October 11, 2021

Europe

RUSSIA/UKRAINE: US-German deal on Nord Stream 2 gives Moscow leverage over Kyiv

BY Andrius Tursa

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( 4 mins)
  • The US-German agreement allowing the completion of the Nord Stream 2 pipeline represents a political victory for Moscow.
  • Nord Stream 2 is expected to substantially lower Russian gas shipments through Ukraine after 2024 thereby limiting Kyiv’s revenue from transit and heightening security concerns.
  • The deal also raises questions in Kyiv about the extent to which its key Western partners are ready to consult and support Ukraine over critical security issues.

On 21 July, US and Germany announced an agreement to lift measures hindering the completion of the contentious Nord Stream 2 (NS2) pipeline between Russia and Germany. Given the negative effect the pipeline will have on Ukraine, the US-German deal includes several measures to reassure and support Kyiv:

  • Germany pledges to facilitate an extension of a gas transit agreement between Russia and Ukraine beyond 2024.
  • Supported by the US, Germany is set to establish and administer a USD 1bn Green Fund for Ukraine – with most funding coming from the private sector.
  • In case of Russian aggression or use of energy as a weapon against Ukraine, Germany pledges to take unspecified action at national and European level to limit Russian energy exports to Europe.
  • Berlin also pledges to abide by the Third Energy Package with respect to NS2 under German jurisdiction to ensure unbundling and third-party access.
  • Germany and US are set to invest in infrastructure connectivity and energy security in Central and Eastern Europe via the Three Seas Initiative.

Reduced transit and security concerns in Ukraine

Under the existing contract between Gazprom and Ukraine’s Naftogaz, Russia is obliged to ship at least 40bncubic meters (bcm) of gas per year through Ukraine during 2021-2024, bringing around USD 7.2bn of transit fees to Ukraine. However, the new 55bcm NS2 pipeline – along with the 31.5bcm TurkStream pipeline launched in early 2020 – will likely result in a significant reduction of transit flows after 2024. The terms of the US-German deal do not (nor can they) give a firm reassurance for Ukraine that significant transit flows will be sustained. Besides the loss in transit revenue, Ukraine will also face the challenge of maintaining its vast and outdated gas transit infrastructure.

In addition, Ukraine is concerned about the security implications of NS2, as gas transit through its territory was seen as deterrence against potentially more expansive Russian military action. The so-called US and German “grand bargain” on NS2 also raises questions in Kyiv about the extent to which its key Western partners are ready to consult and support Ukraine on critical security issues. In this respect, it brings back memories of the unfulfilled 1994 Budapest memorandum under which Ukraine gave up nuclear weapons in exchange for security guarantees from both Russia and the US, among others. Washington will likely seek to address these concerns during the long- anticipated meeting between President Volodymyr Zelensky and his US counterpart Joe Biden scheduled for 30 August.

Political victory for Moscow despite regulatory concerns

For Moscow, the greenlighting of the undersea pipeline represents a political victory. Once NS2 is fully completed, commissioned, and certified – expectedly in Q4 2021 or Q1 2022 – Gazprom will have the possibility of shipping natural gas to Western Europe without having to rely on Ukraine and Belarus as intermediaries. The pipeline project is also commercially beneficial for Gazprom, which could potentially raise its margins of gas exports to Europe in the absence of transit fees. In addition, NS2 mitigates the risk that a potential escalation of the conflict in eastern Ukraine would have spillover effects on Russian energy exports and its reputation as a reliable supplier of gas. Finally, the ability to complete and operate the pipeline despite strong opposition to NS2 from the majority of EU member states and the US could be seen as a geopolitical victory for the Kremlin.

Looking ahead, Russia is not committed to continuing its shipments of natural gas through Ukraine after the current contract expires at the end of 2024. Given Berlin’s pledge to push for an extension of transit post-2024, negotiations on the topic could pick up in the coming months. In such case, Gazprom will likely seek to replace long-term, ship-or-pay transit contracts with shorter-duration volumes booked on flexible transit pricing. However, its negotiating position could be affected by the EU’s regulatory restrictions on the use of connecting pipelines onshore. In fact, a Court of Justice of the European Union (CJEU) verdict of 15 July limits Gazprom’s access to the OPAL pipeline, the extension of Nord Stream 1 in Germany. This could partly restrict the operational capacity of NS2, too. Such measures could support continued Russian gas shipments through Ukraine post-2024, although the transit volumes would likely remain low.

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