Dissecting the Prospects for South Stream Beyond the Media Hype

Gazprom’s South Stream gas pipeline project has been highly visible in the European media in recent months and appears to be going from strength to strength. The project seems to have high level political support and there is much speculation that actual construction is imminent, particularly in Serbia and Bulgaria. There are also rumors that the Russian company, Stroytransgaz, has signed “construction contracts” and is ready to commence operations. Further, in December 2012 there was even a symbolic first welding of pipes in the Russian coastal town of Anapa. For better or for worse, and taking into account the wider energy security debate between the EU and Russia, all of these developments appear to reflect “evidence” that the South Stream project is just about upon us.

While coverage of the South Stream project in the international media may project the perception that Gazprom’s newest major export pipeline may have already been launched, the actual situation is somewhat different. The fundamental precondition for the beginning of the project is the so called ‘derogation’ which is to be granted by the European Commission, i.e. that South Stream is to be exempted from the rules of the Third Energy Package. Specifically, this refers to European Commission Directive 2009/73/EC concerning common rules for the internal market in natural gas (Gas Directive).

There are two main requirements for the eligibility of projects like South Stream (major new gas infrastructure projects) to be developed in the EU if we take into account the Gas Directive. The first one relates to the unbundling between the suppliers and the owners of infrastructure. Article 9 of the Directive clearly stipulates that “each undertaking which owns a transmission system” is “entitled neither … directly or indirectly to exercise control over an undertaking performing any of the functions of production or supply…”.

The second main requirement for conformity of South Stream with the EU legislation under the Gas Directive is the granting of third party access (TPA) to the infrastructure. Article 32 of the directive states that “Member States shall ensure the implementation of a system of third party access to the transmission and distribution system,… based on published tariffs, applicable to all eligible customers, including supply undertakings, and applied objectively and without discrimination between system users”.

Taking into account EU internal energy market legislation, therefore, it is quite likely that South Stream would have problems with fulfilling these two requirements. This is why the project needs an exemption from the rules of the Gas Directive. However, in order to qualify for an exemption, South Stream would have to satisfy further conditions, which are found in Article 36 of the Gas Directive:

“Major new gas infrastructure … may, upon request, be exempted, for a defined period of time, from the provisions of Articles 9, 32 … under the following conditions:”

1. the investment must enhance competition in gas supply and enhance security of supply;
2. the level of risk attached to the investment must be such that the investment would not take place unless an exemption was granted;
3. the infrastructure must be owned by a natural or legal person which is separate at least in terms of its legal form from the system operators in whose systems that infrastructure will be built;
4. charges must be levied on users of the infrastructure; and
5. the exemption must not be detrimental to competition or the effective functioning of the internal market in natural gas, or the efficient functioning of the regulated system to which the infrastructure is connected.”

As to satisfying the first condition, concerning the enhancement of competition and security of supply, South Stream’s contribution appears rather questionable. In the specific case of Bulgaria, for example, it is difficult to see how South Stream would improve competition in the gas market while future positive outlooks for security of supply scenarios could not be taken for granted. We could also apply the same argument to the wider-EU context. Regarding the second condition, Gazprom will not invest unless an exemption is granted: that is for certain. Neither is a partial exemption likely to satisfy the Russian gas giant.

The third condition is a mere formality and is therefore devoid of polemics. It has already been practically fulfilled with the creation of the national project companies: in legal terms, OAO Gazprom, OOO Gazprom export and South Stream Bulgaria JSC are all different legal entities. We could assume that the fourth condition will likewise be fulfilled, since charges are to be levied on the users of the infrastructure. Condition five is subject to discussion in countries like Bulgaria: the “jury is still out”.

Taking into account the conditions required for gas infrastructure projects to receive exemptions from Articles 9 and 32 of the Gas Directive as briefly reviewed above, clearly suggests that South Stream still has a long way to go before it can be considered as a ‘done deal’ inside the EU. The process of legal approval of the project inside the EU remains distant, not to mention the economic, technological, environmental, let alone political challenges that still confront it. While the conditions stipulated above are yet to be fully interpreted in the case of South Stream’s approval process, we should also take into account the EU’s geopolitical considerations: the Community still has space for maneuvering in relation to its security of supply doctrine. Furthermore we should add that the exemption procedure starts with the national regulatory agencies, with the European Commission in Brussels making the final decision, as stipulated in Article 36. In this case the exemption procedure with the national energy regulators of the EU countries involved in South Stream has not even started.

Unless we have a clear decision on derogation applied in the South Stream case, the project will remain in the sphere of wishful thinking and geopolitical contemplation. Further, the final technical aspects of the project are yet to be endorsed: resolving the issues of having to alienate thousands of land plots and setting thousands of kilometers of easement lines in a number of countries along the designated route of the project still lies ahead. Tenders for fully fledged financing, construction, subcontractors and suppliers are all yet to be made. More elements could be added to this ‘shopping list’.

While we should not take it for granted that South Stream is unlikely to move ahead, the project remains quite distant from anything that can be referred to as a ‘launching phase’ at the present time. That said, the vociferous media publications, feasibility studies, expert roundtables, ongoing negotiations and fierce lobbying are likely to continue, perpetuating the image that Gazprom’s newest and biggest project is already upon us. 

Valentin Stoyanov is an energy consultant and former energy expert at the Bulgarian Parliament. This article was first published on 25 September 2013 on the Geopolitical Forum and is republished with permission.