South Stream Advances Despite Shtokman Halt

The suspension of Gazprom’s enormous Shtokman project on 29 August was a surprise but not much of a shock to many energy watchers. The giant Arctic project, run by a consortium of Gazprom, Statoil and Total, had become increasingly costly in light of its technical challenges and the downward trend of global gas prices. In a world revolutionised by shale gas, new LNG producers, and more efficient markets, developing a fiendishly complex project 340 miles into the Arctic sea became unjustifiably costly. The latest price tag for Shtokman was around $20 billion.

Opinion on the significance of the suspension has been split, with some arguing that it is a catastrophe for Vladimir Putin’s statist gas policies, and others suggesting that it shows that Gazprom is becoming a more realistic and commercial actor.

But the halt (which may only be temporary) is also likely to have repercussions for Gazprom’s other grand energy projects, particularly the South Stream pipeline across the Black Sea and into Europe. South Stream, like its former rival Nabucco, increasingly looks like a relic of another era, when state-funded behemoth pipelines were king.

Gazprom has never made it fully plain where South Stream’s 63bcm per year would come from. The general assumption has been that the pipeline would be supplied from a variety of domestic and Central Asian sources, which would require upgrading Russia’s pipeline infrastructure and recalibrating the internal gas distribution network. 

But Gazprom’s domestic production is entering a slow decline, particularly as more independent operators snap up new fields. Central Asian states are increasingly looking east to China, not north, as an export market. With Shtokman now suspended, the availability of domestic reserves is set to become even tighter for Gazprom. 

One resulting scenario could be that South Stream will be seriously weakened. With domestic production declining, at least until new reserves from Yamal and other Siberian fields can be brought onstream (neither technically nor financially easy), filling the pipeline to capacity would be difficult. One solution is a phased approach, with two initial strings carrying 15.5bcm each. This would be more feasible in the short-term but also significantly more modest, and given the length of the subsea section would remain a serious loss-leader.

But this presupposes two things: that Gazprom’s gas prospects are quite that bleak and that Russia is willing to give up so easily. In fact a more likely scenario is that the company and the Kremlin will double down on conventional export projects, principally South Stream and the Nord Stream extensions.

Matthew Hulbert argues that “The fact that Russia has flopped on the global gas scene won’t matter if the ‘Muscovite street’ can see Putin strutting his stuff in adjacent SE European states”. The failure of Shtokman will be compensated by driving South Stream forward, locking the Balkans into Russia’s embrace and renewing efforts to control national downstream sectors through Gazprom-affiliated companies. This strategy, and South Stream in particular, could be boosted by reinvestment of Shtokman funds - provided Gazprom manages to keep the money back from the project’s shareholders.

This would mark a return to the tactics used (with some success) by Gazprom during the last decade, but the shifts in the global and European gas markets is likely to make it less successful this time around.

Nonetheless Russia shows every sign of pressing ahead with South Stream. On 31 August it was announced that the engineering phase for the project was underway in Serbia; on 28 August Gazprom signed an agreement with Bulgarian Energy Holding on the connections between South Stream and the Bulgarian grid; and, most interestingly, on 21 August, it was revealed that Gazprom is in talks with Croatia’s transmission operator Plinarco to re-route South Stream through Croatia rather not Hungary as originally planned. 

Budapest dismissed the news as “some kind of bluff”, but it follows rumours that Moscow has been pressuring the Croatian government to choose South Stream before it formally joins the European Union next year and has to abide by the EU Third Energy Package. This contains anti-monopoly regulations which force the unbundling of vertically integrated distribution and transit systems – a blow to Gazprom’s strategy of dominating the gas networks in smaller European states.

Given that building South Stream through Croatia would violate these provisions, it seems unlikely that Zagreb would risk its EU accession for Gazprom. Instead, the leaking of the talks seems to be in response to Hungary’s granting of a final permit for the construction of Nabucco West across its territory. Hungary approved the environmental permit (the first country to do so) on 14 August, just a week before the Gazprom-Plinarco talks were confirmed. In other words it is a warning to Hungary that it cannot hedge its bets by welcoming both South Stream and Nabucco West.

If so this is classic Gazprom politicking. Along with the recent developments in Serbia and Bulgaria it shows that the energy giant is indeed pushing ahead on South Stream, and construction is likely to begin in December as planned.

The lesson of Shtokman is that the changing gas market – thanks largely to shale, as well as increased LNG and the more flexible European market ushered in by the Third Energy Package – is making Russia’s old model of colossal upstream projects linked to colossal downstream infrastructure financially unsustainable. But although Gazprom has acknowledged that things have changed upstream, in the downstream sector it seems to be (bad) business as usual.

Alex Jackson is an analyst of political, energy and security issues in the Caspian region. He is based in London and can be contacted at ajackson320@gmail.com.