Why the closure of the South Stream project was a foregone conclusion

In early December, Russian President Vladimir Putin announced that Russia had abandoned its project to build the controversial South Stream gas pipeline linking Russia and Central Europe via the Black Sea, citing Bulgaria’s refusal to allow construction on its territory as a key factor. Energy analyst Alexander Kurdin argues that geopolitical and market factors meant the closure of the project was inevitable.

Click to enlarge the image. Drawing by Natalia Mikhaylenko

Russia's decision to close the South Stream initiative to bring gas to Central Europe via a pipeline under the Black Sea and through the Balkans, despite all the complexities surrounding the project, came as a surprise to many Russian observers. However, there had been signs for some time that the project’s future was in doubt.

There was a real chance that the project would be canceled or substantially modified last year – and even the year before last – when the political expediency of the project was limited when compared to the economic expenditures required to construct it.

The cancelation of the project provides an opportunity to take a look back at the reasons it was developed in the first place.

Auspicious beginnings

In mid-2007, Gazprom and Italian energy firm Eni signed the first memorandum on implementing the South Stream project (Eni sold its 20 percent share in South Stream to Gazprom on Dec. 29 – RBTH). In early 2008, intergovernmental agreements were signed with the countries that had the biggest involvement in the project and that are now worried the most by its cancelation: Bulgaria, Hungary, and Serbia.

Gazprom buys out partners in South Stream

Gazprom has obtained 100 percent ownership of the South Stream project by buying out the shares of its Italian, German and French partners in South Stream Transport BV, the company responsible for construction of the undersea section of the abandoned pipeline. News agency RIA Novosti reported on Dec. 30 that Italian energy company Eni, Wintershall of Germany, and French firm EDF had sold their shares to the Russian gas giant, which already had a 50 percent stake in South Stream Transport BV.

The global financial crisis had yet to begin, the EU’s energy-saving and green programs were just being adopted and European demand for gas was expected to grow. In 2005, net gas imports into Europe amounted to 300 billion cubic meters and the International Energy Agency forecasted that by 2015 they would increase to more than 430 billion cubic meters a year.

Meanwhile, the European Commission’s Third Energy Package, which bans gas suppliers from owning pipelines, had been approved but had not yet come into force. And, in 2007-2008, the spot price of gas at European hubs was higher than Gazprom’s price. At the time, a considerable rise in demand for Russian gas seemed inevitable.

The wind changes

However, in subsequent years, the grounds justifying the South Stream project began to falter. The economic crisis and environmental programs resulted in a revision in the gas import forecast for Europe for 2020, when South Stream was supposed to be fully operational: from 450–500 billion cubic meters down to 300–350.

Thanks to the emergence of alternative supplies and the shale boom in the U.S., competition on the European markets became stronger and Russian gas, at the time of a global crisis, became more expensive than gas sold on Europe’s trading floors.

Then the Nord Stream gas pipeline, running across the Baltic Sea, was put in operation, ensuring back-up transit capacity though not yet making it possible to bypass Ukraine altogether. Furthermore, in Ukraine the presidential post went to Viktor Yanukovych and Gazprom could more safely rely on the Ukrainian gas transportation system. There were not that many grounds left to justify South Stream on its original gigantic scale of 63 billion cubic meters a year.

The events of 2014 in Ukraine could have drastically changed the situation, breathing a new lease of life into the project. Its only and key motivation de facto remained the need to bypass Ukraine, if only just to be on the safe side. The fact that Russia, Ukraine and the EU were unable to agree on gas supplies to Ukraine for the most part of 2014 was yet another indication of how relevant an alternative route is, to ensure gas exports to Europe independent of Ukraine.

However, the position of the EU (the passing of the Third Energy Package meant that South Stream did not comply with EU competition and energy legislation, which was then enforced with a ban on construction in Bulgaria – RBTH) turned out to be more conservative than could have been expected. It is hard to say what it is based on: adherence to the letter of the law, the negative repercussions of the Ukrainian conflict, or just unwillingness to accommodate Gazprom and Russia. If even in the current conditions European bureaucrats are not ready for a compromise, then it can hardly be expected in the future either.

A pragmatic choice for Russia

The chosen alternative – a pipeline running across the Black Sea to Turkey – appears currently the most consistent option. If Russia has prepared its own infrastructure for exports to the EU in the south of the country and if there is still the need to bypass Ukraine, then the only remaining option is to build a pipeline through Turkey to its border with EU countries. Where the gas will flow on from there is another question.

Having said that, this decision does not mean that Russia’s gas policy has turned away from the European Union. Even its “eastern” direction is developing of its own accord, on the basis of its own gas resources.

Russia and Gazprom are just streamlining the form of their strategy in Europe, keeping its substance on the whole intact, with the exception of owning gas pipelines in the European Union, which is exactly what the European Commission wanted.

The author, Alexander Kudrin, is the head of the strategic energy research directorate at the Analytical Center under the Russian Government. 

Read more: Russia turns to Turkey in EU gas clash>>>

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