Russia is using its controversial South Stream pipeline project to divide opinion among countries in the European Union about imposing tougher sanctions over the Ukraine crisis. Some countries are taking a narrow view of their trade with Russia rather than a wider geopolitical context. This flies in the face of the EU’s own energy security policies.

Summary:

Russia’s highly controversial South Stream pipeline encapsulates the geopolitical conflict between the European Union and Russia. The Ukraine crisis and the pipeline project have polarised opinion in the EU with some countries flying in the face of the EU’s declared energy policy objectives. These aimed to diversify Europe’s gas imports to reduce its dependence on Russian gas, strengthen Ukraine’s energy security, and increase the EU’s overall economic competitiveness. Contradictions have emerged between declared energy policy objectives, imposing greater sanctions on Russia and pursuing national or corporate interests at the expense of long-term energy supply security interests of the EU and Ukraine.

Report:

RUSSIA’S South Stream gas pipeline project is the European Union’s most controversial challenge in the wake of the Russia-Ukraine conflict. It impacts the bilateral relationship with Russia and relationships between the 28 member states in the EU.
Building the pipeline has already started in Bulgaria and Russia. Conflict over the project highlights the internal structural weaknesses and competing national interests between the EU’s 28 member states and their often short-term defined strategic interests. It also demonstrates the EU’s inability to speak with one voice towards Moscow and an inability to present a coherent strategic response to Russia’s geopolitically defined energy and foreign policies.

South Stream has never received the trans-European energy networks (TEN-E) priority status for being a ‘Project of European Common Interest’ (PCI) – a list of 248 projects announced in 2013.

Strategic implications

The European Commission acquired more power and influence, particularly in the European gas sector, with a gas directive in 2010 following two Russian-Ukraine gas crises in 2006 and 2009. Regulation for a competitive gas market is the only weapon the EU has to strengthen resilience of its energy supply security and taking wider economic and public interests into account.
But EU member countries often support their national energy champions rather uncritically and fail to review their energy projects with Russia taking into account the wider strategic implications for overall national economic competitiveness and public interests.
The European Commission often appears to be the only institution which takes the view that wider economic and public interests are more important and valuable than single corporate interests and projects.
The European Commission used its authority to put the South Stream project on hold, but it cannot directly or physically ban or prevent the building of the pipeline. It can only regulate the pipeline’s usage and capacity.

Divide and rule

South Stream has never been just an economically driven project for Russia. It is primarily geopolitical, as Russian experts have admitted publicly.
Russia’s agreement on a new gas contract with Ukraine’s previous pro-Russian President Viktor Yanukovych in December 2013 appeared to signal to the West that Russia had no further interest in South Stream. Ukraine was seen to return to Russia’s energy and foreign policy orbit, so an extremely expensive pipeline bypassing Ukraine, previously an unreliable gas transit-state, would no longer be needed.
But Russian energy experts, diplomats and its energy giant Gazprom insisted on building the South Stream pipeline in response to Russia’s wider geopolitical interests in Europe.
The pipeline project is now another weapon to ‘divide-and-rule’ the EU. It is being used during the Russia-Ukraine crisis to undermine the EU’s energy diversification efforts and its common energy foreign policies. And it will increase pressure and leverage on Ukraine in the future.
The South Stream project is non-compliant with the EU’s energy regulation and its Third Energy Package (TEP). It also flies in the face of the EU’s newly-declared energy policy objectives since March 2014:

Gazprom contracts

  • Diversification of gas imports -The European Council agreed to strengthen its gas import diversification options in March 2014 to reduce the EU’s energy dependence on Russia, following Russia’s annexation of Crimea.
  • Strengthening Ukraine’s energy security – The EU agreed to support Ukraine in its own diversification strategy aimed at reducing its gas dependence on Russia and strengthening its domestic energy reforms.
  • Enhancing overall economic competitiveness – The EU is following policies which aim to lower, or at least contain, gas prices in order to strengthen overall economic-industrial competitiveness towards the US. European gas prices are two or three times higher than those in America.

This objective, since 2013, is not just a reaction to the US shale gas revolution, but reflects Europe’s dependence on expensive long-term gas contracts with Russia’s monopoly gas exporter Gazprom. These contracts are based on oil-indexed gas prices and Gazprom’s outdated and problematic pay-or-take and destination clauses.
The European Commission intervened over the signed Intergovernmental Agreements (IGAs) with Gazprom and received a mandate from EU member states to negotiate directly with Russia to find a solution.

Pipeline on hold

A newly-established joint working group of European Commission and Russian government officials made no progress in January 2014 due to competing strategic and geopolitical interests.

The South Stream consortium has not applied officially for any exemptions from the EU’s Third Energy Package (TEP) so far. It is still unclear how the South Stream consortium will be able to avoid capacity limitations imposed by the TEP. South Stream could be limited to using only half its pipeline capacity unless it has the status of a Project of European Common Interest (PCI) and an exemption from the TEP.
Gazprom and Bulgaria have argued that the sub-sea section through the Black Sea, which was planned for November 2014, may not be covered by the Third Energy Package as other offshore pipelines such as Green Stream, Maghreb Europe Pipeline, Transmed-Pipeline and the planned Galsi-Pipeline from Algeria to Italy.
The European Commission suspended the bilateral working group meetings on March 10, 2014, and put the South Stream pipeline on hold and forced Bulgaria to suspend any South Stream activities at the beginning of June 2014.
The Russian government denies that the South Stream pipeline project fails to comply with EU laws and regulations. Russian President Vladimir Putin has warned European businesses ‘not to politicise’ the pipeline project, as it is an ‘all-European project’ which benefits Russia and the EU.

Russian dominance

Russia asked the World Trade Organisation (WTO) to get involved on April 30, 2014, and claimed the Third Energy Package (TEP) is inconsistent with WTO trade rules.

For the Kremlin and Gazprom, the South Stream pipeline would allow Russian gas supplies to circumvent Ukraine and consolidate, and expand, Russia’s geopolitical position as Europe’s dominant gas supplier, particularly in central and southeastern Europe.
It would effectively block any alternative projects in the region in an already stagnating, if not decreasing, European gas market.
New gas supply contracts with European countries involved in the South Stream project, based on an oil-indexed price system, would make alternative non-Russian gas supply options economically unrealistic in the constrained European gas market. It will also increase Russia’s leverage in European energy and wider foreign politics contrary to what the EU has just agreed on paper.
Russia also sees the South Stream pipeline as a way of gaining control over Ukraine’s gas transit network. It has tried to buy and control the Ukrainian gas network since the 1990s.
Russia forced Ukraine to pay the highest gas prices in Europe and then offered lower gas prices as compensation if Ukraine sold its national gas infrastructure to Russia. It acquired the Belarus pipeline network in the same way.

Political pressure

Ukraine’s new government presented a draft law to parliament in early June 2014 which would allow the government to create a new gas transit network operator. Forty-nine per cent of the company would be offered only to investors from the EU, the US and the European Energy Community.
The bill excludes chances of Gazprom or another Russian investor from buying a stake in the gas transit network operator. The new operator will become a member of the European Network of Transmission Systems Operators of Gas (ENTSO-Gas).
Russia’s view is that if South Stream is completed by 2018 and exempt from the EU’s TEP and its Third-Party Access-rule, then there is no further need for Russian gas supplies to cross Ukraine and no strategic importance in the EU taking an interest in the Ukrainian gas pipeline network.
Circumventing Ukraine will lead to significantly less Russian gas going through Ukraine and Moscow will be able to maximise its political pressure on future Ukrainian governments as long as Kiev remains dependent on Russian gas supplies. This will make Kiev much weaker in future gas negotiations with Russia.

Precarious economy

The European overland segments of South Stream will cost more than 16 billion euros and the sub-sea section another 16 billion euros. The entire real costs, including investment in new pipelines, gas compressors and other gas infrastructure for Russia’s Southern Corridor, have been estimated at 65 billion euros.
Russia’s own gas transmission system will be increased in its Southern Corridor by building an extra 2,446 km (1,520 miles) of pipeline and 10 compressor stations with a capacity of 1,473 MW. It will be implemented in two phases before December 2019.
Gazprom and the Russian government need to price in the entire South Stream infrastructure investment costs into the newly-signed gas contracts with its European customers at a time when Russia already faces a precarious economic-financial situation. Russia has spent up to US$100 billion subsidising investment in oil and gas production in the remote Yamal region of northwest Siberia and spent another US$50 billion on subsidising the Sochi Olympic Games.
Russia’s gas supplies to Europe will become the most expensive option compared with those from the Romanian and Bulgarian offshore gas projects, Croatia’s offshore resources in the Adriatic and the Israel and Cyprus options from the East Mediterranean, despite Russia offering some temporarily lower gas prices.

Deeper divisions

These supply options will be much closer and reduce transport costs substantially compared with Russia’s links to its more remote gas fields with higher production costs. Even Russia’s energy ministry warned Gazprom in 2013 that its gas exports to Europe may no longer be sufficiently competitive following new US and other LNG exports to Europe from 2016-2018.
Signing new gas supply contracts with Russia, particularly those linked with the South Stream project, flies in the face of the EU’s declared polices of lowering or containing gas prices in order to strengthen the EU’s overall industrial competitiveness, particularly for energy-intensive industries using large and expensive gas supplies.
The Ukraine crisis and the EU’s conflict with Moscow over the South Stream pipeline have deepened existing divisions within the EU and damaged EU-Russian political and energy relations.
The European Commission has demonstrated a willingness to enforce its own regulations and halt Russia’s planned gas pipeline across Bulgaria and the Balkan states to Western Europe. Whether it will be able to enforce this against strong Russian opposition and European business interests with Russia, remains unclear and depends ultimately on support from all 28 governments. That support has been lacking during the escalating Ukraine conflict.

Pipeline justification

The South Stream pipeline highlights various contradictions. These are between declared energy policy objectives, adopting sanctions and the policies to pursue national or corporate interests at the expense of the EU’s, and Ukraine’s, energy supply security. Lower gas prices would also strengthen overall economic competitiveness.
Various European gas companies have signed new expensive long-term gas and oil contracts with Gazprom. They may increase their gas dependence on Russia and make themselves hostage to the most expensive gas option.
Russia has always argued that Ukraine is an unreliable gas partner and for this reason another large bypassing pipeline is needed. But Russia has now annexed Crimea and destabilised Ukraine. It is using Ukraine’s current political instability as justification to build South Stream as a bypassing pipeline, having created the problem itself.
Russian energy experts and diplomats say that if the EU manages to reduce its gas consumption as planned and Russia builds South Stream, the Ukrainian gas transit network would become meaningless.
This would allow Russia to impose more pressure on Ukraine and weaken its political clout in relations with Moscow.

Plan B pipeline

South Stream is not just a corporate project or an energy security issue. It is the core of the ongoing ‘Ukrainian question’ and the geopolitical conflict involving Moscow, the EU and Kiev.
Ukraine’s natural gas transit status will influence its future development with the EU and Russia. If the EU compromises over the South Stream project, it will undermine Ukraine’s future democratic path and reform of its energy sector. It will, in effect, support Russia’s pressure on Ukraine.
The South Stream conflict between the EU and Russia is ultimately a geopolitical conflict of competing regional orders. Experts say the EU has to make it clear that Russia has a strategic choice: either continue refusing the EU’s free and liberalised energy markets, or face a future where the role of gas in Europe’s energy mix will be limited to reduce its risks.

Russia would also have to liberalise its own export and investment regime, including opening access to its pipelines for foreign investors, and accept that Europe diversifies its energy mix as well as gas imports.
Bulgaria’s new interim government took office on August 6, 2014, and suspended all orders and contracts for the South Stream pipeline construction in the country. Russia reacted by threatening Bulgaria with a ‘Plan B’ of an alternative pipeline route through Turkey and Greece to Italy.
Russia’s alternative ‘Plan B’ lacks credibility as it contradicts Russia’s wider economic and geopolitical interests in southeastern Europe and the EU and would not solve the regulatory conflicts with the European Commission.

Dr. Frank Umbach
Dr. Frank Umbach

This report has been written by Dr. Frank Umbach and made available to ourmembers through the courtecy of ©  Geopolitical Information Service AG, Vaduz www.geopolitical-info.com

Related reports:

Russia’s South Stream pipeline widens EU division
Russia’s gamble over Crimea could deliver major energy rewards and influence
EU can beat Russia’s threat of new gas supply cuts

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