Thursday, November 15, 2012

Gazprom Formally Agrees to Build South Stream

The speculation is over:  after years of planning and speeches by Russian President Vladimir Putin, Gazprom has formally committed to the construction of the South Stream natural gas pipeline.  This route, to be filled with natural gas Russia formerly transported to Europe via Ukraine's Cold War-era Peace Pipeline, is expected to deliver 63 billion cubic meters (bcm) annually to Europe.  According to the company, it has signed the final investment agreement with its European partners and will commence construction in December 2012.

The last hold-up before making a financial commitment had been Bulgaria, the first European country the pipeline would transit.  The Bulgarians had little choice except to sign.  They had been receiving Russian gas since 1 April at an 11% discount, but the discount was predicated on Bulgaria's agreement to South Stream.  If Bulgaria had refused to allow Gazprom to build the pipeline, it would have been obligated to repay the discounted funds, estimated at $70 million.  Russia increased the pressure when state-run Atomstroiexport filed a $1.3 billion compensation claim against Bulgaria before the International Court of Arbitration for a planned nuclear power plant at Belene that Bulgaria cancelled.

In the end, the Bulgarians received a sweet deal.  When the government signed the investment agreement with Gazprom, they also signed a long-term gas contract with a 20% price discount beginning January 1, 2013.  While the discount is a plus, Gazprom also got good news:  maintenance of the linkage between oil and gas prices, and a take-or-pay obligation for 80% of the contracted 2.9 bcm annually.  "We've agreed on very preferential prices for Bulgaria," said Gazprom CEO Alexey Miller.  "With South Stream, Bulgaria becomes the biggest transit country for Russian gas in Europe."  Interestingly, Miller denied the price discounts were part of the South Stream negotiations.  "These issues are not related," he said.

Bulgaria does not have to pay anything for construction of its share of the pipeline.  Gazprom will lend the funds to Bulgarian Energy Holding, to be repaid out of dividends earned on the project.

Obtaining financial commitments is not the entire battle, however.  Since the pipeline will go through members of the European Union, the European Commission must approve an environomental impact statement before construction.  Without an official communique to get the review started, the European Commission does not even acknowledge that South Stream is a viable project.  "It was never communicated to the Commision that South Stream has a final route," said EC energy spokesperson Marlee Holzner.  "We don't regard this as a final investment decision."

There have also been various reports that Russia believes a quick start to the project will mean the project does not have to meet the EU's third energy liberalization package, requiring the divestment of the distribution network from the transportation network.  According to the Commission, however, the package is already in effect and South Stream must abide by it.  To that end, it has held meetings with South Stream transit countires to make sure any bilateral agreements with the Russians will comport with EU rules and regulations.