A Transformational Crisis

South Stream, Ukraine Crisis and Institutional Transformations of the European Gas Market: Implications for Russia

The recent decision of Bulgaria to postpone the construction of South Stream after the European Commission’s warnings has highlighted the long lasting dispute between the European Commission and Russia about the pipeline’s compliance with EU legislation that requires third party access to the pipeline. This decision, slightly softened by Bulgarian officials afterwards, was immediately associated with tensions between the EU and Russia regarding the crisis in Ukraine. Thus, Russia's EU envoy Vladimir Chizhov said this intervention of the Commission was a "creeping shift to economic sanctions against Russia"[1].

These tensions inevitably reflect ongoing political confrontation and the issue of gas transit via Ukraine is a serious bargaining chip for both parties. Suspension of the project could also become part of EU economic sanctions towards Russia. Moreover, despite the fact that in the beginning of the crisis, Ukraine, Russia, and the EU seemed to remain reluctant to involve energy issues in political confrontations, security of supplies appears to have risen once again to the top of the EU agenda. It also concerns Russia’s ability to deliver agreed gas volumes to EU consumers using additional infrastructure, such as Yamal, Nord Stream, and OPAL, in case gas transit via Ukraine is interrupted^[2].

No doubts, if tensions between the EU and Russia are escalated, the construction of South Stream can be suspended as part of EU economic sanctions and political support for Ukraine, given the agreement is reached within the EU. However, this is the worst case scenario—the construction of the pipeline has begun and is likely to be completed since investors and national governments try to lobby EU institutions as much as possible in order to let the project to proceed[3]. The long-term implications are more serious—the decision about the status of South Stream is likely to demonstrate which model of the European gas market would prevail. Unlike the Nord Stream pipeline, which has been proclaimed the success of ‘special’ bilateral relations between Russia and EU member states, South Stream might become a symbol of new, EU-designed regulatory framework for the Wider European gas market.

Therefore, this conflict between the EU and Russia over the status of South Stream is also a struggle for setting the benchmark for further debates about regulatory governance of the wider European gas market. This is also a struggle about the prevalence of EU law over international law and EU legislation over intergovernmental agreements. South Stream is likely to become a test version of the EU model to be applied to the European gas market.

The pending decision over South Stream at the stage of its construction has also witnessed the weaknesses of Russian strategic thinking. In fact, adherence to traditional geopolitical thinking might become the major flaw in Russian energy policy formulation. Until now, Russian energy strategy has included prioritization of infrastructure control, complemented with bilateral arrangements. Bilateral infrastructure projects and ad hoc reciprocity in investments (asset swaps) have been framed as the core approach for securing and strengthening relations with EU member states and their energy companies. By far, the emerging model of gas market organization within EU integration processes has been perceived as inconsistent at best (including, inter alia, critique of its hub-based system and the spot pricing mechanism) and as hostile to Russia at worse (e.g., the unbundling rule under the Third Energy Package was defined as “de facto expropriation of Russian companies”^[4]).

In the light of the post-2008 transformations of regional gas markets, this status quo preservation has become a priority of Russian energy policy: Russia has preferred to enhance cooperation with EU member states, pointing to incoherence of the EU Internal Gas Market initiatives, and has attempted to preserve the current gas trade model with its oil-indexed pricing mechanism and take-or-pay obligations (yet renegotiated with some European energy companies).

This apparent disparity between Russia and the EU has been also accompanied by Russia’s persistent drift from multilateral frameworks of energy governance, increasingly viewed as pro-Western biased. In this regards, termination of provisional application of the Energy Charter Treaty (ECT) by Russia in October 2009 underlined this significant shift in Russian political thinking—the only legally binding multilateral framework for energy trade, transit, and investment was framed as being in contradiction to Russian interests and biased in its proper design.

There is a certain concern that recent Russia’s assertive claims for international norms’ revision will spread to the energy sphere and will further reassure Russia’s preferences for limited formalization of the regulatory governance framework in the European gas market. The gas contract with China, signed on 21 May 2014 and already declared to be a path-breaking opening of a new gas market for Russia^[5], might facilitate Russia’s isolation from governance arrangements in the European gas market and increasingly bullish rhetoric towards Europe^[6]. “Going East” strategy might be prioritized at any cost—even if this gas contract is questioned to provide strategic advantages to Russia and is assessed by some experts as extremely unfavorable for Russia^[7].

Self-exclusion from institutional developments of the European gas market—aggravated with clear foreign policy shifts and increasing tensions with European counterparts—might have serious consequences for Russia’s ability to frame the rules of the game in the European (and potentially, global) gas market. Having decided to play tough, urging debt repayments by Ukraine, Russia might be trapped in another extreme—considering governance arrangements for investment protection, transit and access to infrastructure, and the gas trade have no importance. Thus, disregarding a gradual inclusion of the South-East Europe, Turkey and Ukraine in the sphere of EU norm-making under the Energy Community Treaty and challenging existing multilateral frameworks (the ECT), Russia risks facing ex post an unfavorable position of a rule-taker, not a rule-maker, in the European gas market.

Even if EU internal coherence is questionable, given struggles between the European Commission and Bulgaria regarding the status of the South Stream, Russia’s self-exclusion from governance frameworks is counter-productive for mid- and long-term strategies of controlling agenda and setting discourse practices in the international energy community.

Therefore, weakness of EU foreign policy, such as inability to agree on the list of sanctions, can be overcome by the expansion of the EU internal market regulation to the neighborhood. In this regards, a lot depends on the internal consistency of the EU internal gas market model and the ability of the Commission to reallocate authorities and steer control over implementation of the new regulatory framework, introduced by the Third Energy Package. The Commission’s efforts can be also facilitated by the ongoing changes in gas markets and stagnating gas demand in the EU. Under these conditions, Russia might face the need to make serious concessions regarding the status of the South Stream, which will facilitate the prevalence of the EU model.

Moreover, the recent U-turn in Russian foreign policy, accompanied with more assertive and anti-Western rhetoric and highlighted with ever growing regional tensions, might jeopardize already weak energy governance in Europe and facilitate increasing radicalization of Russian energy policy. Russian energy strategy might continue moving towards a fruitless self-perception as an Energy Power, based on large energy reserves and the system of long-term contracts. However, quod licet Jovi, non licet bovi. In other words, resigning from participation in governance arrangements in gas markets and risking to face economic sanctions that can include a ban for technologies that are crucial for Russian LNG and Arctic offshore projects is a short-sighted policy given the energy export dependent economy. More pragmatic assessment of current trends in gas markets—such as spot market share increase and developments of the shale gas—might be also overlooked in the light of proclaimed foreign policy success with China. In addition, domestic shifts towards anti-western discourse are likely to facilitate overseeing Russia’s weakening positions in the participation in institutional transformations of the European gas market.

Irina Kustova is a PhD candidate in International Studies at the School of International Studies, University of Trento, Trento, Italy