With only a month left in office German Chancellor Angela Merkel is trying to cut an energy deal that will allow Germany to receive gas from Russia’s new Nord Stream 2 gas pipeline but keep some gas flowing through Ukraine’s Druzhba gas pipeline system.  

But the deal remains elusive. The cash-strapped Ukrainian government is concerned that it will lose out on the $2bn of transit fees it currently earns from the gas transit business, which have already fallen from the $3bn a year it used to earn until Russia’s TurkStream pipeline came online at the end of last year – the southern sister pipeline line to Nord Stream 2, as Russia is building pipelines that will entirely cut Ukraine out of the transit business.  

Nord Stream 2 was due to come online this week, as there are only 15 km left to build, according to Russian President Vladimir Putin; however, Gazprom said in statement that the work will now be finished at the start of September.  

The US has also objected to the Russian pipeline that Washington claims will “undermine European energy security.” However, the Biden administration dropped its efforts to block construction in June and struck a deal with Germany in July to allow it to be completed, admitting that the pipeline was a fait accompli. The US had been hoping to kill Nord Stream 2 off in order to boost its own exports of the much more expensive LNG to Europe, where it is already the biggest exporter to the bloc.  

But Merkel has insisted the project will be to the benefit of all countries in Europe, not just Germany. She also hinted that as it will be covered by EU rules there may be demands put on the pipeline thanks to EU energy laws, such as forcing Russia to give access to the pipeline to companies other than Gazprom. 

"It has to be said that Nord Stream 2 is not a German-Russian project; there are companies from Germany, the Netherlands and France there. And therefore it's a European-Russian project, it is subject to European law, it is subject to the law of the Third Energy Package because we are not fully free in regulation, but should cite exactly that, therefore we didn't hold these talks from the German side, but we supported that on the European side," Merkel said during her Moscow visit. 

Germany’s backing of the pipeline is based on two grounds: bypassing Ukraine actually improves its energy security as the Russian gas, which accounts for about a third of its energy needs, will not transit a war zone where the two contesting countries are also extremely litigious; and by cutting out the middle man, Nord Stream 2 gas is much cheaper than that arriving via Ukraine, not to mention cheaper still than the even more expensive US LNG.  

However, aware that Germany has to an extent betrayed Ukraine, Merkel is seeking some sort of compromise for when the current transit deal between Russia and Ukraine expires in 2024. Gazprom signed off on a new transit deal at the last minute in December 2019 that commits the Russian gas giant to send 40bn cubic metres via Ukraine’s Druzhba pipeline until 2024. There is an option to extend that deal for another ten years after it expires.

Ukrainian President Volodymyr Zelenskiy told Merkel during her visit to Kyiv on August 22 he is hoping Germany can give him "guarantees" of a continuation of the transit deal after 2024 and "Russia will pledge a minimum amount of gas to be passed through Ukraine's pipelines," despite the completion of Nord Stream 2.

Russia has been sending just under 200 bcm of gas to Europe a year via a combination of pipelines that include Nord Stream 1, Ukraine’s Druzhba system, the southern route of TurkStream that came online last year and pipelines that traverse Belarus. The combined capacity of Nord Stream 1 & 2 will be approximately 110 bcm, which is currently just enough to cater to all the demand for gas travelling by the northern route.

Merkel met with President Putin two days before arriving in Kyiv in order to try to pin Russia down on some sort of compromise deal, but didn't get very far.

Merkel wants to use the Russian gas to decommission Germany’s nuclear power stations – an election promise she reneged on much to the annoyance of the German electorate – and buy time to continue investing heavily into renewables as the EU’s Green Deal kicks in next year that will eventually lead to a reduction in demand for Russian gas.  

"We will export gas from Russia to Europe after 2024, and it's important here that Ukraine should stay a transit country, and it's important that this agreement should stay, and then step by step – it's very important to Russia – Ukraine should also develop in the direction of climate neutrality. Germany should achieve that by 2045. That is why gas consumption will decrease, and then gas will not go on Nord Stream or via Ukraine's gas transport system, and then Ukraine should be ready for what can be done then," Merkel said.

Europe will no longer need Russian gas in 25 years' time, Merkel told Zelenskiy. "Europe will need to achieve climatic neutrality step by step by 2050," Merkel said, as quoted by Russian news agency Tass. "It means that in 25 year[s] no gas, or very small volumes of gas, will be supplied to Europe from Russia," she added.

And that is the crux of the problem: the EU demand for gas is expected to start falling as more and more countries make the transition away from fossil fuels as their new wind and solar power comes online over the next decade.  

For the transit via both Nord Stream 1 & 2 as well as sufficient volumes via Druzhba to work, the EU will have to commit to taking some 150 bcm of gas via the northern routes, which is probably more than demand will sustain. The Gas Transmission System Operator of Ukraine (GTSOU) CEO Sergiy Makogon told bne IntelliNews in an exclusive interview that if Russia sends less than around 30 bcm of gas a year via its pipeline Ukraine would decommission a large part of its network, as it would cease to be economic viable.  

During Putin’s meeting with Merkel on August 19 the Russian leader said that he remained open to sending gas via Ukraine in addition to Nord Stream, but Russia also wants guarantees on the volumes the EU will buy. The difficulty is the existing Ukrainian transit deal is a take-or-pay affair; in 2020 due to the high levels of gas storage both sides built up in expectation of a failure to sign a new transit deal Gazprom sent less than the agreed amounts of gas and paid the transit fees anyway. If Russia is to sign a new deal for post-2024 it doesn't want to be put in the same position again where it has to pay for transit it doesn't use because of falling European demand.  

"We need to get an answer from our European partners on how much they are ready to buy," Putin said, throwing the main problem into stark relief. Putin added that Russia needs to understand what the scale of demand will be before it can commit to a new transit deal and this was all simply a question of business. "We cannot sign a transit contract [with Ukraine] if we don't have supply contracts with our consumers in Europe,” Putin added.  

The International Energy Agency (IEA) estimated in October last year that European gas demand would decline from 606 bcm in 2019 to 598 bcm in 2025, 570 bcm in 2030 and 563 bcm in 2040. But the good news for suppliers like Gazprom is that the continent's import needs are nevertheless set to rise from 346 bcm in 2019 to 360 bcm in 2025 and inch up to 362 bcm in 2030. They will then contract to 351 bcm by 2040.

Merkel is not in a position to promise a guaranteed offtake of Russian gas, nor can she sign that kind of contract, leaving the negotiations in limbo.  

Zelenskiy was clearly frustrated with his meeting with Merkel. Germany’s compromise is to fund heavy Ukrainian investment into renewables to wean it off the gas business, which is a dying enterprise anyway. A sum of $2bn has been mentioned and Ukraine has already seen some $5bn invested into renewables in recent years as the sector has blossomed on the back of very generous green tariffs. But Kyiv is more concerned about the cash it will lose now from gas transiting than the money it will make later from renewables.  

“Renewables is the energy of the future, but gas is the business of today,” said an increasingly exasperated Zelenskiy. “We need guarantees now.”  

It doesn't seem that Merkel is going to solve this problem with only weeks left of her last term in office. She appeared to snub Ukraine by not staying on in Kyiv an extra day to attend the inaugural Crimea Platform, a clever PR exercise to put Crimea’s annexation issue back at the top of the international agenda that was attended by 44 countries at minister level or above. But the negotiations continue as Merkel chose to send not German Foreign Minister Heiko Maas, who is busy dealing with the fallout of the collapse of the Nato-backed government in Afghanistan anyway, but Peter Altmaier, the head the Federal Ministry for Economic Affairs and Energy, who met with his Ukrainian and US counterparts on the sidelines of the celebrations.  

Merkel appears to be pushing ahead with her plan B to invest into Ukraine’s renewable sector in lieu of any progress on a new post-2024 transit deal. After the Crimea Platform summit began Ukrainian state energy company Naftogaz and German energy trading company RWE Supply & Trading announced they signed a memorandum of understanding (MoU) to develop hydrogen production in Ukraine – one of the alternatives to the gas business that Ukraine is well positioned to build up.

"But it's not a problem that can replace transit via the Ukrainian gas transport system from 2024. However, due to the renewable sources of energy, which can be expanded in Ukraine, it is possible to help here to produce green hydrogen by means of hydrolysis, by means of green energy from renewable sources of energy and use it," the chancellor said in Moscow.

Altmaier said very little following his meeting with the other energy ministers in Kyiv, but did reveal that Berlin wants to support Ukraine’s transition to renewable energy. Altmaier already signed off on establishing an Energy Partnership with Ukraine in August last year.