In 2006, Gazprom and the Italian company ENI announced a joint venture to build the South Stream pipeline system across the Black Sea, and signed a memorandum of understanding the following year. (1) Subsequently, EdF and Wintershall joined this technically challenging project--four pipelines, each 930 km in length to be laid from Anapa on the Russian Black Sea coast to Varna in Bulgaria in water depths of up to 2,250 meters. Originally the project was planned to be two lines with a capacity of 31 Bcm/year but, following the January 2009 Russia-Ukraine crisis, this was then expanded to four lines and 63 Bcm/year. The plan was to flow gas through the first pipeline in the 4th quarter of 2015, with full capacity of the first two lines to be reached by the end of 2017 and four lines by 2020. Tenders were issued, and when the project was cancelled in early December 2014, the pipe for the first string of the offshore line and the laybarge were already on site in Varna and were within days of starting to lay the offshore section. (2) By then, work on the eastern and western strings of Russia's "Southern Corridor" onshore pipeline (3) bringing gas to Anapa had also started, as well as work on the Russkaya compressor station which would move gas through the offshore lines. (4)
From 2008-10, Russia signed intergovernmental agreements with seven European countries for the onshore section(s). (5) The routes of the two onshore pipelines changed over time as the project encountered increasing national and EU regulatory challenges. (6) The total cost of South Stream (for the full 63 Bcm/year of capacity) was estimated at around $40 billion in mid-2014, comprising: $17 billion for the Russian Southern corridor; $14 billion for the offshore section and $9.5 billion for the onshore European sections. (7)
South Stream was by far the largest ongoing European gas infrastructure project. Its cancellation and potential replacement with pipelines across the Black Sea to Turkey, is an event of significant importance for the European gas industry. It has repercussions for future flows of Russian gas across Europe and the Russian-Ukrainian gas relationship. But more importantly, when combined with other developments such as Gazprom's cancellation of its Wingas joint venture purchase (8) and abandonment of efforts to obtain 100% of capacity in the OPAL (Nord Stream onshore) pipeline, (9) and the possibility that a second major pipeline export contract may be signed with the Chinese company CNPC in 2015, it may have signaled a sea-change in Russian gas export policy.
The Rationale for South Stream
The timing of South Stream discussions, following the first major interruption of Russian gas supplies through Ukraine, in January 2006, was not an accident. (10) In retrospect, it could be argued that the major consequence of the (short-lived) January 2006 crisis was that president Putin decided that transit diversification capacity--which was already well advanced with the Yamal-Europe, Blue Stream and Nord Stream pipelines--needed to be expanded to the point where Russian gas exports to Europe could completely avoid Ukraine. (11) In addition, at that time it was still possible to imagine that European gas demand might expand to the point where very substantial additional Russian delivery capacity could be required. A geopolitical explanation of that decision is that South Stream formed part of a strategy to isolate and exert political pressure on Ukraine using gas supplies and prices. (12) An alter native explanation was that South Stream was a "bluff' designed to prevent the EU's Southern Gas Corridor (and specifically the Nabucco pipeline) from progressing. But such speculation was dwarfed by president Putin's apparent conviction that it would never be possible to establish political and commercial relations with Kiev which would allow secure gas flows to Europe across Ukraine and, given the size and importance of export revenues for Gazprom and the Russian government, the only option was to eliminate this transit dependence. This conviction hardened following the more protracted January 2009 supply crisis and the financial losses and reputational damage to Russia as a gas supplier to Europe. (13) Thus, from the Russian side, South Stream was part of a policy which began well before even the 2006 crisis.
Gazprom's EU Regulatory Problems and South Stream
The regulatory environment worsened dramatically for Gazprom, following the introduction in 2011 of the EU's Third Energy Package (TEP). (14) The TEP mandated regulated third party access (TPA) to pipeline capacity based on published tariffs (or their methodologies) approved by national regulatory authorities (NRAs) as well as unbundling of transmission assets and certification of transmission system operators (TSOs)--unless an exemption from these rules is granted by an NRA and approved by the European Commission (EC). Thus the TEP created major problems for Russian gas exports to EU countries in terms of compliance with the changing regulatory environment both in respect of existing and new pipeline capacity.
Gazprom has been unable to utilize full capacity of the onshore extensions of the Nord Stream--pipelines OPAL and NEL. Although the German regulator granted an exemption allowing Gazprom to use 100% of OPAL, the EC Competition Authority capped it at 50%, following which Gazprom and the EC negotiated for more than a year, and reached a solution allowing Gazprom to utilize 100% of capacity unless access requests were received by third parties (to be determined through auctions). The EC was expected to approve the exemption by March 2014 but repeatedly postponed the decision citing technical issues and linking it to the worsening EU-Russia relationship over Ukraine. However, the EC terminated its OPAL exemption review procedure in December 2014 due to Gazprom's failure to prolong the deadline under its settlement agreement on the exemption with the German regulator (thus rendering void the exemption's substantive changes, which were being assessed by the EC). According to Russian energy minister Novak, Gazprom intends to apply for a new exemption instead and demand 100% capacity in OPAL. However in the current environment it seems unlikely this will be successful. (15)
Given its negative experience with OPAL, Gazprom did not apply for an exemption for South Stream but based the project solely on a set of intergovernmental agreements (IGAs) signed with host countries. The EC deemed these agreements in breach of the TEP and called for their re-negotiation or renunciation, otherwise threatening infringement procedures against member states concerned. (16) The Russian government declared that the IGAs took precedence over the TEP and that the EC had failed to prove otherwise. (17) It also filed a request for consultations under the WTO, alleging the discriminatory nature of the TEP. (18) Meanwhile, the South Stream host countries faced a choice: renounce the IGAs thus making themselves liable to penalties imposed by Russia, or retain the IGAs intact thus making themselves liable to penalties imposed by the EC. Indeed, the EC started two infringement procedures against Bulgaria--one on the grounds of TEP incompatibility and another in respect of the legality of procurement for the pipeline--which led to the suspension of pipeline construction in Bulgaria in August 2014. (19)
The TEP (in)compatibility argument, which was the main reason for the South Stream cancellation, is somewhat flawed as the TEP in its current form does not contain any rules for construction and utilization of new pipeline capacity, but only rules for existing pipeline capacity. For as long as the TEP does not contain rules for new pipeline capacity the latter would fall under rules for existing capacity. The set of rules for new capacity is under development (to be formalized as an additional chapter in the Capacity Allocation Mechanisms (CAM) Network Code) and expected to become applicable in 2017-18.
Given this regulatory void in respect of new capacity, which would not be filled until the second half of the 2010s, Gazprom and the Russian government should have recognized and acknowledged much earlier in the process that South Stream could not proceed on its original timetable. (20) While it was somewhat disingenuous of the EU to continue to insist that South Stream had to conform to EU legislation and regulation--given that the detail of the latter in relation to large new gas transportation infrastructure was several years away from being clarified--the Russian side appeared to believe either that the EU would be forced to agree a compromise (because of its need for the gas), or that once pipeline construction began it could be presented with a fait accompli.
These assumptions seemed dubious even before the Ukraine crisis, but a compromise solution between the EC and the Russian government--that would have allowed Gazprom to ensure access to South Stream capacity sufficient for deliveries under its existing European supply contracts (in the event of transit across Ukraine becoming fully or partly halted)--would have been entirely possible from a legal/regulatory point of view. However, following the Ukraine crisis and Crimean annexation, relations between the EU and Russia on all gas issues were "frozen," creating great difficulty in even scheduling meetings between the two sides. This caused a suspension of the EU-Russia working group on South Stream, and a delay in EU decision-making on all other Russian gas issues including OPAL and the DG COMP proceedings. (21) The inability of the parties to even negotiate, let alone reach a compromise, on regulatory issues ultimately led to the South Stream cancellation.
The December 2014 Cancellation and Announcement of "Turkish Stream"
On December 1, 2014, following a meeting between the Russian and Turkish presidents, president Putin...
Does the cancellation of south stream signal a fundamental reorientation of Russian gas export policy?
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