The End of the Line for South Stream

On December 1, during his state visit to Turkey, Vladimir Putin announced that Russia would cancel the construction of the ambitious South Stream pipeline. According to Donald Jensen, resident fellow at the Center for Transatlantic Relations, this decision does not mean an end to Moscow’s search for ways to transport natural gas to Europe while bypassing Ukraine.

Set up by the Russian energy giant Gazprom in 2007, the South Stream pipeline project brought together a consortium that included major energy companies in Austria, Italy, Hungary, and Bulgaria. With a design capacity of 63 billion cubic meters per year, the project would have carried about 12 percent of Europe’s annual gas consumption and was estimated to cost $40 billion. The pipeline was designed to send Russian gas through the Black Sea to Bulgaria, Serbia, Hungary, Slovenia, and Austria.

In the weeks leading up to Russian president Vladimir Putin’s recent state visit to Turkey, Russian officials brought pressure to bear and offered incentives to Hungary, Serbia, and Bulgaria to promote the project. So Putin’s announcement that construction on the pipeline would be canceled came as a surprise, even though the president reportedly makes all key decisions in the Russian energy sector personally. Announcing that the original project would be suspended, Putin said that Russia would redirect the pipeline through Turkey instead. He portrayed his decision as a loss for Europe and criticized the “non-constructive” approach of the European Union. Though the new pipeline seems an uncertain prospect at best, Putin went so far as to voice the possibility that a hub might eventually be constructed on the Turkish-Greek border that could ship gas to southern Europe.

Russia has long claimed that the construction of South Stream was a sound business move, but at its core, the project was grounded in politics. South Stream’s purpose was to isolate Ukraine from Europe by redirecting Russian gas flows away from that country to the Balkans, thereby forcing Ukraine into greater energy dependence on Russia and reducing Kiev’s leverage over Moscow. Much of the gas that Russia now sells to Europe passes through Ukraine. Price disputes between Kiev and Moscow have interrupted supplies at least twice in recent years. Moscow also hoped to use South Stream to prevent Central Asian gas from reaching Europe by any means other than those under Russian control. Finally, the Kremlin hoped to use South Stream to secure Russian political and economic influence in the Balkans and Central Europe.

South Stream’s prospects began to dim this past year, however, when the EU sought more vigorously to reduce its energy dependence on Russia. First, the European Commission ruled in December 2013 that the existing South Stream plan was illegal, since, under the rules of the EU’s liberalized gas market, a company cannot own both own a pipeline and the gas that flows in it. Second, the war in Ukraine increased EU opposition to the project. Bulgaria halted construction of its portion of South Stream in June, after the EU began an investigation into how pipeline contracts were awarded.

Putin’s decision was ultimately forced by difficulties relating to Russia’s present economic and international position. First, under current economic conditions, South Stream was too expensive. The plummeting price of oil has strained Russia’s finances. The project also failed to win the support of Western creditors as a result of sanctions (Gazprom reportedly needed a credit line of 14 billion Euros to build the offshore part of the pipeline). Second, EU gas consumption is dropping along with the gas price, and competition is increasing. Lithuania, for example, which previously imported 10 percent of its natural gas from Russia, just opened an import terminal for liquefied natural gas. Third, the decision reflects the effectiveness of EU diplomatic pressure. Italy announced in November that the project was no longer a priority. Austria reduced its support recently, as well, while Bulgaria changed its energy policy (and, in October, its government). Finally, some senior Gazprom managers reportedly never liked the plan, and the company had quietly begun seeking alternative customers in East Asia.

Putin’s South Stream decision changes the dynamics of the region with one stroke. In Ukraine, understandably, the reaction was one of relief. With South Stream canceled, Russian gas will continue to flow through Ukraine, and Moscow may now be more willing to negotiate a deal over long-term supplies.

Although the project’s collapse is a diplomatic victory for Brussels and a step toward energy independence from Russia, EU members must now look for alternative sources of supply. Serbia, Hungary, and Bulgaria in particular were relying on South Stream because it offered a supply of gas that did not go through Ukraine and was at a low risk of disruption. Officials from all three countries said they received no advance notice of Putin’s decision, despite the large political and social capital they had invested in South Stream. The project would also have provided these countries lucrative transit fees and new jobs. As a result, the Austrian energy company OMV and the Italian giant ENI will suffer huge losses. Since the announcement, officials in Brussels have held out hope for another energy deal with Russia, but in any agreement, Moscow must comply with EU regulations of free-market competition, which makes this prospect unlikely.

The big winner here is Turkey, since the Kremlin has apparently concluded that it is a more promising long-term customer than the EU. Assuming the new project moves forward, Turkey will play a larger role in the Balkans, Central Europe, and the European Union more broadly, since it will be the hub for Russian, Azeri, and perhaps even Kurdish gas. Moreover, with discounted prices from Russia under the current deal, Turkey’s position as an importer will also be stronger with regard to Russia. Still, Turkey is not a large enough customer to replace the European market South Stream would have served. Turkey’s growing energy ties to Russia will also make the West question how much it canrely on Ankara at a time when the Unites States is looking at Turkey as a strategic partner to counter Moscow. Turkey is not observing the current sanctions against Russia, but Ankara and Moscow disagree over Syria, Cyprus, and the annexation of Crimea.

As Vaclav Bartuska, the Czech Republic’s ambassador for energy security,commented in the wake of Putin’s decision, the end of South Stream shows that the outside world can have an impact on Russia, and probably a bigger one than Russia would like to admit. But it does not mean an end to Moscow’s search for ways to get natural gas to Europe without going through Ukraine. Russian officials have also indicated that they are ready to continue talks with Austria, Hungary, and Serbia on future energy relations. Even a new project, however, is unlikely to spell the end of the larger dispute over whether Gazprom can operate in the EU on its own terms or whether it will eventually have to bend to the will of the European Commission. Nor is it likely to restore the strategic partnership between Russia and the EU that has foundered so badly over the Ukraine crisis.

This piece by Donald N. Jensen originally appeared on The Institute of Modern Russia