The Russian cancellation of South Stream is not an end, but a beginning: a new start of Russian gas games in Europe and beyond, writes Agata Łoskot-Strachota of the Centre for Eastern Studies (OSW) in Poland. She discusses three likely scenarios for what will happen after South Stream and notes that this is a chance for Russia and Europe to look afresh at their bilateral gas relations and new pipeline options. But, she adds, it also makes it incumbent on the EU and its Member States to finally, unambiguously define their common natural gas strategy and interests.

If you don’t like how the table is set, turn over the table.
Francis Underwood, House of Cards

News of Russia resigning from its strategic project of South Stream, announced by president Putin during his visit to Turkey on 1st of December (and later confirmed by Gazprom’s CEO Alexei Miller), shocked Europe and the world, and led to an avalanche of speculations regarding the precise reasons for the Russian decision and its possible consequences. The fact that the Turkish side did not confirm the alternative project announced by Putin, of building a large new natural gas pipeline to Turkey, stating only that gas talks with Russia are on-going, only added fuel to fire.

Similarly, none of the other countries and companies engaged in the South Stream project was informed in advance of the Russian change of plans (the Saipem construction company was asked to suspend its work only on the 4^th of December). ­­­Therefore, everything which is known so far about the sudden change of plans originates from Russian sources. This makes it difficult to differentiate between rhetoric and reality, and to unequivocally state what the actual Russian plans are now. However, one certainly can say that the renunciation of South Stream’s construction and Putin’s announcement of new ambitious natural gas pipeline projects commences a new chapter in the game of Russia’s gas relations with Europe.

What we know

South Stream was a strategic project of Russia and Gazprom. Undoubtedly it was also one of most technologically ambitious – the 63 billion m³ pipeline was to run along the deep seabed of the Black Sea – and expensive ones – its projected costs grew ever higher, reaching almost € 40 billion recently. From the very beginning this bred questions regarding the project’s economic feasibility, strengthened lately in the context of lower natural gas demand in Europe, the financial problems of European utility companies and finally the events unfolding in Ukraine.

From the very beginning South Stream also did not have a fixed route – especially its land legs in the EU were subject to frequent changes, shifting from Greece to Serbia and from Italy to Austria. The project was established in 2007 as a direct competitor to the Nabucco pipeline (and later the entire Southern Corridor), and as a way for Russia to bypass Ukraine. It therefore was aimed at securing several key goals of Russian gas policy: lower dependency on transit, opening of a new direct route to Europe and in this way consolidate Russian market share and influence, as well as to limit the possibility of diversification in Central and Eastern Europe and the Balkans and hampering exports to the EU from the post-soviet Caucasus and Central Asia.

There is no evidence that Russia has abandoned its strategic natural gas goals in Europe

Therefore from the outset it was a counterproject to the projects supported by the EU (however, not necessarily by all member-states), an antithesis of the goal of diversification of routes and sources of supply, at times strongly and at times weakly pursued by Brussels.  From the beginning South Stream divided the EU and European countries internally, with some strongly opposed to it (as it increased dependency on Russian natural gas and limited the role of transit through Ukraine and Slovakia) and with some openly or covertly  favouring it, hoping to benefit from its realisation both energy-wise and politically (in part by strengthening their partnership with Russia).

Controversies around South Stream significantly increased during the last year. Around the end of 2013 the EU claimed that the project and its associated intergovernmental agreements violated the Union’s law. At the same time Russia, due to the Ukrainian crisis, intensified its actions aimed at completing South Stream as soon as possible and o exclude it from EU law as much as possible.

The Ukrainian context brought to the fore the differences of interests regarding the project within the EU.  On the one hand it strengthened worries of the European Commission and some of the member states, that South Stream would be utilised by Russia as an instrument to increase pressure on Kiev. After the annexation of Crimea and the Russian actions in the Donbass region and the introduction of sanctions, the European Commission put on hold all negotiations with Russia about the settlement of disputed legal matters regarding South Stream. On the other hand, the increased risks around the supply of natural gas through Ukraine strengthened the support for the project, since it offered an alternative route of supply for several other member states, including Austria and Hungary.

During the last year the financial problems of the project also deepened. Sanctions put on Russia by both the US and the EU made it difficult to find financing for the gas pipeline among Western financial institutions. They also complicated the planning of specific tasks associated with completing the route (for example the construction of the Bulgarian part).  Simultaneously Russia’s own financing capabilities have worsened, due to Gazprom’s diminishing  natural gas exports and thus income, its prioritizing of alternative export projects (for example to China), the decreasing oil price and the worsening of Russia’s general economic condition.

In this context Putin’s decision to cancel the project seems well justified. It allows Russia to avoid large expenses in the context of growing uncertainties regarding the project’s feasibility.

At the same time there is no evidence that Russia has abandoned its strategic natural gas goals in Europe and towards Ukraine, or that it has substantially altered the way it shapes its energy policy, for example that it will henceforth base its decisions only on ad-hoc economic principles.  Therefore the announcement of the cancellation of South Stream project is a beginning rather than an end. It is a new opening of Russian gas games in Europe and a new starting point for natural gas pipeline ideas.

What we do not know and what can happen – three scenarios

Due to lack of hard data it is difficult to say today what exactly will arise from South Stream’s ashes. It is not even clear whether the Russian side already has a final game plan. It does seem, however, that at least three scenarios are possible.

First of all it is very well possible that things will go as announced by president Putin. Russia and Turkey will agree upon the construction of a large natural gas pipeline to Turkey through the Black Sea.

It is also possible that the cancellation of South Stream is a bluff

The simplest option would be to lay additional legs to the already functioning Blue Stream natural gas pipeline and hence increase its capacity three to four times. It cannot be ruled out, though, that Russia will want to utilise the already constructed South Stream’s compressor station on the Russian Black Sea coast, and from there build a new natural gas pipeline to Turkey. Except for the submarine section, such a project would not need too big an investment.

Natural gas not intended for the Turkish market could then be transited either through a broadened Turkish network or the planned Azeri-Turkish natural gas pipeline TANAP to the Turkish-Greek border (as suggested by Putin), but also to the Turkish-Bulgarian border. From there, the gas could be transferred further to Europe, for example through the projected TAP route or the already existing Western Balkan natural gas pipeline, currently utilized for deliveries via Ukraine.

Such a scenario would allow Russia to achieve two key goals: it would allow it to fully bypass the Ukrainian system and to minimize chances for competition from Caspian (Azeri) or Middle Eastern natural gas. It would put a lot of pressure on the EU concept of creating the Southern Gas Corridor through Turkey, projected as an alternative to Russian routes and supplies. Russia could outcompete newcomers with lower prices. It could also put pressure on Azerbaijan to make some sort of deal with Russia.

If this scenario were to come true, it would force the EU to revise its present diversification of supply strategy and policy towards Turkey and the entire Southern Caucasus, Azerbaijan first of all. It could serve as a stimulus for the EU to intensify actions aimed at the integration of Central and Eastern European natural gas markets as well as redefine its goals and strategy in its cooperation with Ukraine.

The feasibility of this scenario for Russia would be largely dependent on Ankara’s policies and interests, and on what kind of gas agreement it would like to secure with Russia. Becoming a natural gas hub has been one of Turkey’s strategic goals for many years and access to huge quantities of Russian natural gas would certainly help. However, it is unclear if and on what terms the sides would come to agreement on the rules of transit and sales (control over the gas pipelines, access of non-Russian suppliers), especially keeping in mind the significant interests and ambitions of both Russia and Turkey.

Secondly it is also possible that the cancellation of South Stream is a bluff, with Russia desiring to return to this, possible slightly modified, project with a stronger bargaining position. A long time ago from the ashes of the Finnish-Russian project of the North Stream natural gas pipeline (which was supposed to run from Russia through the Baltic Sea to Germany) arose the German-Russian project of Nord Stream. In this case Putin’s declaration in Ankara was aimed at causing commotion within the EU and further embroilment of the member states.

Possible problems with supplies of Russian natural gas through Ukraine this winter (which will be larger if the EU and member states, lulled by the signing of a temporary Russian-Ukrainian agreement, will slow down their own actions to increase the EU’s resilience) would undoubtedly strengthen the arguments of the current South Stream proponents regarding the need of a settlement with Russia and a renewal of the project.

In such a scenario Russia would count on such voices prevailing inside the EU, hoping that the European side itself would strive for completion of South Stream, and hence come up with a proposal of a comprehensive settling of bilateral gas relations. This would not only allow for launching a route bypassing Ukraine, but also settlement of the OPAL pipeline dispute and even of the Commission’s ongoing antitrust proceedings against Gazprom.

It is difficult to say how realistic this scenario is, not only from the Russian perspective, but also due to the different EU reactions. Most of South Stream’s European partners seem to be negatively surprised by Russia’s sudden and one-sided decision. Simultaneously, European Commission president Jean-Claude Juncker did not rule out on December 5^th that South Stream could still be built. But the realization of such scenario would necessarily involve lower EU engagement with Ukraine and a loss of the EU’s credibility in Ukraine, which could slow down pro-European reforms in this country. It would also hinder a real diversification of supplies in Eastern Europe and the Balkans as well as the integration of regional natural gas markets with each other and the rest of EU.

A new great gas game has begun and the next moves will come from Russia

Thirdly it is possible, although this seems least probable, that Russia, due to the financial and regulatory challenges, as well as the political situation, will resign, at least for the time being, not only from South Stream, but also from all large southward natural gas pipelines.  Russia would still expand, according to prior agreements, the Blue Stream’s capacity to Turkey (at least to 19 bcm) and allow the establishment of an export route to Europe for Azeri (and potentially for example also Kurdish) natural gas. Russia would instead concentrate on alternative markets and directions. In an extreme scenario it would limit its engagement in Europe in order to accelerate the realisation of export projects to China and other Asian markets, which would force the EU to accelerate diversification of supply sources of gas and energy more generally.

One also cannot rule out an intermediate scenario in which simultaneously with a new focus on Asia, Russia will attempt to increase its presence in the North-Western European natural gas market, for example through the intensification of cooperation with Germany. This could involve the renewal of actions aimed at realisation of  subsequent legs of already existing natural gas pipelines to Europe, first of all Nord Stream 3 and 4.

In both cases, the substantial role of Ukraine in the transit of Russian natural gas would be maintained, as would be the EU’s vulnerability to further Russian-Ukrainian gas problems, at least for the next several years. Therefore for the EU it would be imperative to develop instruments increasing the energy security in the most vulnerable parts of Eastern Europe and the Balkans, for example speeding up the region’s integration by expanding interconnectors, etc., and diversification of supply sources. In this case it would also be important for the EU to be actively engaged in reform in Ukraine, aimed inter alia at more transparency in the gas sector .

In short, a new great gas game has begun and the next moves will come from Russia. Every scenario – and more scenarios are possible than the ones described above – will affect the natural gas situation of the EU and its energy relations both with Russia and the broadly defined European neighbourhood. For this reason, in order not to be limited to reactive actions, the first step the EU should take now is to unambiguously define its strategic and common  natural gas interests towards Russia, Ukraine, Turkey, the Balkan states and the Southern Caucasus. As long as the EU does not have a unified gas policy, it will remain vulnerable to manipulations from Russia and other players.

Editor’s Note

Agata Loskot-Strachota is Energy Policy Expert at the Centre for Eastern Studies (OSW) in Warsaw. A Polish version of this article was published on 10 December in Tygodnik Powszechny.

For her previous articles on Energy Post, see here.

Note that on 9 December, the European Commission and member states Austria, Bulgaria, Croatia, Greece, Italy, Romania and Slovenia gave out a joint statement on South Stream. They agreed that “the EU must remain strongly committed to integrating Central and South-Eastern European gas markets”. They also announced they will set up “a high-level working group” which will “develop an action plan for integrating Central and South-Eastern European gas markets and interconnections.”