Sochi Agreements and Aftermath Deflate South Stream Hype

Publication: Eurasia Daily Monitor Volume: 6 Issue: 101
May 27, 2009 04:28 PM Age: 4 days
Category: Eurasia Daily Monitor, Vlad’s Corner, Home Page, Energy, Russia

Italian Prime Minister Silvio Berlusconi (left) with Vladimir Putin

On May 15 in Sochi, Gazprom signed bilateral agreements with Italy’s ENI, Bulgarian Energy Holding, the Greek DESFA Corporation, and Serbia Gas -all state-controlled companies- on implementing Gazprom’s South Stream project for gas export to Europe. Russian Prime Minister Vladimir Putin attended the signing of all these agreements; and Italian Prime Minister Silvio Berlusconi joined Putin for the signing of the Gazprom-ENI document (Interfax, May 15, 16).

ENI is supplying the technology for South Stream’s section on the seabed of the Black Sea – the most challenging part of the entire project. The Gazprom-ENI agreement just signed is essentially a political declaration of intent to expand the line’s planned capacity to 63 billion cubic meters (bcm) annually. This document takes the form of an addendum to the Gazprom-ENI agreement of intent signed in 2007 on this project.

The expanded capacity figure seems purely arbitrary and possibly improvised. Planning on the South Stream project had been based since 2007 on a throughput capacity figure of 31 bcm annually. In February 2009, Gazprom upped the ante to 47 billion cubic meters and has now increased this double the initial proposal. Russia, however, has not specifically earmarked any gas resources for supplying South Stream. Declaratory increases in the project’s capacity are at odds with Gazprom’s own anticipation of gas shortfalls within Russia itself from 2010 onwards.

Meanwhile, Moscow has identified some specific gas fields as a resource base for the Nord Stream pipeline project on the seabed of the Baltic Sea to Germany and farther west. Volumes and time-tables are questionable even for that project. By contrast, however, no Russian fields are identified for the South Stream project. South Stream takes second place to Nord Stream in Moscow’s order of priorities, where the quest for a Russo-German strategic partnership outranks Russian relations with South Stream’s potential customer countries.

On the occasion of the signing in Sochi, Gazprom’s CEO Aleksei Miller estimated the cost of South Stream’s seabed section at 8.6 billion Euros. The project’s overall cost has been estimated at $19 billion to $24 billion by Gazprom’s vice-president Aleksandr Medvedev in February of this year (EDM, February 12). The latest, massive increase in capacity will correspondingly add to that cost estimate.

These cost estimates look as unreal as does the throughput capacity hype. The $19 billion to $24 billion figure seems arbitrary or even guesswork, due to its wide approximation and is almost certainly out of range for investors -even in the best of economic times. Meanwhile, Gazprom hopes to see the project underwritten by the Russian government; while the government hopes to persuade the European Union to include South Stream among its priority projects that are eligible for EU funding and soft credits (Interfax, May 22, 23).

Gazprom’s agreements just signed with Bulgarian Energy Holding, Greek DESFA, and Serbia Gas cover the construction of South Stream pipeline sections on the territories of these three countries. Bilateral joint ventures of Gazprom with each of the national companies will build and operate those sections. Feasibility studies are to be drawn up by mid-2010 and the construction work on the overall project is due to be completed by the end of 2015, instead of the previous target of 2013 (Interfax, RIA Novosti, May 15, 16).

Unlike those three national companies, ENI did not sign an agreement on pipeline construction with Gazprom in Sochi. The Italians are demanding rights to sell on ENI’s behalf a substantial portion of the gas in countries along the pipeline route. Although Gazprom will provide the gas in the pipeline, ENI will supply the pipeline’s underwater technology and feels therefore entitled to marketing a portion of the gas directly to participant countries. Moreover, ENI wants to increase the gas volume destined for Italy itself and which the company will sell directly. Serbia also demanded more gas for its consumption and storage than Gazprom had promised prior to the signing event in Sochi.

Russia, moreover, seeks to attract additional countries for political reasons into the South Stream project. To that end it is currently negotiating with Slovenia and Austria as well as making overtures to Romania. In trying to keep participant countries committed and to entice new ones, Moscow constantly raises the overall gas offer without the necessary resource backup.

Moscow’s underlying reasons are political and diplomatic. First, it seeks to slow down the recent momentum of the EU-backed Nabucco and Southern Corridor projects. The signing in Sochi and the hopes to sign further documents in the weeks ahead is intended to upstage the intergovernmental agreements on Nabucco, which is expected in June. By hyping the South Stream project, Moscow seeks to inhibit European investors from making commitments to Nabucco as well as discourage trans-Caspian gas transport projects for the Southern Corridor to Europe.

Hyping South Stream also responds to the recently signed agreement on EU support for the modernization of Ukraine’s transit pipeline system. South Stream, if implemented, will divert a large part of the transit volume away from Ukraine. In effect, Moscow threatens to punish both Ukraine and the EU for their agreement to upgrade and expand the transit system outside Russian control. Russian President Dmitry Medvedev indicated this obliquely, but unmistakably during the summit in Khabarovsk with EU leaders (Interfax, May 22, 23).

Despite facing gas production shortfalls (relative to internal and external supply commitments) post-2010, Russia is multiplying its supply offers to European consumer countries through South Stream and other pipeline projects. Gazprom signed bilateral agreements on building South Stream with state-controlled Italian, Bulgarian, Greek, and Serbian companies on May 15 in Sochi, with Prime Minister Vladimir Putin attending, and it is negotiating similar agreements with more countries (Interfax, May 15, 16; EDM, May 27).

As enticements, Moscow is declaring ever-larger design capacities for the putative South Stream pipeline system, rival to the European Union and the United States’ backed Nabucco and Southern Corridor projects. South Stream’s other goal is to threaten Ukraine with diverting gas transit volumes, from the Ukrainian transit system into the South Stream pipeline on the seabed of the Black Sea. The Kremlin will most likely roll back its South Stream project, if Moscow achieves its earlier goal of gaining control over the Ukrainian gas transit system.

During the EU-Russia summit in Khabarovsk, Russian Energy Minister Sergei Shmatko announced that Gazprom is well-advanced in negotiating with Austria and Slovenia toward intergovernmental agreements on their participation in the South Stream project (Interfax, May 22). The Austrian economics ministry has obliquely confirmed this assertion, not without embarrassment; these talks with Moscow are a legacy of ministers previously in office (Der Standard, May 25). Austria’s government-linked OMV is a participant and indeed an initiator in the Nabucco project; but it has come perilously close to compromising it through CEO Wolfgang Ruttenstorfer’s deals with Gazprom and, more recently with the Kremlin-controlled Surgut Neftegaz.

Meanwhile, Gazprom is encouraging the Slovenian Economics Minister Matej Lahovnik’s hopes for an agreement to join South Stream by June. Such a deal will be linked with the renewal of Gazprom’s long-term supply agreement with Slovenia, which expires in 2010. Openly pessimistic about the availability of gas supplies for Nabucco and the Southern Corridor projects, Lahovnik and the national company Geoplin considered signing a supply agreement with Gazprom for another 15 years (STA, May 22).

In Serbia’s case, the Serbia Gas CEO Dusan Bajatovic announced in the wake of the Sochi meeting that South Stream will transport 20 billion cubic meters (bcm) of gas annually through Serbia. The Russian government and Gazprom had made that promise in 2007 in inducing Belgrade to sell majority control in the Serbian Oil Industry at a deeply discounted price to GazpromNeft. Soon afterwards, however, Moscow reduced the promise to a maximum of 10 bcm, much to the Serbs’ indignation. In Sochi with a sleight of hand, the Russian side revised South Stream’s annual capacity upward to 63 bcm and, on that wholly unsubstantiated basis, reverted to the 20 bcm promise to Serbia for transit, supply, and storage (Tanjug, May 22).

Romanian Economics Minister Adriean Videanu led a delegation of the Romgaz, Transgaz (Romanian participants in Nabucco), and RomElectrica companies for talks on May 21 in Moscow. There, Shmatko and Gazprom vice-president Aleksandr Medvedev proposed to examine the possibility of building a section of the South Stream pipeline through Romanian territory, for transit purposes, and possibly for delivering supplies to Romania depending on South Stream’s overall capacity. Considering the declaratory facility of Moscow’s promises to expand South Stream (from an annual 30 bcm declared in 2008, to 47 billion declared in February 2009, to 63 bcm annually as just declared at Sochi), Romania may find it politically difficult to turn down even dubious promises in this election year.

For now, Moscow is willing to build an underground storage site for Russian gas at Margineni in north-eastern Romania to a capacity of 2 bcm, which will double the existing Romanian storage capacity. They also agreed to launch a feasibility study on this project and create a parity joint venture. They also formed a joint group to examine the construction of gas-fueled power plants in Romania, as a joint venture of RomElectrica and Gazprom (Agerpres, NewsIn, March 21; Rompres, May 26; Romania Libera, May 22, 25, 27).

The Margineni storage project is consistent with Gazprom’s recent policy to build storage sites in countries west of Ukraine. The goal is to leapfrog Ukraine in terms of gas storage, corresponding with the Russian goal to circumvent the country with new pipelines under Russian control in some of the same countries. In this new context, Moscow is finally lending an ear to Romania’s long-desired proposals on the Margineni storage. By now, however, Moscow’s capacity to deliver more gas (for storage and electricity generation) seems far from certain, amid growing tensions between stagnant Russian production and growing supply commitments.

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