Ambassador Peter Poptchev offers an ingenious compromise on the stalled South Stream project: let Russia build half of it, to be filled with only new gas. The European Commission’s new Vice-President for Energy Union could make this work – if she has a convincing strategy for South East Europe. (Plus: an overview of all stakeholder positions on South Stream.)
The legacy of South Stream is one of the most complex and urgent issues the new European Commission is confronted with. According to Peter Poptchev, Ambassador and energy consultant in Bulgaria, the EU should offer a compromise solution: let Russia build half of South Stream’s proposed capacity, to be filled with “new” gas only, and at the same time ensure that Ukraine will meet its transit obligations. Moscow may agree to such a proposal if confronted with a convincing EU strategy to develop a competitive, diversified gas market in South East Europe – and if offered long-term investment guarantees. That, says Poptchev, is a job for the new European Commission and its VP for Energy Union.
The Gazprom-driven South Stream pipeline system is presently immobilised, pending the negotiation of a comprehensive agreement on the project’s regulatory and commercial framework between the European Commission and Russia. The activities of the joint project companies, set up in the countries lying along the land route of South Stream, have been halted or slowed down. A loss-making delay has occurred at the Bulgarian end of the pipe-laying operation easterward. Yet, South Stream Transport, an Amsterdam-based consortium co-owned by Gazprom, ENI, EDF and Wintershall, considers the maritime section outside EU jurisdiction and plans to start laying subsea pipelines from the Russian shore westward, in November.
The current problems for South Stream started in the spring of 2013 when the European Commission initiated a thorough reassessment of the intergovernmental agreements and corporate contracts that EU Member States, among them Bulgaria, Hungary, Greece, Slovenia, Austria and Italy, had signed with Russia or Gazprom in the preceding five years. That was well before, and unrelated to, the dramatic events in and around Ukraine.
Following the developments in Crimea and Eastern Ukraine, a business-as-usual policy to South Stream has become unacceptable. Indeed, the project has always been regarded by many as acceptable only within the context of a strategic relationship between the EU and Russia. With the prospect of such a relationship fading away, how could the EU concur with a project that openly challenges its energy policy and regulations? Moreover, this project is to be implemented in Europe’s economically most vulnerable region, which also finds itself most affected by the aggravating security trends in the Ukrainian conflict. The Commission has accordingly interrupted talks with Russia on South Stream but has engaged Moscow and Kiev in gas negotiations, many aspects of which pertain to the project.
The project has always been regarded by many as acceptable only within the context of a strategic relationship between the EU and Russia.
The Commission’s pragmatic approach is in principle reasonable. It rests on the EU’s continued appreciation of Russia as a leading supplier of energy, and takes into account the interests of a number of European countries in South Stream.
Time to put all cards on the table
But what to do next? Under what conditions should the EU go along with South Stream? Or should it try stop the project altogether?
The first principle in any renewed diplomatic effort should be that South Stream must be open to rethinking and restructuring. This will disappoint some of the political lobbies and companies involved but, under the circumstances, it is the only plausible path to a win-win situation.
South Stream’s capacity, route and engineering design have been changed repeatedly throughout the years, reflecting Russia’s strategic considerations and economic interests. Europe has been largely missing in this process. For the decisive on-shore part, neither the local project companies, nor their respective governments, with barely one exception, cared to coordinate and consult with each other. That omission should now be repaired.
A rethink of South Stream’s concept and contractual basis should address at least three key issues:
- the primacy of the European energy acquis, in particular, in this regard, the establishment of a functioning regional gas market in South East Europe as intended by the EU’s energy policy
- consideration of a more rational “same gas”- “new gas” ratio in South Stream’s throughput capacity
- and, taking into account legitimate Russian concerns and interests
South Stream should above all be subjected to the systemic requirements, approaches and goals of the Internal Energy Market (IEM) – not vice versa. It is Moscow’s defiant and irreconcilable stance on the Third Energy Package and other European market rules that has effectively brought the project to a standstill. This stance has also complicated Gazprom’s market position in Europe.
Putting the logic of the IEM at the centre of an EU strategy to restructure South Stream would inevitably lead to the realisation that Europe needs to establish – before or, as a compromise, in parallel with the construction of South Stream – an integrated and functioning regional gas market in South East Europe. This market space, potentially consisting of regional EU Member States and the members of the Energy Community (i.e. the countries of the Western Balkans, Ukraine and Moldova), should be an integral part of the single European gas market. It should preferably include Turkey as well.
Europe needs to esbtalish an integrated and functioning regional gas market in South East Europe. The countries there need it above all for economic reasons.
Of all the long-haul gas pipeline projects designed to bring new gas to Europe, South Stream is the only one which aims to develop as “a gas pipeline system”. Accordingly, with its massive 63 bcm per year, South Stream targets existing and planned key gas infrastructure in the region like free pipeline capacity, interconnectors, underground gas storage facilities, trading platforms and, lately, gas exploration and production sites.
So far neither Gazprom, nor local jointly-owned project companies had any incentive or felt any particular pressure to comply with European legislation. In fact they relied on derogations but no party ventured to suggest this formally because of obvious regulatory irrelevance. The current stern position of the Commission versus South Stream will achieve little without a coordinated and across the board effective implementation of the European energy acquis. The countries of South East and Central Europe need such an integrated regional gas market above all for economic reasons. They need the market’s inherent values like a uniform and predictable regulatory environment, trans-border sharing of investment risks and opportunities, regional trading markets (an Azerbaijan-Turkey-Bulgaria gas hub and a Bulgaria-Greece-Turkey gas price hub have already been proposed), exchange of transparent and standardised energy data, and competition on agreed principles leading to downward pressure on energy prices. This is a medium-term undertaking – which includes diversity of supply measures – but it has to be started now. There may be a need for a regional “gas target model” – to define the relationship between long-term and spot delivery contracts, the role of interconnections, the location of LNG terminals and underground storage, the rules regarding congestion management and prevention of hoarding, etc. In a constructive spirit and in view of her market role, Russia/Gazprom could be invited to participate in this exercise.
South Stream’s overall capacity of 63 bcm has been taken for granted. There is however little understanding of the implications of this figure. A recent Commission analysis says that “under any scenario the EU will need new gas volumes from external sources”. In June 2013, in a rare instance of transparency, Gazprom stated at a public event that two-thirds of South Stream’s total capacity, or 40 bcm, would be “same gas” and one third, or 20 bcm, would be “new gas”.
To fill Nord Stream, Gazprom has already diverted 20 bcm annually of gas formerly shipped to Europe through Ukraine. The planned diversion of another 40 bcm across the Black Sea – and the construction of new land pipelines in both Russia and the Balkans – will happen at enormous cost. The 20 bcm of “new gas” for Europe will be just 3.5% of its projected consumption after 2025.
Supporting this “same gas-new gas” ratio would mean that Europe agrees with reducing Ukraine’s annual revenues by an additional US$2 billion in transit fees, weakens the case for international rehabilitation of Ukraine’s formidable gas transit system and shows indifference to the geopolitical motives that have led to this project design in the first place.
Supporting South Stream’s plans to transport 40 bcm “same gas” – i.e. diverted from Ukraine – and only 20 bcm “new gas”, would mean Europe agrees to cut Ukraine’s annual transit revenues by US$2 billion. Instead, why not build just two of the four planned pipeline strings acros the Black Sea and fill them with “new gas” only?
The EU’s new partnership with Ukraine and its consistent search for a political solution to the Ukrainian conflict allow Europe to propose a strategically and economically much more viable option for South Stream: the EU and Russia could agree on laying just two of the four pipeline strings (parallel branches) across the Black Sea, to be filled with “new gas” only.
This would amount to 31.4 bcm, which is in fact the original volume Russia signed on to in a series of intergovernmental agreements. Outside geopolitical considerations, from a technological and investment perspective this might not be an attractive proposition to Russia, not in the short timeframes envisaged for South Stream. A fresh and unbiased analysis would show however that there is no hurry and Russia would lose nothing. By all accounts, Kiev does intend to adhere to its transit obligations, Gazprom has solid long-term export contracts to Europe, and the EU is capable of mediating at short notice, if necessary.
Keeping the existing transit arrangement in Ukraine, albeit on a trial basis, could be accompanied by opening new exploration and production opportunities for European and US international oil majors in Russia. They could be invited to form joint ventures with Russian companies to develop gas fields and related infrastructure intended to bring “new gas” to Europe. South Stream on-land infrastructure would undergo a manageable alteration, while the market effect would be real.
Diversification remains a principal goal
It would be naïve to expect Russia to agree to changes in South Stream’s capacity and design simply to facilitate regulatory coherence and market integration in Europe. South Stream has been developed as a system capable of establishing its own operational norms and of offering all sorts of energy and industrial business opportunities. But Russia might agree if it was confronted with a consistent and comprehensive EU gas strategy.
For Europe to be able to extend the functionality of gas markets to its Central and South Eastern parts it should be prepared to undertake a substantive and viable gas diversification strategy – in terms of origin, form of transportation and mode of exploration and production, including shale and synthetic gas. A new emphasis on renewables and energy efficiency will help tremendously. Profound changes in the EU’s external energy policy should take place, including a return to Nabucco and other supply concepts (as implicitly suggested in the Projects of Common Interest list of priority infrastructure projects for Europe). Brussels should display resolve to address the strategic concerns of energy-rich countries interested in working closer with the EU. The elaboration of a strategy on multi-purpose use of LNG is also long overdue. All of this would fit into the concept of an Energy Union as has been proposed by Poland’s premier Donald Tusk. This concept now seems to be under further development within the EU, as evidenced by the establishment of a Vice-President for the Energy Union in the new Commission. Indeed, the new executive organisation of the Juncker Commission is ideally suited to ensuring a holistic and strategic solution to this landmark gas project between the EU and Russia. It is only against the backdrop of such developments that Russia might resign itself to the logic of restructuring South Stream.
A renewed drive for diversification and a more effective outreach to gas exporting countries in Central Asia, the East Mediterranean and Africa will take a while. The EU could incentivise Russia to begin changing its views on South Stream now by offering to negotiate the embodiment of Russian concerns in contractual form. Moscow is for example interested in developing criteria on “projects of mutual interest” with the EU and of relying on “long-term contractual certainty”. It wants a “facilitated and free movement of manpower, materials and equipment” between the two sides as well as information exchange, protection of investments and trade in energy technologies. Russia needs predictability for the next 30–50 years in her commitments to supply Europe with gas through both South Stream and Nord Stream as interrelated projects.
Barring further aggravation of the Ukrainian crisis – which increasingly depends on Russia – the incoming European Commission will have to address South Stream as one of its most complicated inherited challenges.
A SHORT OVERVIEW OF SOUTH STREAM STAKEHOLDERS’ POSITIONS
Gazprom presents South Stream as a boost to European energy security, emphasises its diversity of delivery routes value, and insists it is “a European project”. In mid-November 2013 Gazprom’s Management Committee made an official statement that South Stream was progressing steadily. Gazprom Export and South Stream Transport had in the previous month signed a Gas Transmission Agreement. Everything had been set for a 1,455-kilometer onshore gas pipeline section to cross Bulgaria, Serbia, Hungary and Slovenia. The gas pipeline would end at the Tarvisio gas distribution station in Italy. Gas branches from the main pipeline route would be built to Croatia and to Republika Srpska (at the time there was no OMV-Gazprom deal on a branch into Austria). Gazprom is heavily dependent on strategic, foreign policy, economic and financial decisions taken by the Russian political leadership. This explains the strong geopolitical component of South Stream. On the other hand, the personal involvement of President Putin in fostering South Stream has been a distinct strength of the project. A number of European leaders have been pleased to signal support for South Stream in direct discussions with the Russian president. Hence, the bewilderment in Moscow as to how Brussels “officials” could be allowed to have the final say. The Russian government has been fiercely opposed to, in particular, the Third Liberalisation Package and the EU’s policy of diversification of gas sources, routes and suppliers. Both Moscow and Gazprom have been publicly defiant of EU institutions’ objections to South Stream. Nonetheless, Energy Minister Alexander Novak and, in particular, Gazprom have quietly indicated a readiness to negotiate, including on compliance with the Third Package.
South Stream Transport, B.V.
Initiated as a Special Purpose Vehicle (SPV), this consortium comprises Gazprom (50%), ENI (20%), EDF (15%) and Wintershall (15%). It is in charge of planning, construction and subsequent operation of the offshore pipeline (four strings) through the Black Sea, which will eventually transport up to 63 bcm of natural gas per year from Russia to Central and South East Europe. South Stream Transport has already ordered specially coated subsea pipelines in a UK facility: a barge, carrying 6,000 of the pipelines for the first string has recently moored in the Bulgarian port of Bourgas. A local South Stream Transport manager has said that, rather than from Bulgaria where temporary impediments have occurred, the company would start laying the pipelines from the Russian shore westward, claiming the Black Sea is outside EU jurisdiction. Gazprom has repeatedly declined to present South Stream as an integrated, single-schedule international project. Thus, sectioning the pipeline into maritime and several on-land national stretches has given rise to various legal interpretations.
It was the first European country to sign an intergovernmental agreement with the Russian Federation on South Stream. Between 2007 and 2009 the project was based on a concept much closer to EU energy policy. For example, Gazprom repeatedly acknowledged Nabucco could have its own role. Bulgaria’s experience, argumentation and host country procedures have been borrowed by other EU Member States. After 2010, Bulgaria gave in to key Russian demands, the most important of which was the early signature of a final investment decision (FID) on the construction of the Bulgarian stretch. The Commission challenged the viability of this FID. Gazprom then indicated a three-fold increase in the cost of construction works in Bulgaria (to above €3,5 billion). At the end of 2013, a hastily organised tender, which was publicly criticised by the Commission, awarded the construction contract to a Russian consortium, now withdrawn, and five Bulgarian companies, two of which subsequently had to be restructured for not meeting basic criteria. The project is effectively frozen in Bulgaria, although the leading political parties and business community support South Stream, differing only in the degree to which it should be subject to EU energy policy and regulation.
South Stream has always been regarded by Belgrade as a strategic asset, in particular at the time of signing the intergovernmental agreement. The latter is the only agreement which envisages a 51:49 distribution of stakes in favour of Gazprom in the South Stream Joint Project Company. This situation could potentially make Serbia the centre of the South Stream system, an important component of which is the Banatski Dvor storage facility. The landmark agreement between Belgrade and Pristina and the subsequent March 2012 decision by the European Council to grant Serbia candidate status for EU membership have made Belgrade’s strategic thinking more EU-oriented but it goes in ups and downs. Commercially, South Stream is very important to Belgrade, which notes that Serbia was not invited to join either Nabucco or TAP, so South Stream is considered its only gas supply lifeline. In the Energy Community, Serbia has helped the selection of South Stream as the principle pipeline in many Community Projects of Common Interest (CPCIs). After some hesitation, Serbia has taken a defiant attitude to EU restrictions and has insisted that South Stream-related construction works in its territory start unabated.
Greece joined South Stream by signing an intergovernmental agreement, expecting that it would be a key transit country to South Stream’s final destination, Italy. The main land route of South Stream has since changed several times but the positive attitude of Athens to South Stream and Russian energy in general has remained the same. In 2012-13 Greece was preparing for Gazprom to win the tender to buy a stake in DEPA, the national gas trading company, but following advice by the Commission that this would increase Gazprom’s dominant market position, Athens tactfully unravelled, perhaps temporarily, a deal with Gazprom. This facilitated a final decision by the Shah Deniz Consortium to choose the Greek outlet for Azeri gas to Europe (TAP). In the meantime, South Stream indicated it could build an extension from Bulgaria into Greece but no details or contracts have been revealed. Greece has a central position in transporting and distributing Southern Corridor gas to various European markets. It is open to playing a similar role for South Stream and claims it is best suited (rather than Turkey) to transport Cypriot and Israeli gas to Europe. It also plans to play it big in the LNG sector. All of this makes Greece an important hub in a future integrated regional gas market. However, Athens needs to integrate its comparative advantages with those of its neighbours, a policy that seems lacking for now.
For a long time Budapest gave the impression of being critical or at best indifferent to South Stream and concentrated on Nabucco as the long-haul gas project of choice, claiming a European stance on energy security. In 2008-09 Hungary developed initiatives geared towards turning Budapest into the political centre of Nabucco as a counter-balance to Vienna being the seat of Nabucco International Co. On the other hand, the Hungarian shareholder in Nabucco International was the first to exit the consortium in 2012. Hungary is one of the big gas markets in Central and South East Europe (12 bcm per year). Its gas transmission network and storage capacity are appreciated by South Stream. Hungary is positive on the implementation of the Third Liberalisation Package. Hungarian gas experts are the authors of working ideas on the development of a regional gas market. The Hungarian professional community would probably prefer that the Hungarian government’s embrace of South Stream is a purely pragmatic choice. Recent statements at the highest Hungarian level however, have put the country firmly in support of the strategic concept of South Stream with all its controversial implications for Europe.
Austria is ideally placed because any plans affecting European gas liquidity and security of supply would always take a market – and therefore acceptable – form through the Central European Gas Hub (CEGH) in Baumgarten. Gazprom appreciates CEGH more than anything else since, from a commercial point of view, South Stream is intended to create a long coveted business opportunity of participation in the distribution and retailing of natural gas in the European market. Like other countries in the region, Austria hoped to have the privilege of two worlds, Nabucco and South Stream. With the demise of Nabucco, OMV and Gazprom found soon a perfect match for their interests, including a stake in the Austrian gas exchange for the Russian company. A few years ago the Commission did not allow Gazprom to acquire a 50% stake in CEGH. This time round there has not been, at least not yet, any regulatory objection to the gas exchange deal. Vienna of course knows very well the strategic implications of the South Stream project. On this point it believes others should take responsibility or, as the Austrian President recently famously said: “No one can tell me why… a gas pipeline that crosses NATO and EU states can’t touch 50 kilometers of Austrian territory.”
It has tried, and largely succeeded, in presenting its participation in South Stream as a strictly pragmatic, commercial move while politically in line with its traditionally friendly relations with Russia, yet devoid of any strategic content. Ljubljana has very rarely issued official statements concerning South Stream but it has made clear its view that the Commission is overstating its powers with regard to South Stream. Moscow appreciates this attitude. Notably, Gazprom has selected a Slovenian company to develop and supply the software and equipment necessary for commercial data collection and monitoring the whole length of the South Stream pipeline. On the other hand, Ljubljana has probably been the only European capital to explore the possibility of organising a conference or coordination meeting among European countries with a stake in South Stream, but met with reluctance from the main stakeholders and other, undisclosed, impediments.
This is the most informed European country on the concept and implementation of South Stream but it has been very careful to distinguish between ENI’s relationship with Gazprom and other corporate stakeholders in the project and the position of the Italian government, which has often been of a wait-and-see kind. ENI’s engineers were invited to work alongside Russian colleagues at the Gazprom laboratory in St. Petersburg soon after a Memorandum of Understanding on South Stream was signed in Milan in June 2007. ENI’s former CEO, Paolo Scaroni, has tried to be a partner to both Russia and Europe: he proposed compromise steps which Moscow should take – for example a merger between Nabucco and South Stream – but Russia has always kept the strategic decision-making to itself. Only two months ago, the official Italian position regarded South Stream as “a project of strategic significance for Italy since it would help to diversify routes for Russian natural gas supplies, eventually enhancing energy security both for Italy and the European Union.”
What is significant however, is that Federica Morgherini, already in her capacity as High Representative for Foreign Affairs and Security Policy, has seen the need for a reversal of course on South Stream and has actually conveyed such messages, for example to Belgrade.
Ambassador Peter Poptchev is a career diplomat, with over 30 years contribution to Bulgaria’s bilateral and multilateral diplomacy in Lagos, Geneva, Brussels, Dublin and Vienna. From 2007, he was Ambassador-at-large for Energy, Security and Climate Change at the Bulgarian Ministry of Foreign Affairs. He was on the Bulgarian delegation negotiating the South Stream intergovernmental agreement (IGA), headed the team negotiating the Nabucco IGA and helped establish an international programme on energy security at the Diplomatic Institute. He has also held a number of elected positions at UN and specialised international organisations. A series of international treaties, conventions and protocols have been negotiated under his chairmanship and drafting. The author of four books and numerous articles in Bulgarian and English, he researches in particular the development of the EU and NATO in the framework of globalisation and asymmetric threats and challenges to security, including energy security, and climate change. For Energy Post he earlier wrote an analysis advocating a rethink of the Nabucco pipeline project.