By Annie Medaglia

The Nord Stream 2 pipeline project is rattling Europe — a visible reminder of Russia’s ability to fracture the EU and call into question Western Europe’s commitment to an energy secure continent.

While the project’s future is uncertain and its contribution to Europe’s energy security questionable, the Commission, Eastern Europe, and Ukraine already have the tools — if strongly implemented — to be energy secure even if the pipeline is built.

This period of great uncertainty may even spur much-need action by slow-movers and enable Europe to extract the maximum amount of concessions from Gazprom. That will not only make countries more resilient to potential Russian manipulation — or for that matter any other supplier — through Nord Stream 2 or any other pipeline, but also to changes in energy markets over time.

Eastern Europe, with support from the Commission, can wield power by strongly upholding the EU’s Third Energy Package, investing in increased infrastructure and allowing reverse flows in gas pipelines, enforcing other regulations, and leveraging changing gas markets to support the ultimate objective of access to secure, diversified, and reliable flows of gas at competitive prices, no matter the source.

Keeping Gazprom in check

First, the EU’s Projects of Common Interest (PCIs), including reverse flows and interconnections, are designed to create a liquid market by 2020 that enables Central and Eastern Europe to import from multiple sources. Much progress has been made, with new infrastructure radically diminishing dependency. But many of these projects are delayed or blocked by vested interests within Eastern European countries or they need public financing to attract commercial funding. Once they are implemented, it will not matter whether gas comes from Nord Stream 2, Ukraine, or any other east or west transit route.

Second, strong EU enforcement of its own regulations that require competition, third party access, and market based mechanisms force sellers to play by the rules. The EU’s antitrust case against Gazprom, considerations regarding access to the OPAL pipeline connecting  Nord Stream to the German grid, and other Third Energy Package regulations are driving previously unseen concessions. Gazprom is trying to sweeten the Nord Stream 2 deal by claiming they’ll sell more gas at the spot market price, and reducing its shares in the project. The EU and national regulators need to hold all sellers to the same standards and force these types of compromises to ensure a fully competitive market, whether or not Nord Stream 2 happens.

Third, major shifts in global gas markets coupled with the aforementioned actions and changed regulations regarding gas delivery points vastly increase Europe’s bargaining power. A few years ago, liquified natural gas displaced by U.S. shale gas production flooded the market and forced Gazprom to renegotiate contracts in the consumers’ favor.

This time, if Nord Stream 2 is built, Gazprom will likely have to change the delivery point for the gas (transfer title), which may require a modification in contract and renegotiations in 2019. Renegotiations are always uncertain, but unlike in the past, by the decade’s end there will be an array of alternatives: spot market trades are more prevalent and liquid, Poland’s LNG terminal came online in 2015, Azeri gas via the Southern Corridor may be available in 2019, and there is a projected glut of LNG as a result of new U.S. and Australian projects.

Couple this with progress on PCI projects and the full weight of the EU behind negotiations, and Eastern Europe has leverage.

The question of Ukraine

In addition to Eastern Europe, Ukraine deserves special and separate attention. Nord Stream 2 may mean a loss of significant transit revenue. Yet, regardless of that project’s realization, Ukraine is still better off not being tied politically and economically to the might of the Russian energy monopoly. Further modernizing Ukraine’s energy industry will strengthen Ukraine’s political independence and its position in a competitive gas market in Eastern and Central Europe.

From a security of supply perspective, Ukraine has made truly remarkable strides by decreasing its Gazprom purchases nearly 60 percent in 2015 by utilizing increased interconnections with Slovakia, Hungary, and Poland. Ukraine has shown its ability to mitigate this historical dependence, but it should still be diligent as demand may increase as the economy recovers.

Yet, the remaining tie of transit revenue still heavily binds Ukraine to Russia as evidenced by the understandably persistent outcry against the loss of revenue if Nord Stream 2 is built. Anywhere between $1 billion in transit revenue (0.75 percent of 2014 GDP) according to Naftogaz’ 2014 financials to the government’s $2 billion transit figure (1.5 percent of 2014 GDP) will be lost. Ukraine’s future should not be tied to this revenue and political manipulation. The end goal should be transit revenue as an added economic bonus stemming from normal economic relations, not an essential component of Ukraine’s economic well-being and subject to political leverage.

Ukraine could overcome this bind by continuing to seek ways to monetize and leverage their more than 30 billion cubic meters worth of storage capacity for western neighbors, raise domestic gas prices to market levels, reduce subsidies, restructure or break up Naftogaz, and institute other necessary actions to further or more efficiently develop their domestic resources.

Since implementing the new IMF reforms, Ukraine has reduced the Naftogaz deficit from $10 billion (7.5 percent of GDP) to $2 billion by tripling gas prices and reducing subsidies, which had largely benefited the wealthy. As billions of dollars were lost each year, the Ukrainian government recapitalized Naftogaz to cover the losses. And, by some estimates corrupt arbitraging of gas prices allowed some politically connected people to make $2.5 billion in 2014. Clearly there’s room for savings, and in fact greater sources of “revenue” than Ukraine’s current reliance on Russian transit. By taking these measures, Ukraine increases its own power, and chips away at one of Ukraine’s largest sources of corruption and of ties between Russian and Ukrainian oligarch.

What’s at stake

Ultimately, the future of Eastern Europe and Ukraine requires that the EU and its member states fulfill their commitments to a strong, internal market that is liberal, liquid, interconnected, and underpinned by diversified routes and sources of supply — Russian, Norwegian, American, Algerian, Azerbaijani, and more.

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