Since the very beginning of the conflict around Ukraine, the energy trade has been the most obvious battlefield of the ensuing confrontation between Russia and Europe. Europe was very clear that it would limit its military support to supplying Ukraine with arms and training, but would go to great lengths to exert economic pressure on Russia. Energy is the largest source of revenue for Russia as a country and for the Russian government, and it accounts for the largest share of Russian-European trade.
Nevertheless, three months after the war started, the EU is still contemplating concrete sanctions on Russian oil and gas. The problem is that any material sanctions may be quite painful for Europe, too, and EU commissioners and national leaders have repeatedly said that the sanctions will be designed and implemented in a way that will maximize their impact on Russia while limiting that on Europe.
It also has become clear that Russian gas is much more difficult to replace than Russian oil or oil products. The plan was that sanctions would initially target the latter, while an effort would be made to wean Europe off Russian gas as much as possible and as soon as possible, though a complete switch-off might take years. Russian policymakers understand this predicament and would probably like to play the game in precisely the opposite manner: by shifting the conflict toward gas, where Europe is more vulnerable. This conflict was likely already under way at the end of March.
The turning point may turn out to be almost simultaneous actions by the Russian and German governments: the former passing a decree stipulating payment in rubles for Russian gas, signed on March 31, and the latter putting Gazprom Germania and its subsidiaries into administration on April 4.
Russian President Vladimir Putin signed a decree on March 31 requiring Russian gas exports to be paid for in rubles from the very next day. The new requirements prompted an initial outcry among Russia’s trading partners. Within a month, however, there was a stand-down: the Russian government came up with a scheme that commercially leaves things more or less as they were before the decree, except for changing the payment bank to Gazprombank in Moscow (previously, it was most likely Gazprombank International in Luxembourg). European buyers would still send euros, the amounts would not change, and it would be up to Gazprombank to make the conversions and pay Gazprom Export in rubles.
Initially, the EU Commission issued warnings that compliance with the scheme might comprise a breach of the European sanctions on Russia’s central bank, but later it produced a more conciliatory statement, effectively allowing the arrangement to function, at least until it is included—directly or indirectly—in some future sanctions package, or until the Russian government alters the scheme, for example, by changing the rules of access to the ruble market.
Two countries—Poland and Bulgaria—jumped the gun, however, and said they would refuse to comply with the proposed terms before any clarifications had been issued, prompting the swift cutoff of their gas supplies. This step might at first look like an act of extraordinary bravery, since both countries are usually listed as highly dependent on Russian gas, but it’s not quite as simple as that.
Most sources list Bulgaria as 100 percent dependent on Russian gas, and Poland as 40–45 percent dependent. On the other hand, their total gas consumption is small, accounting for just 15 percent of Bulgaria’s total energy mix, and 20 percent of Poland’s. Both countries have acquired additional gas supply routes: Poland has an LNG terminal, and a pipeline from Norway will be completed by October, while Bulgaria has a pipeline from Turkey, fed by Azerbaijani gas or from an LNG terminal in the Sea of Marmara.
Both countries control important pipelines that connect Russia with European markets. Poland controls the Yamal-Europe line to Germany, while Bulgaria transports gas via a newly built pipeline of the TurkStream project to the Serbian border, supplying Serbia, Hungary, and Austria with gas, allowing Russia to partially circumvent Ukraine for gas deliveries. As a result, both countries have some leverage with Gazprom, but may also force the hand of some hesitant European countries by adopting country-level legislation or decrees and sanctioning Gazprom locally, and stopping deliveries to their neighbors.
There are also political reasons for the actions of both Poland and Bulgaria. Poland has traditionally been one of the staunchest hardliners on Russia in the EU, especially since 2014, when Poland became Ukraine’s main supporter and ally. Bulgaria under the premiership of Boyko Borisov was playing a much more pragmatic game, but since a new government came to power in late 2021 with a strong anti-corruption agenda, it has also been highly critical of the Balkan Stream deal overseen by Borisov, and of any dealings with Russia and Gazprom in general.
It turns out, therefore, that neither country was particularly vulnerable to the termination of gas supplies, at least at the moment, while both had political reasons for adopting a hardline approach, and have some leverage over Gazprom and their European neighbors. In other words, they have the means, resilience, and inclination to be more principled than some other European countries. On the other hand, this relatively small skirmish may provide an indication of how far Gazprom and Russia are willing to go to push their agenda, not only where Poland and Bulgaria are concerned, but to provide credibility for a larger threat.
A Sanctions Home Goal?
On May 11, the Russian government took another major step in the energy sanctions war. It placed EuRoPol Gaz and Gazprom Germania and its affiliates under sanctions, prohibiting Russian companies from having any dealings with these entities. This seemed like a highly unusual move, as EuRoPol Gaz is 48 percent owned by Gazprom, which is in turn majority-owned by the Russian state, while Gazprom Germania is 100 percent owned by Gazprom. Why would the Russian government sanction its own companies?
Let’s start with EuRoPol Gaz. The company was set up as part of an intergovernmental agreement between Russia and Poland in 1993 to build and operate the 33 billion cubic meters per annum (bcm) Yamal-Europe pipeline that would deliver 10 bcm to Poland, and the rest to Germany and onward to Western Europe. In addition to the 48 percent owned by Gazprom, another 48 percent belongs to the Polish state-owned oil and gas company PGNiG, and 4 percent to a PGNiG trading arm. Construction was funded by Gazprom. Since 2010, the operator of the pipeline has been a Polish state-owned company, Gaz-System.
Until 2020, it operated under a long-term agreement that gave Gazprom full use of the pipeline at a cost that covered operating expenses and made some nominal profit. EuRoPol Gaz was earning about 200 million euros per annum for transporting 33 bcm over 700 kilometers, or about 0.9 euros for transporting 1,000 m3 over 100 kilometers. The comparable tariff in Ukraine is 2.3 euros. The reason for this was clear: Gazprom’s aim was to ship gas via the pipeline at a lower cost, as opposed to earning a profit for transportation services.
After 2020, however, the pipeline fell under standard European gas pipeline regulations, with basic rates set by the Polish regulator on Replacement Asset Base (RAB) principles. From then on, Gazprom would have to book shipping capacity through capacity auctions.
Therefore, as Gazprom was allocating its shipping needs over various capacity options, it would first fill the options with either shipping obligations (the Ukrainian route) or fully controlled ones (Nord Stream and TurkStream plus Balkan Stream), and then decide what to do with the rest, if there was anything left, allocating it between the Ukrainian and Polish routes.
This approach was one of the reasons Poland was so fiercely opposed to the construction of the Nord Stream 2 pipeline: both to keep demand for Ukrainian transmission services, and to maintain the importance of the Yamal-Europe pipeline.
This confrontation peaked again on April 26 this year, when Poland put Gazprom (among other Russian companies) on its sanctions list. However, while the other Russian companies on the list had all their assets frozen, including physical goods located in Poland, the Gazprom sanctions refer only to shareholders’ rights, such as execution of control and dividends, thereby still allowing the transit of Russian gas via the Yamal-Europe pipeline.
Nevertheless, the Russian government treated the asset freeze as a seizure and considered EuRoPol Gaz a trophy in its adversary’s hands. On May 11, it put the company under its own sanctions, thus making the Polish route unavailable to Gazprom. The formal logic behind this is likely that from the Russian point of view, Gazprom has been unlawfully deprived of the profits and control of its property, and that the government is trying to minimize the asset’s value for the capturing party. The real impact of this move is the introduction of a commitment device for the Russian player and raising the stakes for Europe through the preemptive closure of a gas transport route.
EuRoPol was just one line in a two-page list of sanctioned companies. The rest were the various parts of the Gazprom Germania empire. So what is Gazprom Germania, and why is it important? Since the 1970s, the Soviet Gaz Export company had a subsidiary in every major European country to which it sold gas. These companies acted as counterparties to Gaz de France, RuhrGas, and the like, and were the legal holders of export contracts.
In the 2000s, when European gas markets started to liberalize, Gazprom adopted the strategy of going downstream to get closer to the customer, and started to acquire distribution, storage, and trading businesses, either directly or via joint ventures with its European partners. It also went ahead and built a sizeable energy trading business in London called Gazprom Marketing and Trading, with subsidiaries in Houston and Singapore, trading in pipeline gas, LNG, electricity, and accounting for more than 20 percent of the UK commercial gas market.
For a while, all of these companies were run as individual fiefdoms, but in the middle of the 2010s, they were consolidated—both legally and, to a large extent, managerially—under the umbrella of Gazprom Germania. One of the companies in this conglomerate is Gascade, which owns and operates the German pipelines NEL and OPAL that distribute gas brought by Nord Stream and Yamal-Europe through Germany and to the Dutch and Czech borders.
After the outbreak of war in Ukraine, Gazprom’s management apparently decided that Gazprom Germania could easily become a sanctions target, and scrambled to formally shift ownership and control over Gazprom Germania to a shell company that would own 99.9 percent of its capital, while the remaining 0.1 percent of ownership and 100 percent of voting rights were signed over to another shell company with a single room in a Moscow business center. The German Ministry of Infrastructure intercepted the deal, citing public interest over the proper management of critical infrastructure rather than political reasons, and placed Gazprom Germania under the administration of Bundesnetzagentur, the federal agency in charge of infrastructure.
As a result, the federal agency is now in control of a number of companies and joint venture shares in gas storage, pipelines, gas merchants, upstream operations in the North Sea, and a large energy trading business. Some of these companies also had gas purchase contracts with Gazprom, and Gazprom was already refusing to work under these contracts back in April, even if paid in rubles, probably citing a change of control clause that would allow for a renegotiation. Most likely, these contracts were on somewhat beneficial terms for Gazprom Germania’s Europe-based subsidiaries, at least in the current gas price environment, probably with the idea of transferring some profit and value to these subsidiaries and Gazprom Germania and using them to fund some activities in Europe.
Probably, the logic behind the sanctions was to provide Gazprom with a stronger argument that would absolve it from any obligations to its subsidiaries now under German government control. However, Gazprom may now be in a legal bind: although OPAL, NEL, and Gascade were not explicitly mentioned in the sanctions decree, these companies are minority-owned by Gazprom Germania (just under 50 percent) through WIGA, a joint venture with Wintershall-DEA. Depending on the interpretation of the sanctions decree, Gazprom may from now on be legally precluded from using these pipelines. It is unclear whether this is an oversight or an intentional development. In the past, these companies managed to argue to European regulators that as separate corporate entities with independent management, they are not controlled by Gazprom, at least for the requirements of the European gas unbundling regulation.
Russia did not have any sanctions regulations until recently, and the new measures it is adopting look more like a quick copy of U.S. legislation than a well-thought-through system. In addition, it does not have an equivalent of the Office of Foreign Assets Control, the enforcement body, or any track record or precedent of implementing sanctions, so we can only guess right now how these sanctions will work in reality.
The potential application of the sanctions to key pipelines may be an oversight that can be fixed by an agreement between the government and Gazprom, or an intentional inclusion that would raise the stakes in the new gas war. It could also be a deliberate or fortuitous ambiguity that makes it possible to create a very plausible threat, but to only pull the trigger on it at a convenient moment, should one arise.
We are likely to enter a summer of discontent, which might turn into a winter of crisis. Many developments are still hard to predict, but a few possible scenarios are starting to emerge, and the outcome of the initial skirmishes might give an indication of their likeliness.
