A pipeline from Russia across North Korea to South Korea is still a long way off. Photo: iStock
The direction of Russian gas pipelines is shifting from west to east. Photo: iStock

The construction of Nord Stream 2, a natural gas pipeline connecting Russia’s Leningrad region with Northern Germany via the floor of the Baltic, is almost complete, but controversies hover over the project.

Officially, Nord Stream 2, which will come online in early-mid 2020, will provide additional gas to Europe and optimize transportation costs.

Critics, however, are suspicious. They suggest that the Kremlin is, in fact, deploying a dual-pronged, below-the-radar strategy that will financially impact Ukraine while also driving a wedge into European energy security.

Here comes Nord Stream 2

Last week, Russian state gas giant Gazprom received long-awaited permission to build one of the last sections of Nord Stream 2 through Denmark’s territorial waters.

Designed to replicate the already operational Nord Stream 1, Nord Stream 2 will consist of a pair of parallel pipelines running along the floor of the Baltic Sea, with an annual capacity of 55 billion cubic meters.

Meanwhile, TurkStream – another Gazprom-owned pipeline running through the Black Sea, connecting southern Russia with Turkey and then continuing through Bulgaria and Serbia and into Hungary – is set to go operational at some point in 2020 with a capacity of 31 billion cubic meters.

The two pipelines are core components of Gazprom’s increased supply of gas to capital-rich, energy-poor Europe. The Russian giant already supplies about 40% of total European imports, flowing through three existing routes: Nord Stream 1; a pipeline through Ukraine; and a third through Belarus.

Given the capacities of existing routes, questions hang over the new pipelines.

What’s the rationale?

As pointed out by Dmitry Marinchenko, lead analyst for oil and gas at Fitch, the extant infrastructure is enough to meet Europe’s current gas demands. “Even if Europe’s demand for Russian gas increases, it won’t be enough to justify all these supply routes working at full capacity,” he told Asia Times.

Gazprom, in fact, is carrying out an “optimization program,” which by 2020 should reduce the Ukraine-routed supply down to about 10% of current levels. What, then, is the rationale behind building new capacities while dismantling other capacities elsewhere?

Gazprom CEO Aleksey Miller would answer that Nord Stream 2 is 1.6 times more cost-efficient than the Ukrainian route. And he has every reason to talk about upsides. Gazprom stocks have been surging since the announcement that Denmark had green-lighted Nord Stream 2, reaching their highest value since August 2008.

The company is now worth $98.8 billion in market capitalization.

However, those looking closely at Gazprom’s numbers are raising their eyebrows.

Critically, Gazprom’s official financial estimates fail to include the huge costs of on-land infrastructure connecting the pipelines in the west with the natural gas fields located deep inside the vast Russian landmass.

Factoring this element in, real costs exceed official figures by a hefty 60% for Nord Stream 2, and by a whopping 160% for TurkStream, according to estimates by analysts at Russia’s biggest commercial bank, Sberbank CIS.

And some estimate that the costs for Gazprom will be even higher. They include Mikhail Krutikhin, partner at independent, Moscow-based consulting firm RusEnergy, who believes it will take decades for Gazprom to profit from the lines.

The crafty Kremlin

Considering these numbers, the rationales for neither Turkstream nor Nord Stream 2 appear to be economic. “The new pipelines mainly have a political goal: ‘Punish Ukraine,’” says Krutikhin.

If he is correct, it wouldn’t be the first time Russia has used state-company Gazprom as a tool of leverage against Ukraine and Europe – by raising gas prices or reducing supplies in times of worsening diplomatic relations.

“Often, Gazprom’s decisions are not based on profit-oriented calculations, but on the state’s political interests,” Marinchenko said.

Since Moscow’s relations with Kiev hit historic lows following the 2014 annexation of Crimea and the ongoing secessionist war in Eastern Ukraine, Russia has been applying steady pressure to the former Soviet state, whose fragile economy is heavily dependent on the annual $3 billion in transit tariffs from Russia.

It is not just about Ukraine. In addition to depleting Kiev’s coffers, Nord Stream exacerbates divisions among EU states, which some allege is Russian President Vladimir Putin’s “divide and rule” strategy for Europe.

The main beneficiaries of Nord Stream 2 will be Germany, which will profit from gas transit fees, and Austria, the final destination of the new gas supply route, strengthening that country’s position as Europe’s key gas hub.

And Hungarian President Victor Orban has recently said joining TurkStream is a priority. “If Russian gas comes only through Ukraine, that is not good for Hungary,” he said in a recent meeting with Putin.

The losers will be Poland the Baltic States and Slovakia, which will be deprived of transit tariffs as the Ukrainian route progressively loses significance. It may be no coincidence that Moscow considers the Baltics and Poland highly sensitive NATO bulwarks on Russia’s flank.

Adversaries of Nord Stream have found an ally in the US, a nation with duel interests. It is a lead player in NATO and also seeks to increase sales of its own liquefied gas to Europe. Some US senators have waved the stick of sanctions at European companies participating in the construction of the pipelines.

In response, Berlin has warned Washington not to meddle. “Matters related to European energy policy must be decided upon in Europe, not in the United States,” German Foreign Minister Heiko Maas said during a reception organized by the German Committee on Eastern European Economic Relations earlier this year.

Overland or undersea?

Combined, TurkStream and the two Nord Stream pipelines could potentially match the 146 billion cubic meters capacity of the trans-Ukrainian route, making it superfluous. However, running the two pipelines at their full capacity won’t be possible in the short term, given that the receiving infrastructure on European soil is not yet completed.

And there are inherent risks in off-shore transit, which makes the Ukrainian overland route the safer bet. Despite the on-going conflict in Eastern Ukraine, Ukrainian pipelines have proved their worth over the years.

“Ukrainian pipelines are well guarded, and have proven to be more reliable than Gazprom pipes, with a failure rate eight times lower,” said Krutikhin.  All this  “… makes full dependence on Nord Stream quite risky,” he added.

Moreover, Nord Stream 2 won’t be as flexible as the Ukrainian route in terms of supply volumes. “Nord Stream and Nord Stream 2 are designed to pump an equal amount of gas all year long, with no chance to regulate [volumes] according to seasonal needs,” Krutikhin said. “This lack of flexibility increases the chance of possible gas outages.”

For these reasons, Russia and its customers will have to rely on the Ukrainian route over the near term. But volumes will be drastically reduced.

According to Marinchenko’s estimates, as of next year, gas volumes through Ukraine will shrink by roughly 50%.

“In the following years they are likely to fall even further,” Marinchenko told Asia Times, noting that this will lose Ukraine billions per year.

Looking eastward

Oil and gas revenues make up some 40% of Moscow’s state budget. As the double-headed eagle on its national coat of arms makes clear, Russia is a country that looks both east and west. Unsurprisingly that east-west view also represents Gazprom’s gas exports, which now aim at both ends of the Eurasian continent.

While political controversies hang low over Russia’s westward-running pipelines, that is not the case in the east. Power of Siberia, a 3,000-km pipeline connecting Russia’s Eastern Siberia to capital-rich, energy-hungry partner China, is expected to be completed by the end of this year.

The project, with its estimated $55 billion cost, represents Moscow’s largest investment ever in its underdeveloped and under-populated eastern provinces. It also represents a major bet that future China-Russia relations will continue on their current amicable course.

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