.

Whereas, Gazprom’s “Nord Stream 2” had achieved a significant breakthrough after the five ex-partners had re-joint the project and concluded a financing agreement of €4.75 billion. As the construction phase would begin anytime soon, NS2 shows a clear case that aptly illustrates future trends of EU foreign energy policy. The fragmentation of energy markets in the EU, where members are pushing different agendas considering a mix of political and economic motivations, had led Central and Southeastern EU members to adopt alternative options to diversify gas supplies away from Russian and secure their natural gas flows. A new set of gas transit project would take a place to link Balkan countries with gas resources in the Caspian Sea and the East Mediterranean. However, low-priced Russian gas flows will be the central factor to assist the feasibility of any future pipeline lands on EU countries.


Financing the controversial pipeline

Russia’s ambitious pipeline project “Nord Stream 2” has another breakthrough in April after ex-partners Shell, ENGIE, Uniper, OMV, and Wintershall have committed to provide long-term financing for 50 percent of the project’s total cost estimated to be €9.5 billion. Each company will fund up to €950 million, whereas Gazprom will remain the sole shareholder of the project. The financing deal announced on April 24 would probably allow the lenders to convert their debt into equity later and become shareholders in the project. The agreement was a significant relief for Gazprom as it will help the company to spread some of the project risks and increase its expansion budget over the next years.


No political opposition in Germany

Governments of Sweden and Germany has received permit applications and environment studies for NS2 from Gazprom. The pipeline route goes through 510 km in Swedish waters and 85km in German territorial waters. As the public discussion of the Nord Stream 2 project is expected to end on May 17, yet there are no signs for potential legal nor political issues to face the project. Peter Ramsauer, the chairman of the Germany’s Parliamentary Committee on Economy and Energy, supports the implementation of the pipeline and believes that the offshore section should not be subject to EU legislation. Ramsauer’s views are close to Merkel’s economic rationale behind Nord Stream 2; wherein, low-cost gas supplies and Long standing energy relations with Russia are seen as the right tools to re-engage with Russia, and on the contrary, forming a competitive gas hub in Germany and a bigger role in EU gas supplies.


Merkel has a definite plan

Clearly, Merkel priority is to ensure low-cost gas supplies to help the country archiving its Electrification Plans. Bearing in mind the undergoing fundamental shift of power in the energy market as it moves from sellers to buyers’ market, Nord Stream 2 would be the answer to Berlin’s needs only if Russia’s Gazprom will adopt fundamental changes in its pricing strategy by carefully lowering transmitting costs and supplies more gas to EU hubs.

A recent study has presented to the Federal Foreign Office in Germany, proposed that the EU should proceed with completing both Nord Stream 2 and the Southern Gas Corridor to benefit from competitive prices and boost market efficiency. Other scenarios would let to higher cost for Russian gas supplies would be for the advantage of one of the two projects only. The main argument is that competitive gas prices will be the main consideration to assist the feasibility of any future pipeline lands on EU countries.

Brexit has left Germany as the major responsible for the EU as it will become the biggest contributor to the union’s budget. Merkel will face in the future serious challenges to continue financing EU cohesion projects, and to its role as the leader of the EU where she should address the common policies in energy and foreign relations away from national interests. It is clear now that Merkel will keep on Nord Stream 2 as the first step in ensuring market fundamentals before any attempts to address concerns of her EU partners where Russia is the less popular option for gas supplies.

Market fragmentation has led to different approaches

In fact, Eastern European countries are keen to find alternative routes for natural gas supplies away from Russia as they left behind Berlin’s narrow interest policies. “Eastring Pipeline” is a new transmission project alternative to South Stream. The project is set to carry natural gas from Western Europe to the Balkan countries, enabling those countries to diversify their natural gas sources; including but not limited to Russia, Southern Gas Corridor, Iran, Iraq, Egypt, Israel and Cyprus to Central, South and Western Europe. Also, Ukraine had signed off last month an initial deal that could hand of its damaged gas network to be used in Eastring pipeline.

Moreover, Italy, Cyprus, and Greece had signed up to build a new 2,200 Km gas pipeline “East Med” from Israel to Europe. The project would come online in 2025 with a capacity of up to 16 bcm of gas annually. Despite high political risks associated with future gas supplies from the Middle East, particularly from Israel; The EU is backing the project as it energy commissioner, Miguel Arias Canete, has stated that Israel was a safer partner than Russia. Italy will try to seek the support of G7 countries later this month during the coming summit in Sicily. Investment banks in the US, such as JP Morgan and Goldman Sachs, would support such project as they had expressed their interest in the €6 billion project as long as the EU is on board.

Gas price collateral factor

In the view of the current development of the Brexit and Germany’s overtaking the leadership of the EU, the union may have little options but to shift its strategy to accept the NS2. The draft antitrust deal with EU which was proposed by Gazprom last month has sent a clear message to officials in Brussels that Russia is willing to change its EU market strategy and to set more fixable terms for in its natural gas contract. Besides, the penalty-free settlement would allow the EU member states to virtual sell spare Russian gas anywhere in Europe. By contrast, the EU has announced a deal that opens the way for countries to demand help from the rest of EU members in case of a supply cut in natural gas and makes the union resilient to any abuse energy supply as a political weapon.

In the medium term, the Gazprom will keep exploring its low-price strategy to boost gas export to EU markets in the hope that boosting its supply of relatively cheap gas will help kill off the development of EU energy infrastructure and more expensive alternative gas sources such as LNG. As the Russian company dropped prices to 12-year lows in last year, data provided by Gazprom shows an increase by 15% to 51 bcm in exports to Austria-Hungary, Germany and France during the first quarter of 2017.

The fragmentation of energy markets in the EU had led Central and Southeastern EU members to adopt alternative options to diversify gas supplies. However, The feasibility of EU’s new gas transit project will interact with low-priced Russian gas flows in the future. Nord Stream 2 is a significant project to provide sufficient capacity to ensure natural gas flows into EU hubs and to lock Gazprom thereafter in a low-price market environment as it is the only option for Gazprom to block alternative supplies in the future and to maintain its market share.