Nord Stream 2: Don’t Make a Bad Deal Worse
Rather than antagonize its European partners with more sanctions in a crusade to preserve the status quo, the Biden administration should direct its resources toward preparing for a world in which Nord Stream 2 becomes a reality.
The Biden administration faces an urgent decision on the controversial Nord Stream 2 gas pipeline project that will test its diplomatic skills and policy judgment. For the past two years, the United States has escalated sanctions against Russian and European firms in an effort to stop the project, which is over 90 percent complete, on the grounds that it poses an unacceptable threat to European energy security and Ukraine’s independence. Congress is pressing hard for more sanctions now to decisively foreclose any possibility of the pipeline’s completion.
Although President Joe Biden has declared Nord Stream 2 a “bad deal,” he would be wise to resist this congressional pressure. Not only is the danger posed by the pipeline overblown, but sanctions also risk gratuitously straining U.S. ties with Europe, which Biden has pledged to restore after his predecessor’s disruptive rhetoric and behavior. There is a better approach: Instead of levying new sanctions, Washington should work with its European partners to pursue a more proactive strategy to ensure Europe’s long-term energy security and enhance Ukraine’s independence, even in the shadow of a fully functioning Nord Stream 2.
What’s the Problem?
Russia now covers roughly 40 percent of Europe’s imported gas requirements and will do so for the foreseeable future, under most scenarios. If completed, then Nord Stream 2 could carry over a quarter of those Russian exports, but it would not tangibly increase Europe’s overall dependence on Russian gas. The only thing it would change is the routes by which that gas enters European markets: Gas exports through it could mean less gas through pipelines that cross Ukraine (and a reduction in—though likely not a total elimination of—the transit fees Kyiv now collects on Russian exports).
The Europeans have long been aware of the risk of this high dependence on Russian gas for their security and have taken major strides in mitigating it. Gas cutoffs resulting from Russian-Ukrainian disputes in the 2000s spurred Europeans to liberalize and integrate the gas market inside the EU, better interconnect their pipeline network for cross-border flows and augment storage capacity to weather short-term interruptions in supply, whether due to geopolitical clashes or technological accidents. These disruptions also encouraged Germany and other European states to support the construction of new pipelines circumventing Ukraine, such as Nord Stream and Turk Stream, thereby alleviating the risk to supplies from chronically troubled Russian-Ukrainian relations.
In addition, the Europeans have instituted regulations to erode the leverage of Gazprom (the Russian supplier) in their markets. In accordance with a 2018 antitrust decision, for instance, the European Commission imposed restrictions to ensure that Gazprom provides reliable and competitively priced gas to all its members, backing them up with a threat of a 10 percent fine on the company’s total global revenue should it seek to exploit its dominant position for uncompetitive advantages.
At the same time, technological advances and energy policy have further eroded Gazprom’s position. The rapid development of shale gas and more abundant supply of liquefied natural gas (LNG) have provided Europeans with an alternative source of supply that will continue to expand in the future as a competitor to Gazprom. The shale revolution also facilitated the emergence of electronic gas trading hubs to set prices in European markets, which has shifted pricing power from the supplier (Russia) to the buyer (European states). Meanwhile, the push to develop renewable energy sources to mitigate the effects of climate change will slowly reduce European demand for gas in the long-term: By 2030, regional demand is projected to fall by roughly 8 percent, relative to 2019 levels.
As a result, Gazprom’s leverage has diminished rapidly in recent years and will likely continue to do so. Nord Stream 2 will not reverse this trend, nor will it have a deleterious impact on either Europe’s overall energy security or that of most European states.
How to Alienate Europe
In these circumstances, the American effort to stop Nord Stream 2 will do little to enhance European energy security, but it could do much harm to Biden’s goal of restoring Transatlantic relations. It unhelpfully interjects the United States into an intra-European dispute—Central and Eastern European members have staunchly opposed Nord Stream 2, whereas the bloc’s most powerful member, Germany, has resisted calls to abandon the project—while the threat of extraterritorial sanctions only antagonizes key European partners.
Last July, EU High Representative Josep Borrell released a statement expressing “deep concern” about Washington’s unilateral intervention in European affairs. The European Union, he noted, not only “opposes the use of sanctions by third countries on European companies carrying out legitimate business,” but considers such actions to be a violation of international law.
Fueling this U.S.-EU antagonism could have serious consequences for U.S. national interests. For one thing, it could provoke countermeasures against American firms. One German think tank has already proposed enacting “climate tariffs” against U.S. energy companies engaged in fracking, including LNG firms hoping to make inroads in the European gas market.
It could also inspire European governments to question the economic arrangements that leave them vulnerable to U.S. sanctions, namely, their dependence on access to U.S. financial and commercial markets. Especially when faced with a policy they consider illegitimate, states may begin exploring ways to circumvent sanctions. For precedent, one can look to Germany, France, and the UK’s response to the Trump administration’s decision to renege on the Iran nuclear deal: Their creation of a “special purpose vehicle” to evade U.S. sanctions, while ultimately ineffectual, offers a glimpse of the sort of strategies available to states opposed to U.S. unilateralism.
In the long run, alienating European allies could hasten the ultimate erosion of the United States’ central role in global finance and, as a result, the efficacy of sanctions as a diplomatic tool. As former Treasury Secretary Jacob Lew explained back in 2016, “the more we condition use of the dollar and our financial system on adherence to U.S. foreign policy, the more the risk of migration to other currencies and other financial systems in the medium-term grows.”
Keeping Ukraine Captive
Perhaps the most convincing argument for opposing Nord Stream 2 is the economic impact the project could have on Ukraine. A substantial proportion of Russian gas flows through Ukraine every year, an arrangement that Kyiv profits from by charging transit fees. In 2018, this transit amounted to roughly 80 bcm (40 percent of all Russian gas exports to Europe), though that number has already begun to drop. According to the current five-year contract, signed by Gazprom and Ukraine’s state-owned Naftogaz at the end of 2019, Russia is obliged to pay fees for a minimum of 65 bcm in 2020 (despite the fact that Gazprom only shipped about 50 bcm, given the pandemic-induced drop in demand) and 40 bcm per year between 2021–2024. All told, the contract guarantees Ukraine a minimum of $7 billion over five years. Averaged out to roughly $1.4 billion per year through 2024, this constitutes about 3.6 percent of revenues to the 2021 state budget. Were Russia able to direct an additional 55 bcm per year through a fully functioning Nord Stream 2 pipeline, it could send less gas through Ukraine. It would thus have more flexibility to negotiate down its future transit obligations to Kyiv once the contract lapsed. However, given Gazprom’s interest in minimizing future disruptions to gas flows—whether through planned maintenance or unexpected shocks—it will likely not seek to end its transit through Ukraine altogether.
While the United States has a strong interest in supporting the development of an independent, robust, and liberal Ukraine, and its opposition to Nord Stream 2 is aimed at advancing that goal, the effect is otherwise. The current transit arrangement between Kyiv and Moscow leaves Ukraine dependent on payments from a belligerent neighbor, thereby hindering its ability to break out of Moscow’s unwanted embrace.
What’s more, Kyiv collects the transit fees through the energy sector, one of the most corrupt in a country that ranks 117th in Transparency International’s 2020 Corruption Perceptions Index. The National Anti-Corruption Bureau of Ukraine reports that, among corruption cases brought to court, the energy and fuel industry accounts for the lion’s share of economic losses to the economy (over 3 billion UAH, or roughly $100 million USD between 2012 and 2018). By another estimate, graft schemes in the industry have cost Ukraine at least $2 billion USD since independence.
To be sure, the state-owned enterprises involved in collecting transit fees, Naftogaz and the newly independent Gas Transmission System Operator (GTSO), have been models of success in Ukraine’s crusade against corruption. But even those success stories are not immune to backsliding. Both companies are currently facing an onslaught of political interference from government officials seeking to undermine or reverse the progress that has been made. These efforts have included the politically motivated removal of reform-minded figures from independent supervisory boards and an effort by forty-seven members of parliament to nullify the unbundling of the GTSO—led by former Prime Minister Yulia Tymoshenko, whose immense wealth came from the sort of corrupt energy schemes these reforms are meant to prevent.