Nord Stream 2 - the end game

Nord Stream 2 - the end game

by Pininvest Analysis

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American lobbying efforts to block the construction of a second gas pipeline on the seabed of the Baltic – Nord Stream 2 – delivering Russian gas to Germany and various European countries are something to behold

Neither is it the first time the U.S. interferes with the energy policy of close European allies, with attempts to bully Germany into accepting its playbook in the early 1980's

Sensitive in their own right, the American sanctions of 1981 heightened tension to a pitch by throwing a spanner in the works of the German Chancellor, Willy Brand, because energy was at the heart of his country’s rapprochement with East Germany… and with the USSR, the ‘Ostpolitik’

Nothing came of it as the USSR developed alternative technologies and the Reagan administration abandoned its policy in 1982, after less than two years

Seeming to revisit the past, the attempt to block the final leg of the construction of the new pipeline between the fields of Siberia and Germany, and leaving approx. 75-mile unfinished track (120 kms) after the laying of 690 miles of pipe (1 100 kms), is a bipartisan effort in U.S. Congress, orchestrated by Senator Cruz (Rep. Texas)

This is not to suggest geopolitics do not dominate every energy policy decision, because they do – the U.S. being an energy strategist par excellence

However, Russian gas exports operate on entirely different terms from the Reagan era, back in the 1980’s 

And this radical transformation pivots on two dimensions – a market pricing revolution driven by technology and an ironclad European legal framework

The Reagan administration announced economic sanctions through the Export Administration Act of 1979, including a block on exports of compressor equipment, formally aimed at the Soviet Union following the declaration of martial law in Poland, but impacting the European countries in its application

The American technology was an indispensable component in the construction of a Euro-Siberian pipeline at the time, and the embargo put the reliance of European energy policy on a grid connecting European natural gas demand with Siberian production capacity at risk

Raising vocal protest in Europe, the measures were perceived as an infringement on the sovereignty of foreign states by imposing U.S. law on foreign soil

 

Nothing changes… but still, everything is different

Usually not a constructive approach in diplomacy, the combative stance in Congress is presumably aimed at domestic interests and at public opinion, with a few US. Senators draped in a toga of good conscience

U.S. officials once again hope to bully allied nations into submission, although the low profile of the State Department and the pushback by the Treasury speak volumes about the disjointed American foreign policy

 

As discussed in ‘Russia’s Rattenfänger’, the project initiated in 2005 by Russia’s Gazprom  has direct participation of the French (Engie ), the Dutch (Nederlandse Gasunie), Shell  and the Austrian energy company OMV , along with Germany's Uniper and Wintershall-Dea entities, allies which will be more than a little miffed at the prospect of abandoning a €9.5 billion ($11 billion) project

Energized by Poland and the Baltic States, countries which learned firsthand about Russia’s looming influence in Eastern Europe, the American congressmen cannot be criticized for flagging the risks of Europe’s dependence on energy provisions – an occurrence which, not coincidentally, lines up with America’s interest in exporting its overabundant gas (LNG)

Whether Congress’ strong-arming of foreign policy is wise remains to be seen

 

Geopolitics with a purpose

This is not to suggest geopolitics do not dominate every energy policy decision, because they do – the U.S. being an energy strategist par excellence

While shared energy interests between East (to sell) and West (to consume) were a building block of Chancellor Willy Brand’s Ostpolitik leading to the German treaties with the USSR and with Poland (1970), engaging a normalization of relations and leading to a new international rapport, firebrand Cold Warriors could express legitimate and forceful concerns at the time

In fact, geopolitics continue to play out in an even broader context of East-West relations, complex interactions of which energy policies are a cog, an important constituent which should not be ignored but a big stick not to be brandished without a clear purpose

Taking another look at the Senate activists – foremost Senator Cruz of Texas – it should become obvious that temptations to meddle with foreign policy in the name of the world’s superpower could flounder embarassingly in vain posturing

 

By putting his signature in Dec. 2019 to a formal warning to Allseas, a firm which had been laying the pipes in the Baltic Sea, Senator Cruz may have gone beyond his elective mandate, infringing on the responsibilities of the State Department and the Treasury

Not one to be holding back on a matter of principle, Senator Cruz pressed ahead after the withdrawal of Allseas, which, with exposure across the world, was not prepared to face down a U.S. Senator and stopped its operations

  • This is how the German port of Sassnitz, a large publicly owned infrastructure project on the Baltic sea, which happens to be located in Chancellor Merkel's home state and in her electoral district, got caught up in a regime of secondary sanctions targeting companies involved with Gazprom to finish the pipeline, with the clear purpose to cut off support services
  • In a letter Aug. 5, 2020, Senator Cruz, refering to legislation expanding sanctions to block completion of Nord Stream 2, which were to be included in the Dec. '20 Defense Appropriation bill, exposed the port’s “board members, corporate officers, shareholders, and employees, to crushing legal and economic sanctions, which our government will be mandated to impose.”

Embarrassingly, the Senators Cruz and his co-signatories and colleagues Cotton and Johnson do not seem to be aware that leading America into battle against a run-down port on the Baltic sea, struggling to survive, is disconcerting and, much worse, will force America into a show down, with nothing to gain

 

A playbook straight from the Cold War

According to CNBC (Dec. 18, 2019), reporting on the first round of American sanctions targeting the Nord Stream 2 pipe line in late 2019, Senator Ted Cruz summed up U.S. sentiment toward Nord Stream 2 by stating it “poses a grave threat to the national security of the United States and our European allies.”

Urging Nord Stream 2′s construction to be halted, he argued “the United States must stand with our European allies, support energy diversity, and combat Russia’s economic blackmail.”

Well aware the storyline for domestic parties about the pipeline being “a critical threat to America’s national security” did not hold water with European leaders, Mr. Cruz sought foreign allies to focus on Eastern European insecurities, downplaying the fact that not only NATO’s commitments but the embrace of Eastern European countries by the EU delivered the strongest guarantees

And Mr. Cruz made the best of what he found, two Ukrainian citizens… an energy-company executive of Naftogaz, Mr. Vadym Glamazdin and a national-security official, Mr. Oleksandr Kharchenko

Ukrainian delegation with Sen. Cruz (holding  a book) - credit D. Vajdich - sce WSJ Nov. 29, '20

From left, Vadym Glamazdin, Sen. Ted Cruz, Oleksandr Kharchenko, Naftogaz CEO Andriy Kobolyev, and Naftogaz adviser Olena Zerkal

Left unsaid in the lobbying effort is the cautious stance of Eastern European States

Poland, a vocal critic of the Nord Stream infrastructure, pursues its effort to limit dependence on Russian gas by filing lawsuits defended in the European courtrooms – apparently not so much in Washington’s lobby circuit

Arguing that the additional gas imports to Germany were "tantamount to breaking the rules of law and of fair competition", Poland's anti-trust regulator has ordered Russia's Gazprom in October 2020 to pay a very large €6.47 billion fine ($7.6 billion), arguing that the construction of the Nord Stream 2 pipeline would increase Poland's dependence on the Russian gas provider - a decision which will obviously be appealed

Leaving the national energy company Naftogaz to its devices, Ukraine's government is not involved at all, and for good reason

The country has concluded a favorable 5-year agreement with Russia about gas transit, payment by Gazprom of sums awarded in arbitration, all just before the existing 2009 contract ran out – Dec. 31, 2019 – after President Putin compelled the Russian company’s negotiators to do so

  • Ukraine had hoped for a 10-year contract while Gazprom wanted no more than a one-year extension of the existing commitment, making a 5-year deal, setting the volume of gaz transiting at 65 bcm in year 1 and 40 bcm from year 2, acceptable by both parties
  • As a result of litigation, which ended with Ukraine winning the first one of its cases, Gazprom was to pay $5 billion for sending less gas than contractually obligated. Much criticized by the Russian parties, including by Mr. Putin himself, Gazprom has committed to the payment and Ukraine to withdraw all other lawsuits, per the new agreement

 

Commercial logic and market realities

Inclined by the nature of their charge as elected officials, U.S. congressmen could not resist the temptation to drive American economic interests of LNG exports on the back of a geostrategic security argument

The argument, however much bipartisan support is mustered in Congress, is bound to fail, and not only for the obvious fact that the European Union itself is as much about guaranteeing its Eastern border as NATO

Interruptions in gas deliveries by Russia in 2006 and in 2009 may have fed American suspicions while the incidents have since been recognized as hiccups in Ukraine’s struggle for independence, and, damaging Russia's reputation as a reliable supplier, were hardly beneficial to Russia’s geostrategic vision

Not to to belabor the point, painting Russia as a command political economy has proven to be woefully outdated, after 50 years of gas exports to Europe

 

The geopolitical significance of the Russian gas industry can, and should be, set in the broad – and very long term – context sought by Russia’s President to balance its current Western clients and its ambitious plans to serve Asian markets

However, for now, as a complex, technically highly sophisticated commercial business, closely linked to European interests on terms which are no less commanding for having emerged slowly, Russian gas fits in an entirely different framework from 1980’s Reagan era

And this radical transformation pivoted on two dimensions – technological and legal

  • Riding the digitall revolution, European gas prices ended up being market-driven in computer trading hubs – the long-term ‘take or pay’ contracts and the strictly bilateral agreements, which Gazprom used to dominate, are a distant memory, replaced by flexibility and cross-selling 
  • Taken a leaf from the University of Chicago’s liberal school thinking, the European Single Market, under the impulse of Lord Arthur Cockfield, the European Commissioner for internal market and services under the Commission President Jacques Delors (1985-1989), thoroughly upended the leverage Russia could have hoped to enjoy originally, as one Energy Directive (the EU legal framework) followed another

Intent on removing barriers to the free movement of persons, goods, services and capital, the approach laid out by Lord Cockfield is worth restating in these Brexit-times (as on any occasion)

  • in the words of David Anderson (Prospect Magazine Oct. '19) : in place of time-consuming attempts to legislate for Euro-bread or Euro-architects came the principles of core harmonisation and mutual recognition of national standards, implemented by qualified majority voting in the Council under the Single European Act of 1986

Adopted at EU level in 2009, the groundbreaking legislation set out by Third Internal Energy Market Package adressed a key constituent of the Single Market by aiming at

  • securing a competitive and sustainable supply of energy
  • enhancing cross border trade of diversified sources of energy

With concepts of ownership unbundling (splitting energy generation from transmission), of independent system operators and of independent transmission operators, some of the largest energy producers lost their control over their domestic markets, nowhere more so than in Germany

…and Gazprom has had no other option but to align its commercial options with the logic of the European framework

Operating in tandem, and mutually reinforcing, the energy trading hubs and the downsizing of the largest power generators in each European country established a global market which makes the American security concerns look outdated

 

Taking the long view

The sizable market share of Gazprom's gas exports to Europe does create dependence - but if Europe relies on the Russian supplier, the reverse is also true as the entire network of pipelines serves European customers, and only those customers

If anything, Russia's President Putin is focused less on wielding illusory market power in Europe for a polical purpose than in articulating a policy to anticipate the challenges which will confront his country's energy exports in the coming decades

Source - Eurostat - EU imports of energy products - recent developments - Oct. 2020

In a broad sweep of what these challenges might be, we hope to discuss in a forthcoming review - Novatek's icebreaker -  how to solve 'the riling russian riddle', our earlier note on LNG

Unsurprisingly, Mr. Putin will be paying attention to

  • dropping gas consumption in Europe, as renewables gain market share and geothermal energy loses attraction
  • climate change, opening the Northern route to Asian markets
  • the questionable future of pipelines as a means of transporting gas 

And so should Senator Cruz...