Baltic States – CIS, Direct Speech, Energy, EU – Baltic States, Gas, Legislation

Nord Stream 2, the Gazprom-led pipeline from Russia to Germany through the Baltic Sea, is strongly opposed by almost everyone in EU circles because it would allegedly increase European dependence on Russian gas – and would cut out Ukraine and Poland as important gas transit countries.

In particular the financial loss for Ukraine has always been a strong argument for many against Nord Stream 2. Georg Zachmann, senior fellow at Brussels-based think tank Bruegel, and a critic of the pipeline project, notes that Ukraine would lose revenues from gas transit of up to 2 billion US dollars a year if Nord Stream is built. The EU, incidentally, has already supported Ukraine with €2.81 billion, “the largest amount of Macro-Financial Assistance the EU has disbursed to any non-EU country”, according to the European Commission.

What the critics of Nord Stream 2 usually ignore, however, is the notorious unreliability of the Ukrainian gas transit system. The famous gas supply interruptions of 2006 and 2009 are invariably blamed on Gazprom, and cited as a reason why Europe can’t rely on Russian gas deliveries. But they were caused by the fact that Ukraine was not paying the bills and siphoning off gas from the system. The Ukrainian gas sector has long been riddled with corruption. This was always a prime motivation for German and other West European gas consumers to build Nord Stream 2.''

Clearly, if Ukraine wants to be credible as gas transit country, it needs to get its gas sector in order. But it seems this is not what is happening. Although one can regularly hear statements to the effect that “Ukraine is making progress on energy sector reform”, recent news shows that the reality is different.

Only last month, on 19 September, the last two independent members of the Supervisory Board of Naftogaz, Paul Warwick and Marcus Richards, handed in their resignation, because they feel they can’t do their work properly. Naftogaz is the state-owned gas transmission system operator of Ukraine which is responsible for the transit of Russian gas to Europe.

In a statement, Naftogaz said the last two members of its independent supervisory board resigned due to “dismantling of reform by the government”. According to Reuters, it quoted Warwick and Richards as saying “no significant progress had been made on reforms over the past five months, despite assurances from the authorities. ‘Not one of the actions that are under the government’s control have been carried out. On the contrary, the level of political meddling in Naftogaz’s work continues to grow and has become, unfortunately, an obvious norm’, Naftogaz quoted them as saying in their letter of resignation.”

Two other board members, Charles Proctor and Yulia Kovaliv, had resigned earlier, for the same reasons, notes Reuters, speaking of an “exodus of reformers”.

Alarm bells

On 20 September, none other than Andriy Kobolyev, the CEO of Naftogaz, gave a press conference in which he lashed out at the authorities responsible for the reform of Naftogaz.

He gave a presentation that surely must raise alarm bells in Brussels about what is going on in the Ukrainian sector, especially seeing that this is coming from Kobolyev himsef.

In one slide, Kobolyev shows all the “setbacks” that have taken place in the reforms this year:

Earlier, in August, the Chair of the Supervisory Board of Naftogaz, Charles Proctor, a man with 24 years of experience at BP, resigned from the board. Kobolyev explains why:

International organisations have also made it clear that they are extremely disappointed by the lack of reform in the Ukrainian gas sector.

In April, Suma Chakrabarti, President of the European Bank for Reconstruction and Development (EBRD) wrote to Ukrainian president Poroshenko: “Following a string of frustrating developments, I understand that the independent board of Naftogaz are about to resign. Should this occur, it would not only severely damage Naftogaz at a time when reforms were finally beginning to take hold, but it would also shatter the international confidence in your government’s commitment to reform and restructure Naftogaz and other key state-owned enterprises. After many months of consultations, the draft state ownership policy for Naftogaz still contains provisions that go against the spirit of the corporate governance reform, thus compromising the intended independence and insulation of the company from undue political interference.”

On 22 September, the EBRD’s regional director Francis Malige announced that the EBRD will not renew a loan facility provided to Naftogaz for gas purchases “unless the company’s reforms get back on track”, according to Reuters.

Ukraine’s “financial and political backers expressed their concern this week after Naftogaz’s independent supervisory board resigned saying authorities were blocking attempts to modernize and clean up the company”, notes Reuters. “EBRD funding to Naftogaz under a three-year $300 million revolving loan facility has been disbursed and further financing of this sort will depend on the appointment of a new, independent board and the continuation of reforms, Malige said.”

The Energy Community – an organisation of “neighbouring” countries to the EU (Albania, Bosnia and Herzegovina, Georgia, Kosovo, Macedonia, Moldova, Montenegro, Serbia and Ukraine) that are looking to join the EU’s internal energy market – is equally critical of Ukraine.

As Kobolyev notes, the Energy Community Secretariat said on 22 August that all of its recommendations for reform, except one, had been ignored by the Ukrainain authorities.

In addition, the Energy Community said on 12 September that the Draft Law 6778 (the reform law) is “a serious obstacle to the unbundling of the transmission system operator in line with the Third Energy Package as well as a threat to Ukraine’s future as a transit country for natural gas to Europe. Unfortunately, the tabling of this Draft Law is not the only step in this direction. We recently observe an increased activity by the Ministry of Coal and Energy and the management of MGU essentially aiming at perpetuating control over the gas transmission and storage assets without respecting the country’s obligations under the Energy Community Treaty. We believe it is high time to come to a solution of this issue in the true interest of Ukraine and not in anybody’s particular interest. The Secretariat will promote and facilitate such a solution. As a first immediate step, we request that any further legislative procedures of the Draft Law are cancelled without delay.”

As long as Ukraine does not puts its gas house in order, the critics of Nord Stream 2 will have difficulty convincing Germany and other major gas importers to give up on the new pipeline.

Legal void

Currently, in Brussels, the battle over Nord Stream 2 centres on the European Commission’s attempt to obtain a mandate from national governments to negotiate with Russia on a special regulatory framework for the offshore pipeline. The Commission at this moment does not have any legal means to stop Nord Stream 2, hence its search for such a mandate.

According to the Commission, negotiations with Russia are needed because it says the project takes place in a “legal void”. Since it is built in the Baltic Sea and is seen as an “import pipeline”, it is not subject to the EU Third Energy Package, with its unbundling and third-party access requirements. These rules apply only to pipelines inside the EU.

Ideally, Brussels would like to see Nord Stream 2 to be fully subject to the Third Energy Package. No doubt there is the secret hope that if this were to happen, the project would become so unattractive to Gazprom and its partners that they would cancel it.

On of a legal void. Nord Stream 2 spokesman Sebastian Sass told Politico: “There was never any notion of a ‘legal void’ in the context of offshore pipelines, until the Commission itself started talking about it.”

On 27 September, the Legal Service of the Council of the EU [i.e. the Member States] issued an advice on this matter – a  “recommendation for a Council decision authorizing the opening of negotiations on an agreement between the EU and the Russian Federation on the operation of the Nord Stream 2 pipeline”. It is not publicly available, but was published on the website of Politico.

Unfortunately for the Commission, the Legal Service roundly rejects the notion that there is any legal void. It makes it very clear that if the Commission wants to stop the project, it would be a political action, without legal basis.

For example, the Legal Service observes “that the offshore parts of the pipeline would in any event be subject to the relevant rules of international law, including the law of the sea.”

And: “Crucially, the third state, on the one hand, and the Member State concerned and the Union, on the other hand, would in any event have jurisdiction to regulate the operation of the pipeline at the respective points of departure and arrival of the pipeline on their territory …”

Therefore, says the Legal Service, “it is not the case that the limited jurisdiction of the EU and its Member States, on the one hand, and a third country, on the other hand, would lead to a ‘legal void’ as regards the operation of the offshore pipeline …”

The Legal Service also unequivocally states that “the provisions of Gas Directive 2009/73 do not apply to the Nord Stream 2 pipeline”, adding, “without prejudice to the issue of whether Article 194 TFEU may provide a legal basis applying to it.” Article 194 TFEU refers to the article in the Lisbon Treaty which says that “Union policy on energy shall aim” at (among other things) security of energy supply.

But the Legal Service goes even further: it also makes it clear that it believes that Nord Stream 2 is more likely to increase security of supply than reduce it – the major argument that critics of the pipeline advance to make their case.

Thus, the Legal Service writes that “(…) it is prima facie evident that the opening of alternative routes with augmented capacity would increase the (…) resilience of the Union’s external supply networks (…).” And: “(…) the assumption that the opening of supplementary routes or capacities might increase the Union’s dependence on its external energy providers is, at the very least, counter intuitive.”

It further notes that the Commission was “unable to demonstrate a link between the operation of the Nord Stream 2 pipeline and any substantiated market or security concern for energy supply into the Union..”

On 12 October, the energy experts of EU member states will discuss the implications of the Council’s legal opinion in the Energy Working Group. But according to Sebastian Sass of Nord Stream 2, it is already clear that, as he tells Energy Post, “there are no impacts on the national permit procedures and the further implementation of Nord Stream 2”.

This article was first published, in a slightly different form, on Energy Post Weekly, our premium newsletter.