South Stream Becoming a Reality

On December 29, 2011, Turkey and Russia signed an agreement to allow the South Stream natural gas pipeline to transit the Black Sea waters in Turkey's economic zone.  This was an important development, in that South Stream now has the necessary permissions to bring the Russian pipeline system to Europe via the Southern corridor.  Russian Prime Minister Vladimir Putin was so excited by the development that he ordered Gazprom to move up the date to begin construction from 2013 to 2012.
There has been much speculation that the pipeline is a bluff--designed to either stop Nabucco construction or to force Ukraine to bend to Moscow's will.  The truth may be more obscure.  US Special Envoy for Eurasian Energy Richard Morningstar commented in a recent speech, "The Russians have...taken to building the South Stream Pipeline, although they are the only ones who know why."
The fact is that, regardless of what the original thoughts may have been concerning the pipeline, Russia has made so many commitments concerning this pipeline that it would be almost impossible for them to back out.  There are three Western European private companies who are partners in this project.  It is extremely doubtful that Germany's Wintershall (a division of BASF), Italy's ENI, and France's EDF would incur start-up expenses in support of a Russian political ruse.  Gazprom still controls 50% of the consortium and could unilaterally kill the project, but it would incur the wrath of its other partners.
The same goes for the various governments that have signed on.  Bulgaria has hired a company for a feasibility study, Slovenia has created a JV to build and operate their share of the pipeline, Serbia looks forward to being a key transit center, Greece (now to be on a spur instead of the main line) has identified the pipeline as a national priority, etc.
Much has been made that South Stream has not identified where it will get the 63 bcm annually it needs to fill the pipeline.  In fact, South Stream never planned to identify new sources of gas, but to use the gas that is presently transiting the Ukrainian pipeline system, according to South Stream CEO Marcel Kramer.  European Energy Review published an interview with Kramer on this subject.  "The basic and overriding target of Russia is to ensure the technical, managerial and economic reliability of its gas supply.  That is where South Stream comes in.  Don't forget that the pipeline system in Ukraine is in a poor state.  It's being said that it is old, dilapidated, without an integrated management system.  To upgrade the entire route through Ukraine would also cost a lot of money.  Then you get into questions of ownership, operatorship, who puts up the money, the chances of political interference.  The bottom line is, is this an arrangement that the buyers of gas in Europe can rely on?  If you put all this together, the answer is clear," he said.
Ukraine, of course, is opposed to the new pipeline.  Energy Minister Yuri Boiko called South Stream a threat to Ukrainian national interests.  "We will always be against it," he said according to UPI.
Another question has been whether there is sufficient demand for Russian natural gas to justify the building of the pipeline.  Andrea Bonzanni, former consultant to the UN and the World Bank, wrote in World Politics Review that the mid- to long-term outlook for gas demand does not seem to justify the construction of both Nabucco and South Stream.
The Russians believe Europe has a long-term need for additional gas, justifying the construction.  After a meeting between Gazprom Chairman Alexi Miller and Bulgargaz executive director Dimitar Gogov, UPI reported the participants issued a statement that both sides "share the opinion that given the inevitable gas demand growth in Europe, timely implementation of South Stream would meet the interests of millions of European consumers."  Miller has said, "It is clear that there will be need for additional pipeline capacities" that would help mitigate risks that could have a serious impact on the European market, according to Platts.  Alexander Medvedev, deputy chair of the Gazprom Management Committee, wrote in Today's Zaman, "The fact that South Stream is primarily an investment in energy security, not in boosting the market share of Russian gas, also means that it does not compete with other pipeline projects that intend to import fresh supply volumes from other possible gas sources.  South Stream does not oppose these projects." RIA Novosti quoted Gazprom's Medvedev, "Even if we take into account the Nord Stream, the South Stream, the Nabucco and liquefied natural gas, all the same, the shortage of gas supplies to Europe will be some 530-700 billion cubic feet."
Some within the European Union appear to agree with this analysis.  European Energy Commission Gunther Oettinger said "we don't want to block South Stream," and arranged for South Stream executives to make their case to the commission in May. At that meeting, the Russians took the opportunity to make the case that South Stream is a continuation of Russian trans-border pipelines, and third parties should not have access to it.  Ths would guarantee a Gazprom monopoly on the project flow. CEO Kramer said requiring the pipeline to open to competitors would affect the project's rate of return, and could make the project more "difficult" to carry out, according to the New York Times.  Oettinger, however, remained adamant:  "If South Stream...gives access to gas independents active in Russia, then South Stream would deliver on two essential criteria:  namely diversification of routes and counterparties.  That means a stronger contribution to European diversification efforts," he said in a speech reported by the Wall Street Journal.
Whether the doubters or the believers are correct, however, it appears that the construction of the pipeline will begin within the next twelve months.

Nabucco Down but Not Out

It's been a tough six months for Nabucco, the European Union-preferred route that is supposed to bring Caspian natural gas to Austria via Turkey, Bulgaria, Romania and Hungary.  Azerbaijan has received bids for its Shah Deniz II oil from several competing consortiums, and several of them are more attractive economically.  On top of that, Nabucco still is unable to find enough feedstock for its pipeline.  Despite these setbacks, some analysts believe the route remains the most viable route:  because it guarantees independence from Russian natural gas, and because it can carry more product than any of the competition (except for South Stream).
On June 8, the Nabucco Gas Pipeline International GmbH signed project support agreements with the transit countries, but Azerbaijan did not sign the agreement as this would have signaled their choice of a route.  Elshad Nasirov, vice present of the State Oil Company of Azerbaijan (SOCAR), said that Azerbaijan was not prepared to commit all its gas to one buyer.  "We prefer diversity among the buyers, so we sell gas to the EU and Iran, as well as Russia," Hurriyet reported him as saying.  Nasirov cast doubt on Turkish support of Nabucco, citing Turkish failure to provide Azerbaijan with a signed copy of the project support agreement, and failure to sign a bilateral transit agreement.  "If we have not yet signed the transit agreement, should we understand that Nabucco has still not been sanctioned byTurkey?"  he asked.  In a foreshadowing of Azeri support for the Trans-Anatolian pipeline proposal, he told the Wall Street Journal that he preferred a smaller pipeline that could be expanded later to meet additional capacity.  He also said that SOCAR would consider becoming a shareholder in this smaller pipeline, in order to influence transit tariffs and other decisions.
Contradicting Nasirov was Azerbaijan's Minister of Industry and Energy Natiq Aliyev.  UPI reported him as saying his country supported the Nabucco project.  "As part of this project, Azerbaijan can serve as a transit country, as well as a gas supplier, as the project is seen as a priority in light of the diversification of gas supplies," he said.  UPI reported the German energy company RWE, whose support had been questioned after they signed a purchase agreement with Gazprom, remained committed to Nabucco, according to RWE Chief Executive Officer Joergen Grossman. In addition, Bayerngas announced its desire to join the Nabucco consortium, according to the Dow Jones newswire.
Nabucco submitted its formal proposal to SOCAR at the end of September, along with all its rivals.  SOCAR spokesmen announced at various times that a final decision would be made as early as October 2011or as late as 2014.
Nabucco's inability to find gas supplies has forced it to delay by 3 years its scheduled date to begin operations.  Orignally scheduled to be completed in 2015, completion date is now scheduled for 2018--although construction is still supposed to begin in 2013, according to the CEO of OMV Gerhard Roiss the Sofia News Agency.  To solve this problem, Austria's President Heinz Fischer asked Turkmenistan to become a Nabucco supplier, according to Associated Press.  According to Dr. Friedemann Muller of the German Institute for International and Security Affairs, the Turkmenistan gas is crucial for Nabucco to be successful. (The issue of bringing Turkmenistan gas to Azerbaijan via the Trans Caspian Pipeline is addressed in numerous other entries on this blog.)
The cost of Nabucco has also become an issue.  Hungarian National Development Minister Tamas Fellegi complained, "No one can predict the final cost of Nabucco, but according to optimistic estimates, its cost may reach 24-26 billion euro," a far cry from the original projection of $8 billion.  The European Commission believes the price will be closer to $10 billion, and Nabucco chief Reinhard Mitschek does not believe financing will be an issue.  "I am confident that once we will have the gas supply and transportation contracts and...with political support we expect financing will be settled and will not create a bottleneck," quoted Reuters.
U.S. Special Envoy Richard Morningstar has never been a Nabucco supporter, and he has continued to denigrate its possibilities.  At a news conference in Baku, he said that Nabucco retained U.S. political backing but that economic concerns should take precedence.  "It's important if Shah Deniz producers and SOCAR choose a smaller pipeline as the first pipeline," he said according to Reuters.
Nabucco's primacy was challenged in December 2011, when SOCAR and the Turkish Pipeline Company (BOTAS) announced their plan to build their own pipeline, the Trans Anatolian pipeline.  According to SOCAR president Sabit Bagirov, however, this development actually helps Nabucco's prospects:  "With the implementation of the Trans Anadolu Dogalgaz Pipeline, the necessity to construct the Turkish section of Nabucco will disappear, and the builder will only need the gas pipeline section from Turkey through Bulgaria to the distribution point in Baumgarten in Austria.  In other words, with the implementation of the Trans Anadolu Dogalgaz Pipeline, only that section of the Nabucco route falling on European teritory will need to be built," quoted the Moscow Times.
As 2012 begins, Nabucco appears no closer to completion than it did at the beginning of 2011.  Construction is scheduled to begin on time, but completion will not be until 2018.  The consortium relies on Shah Deniz II gas, which SOCAR wants to pump through the Trans Anatolian Pipeline.  On the other hand, Nabucco could join this new project.  The price continues to rise, and no alternative feedstock sources have been found.  Nabucco is not dead, but it might be considered to be on life support.

Morningstar Abandons Nabucco

In a surprise development, it appears that the United States is abandoning its support for the Nabucco gas pipeline. In an interview with Kommersant newspaper, Morningstar stated that the United States supports a South Energy Corridor, but that did not necessarily mean the Nabucco project. "We would have preferred Nabucco, but that does not mean it will be implemented first," he said. "It could be Nabucco, ITGO or another project. The main thing is to have the ability to expand the pipe." (www.today.az/print/news/business/77920.html, 09 December 2010) Given that Nabucco is designed to carry 31 bcm annually of gas, and South Stream is projected to carry 63 bcm annually, Morningstar would appear to be signalling surrender to Russia and to Gazprom.

Morningstar has been hedging his support of Nabucco since at least September, when he told a group of journalists, "There will be a Southern Corridor. As for initial gas coming from the Caspian through the Southern Corridor, I think it will be likely that there will be only one pipeline, whether it be Nabucco or ITGI (Interconnector Turkey-Greece-Italy) or TAP (Trans-Adriatic Pipeline)." Morningstar said that sometime in the future when more gas was available multiple pipelines would become complementary ("Nabucco moves a step ahead in pipeline wars," Hurriyet Daily News, 1 October 2010).

Projects such as ITGI, TAP or AGRI (Azerbaijan-Greece-Romania Interconnector) are all designed to provide small, alternative routes for delivery of Caspian gas to Europe. None are scheduled to take the place of Nabucco, however; only South Stream would have that capability. If South Stream were to become the backbone of the South Energy Corridor, then Gazprom would continue to hold a monopoly on gas deliveries from the East.

Nabucco's problem stems from a lack of feedstock for the pipeline. Azerbaijan has pledged 10 bcm annually to the project, meaning the pipeline would only be 1/3 full. The Vice President of Azerbaijan's national energy company Socar said "We are not willing to pay for the empty capacity of Nabucco. Azerbaijan wants to keep all doors open to alternative sources of transportation. We will not put all our eggs in one basket, however attractive and beautiful it may seem." (www.today.az/print/news/business/77676.html, 04 December 2010)

The project initially hoped to fill the remainder of the pipeline capacity with gas from Turkmenistan, but the Trans-Caspian pipeline remains mired in legal disputes over the status of the Caspian itself. Without Turkmen oil, Nabucco backers have proposed various alternatives such as, Iranian natural gas (stymied by sanctions), or Northern Iraqi natural gas (supplies unsure because of physical security issues and ownership of the gas itself).

Left with a limited amount of gas, Nabucco is having difficulty raising the money to build the pipeline. Turkish Prime Minister Recep Tayyip Erdogan complained about this at the Black Sea Energy and Economic Forum in in September. "We say we are ready for everything, but those playing the coordination role have not yet come up with serious action," he said. ("Turkish PM complains about delay in Nabucco project," Hurriyet Daily News, 29 September 2010). The European Investment Bank (EIB), European Bank for Reconstruction and Development (EBRD) and the World Bank's International Finance Corporation (IFC) have begun a due diligence investigation with the aim of providing up to 4 billion euros for the project, but that is only 50% of the money that is needed to complete the pipeline. ("Massive Funding in Prospect for Nabucco Pipeline Construction," Eurasia Daily Monitor 7/164, 14 September 2010)

South Stream, by contrast, is growing by leaps and bounds. Bulgaria had previously opted out of South Stream, but after a November visit by Russian Prime Minister Vladimir Putin, Bulgaria' Energy Holding signed an agreement with Gazprom establishing a 50-50 partnership to build the pipeline. Construction is scheduled to begin in 2013, and may cost Bulgaria up to a half billion euros. Estimates are that the money would be recovered in approximately 2 years, as Bulgaria would earn 200-250 million euros annually in transit fees ("Bulgarian part of South Stream to cost 500 mln euros," Hurriyet Daily News, 15 November 2010). Putin returned home with both an agreement and a puppy!

The German energy company Wintershall denies any interest in joining Suoth Stream but Putin told Italian Prime Minister Silvio Berlusconi that German companies were showing great interest in joining South Stream ("Putin Hints at German Entry in South Stream Project," The St. Petersburg Times, 12 October 2010). Serbia and Macedonia have also expressed interest in the project.

Unless Ambassador Morningstar and his team can find additional funding, it looks like Nabucco might founder on the drawing board.

Dr. James J. Coyle is available to speak to your organization or at your event. Please contact him at jimcoyle@verizon.net.