The OPAL judgment from the European Union (EU) General Court will undermine Gazprom’s market dominance in Central and Eastern Europe.
Case T-883/16 Republic of Poland v. European Commission (hereafter the OPAL case) is likely to have far more impact on European energy policy than just limiting Gazprom’s capacity to export natural gas via Nord Stream 1. In the OPAL case, the judges of the EU General Court established and elaborated a broad principle of energy solidarity drawing upon Article 194(1) of the Treaty on the Functioning of the European Union (TFEU). This principle of solidarity, which will require member states, in all their energy market decisions with a potential cross-border impact, to take into account not only their own interests but also those of other member states and also those of the European Union as a whole, is likely to have a significant impact on the development of European energy law over the next decade. It will no longer be possible for member states to develop energy infrastructure while ignoring the vital interests of other member states. The OPAL case will also provide a basis for the European Commission, member states, and other interested parties to bring legal challenges against those member states who infringe the principle of solidarity.
More immediately, in addition to the OPAL pipeline, the OPAL case is likely to have an impact on Nord Stream 2, potentially making the path to full utilisation of the pipeline much less likely than it previously seemed. The OPAL ruling, for instance, makes it more difficult for Nord Stream 2 to pass the process of security of supply certification required by Article 11 of the Gas Directive 2009. That same directive in Article 36 also imposes significant supply security and competition criteria before an exemption could be granted from its liberalisation requirements. Those requirements will be more difficult to fulfil post-OPAL.
The ruling is also likely to make it more difficult for Nord Stream 2’s owner, Gazprom, to deploy legal mechanisms and corporate structures to avoid the application of EU energy liberalisation law to the pipeline. The OPAL ruling will also bear down on the development of Turk Stream 2. As an import pipeline, it will also be subject to EU law on EU territory, and the local energy regulatory authority will be required to apply EU energy liberalisation legislation in the light of the OPAL ruling.
Overall, the OPAL ruling is likely to make it more difficult for Gazprom to do individual deals that benefit individual member states, but may harm other member states. As a result, Gazprom’s capacity to play one EU member state off against another has been limited by this ruling.
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An undersea natural gas import pipeline such as Nord Stream 1 is not isolated. It requires connection to land-based pipelines that take the imported gas deep into European markets. In the case of Nord Stream 1 (which has a capacity of approximately 55 billion cubic meters (bcm)), there are two connecting pipelines, NEL and OPAL. NEL carries 20 bcm westward from the Greifswald, a Nord Stream landing point on the German Baltic coast, toward the Netherlands and the rest of north-western Europe. The second connecting pipeline, OPAL, goes eastward from the same Greifswald landing point through eastern Germany and on to the Czech border. It has a carrying capacity of 36 bcm.
Following the entry into force of the EU’s Gas Directive 2003, and in subsequently updated legislation in the 2009 Gas Directive, OPAL was, in principle, subject to full liberalisation. This meant that the pipeline would be subject, at the very least, to third-party access requirements and tariff transparency. Gazprom and its German corporate allies, who owned OPAL, wished to avoid these restrictions. Fortunately for them, under the EU’s energy liberalisation regime, it was accepted that in order to encourage the building of new infrastructure, such as pipelines, such infrastructure could be exempted from the liberalisation rules for a limited period (e.g., fifteen to twenty years). Consequently, an exemption was sought under Article 22 of the Gas Directive 2003 (now Article 36 of the Gas Directive 2009). An exemption was granted in 2009 by the German energy regulator and approved by the European Commission in a formal decision. However, in taking account of the exemption requirements regarding security of supply and competition contained in the Gas Directive, the Commission imposed conditions in the exemption decision. The Commission required that the dominant players in the market (Gazprom and RWE) would be limited to half the pipeline’s capacity, unless at least 3 bcm a year of gas was placed on the market under a gas release programme. Gazprom refused to provide a gas release programme because it would have resulted in an open auction for gas with third parties. In such an auction, the prices set at market could have been used against Gazprom. For example, customers with long term supply contracts with Gazprom, with price review clauses, could have been incentivised to use the evidence of those auctions to take Gazprom to arbitration to force a reduction in the price they themselves paid for gas. Therefore, Gazprom and its German ally were limited to using no more than half of the pipeline capacity.
Almost from the outset, Gazprom and its corporate allies sought a more beneficial outcome than they had obtained from the 2009 Commission decision. Not only was the capacity reduced by the Commission decision, but it was a capacity reduction into one of Gazprom’s highly profitable markets. Nord Stream 1 has a carrying capacity of 55 bcm. Gas from Nord Stream 1 could therefore always flow westward via the sister pipeline to OPAL NEL. However, NEL only had a carrying capacity of 20 bcm. Furthermore, NEL took gas to the much more competitive and price sensitive Western European market. The European Commission decision restricting the capacity of the OPAL pipeline effectively limited the access of Nord Stream 1 via OPAL into a potentially highly profitable market. A further concern from Gazprom’s perspective is that being unable to use full capacity of Nord Stream 1 forced it to continue to depend more on the Ukrainian Brotherhood pipeline network, increasing the leverage of Kyiv.
In December 2016, Gazprom—with the assistance and approval of the German energy regulator—was able to obtain an amendment to the 2009 OPAL exemption from the European Commission. In essence, the cap was lifted. 50 percent of OPAL’s capacity would be exempt from third party access and tariff regulation. The rest of the pipeline’s capacity would be subject to two auction regimes. However, as Gazprom was dominant in the marketplace, the reality was that Gazprom or Gazprom’s allies would take up all the auctioned capacity. In essence, Gazprom was gifted the rest of the capacity by the Commission. The actual operation of the pipeline after December 2016 demonstrated that this is exactly what happened. OPAL wholly became a route for flooding Gazprom-controlled gas from Nord Stream 1, while gas flows through the Ukrainian transit route along the Brotherhood pipeline network fell.
Given that Gazprom was already dominant in a number of Central and Eastern European markets, the effect of granting Gazprom yet more capacity was to strengthen its market dominance across the region. Greater access to OPAL raised a series of economically credible concerns from other actors in the market, from increasing pricing power, to increased capacity to exclude other market participants, to the prospect of the loss of capacity to resell gas within the European and Ukrainian markets.
The OPAL pipeline also raised a broader political concern that, with greater Russian control of gas flows, Central and Eastern European governments feared a return of greater Gazprom natural gas market dominance, which in turn would presage a return of Russian political influence. As a consequence, it was not surprising that Poland, supported by Latvia and Lithuania, challenged the Commission’s decision to amend the 2009 exemption decision before the EU courts.
The EU General Court in the OPAL case.
The case was lodged by Poland in the EU General Court, the lower court of the European Court of Justice, in December 2016. The ruling disposing of the case in final judgment was handed down on September 10, 2019.
In that judgment, the EU General Court based its argument on the ‘principle of solidarity’ contained in Article 194(1) TFEU. It argued that this was a sectoral expression of the broader principle of solidarity that binds all member states and is found elsewhere throughout EU treaties. The Court said that there is a general obligation to take into account the interests of both the Union as a whole and other member states. This obligation is not just limited to situations where there are natural disasters or other emergencies, it is of general application in Union law.
In the energy sector, the Court said that member states must seek to take into account the interests of the Union and other member states with respect to security of supply, economic interests, and the diversification of sources of supply. A balancing test of interests should be adopted when applying the principle of solidarity in cases of conflict. The Court said that, in this case, it was incumbent upon the German authorities and the Commission to consider the interests of not just Germany but also of other member states, and where there was conflict, those interests should be subject to balancing assessment. This assessment may include, where appropriate, the interests of the Union as a whole.
The Court pointed out a number of serious flaws in the Commission’s decision. In particular, the failure to even refer to the principle of solidarity in the text of the decision. It also observed that there was even no factual or legal examination of that issue, despite the existence of Article 194(1), which set out the principle, within the any part of the decision.
The judges in Luxembourg were also clearly unhappy with the limitation of the Commission’s market assessment in the decision to the German and Czech markets, despite the broader impact of Gazprom’s increased access to the OPAL pipeline across Central and Eastern Europe. The Court pointed in particular to the glaring absence of any assessment of the potential impact on the Polish market in respect of gas flows from the Yamal and Brotherhood pipelines. It also noted there was no assessment of the impact of supply security of the OPAL pipeline at the Union level.
The Commission has just over two months to appeal the ruling of the General Court to the European Court of Justice. The likelihood of such an appeal is low. In the first place, there is a practical political difficulty in both dealing with the decision at the end of the current Commission and putting in on the desk of the new Commission, which comes into office on November 1 and would only leave a couple weeks to decide about an appeal.
In either case, it is very doubtful that the appeal would prevail in the EU’s superior court. The General Court was clearly unimpressed by the narrow scope of the Commission’s market assessment and failure to even discuss the principle of solidarity. With such a problematic decision, it is likely that CJEU would have no alternative but to uphold the judgment of the General Court.
An alternative option for the Commission would be to accept that the 2016 decision is dead and draft a new decision granting Gazprom full access to the pipeline. This could be a workable solution because a broader market analysis today could take account of both increased liquefied natural gas (LNG) capacity in Poland and the prospect of the Baltic Pipeline coming on stream in 2022, which, it could be argued, undermined the additional market power that Gazprom would obtain via greater access to OPAL. However, the difficulty with any such analysis is that it would also have to take account of the advent of Nord Stream 2, which would significantly increase Gazprom’s market dominance. In addition, any such analysis would be subject to potential legal challenge from Poland, Lithuania, Latvia, and other member states across the region.
It is likely, therefore, that the Commission will not appeal the ruling of the General Court, and, for now, will not attempt to adopt a new decision on OPAL that would effectively grant Gazprom greater access to the pipeline.
Implications of the OPAL judgment
The direct and immediate impact of the OPAL judgment is that Gazprom and Gazprom’s allies’ capacity to sell natural gas via Nord Stream and the OPAL pipeline is reduced by approximately 12.8 bcm per year. The OPAL ruling has a secondary positive effect for Ukraine, in that the only current alternative route for Gazprom is the Ukrainian Brotherhood pipeline. As a result, Ukraine will, for now, obtain additional transit fees from the re-routing of gas flows.
However, the immediate impact of the ruling is of far greater import than the allocation of transit fees and the physical fact of re-routing. Firstly, the OPAL ruling will play into Russian calculations about making a deal with Ukraine over a new transit agreement. The current transit agreement came into force on January 1, 2010and will expire at 10:00 a.m. Moscow time on January 1, 2020. Without an agreement, no gas can flow through the Brotherhood pipeline network (and 86bcm of gas flowed through it in 2018, which is approximately the same as total German annual consumption).
Gazprom was probably relying on the full utilisation of Nord Stream 1 and OPAL as an alternative route for natural gas flows, in the event that it decided to let the Ukrainian contract expire. It still has the rest of the capacity of Nord Stream 1 and Yamal, as well as considerable quantities of gas stored in Western storage facilities, but annual flows of approximately 13 bcm are difficultto replace at short notice.
A second concern for Gazprom is that the OPAL ruling would likely influence the European Commission perspective on the terms of use for any completed Nord Stream 2 pipeline. For instance, even if an exemption were granted from the EUs liberalisation rules to Nord Stream 2, would the Commission impose similar conditions to Nord Stream 2 as it did to OPAL in 2009? The Commission could impose a significant, say 50 percent, capacity restriction in the use of the pipeline in order to account for the supply security and competition impact of Nord Stream 2 on other member states and the Union as a whole. The effect of the two capacity restrictions on OPAL and Nord Stream 2 together would likely change Gazprom’s approach to the Ukrainian transit contract. It would make a refusal to agree to another contract with Ukraine pointless, as Gazprom would need to continue to place significant gas flows via the Ukrainian transit route in order to export at its current scale into European markets.
One broader significant impact of the OPAL ruling therefore is that it could encourage Moscow to seek to negotiate a deal with Ukraine before the January 1 expiration of the current transit contract.
The third implication of the judgment is in respect to Nord Stream 2’s prospects. Even if the Danish Energy Agency finally grants Nord Stream 2 a route permit, the pipeline is now fully subject to Union law. In particular, as a non-EU owned pipeline, it has to be certified by the national regulator (Germany, in this case) that the granting of certification will not put at risk the supply security of the member state or the Union as a whole. Clearly, the OPAL ruling is likely to play a significant role here. Given Gazprom’s behaviour in interrupting gas supplies to EU member states, particularly in 2014–2015, when Gazprom reduced supplies via Nord Stream 1 to member states reselling gas to Ukraine, certification could be problematic. Any attempt to grant a certification without addressing the concerns of other member states would be likely to result in a legal challenge by Central and Eastern European member states in the EU courts.
Equally, if Nord Stream 2 seeks an exemption from the liberalisation rules contained in the Gas Directive 2009, such as ownership unbundling, third party access, and tariff regulation, the OPAL ruling is likely to bite again. The exemption provision of the directive, Article 36, specifically refers to the impact of an exemption on supply security, the functioning of the internal market, and competition. Given the OPAL ruling, Article 36 will have to involve an assessment of the impact on the entire EU market of Nord Stream 2, and balance German interests against those of other member states and the Union as a whole. As there are a number of concrete concerns about higher prices in Central and Eastern Europe as a result of Nord Stream 2, loss of transit security and increased market dominance of Gazprom, together with market division and supply security concerns, would make obtaining an exemption with limited or no conditions problematic.
One alternative option for Nord Stream 2 is to try and avoid the application of EU energy law via a number of legal and corporate mechanisms. For example, Gazprom has promoted the so-called ‘stub’ idea, which suggests that EU law could be avoided by dividing the pipeline up, so that part of the pipeline operating outside EU territorial waters is owned by one company, while a second EU owner would own the pipeline within EU territorial waters. Only the latter would be subject to EU law. It was already doubtful that such mechanisms would work because the Gas Directive was drafted in order to ensure formalistic corporate mechanisms could not be deployed by astute, powerful Western European energy companies. Hence, Recital 10 of the Directive imports the very broad definition of control from EU antitrust law into the Directive (which alone may already undermine the stub mechanism idea). The tenor of the OPAL ruling makes such formalistic mechanisms even more risky. The Court was clearly dismissive of the formalistic approach to the assessment of the impact of the pipeline, which only dealt with the territories affected along its direct route. Equally, it imposed an extensive and thoroughgoing inquiry for any energy solidarity assessment. In that context, the prospect of Nord Stream 2 and the German energy regulator seeking to broker a deal whereby some corporate mechanism will allow the pipeline to avoid the full application of Union law looks extremely doubtful and risky.
Nord Stream 2 receives all the attention, but there is also Turk Stream 2, which will bring natural gas across the Black Sea to Bulgaria. The Bulgarian energy authority will now find itself in the invidious position of having to apply EU law to the Turk Stream 2 pipeline, with pressure being applied by Gazprom and its allies while, at the same time, being overlooked by the European Commission and several member states.
Conclusion: Is OPAL a shadow over Gazprom?
The OPAL judgment places a shadow over Gazprom across Central and Eastern Europe. There is now a serious question as to whether or not Gazprom will be able to play the gas game, whereby it can offer special pipeline deals to one member state while exploiting others. OPAL has made such deals much more difficult. Benefiting member states now face an legal obligation to take other states’ interests into account, and the European Commission hovers over all member state decisions, with additional interested member states ready to bring their own legal challenges before the EU courts.
More immediately, OPAL has changed the calculation for Gazprom in respect to the Ukrainian transit contract. The price for expiration of the contract, in terms of the amount of gas that can be sold via other routes, is now much higher for Gazprom. It is also likely to be even higher in the future, as the OPAL ruling may be applied to Nord Stream 2 itself, with the Commission perhaps limiting Gazprom to using half the pipeline’s capacity.
It may be that, given the amount of gas in storage in Western European and the political needs of the Kremlin, the contract may be allowed to expire in January 2020. However, given the OPAL ruling, Gazprom’s most realistic option may well be to do a deal in the spring of 2020, whereby it is locked into capacity access restrictions to OPAL and Nord Stream 2 by EU decision, with substantial quantities of natural gas still flowing through the Brotherhood pipeline.
Dr. Alan Riley is a senior fellow with the Atlantic Council Global Energy Center. Dr. Riley has previously advised Polish energy company PGNIG and Ukrainian energy company Naftogaz. You can follow him on Twitter
@profalanriley1
Image: Construction of the Ostsee-Pipeline-Anbindungsleitung (OPAL) in July 2010 (photo by LutzBruno/Wikimedia Commons).