Germany – and its chancellor Angela Merkel – deserve credit for the continuation of the EU’s sanctions regime against Russia. But Germany happens also to be home to the energy giant E.ON, which recently signed a (non-binding) memorandum, together with Russia’s Gazprom, Austria’s OMV, and Shell from the UK and the Netherlands, agreeing to the extension of the Nord Stream pipeline, which brings Russian gas into the European Union (EU).
The extension, to be completed by 2020, would double the transit capacity of the pipeline, currently at 55bn cubic meters per year. Together with Turkish Stream, another project Gazprom is toying with, it would make gas transit through Ukraine redundant by the time the country’s current contract with Gazprom expires in 2019.
That is hardly a thrilling prospect for the cash-strapped government in Kiev. But the problem extends beyond transit fees, which have fallen dramatically since the beginning of the conflict. If Gazprom can bypass Ukraine, it will be in a much stronger position in its negotiations over the supply of natural gas to Ukraine proper – including its large energy-intensive industries in eastern and southern Ukraine.
The extension of Nord Stream is bad news for the EU as well. It would cement the dependence of many of its members on Russian gas, instead of encouraging them to diversify. In fact, it appears that the European authorities were caught off guard by the deal. The EU commissioner for energy union, Maros Sefcovic, looked more than a little flustered when quizzed about the memorandum at the Globsec security conference in Bratislava. It is, however, vitally important that the Commission scrutinize the deal carefully, particularly on competition policy grounds, and stop it if necessary – even if doing that would mean going against powerful business interests.
While Russia depends on its gas exports to Europe, the frantic efforts to build alternative gas routes to Europe have little to do with economics or energy security. For the Kremlin, the enhancement of Nord Stream and the possibility of constructing Turkish Stream, leading from Russia through the Black Sea to Turkey and Greece, play the role of a bargaining chip in its dealings with Ukraine.
What is more, as the EU Observer noted, it is possible that the multitude of different plans for alternative gas routes from Russia, including South Stream, which was cancelled last year, are being presented to the west with the conscious purpose of confusing Europeans, creating divisions between member states, and identifying the ‘weakest links’ on the continent, which can be used to exercise further leverage.
Throughout the post-Soviet era, the Russian regime has used gas prices as a means of exercising leverage over Ukrainian politics and maintaining instability. Gazprom cut supplies in January 2006, following a year of threats in the aftermath of the Orange Revolution, and again in January 2009, a year before the election of Viktor Yanukovych. There is little reason to think that Vladimir Putin would hesitate to use the same tools again, if given a chance.
However, for Ukraine, there is a way out – no matter what Gazprom or the EU may do. The country needs a deep program of structural reforms. The energy-intensive sectors in the country’s south-east are hardly the industries of the future. They need to be exposed to market-based energy prices and eventually restructured. While the current government is progressively reducing energy subsidies, it still has a long way to go to eliminate them altogether and to make sure they will not be reintroduced by populist policymakers later on. This can be achieved by privatizing the energy sector, setting up an independent regulatory agency, credibly insulated from political pressures, and diversifying the country’s energy sources.
More importantly, instead of trying to sustain an economy organized around cheap Russian energy, Ukraine needs to be aggressive in attracting foreign investment. That can only be done through a far-reaching program of economic and institutional reforms. The country needs to strengthen the rule of law, fight corruption more effectively, cut unnecessary red tape, and make itself attractive both to foreign and domestic businesses.
Eighteen months since the Maidan, Ukraine is staring into an economic, political, and social abyss. One hopes that an unintended consequence of Gazprom’s current shenanigans will be to force Ukrainians to think carefully about the future of their country and emulate the success of their more affluent neighbors in the west.
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