Russia's decision not to construct the South Stream is the result of purely political reasons – the same types of reasons that forced the European Union and Ukraine to oppose the plan in the first place.


Workers arrange pipes delivered for construction of the South Stream gas pipeline at the Black sea harbour of Varna some 450 kms (260 miles) east of the Bulgarian capital Sofia, Monday, August 25, 2014. Photo: AFP

On Dec. 1, Russia announced its decision to completely cancel construction of the South Stream gas pipeline after eight years of negotiations with European partners and long arguments with the European Commission on applying standards of the Third Energy Packet to it.

As President Vladimir Putin explained during a visit to Turkey, the European Commission's antagonism and the absence of a decision by Bulgarian authorities (Bulgaria was one of the key transit points for the gas line) made implementation of the project impossible.

According to unofficial information, this was a decision made by President Putin as an "executive decision." Consequently, it was a surprise both for the countries participating in the project and for the shareholders of the companies (Eni, EdF and Wintershall, which collectively own 50 percent minus one share of the project as well as the costs incurred by it). Within the project's framework, intergovernmental agreements had been signed with Bulgaria, Serbia, Hungary, Greece, Slovenia, Croatia and Austria.

Now, as the Russian president's press secretary Dmitry Peskov explained, "procedures will be carried out to conclude the agreement." In particular, the issue of a force majeure is being discussed, since Bulgaria, which had a large stake in the project, suddenly changed its position and would not grant permission for laying the pipeline.

Instead of the South Stream, Gazprom will lay a pipeline of the same capacity (63 billion cubic meters) to Turkey. This pipeline, said the company's head, Aleksey Miller, would be a completely new project in which local investors would be able to participate. Furthermore, it is specifically the undersea section through the Black Sea that would be new, since Russia would use the infrastructure that had already been constructed on its territory for the South Stream. The marine section would begin from the Russkaya compressor station, which is where the South Stream was meant to begin and which is the start for the Blue Stream gas pipeline from Russia to Turkey, which has been in use for a long time. The route for Gazprom's new line has not yet been disclosed.

Political squabbling over South Stream

Russia's decision not to construct the South Stream is the result of purely political reasons – the same types of reasons that forced the European Union to oppose the plan. If, before March 2014, the European Commission (EC) was not openly discussing completely blocking the project, then, following the development of the situation in Ukraine and the accession of Crimea to Russia in March, the EC took a tough line, disregarding its own energy security.

It was Ukraine, in particular, that was the main opponent to the South Stream, since in this case, its worn-out gas transmission network which requires investment, would entirely lose its significance and would remove any hope that the country had for attracting investors to modernize it. In addition, the position of individual countries, including long-term Gazprom partners such as Germany, impacts how they are seen in the marketplace for energy.

The final straw for the Russian authorities was when construction on the section of the South Stream in Bulgaria was halted due to pressure from the EU and U.S. In autumn, with the backdrop of a change in government, Bulgaria banned Gazprom from continuing work, which stopped completely the construction of the underwater section, and the European Commission announced that it would not accept delivery of Russian gas even if the underwater pipeline was constructed.

As a result, Moscow decided as an alternative to lay the pipeline through Turkey - Gazprom's second largest export market, whose consumption, in contrast to Europe, is increasing. Now as a result of the redirection of the pipeline, Bulgaria is expected to lose on the order of $500 million a year on transit income.

Russia's cancellation of the South Stream project came as a surprise for European partners. Photo: AP

From South Stream to Blue Stream

Undoubtedly, the tough opposition to the South Stream by the European Union placed Gazprom in a difficult position, taking into account the money already invested in the construction of infrastructure on Russian territory (more than 400 billion rubles, or about $10 billion), the total cost of the project (estimated at one trillion rubles, or about $25 billion), and the signed contracts.

The company had carried out all the preparation work to begin laying the pipeline through the Black Sea. It had already paid for and received the pipes for the first line (partially delivered to Varna, where they were awaiting the pipe-laying ship). Furthermore, the company had invested almost $6 billion in contracts for the project's marine section.

However, not all of these expenses can be seen as complete losses, taking into account the redirecting of material for the new gas pipeline. Furthermore, the construction of a pipeline through the Black Sea to Turkey may come out cheaper, especially if it uses a parallel route to the current Blue Stream.

Apart from the expense to Gazprom, the rejection of the South Stream is hardly likely to cause any problems to the Russian economy or the state of the energy sector, since it will be replaced by another project. On the other hand, it is thought on the market that it might strengthen Russia's position, which has weakened to some degree lately, partially due to Gazprom itself. This is because the company has often made concessions to European partners, and they have perceived this as weakness and continued to press for more concessions.

The changing economics of gas

Experts observe that over the last few years, the risks for large-scale construction projects have fallen on the suppliers of gas, whereas in the past, they were divided between them and the buyers. Furthermore, the supplier's interests are taken less into account. In fact, during the construction of the South Stream all of the advantages were on the European side, and Russia was paying the bill for reliable delivery of gas to Europe. On the market, people are certain that the rejection of a project with doubtful profitability and significant political risks is the right decision.

They observe that, with the construction of the new route, the situation will completely change. Gazprom expects to supply unprocessed products to the Greek and Turkish border where a large hub will be constructed. The route from Russia through Turkey to Greece, located in the EU, eliminates the need for the pipeline to meet European legislative requirements and means that deliveries do not need to go through Ukraine when supplying Turkey, Greece, and probably, Bulgaria.

To supply Slovakia, Austria and Hungary, Gazprom can use the Nord Stream pipeline, going through the Baltic Sea from Russia to Germany. Furthermore, in effect, by receiving their gas from a hub on the border of Greece before the gas reaches their own territory, it becomes a problem not for Gazprom, but rather, for the consuming countries. And these gas pipelines for Russian gas built through consumers' territory, falls within the authority of the Third Energy Package.

It has become evident that in the present situation, economic efficiency has won out over political ambitions. At the same time, risks remain with transit through Turkish territory, which has its own ambitions and has renegotiated contracts that have already been agreed upon with Gazprom. But it is quite clear, that by rejecting the construction of the South Stream, the old system for supplying gas will be severed and a completely new stage in the relations between Russia and Europe has begun.

The opinion of the author may not necessarily reflect the position of Russia Direct or its staff.