Russia's South Stream Decision Changes Regional Dynamics
Summary
The fallout from Russia's decision to abandon its ambitious South Stream pipeline deal continued Dec. 3, as Italian energy services firm Saipem announced that it would lose almost $2 billion because of Moscow's move. On Dec. 2, Bulgarian President Rosen Plevneliev called for the South Stream project's European partners to have a say in its future. The head of Serbia's Gas Association, Vojislav Vuletic, said his country is still interested in South Stream, while Hungarian Foreign Minister Peter Szijjarto said his country will have to look for alternative natural gas sources to replace South Stream supplies.
Russian President Vladimir Putin announced the decision to abandon the pipeline deal on Dec. 1, while visiting Turkey. Putin publicly blamed the European Commission's opposition to the planned pipeline, though the project faced other growing constraints (mainly financing). At the same time, Putin announced that Russia would instead build a pipeline similar to South Stream but ending in Turkey, which could then become a hub for Russia's natural gas exports. The decision changes not only the dynamics of energy in the region, but also many relationships in Europe, Turkey and Russia.
Analysis
South Stream was a large pipeline project by Russian natural gas behemoth Gazprom to export Russian natural gas from the Russian mainland, under the Black Sea, to Southern and Central Europe — Bulgaria, Serbia, Hungary, Greece, Slovenia, Croatia and Austria. The primary purpose of the pipeline was to connect Europe to Russia directly without transiting Ukraine, which previously transported 80 percent of Russian natural gas to Europe. Gazprom held 50 percent of the project, Italy's ENI held 20 percent, Germany's Wintershall held 15 percent and France's EDF held 15 percent. The initial plan was for the South Stream pipeline to reach a capacity of 63 billion cubic meters (bcm) by 2018, which would accommodate approximately 40 percent of Russia's natural gas exports to Europe if run near capacity.
The project became increasingly important to Moscow over the past year as the crisis in Ukraine threatened the reliability — both politically and technically — of Russian natural gas exports to Europe through Ukraine. However, the project has encountered a string of obstacles since its conception in 2007.
First, the European Union has contested the pipeline, saying it violates the Third Energy Package, European legislation that splits energy production and transmission. The European Commission has used the legislation to pressure all of the EU states that had signed agreements with Russia for the construction of the pipeline. As a result, Bulgaria halted the construction of its section of the pipeline in June.
The second constraint was the rising cost of the pipeline. Gazprom projected a $10 billion price tag in 2007, but projected costs grew to $30 billion in 2014 and likely would have risen further. In mid-November, ENI CEO Claudio Descalzi warned that ENI would leave the project if prices continued to rise. Gazprom is relatively healthy financially, unlike its oil company sister, Rosneft. However, with many large and costly projects lined up for the next few years, including the Yamal natural gas project and the Power of Siberia pipeline to China, Gazprom most likely would not be able to foot most of the bill for South Stream without financial assistance from the Kremlin. And with Russia in a sharp economic decline and oil prices falling, the Kremlin has refrained from handing out large sums of money like it has in the past.
Gazprom has already spent $4.5 billion on South Stream, mostly on 300,000 tons of underwater trunk pipelines that have been delivered to the Black Sea coastline. However, these pipes could still be of use in the construction of Russia's new proposed pipeline to Turkey. According to Gazprom chief Alexei Miller, the alternative pipeline could have a capacity of 63 bcm, of which Turkey could purchase 14 bcm of natural gas and transit the rest to southeastern Europe to the same countries that would have received natural gas from South Stream. In short, the change in the pipeline projects is merely one of route; the outcome would be nearly the same. However, the way that natural gas would be transported is in question, since any new pipeline infrastructure reaching into Europe would be subject to the same EU regulations that haunted South Stream.
The Political Aftermath
By scrapping South Stream and proposing a Russo-Turkish pipeline, Russia has shifted the political and energy dynamics of the region. First, Russia had been using South Stream as leverage over Ukraine and several southeastern European countries. Russia offered Bulgaria, Serbia and Hungary investment sweeteners — promises of energy security, construction jobs and transit revenues — for their support of the South Stream project. For example, Bulgaria was set to receive an estimated $500 million annually for transiting natural gas from South Stream. Moscow also used the potential for natural gas transit alternatives in its energy negotiations with Kiev. With South Stream abandoned, Russia's leverage has diminished.
Russia's decision to abandon South Stream also damages Moscow's political ties with some of its European partners in the project. Countries such as Hungary and Serbia spent a great deal of political capital in defying the European Union to support the pipeline's construction. Now some of these same countries are saying they will have to look to the European Union to help secure energy supplies.
Changing Energy Relationships
Should the proposed Russo-Turkish pipeline be constructed, Russia will add capacity to directly supply Turkey, its largest natural gas customer, much like Russia's Nord Stream pipeline connects Russia to Germany, its second-largest customer. Moreover, Turkey is likely to receive a 6 percent discount on its current natural gas supplies as part of the construction deal. With Turkey connected directly to Russia, natural gas supplies will not rely on politically prickly transit states such as Ukraine. Turkey currently receives approximately half of its natural gas supplies from routes going to Europe.
However, the Russo-Turkish pipeline would introduce yet another transit state into Russia's export routes to Europe. The point of South Stream was to directly supply southeastern Europe with Russian natural gas, bypassing Ukraine. Under the new plan, energy supplies would still bypass Ukraine, but would now be contingent on Turkey transiting the supplies. Russia does not hold the influence over Turkey that it has held in Ukraine, meaning that Moscow will be less able to politicize natural gas supplies going to the Continent.
Yet adding a natural gas supply route through Turkey would give Moscow more flexibility in supplying Europe. Russia already has pipelines running to Europe through Belarus, Ukraine and Germany. Adding another major route through Turkey would give Russia a greater ability to shift supplies from one route to another, targeting specific European countries for cutoffs depending on how Moscow wants to shape the political climate.
The proposed Turkish energy connection also adds complexity to other energy projects involving Turkey. The Trans-Anatolian Pipeline has been proposed to move Turkmen natural gas across the Caucasus to Turkey and Europe. Turkey is already moving forward with a similar connection, the Trans-Adriatic Pipeline, which will carry Azerbaijani natural gas. Discussions have gone on for a long time about the possibility of natural gas giant Turkmenistan supplying these routes via the proposed Trans-Caspian Pipeline. Just as the South Stream project competed with these plans, so will the proposed pipeline to Turkey. Ankara will continue to try to balance Moscow with alternative suppliers such as Azerbaijan. However, with natural gas coming straight from Russia, the incentive to continue wooing Turkmenistan for supplies could be reduced.
All of this said, Russia's announcement that it is abandoning South Stream was contingent on the current political tension between Moscow and the European Union. Russia could revisit its plans for South Stream should this relationship change. For now, the abandonment of South Stream looks like a major setback for Russia's energy strategy in Europe, but Russia could simply be playing the similar projects off each other to shape its overall energy and political discussions in the region.
Natural Gas Europe is pleased to provide this article in cooperation with Stratfor, a Natural Gas Europe Knowledge Partner. For more visit http://www.stratfor.com/ Follow Stratfor: @stratfor on Twitter | Stratfor on Facebook