Analytics, Baltic States – CIS, Direct Speech, Energy Market, EU – Baltic States, Gas, Transport

Slightly more than half of the EU’s current supply of natural gas comes from domestic production in the EU 28 plus Norway. But this production is in steep decline. Just last week the Dutch government announced a cap on annual production at the Groningen gas field of 24 billion cubic meters (bcm). As recently as 2014, it was producing 42.5 bcm. UK production is in similar decline and Norway’s will decrease as well, though less precipitously.

If nothing is done, by 2035 Europe will be facing an import shortage of more than 140 bcm. That will be nearly one-third of projected demand (more than 500 bcm).

 EU Gas Supply and Demand Development

Liquified natural gas (LNG) and new supplies via a Southern Corridor may cover part of that gap, but not all of it. Price dynamics favoring Asia will make it difficult for the EU to obtain sufficient LNG. The Southern Corridor will remain a complicated proposition, making it difficult to attract adequate investment and develop much-needed capacity.

At the time of its inception, Nord Stream 1 – the first pipeline to bring Russian natural gas directly to Germany via the Baltic Seabed – was not without controversy. But the fears at the heart of debate about it have proven unwarranted. Nord Stream 1 has been and continues to be a commercially viable, eco-friendly and reliable way to bring gas to the EU from the vast fields in Russia’s Northwest.

A growing network of onshore connections means this gas can travel anywhere, including even non-EU countries like Ukraine. In fact, Ukraine now gets most of its natural gas through new pipelines that run West, not East. Once the gas enters the European internal market created by the EU’s so-called “Energy Packages”, it flows freely following price signals – an effective guarantee against monopolistic behavior on the part of any supplier.

Despite various (mostly politically-driven) objections to the development of Nord Stream 1, the record shows the Baltic Sea pipeline has successfully operated as a commercial, non-political project that helps all European countries meet their energy needs without discrimination. Nord Stream showed it is possible for a consortium of Russian and EU companies to raise funds for, build and successfully operate a large-scale infrastructure project on a strictly commercial basis, complying with all applicable regulations and laws. Thanks to this strong record of success, European Commission representatives have labeled Nord Stream 1 a model infrastructure project.

This bodes well for the development of Nord Stream 2 – the second pipeline that will run along the same route. When it becomes operational in 2019, Nord Stream 2 will offer Europe 55 bcm of additional annual capacity. This will help the EU achieve its three energy objectives: secure supplies, sustainability, and affordable and competitive energy prices. The gas will be supplied by a reliable partner for whom the EU is by far the most important market. It will help deliver efficiency gains and meet emissions targets. It will speed up the phase-out of coal (carbon emissions can be halved simply by replacing high-emitting coal with gas for electricity generation). Gas is also crucial as a baseload energy provider, enabling a higher share of renewables where production patterns are volatile. And, last but not least, it will keep energy affordable.

As was the case with Nord Stream 1, objections to Nord Stream 2 that are based on a mix of political anxieties and misconceptions abound. A prime example is the fear that Europe will become overly dependent on Russia for its energy when, in fact, Nord Streams 1 and 2 actually accomplish the converse. They make Russia far more dependent on the European market than ever before.

Already the EU buys about 60% of Gazprom’s natural gas exports. Any interruption of that would do the greatest damage to the supplier. Meanwhile, Russian gas accounts for only 6% of the EU’s overall energy mix. That share has been stable for the past 25 years. As demand continues to outpace supply (the new pipeline will meet only about one-third of the projected increase in demand), this percentage is unlikely to change much even after Nord Stream 2 goes online.

As for commercial viability, market forces will continue to determine how gas is sourced and from whom. Nord Stream 2 will have to compete with a number of energy sources and suppliers. But the business case for Nord Stream 2 is so strong that the EU-Russian consortium expects to raise 70% of the necessary funding in private equity markets. That means investors, not governments will ultimately judge whether Nord Stream 2 looks to be commercially viable.

A quick comparison: Nord Stream 2 will add 55 bcm of annual capacity for a price tag of EUR 8b, funded by investors. The Southern Gas Corridor will likely cost around EUR 40-50b, a considerable part of which will have to come from public institutions. It will initially deliver only 10 bcm of additional annual capacity. Of course, there is no reason why both can’t compete, but the economics clearly favor Nord Stream.

In light of various attempts to impede the project through legal procedures, it is important to remember that there is an established process for approval and implementation of such infrastructure projects. The permitting process is governed by relevant EU law, international conventions, and national legislation, and these laws are applied equitably.

Like Nord Stream 1, Nord Stream 2 must and will comply with the full spectrum of applicable national, European, and international laws and regulations. It will only proceed with the approval of the countries within whose jurisdiction the pipeline runs. But given Nord Stream 1’s record of success, it is highly unlikely that Nord Stream 2 will be blocked on legal grounds. The UN Convention on the Law of the Seas is very clear: all states are entitled to lay submarine pipelines in the exclusive economic zones of other states. The concerned coastal states may not impede the laying or maintenance of such cables or pipelines, except to take reasonable measures to ensure environmental protection.

In addition, import pipelines that bring gas to the EU’s internal energy market through the exclusive economic zones of Member States do not fall under the jurisdiction of the EU’s internal energy market rules as laid down in the various “energy packages”. For example, North African import pipelines have always been treated as outside the scope of the EU’s Second Energy Package. The Third Ener

gy Package changed nothing in this regard. In the end, the European Commission will not apply rules to one commercial project that it does not apply to another, ignoring decades of legal precedent. This would be the end of a market-based energy policy in Europe and destroy investor confidence.

The simple fact of the matter is that, in the near-to-mid-term future, the only way for Europe to achieve its energy objectives is by strengthening the role of gas in its energy mix. And there is no source as readily available as Russian gas. Nord Stream 2 will deliver the energy that Europe needs economically, ecologically, and reliably.