The decision to stop the South Stream project does not represent a fundamental shift in Russian energy policy, writes Friedbert Pflüger, Director of the European Centre for Energy and Resource Security (EUCERS) at King‘s College London. It is not a political retaliation or a “counter-sanction”, but above all a business decision: South Stream had become far too expensive in the current stagnant European gas market.
In contrast to what many commentators have said, the Russian decision not to build South Stream does not challenge the energy partnership between the EU and Russia. The European supply of Russian gas is not jeopardized.
The Russian communiqués show that the plans to build a pipeline from Russia through the Black Sea remain firmly in place. In contrast to previous plans, the pipeline will, however, not alight in Varna (Bulgaria) in order to travel from there almost 1500 kilometres through Serbia and Hungary to Austria and through Slovenia to Northern Italy respectively. Rather, it will now lead to Turkey.
Ankara has committed itself to buying 14 of the 63 BCM of gas that, according to either of the scenarios, would be delivered through the pipeline. The remaining 49 BCM are still aimed at the European market, although it remains unclear how they are supposed to reach it. The communiqués make repeated reference to a new gas hub at the Turkish-Greek border and the use of Turkish pipeline infrastructure. In other words, Moscow has not renounced its goal to circumvent Ukraine and take Russian gas over the Black Sea to Europe. But now Turkey has a central role in these plans.
So why the change in plan? Contrary to popular belief, Putin’s decision has very little to do with the current crisis between Moscow and the West. His recent remark that Europe had “created obstacles for South Stream” was widely read as an announcement of Russian retaliatory measures, as a threat or at the least as a shot across Europe’s bow.
But these obstacles existed long before the current crisis – and Putin knows it. The EU reminded Moscow repeatedly of the so-called Third Energy Package passed in 2009, which liberalizes the gas market and unbundles the production and distribution of gas. Thereby, it only pointed out market rules that are in place for everyone. Putin himself never made a direct connection between the current crisis and the abandonment of South Stream.
In reality, South Stream simply became too expensive for the Russians. They used the political crisis as a face-saving chance to get out of a project that was oversized from the beginning and has cheaper Russian alternatives.
When the project was launched in 2009, Gazprom was full of vigour. The route over the Black Sea might have been technically challenging, long and expensive – but it pursued multiple goals at once. It disciplined Kiev, maintained Russian influence in Southeast Europe and extended Gazprom leadership into large parts of the EU.
But in recent years, circumstances have changed fundamentally. The price of oil has dropped and the oil-indexed gas prices of Gazprom have followed. In addition, the gas market is faced with an oversupply, mostly as a result of US shale gas production, which made LNG export capacities elsewhere in the world that were initially earmarked for the United States available to Europe.
Out of hand
What is more, projected construction costs of South Stream got out of hand in the last few years. The initially estimated €16 billion were adjusted upwards even by Gazprom itself. Experts expected total costs of up to €50 billion. This is too much given the burden of projects Gazprom currently carries: explorations in areas with extreme geology and climate, the construction of the mega-pipeline “The Power of Siberia” to China and the construction of an LNG terminal in Vladivostok for Asian markets.
Therefore, Gazprom felt compelled to replace South Stream with a more modest version – not least because of the domestic competition Gazprom is now engaged in with Novatek, which has been deliberately promoted by Putin.
There is also a lot to suggest that for a long time the planners of South Stream overestimated the growth of the European gas market. They are not alone. The International Energy Agency (IEA) had to adjust earlier predictions of its yearly World Energy Outlook downward repeatedly. Gas consumption in the EU is stagnating due to gains in efficiency and the constant expansion of renewables.
Even if domestic EU production is set to dip by a third by 2035 due to declining British and Dutch reserves and the need for imports will increase, the initial Russian plan for the supply of the European gas market still seems oversized. South Stream alone would have covered 13 per cent of the total European gas supply of currently 476 BCM. Who was supposed to buy all this additional gas? The finalization of this project would have led to an oversupply and thereby to a drop in prices in Europe – Gazprom would have cannibalized itself. So the state-owned enterprise gave up the project for commercial reasons.
One idea that has not yet been discussed in Russia, at least not publicly: why engage in a Southern adventure, when you have a significantly lower priced alternative available? Nord Stream leads from Russia through the Baltic Sea straight to Germany and has a connection through the Netherlands to the UK. For € 8.8 billion, this double-pipeline was built between 2010 and 2012 at the bottom of the Baltic Sea and can carry up to 55 bcm per year.
Despite initial resistance in Poland as well as in the Baltic and Scandinavian countries and complex environmental requirements, the Nord Stream consortium managed to push this technically challenging project through on time – a remarkable feat, given the problems large infrastructure projects are facing everywhere you turn.
Moscow could add to the two Nord Stream lines a third one. Feasibility studies for two additional lines actually show that the presumed increase in European consumption could thereby be handled much faster and cheaper. From a purely economic perspective, Nord Stream the third would be for Gazprom beyond any shadow of a doubt the optimal alternative. But this plan was put on ice. The consortium, still in existence, currently has – in the truest sense of the word – only the pilot light on.
Balancing of interests
Knowing all this, the termination of South Stream as such should leave us unfazed. Putin obviously does not want to terminate the energy partnership we have in place. It remains a bridge between Europe and Russia – maybe the more so, the more it is depoliticized and needs to obey market rules.
We should be much more worried by the extent to which – beyond energy topics – Russians are turning away politically and ideationally from Europe and looking elsewhere for substitutes for the European connection. It is similar for Turkey: both countries are looking for new opportunities by strengthening their bilateral cooperation – in matters of oil, gas and nuclear power, but also generally by enhancing their trade. Both are also looking with great interest towards China.
Could it be that, because of the (legitimate and necessary) criticism towards their governments, we are forgetting our fundamental interests towards these two countries and their peoples? A balancing of interests with Russia is necessary. Let’s not forget that Russia is our neighbour and will remain our neighbour.
Prof. Dr. Friedbert Pflüger is Director of the European Centre for Energy and Resource Security (EUCERS), King’s College London. For an overview of all his articles for Energy Post, click here.