South Stream: How to Get Ahead

In a speech at South Stream: the Evolution of a Pipeline that sought to reveal both the hurdles and how South Stream might surpass them, Katja Yafimava, Senior Research Fellow, The Oxford Institute for Energy Studies, provided what she said had been the Oxford Institute's main argument regarding the planned pipeline project.

“Essentially, South Stream, Nord Stream, Yamal II, Blue Stream – they're all transit insurance, transit avoidance, transit diversification pipelines and essentially very expensive insurance policies against transit interferences,” she explained.

She showed that there had been plenty of transit disputes over the last 20 years, including the January 2009 transit crisis which was a major security event. Ms. Yafimava recalled, “It is actually an unprecedented gas security event in the history of the European gas industry and that is really the main push for South Stream and the main reason for its justification.”

The second “avoidance” pipeline, she said, was already in operation: the two streams of Nord Stream, which had been preceded by Blue Stream across the Black Sea and to the Turkish market.

According to her, if South Stream were built Russia's Gazprom would have a massive amount of spare capacity, depending in part on prospects for European natural gas demand. She added, “In any event it will provide plenty of spare capacity and Gazprom would be able to arbitrage between Central, Northern and Southern corridors. Essentially that would reduce Ukraine, quite logically, to the route of last resort.”

However, she explained, Gazprom having essentially solved its transit problems in Ukraine, Belarus, Moldova and the rest, it was actually now facing a new problem: the difficult unsupportive regulatory environment inside Europe, created by the fairly recent Third Energy Package.

The Package and the Gas Target Model, she said, provided the vision for how Europe was going to change the architecture of its gas industry and gas market, completely overhauling the previously existing system, providing a long transition period and to be completed by the end of 2014. Realistically, she said, this would take longer.

For Gazprom it made for major difficulties because the company supplied a huge amount of gas in Europe and also had to cross a number of borders, both in- and outside Europe. “And because the new system being put in place on how transportation capacity is going to be allocated, essentially by auctions, the challenge is enormous because Gazprom would have to be successful in several auctions down the pipeline route in order to get that gas in line with existing long term supply contracts which incidentally do not expire for the next 20 plus years. At the same time the existing capacity contracts expire much sooner -  about a decade sooner: around 2020-2025.”

A main concern for Gazprom, offered Ms. Yafimava, is that, as a result of the implementation of the new “entry-exit methodology,” capacity under the existing capacity contracts might be lower than it was actually booked in existing contracts, which might lead the company towards booking additional capacity. She commented: “That is again a challenge because one would have to be successful at many auctions down the road. It might successful, it might be not; it might just simply cost more, and no one can really tell at the moment.”

Alternatively, she said, Gazprom could get additional capacity in existing infrastructure, or build brand new capacity - essentially what South Stream was doing.

“If one is trying to build such a massive piece of new infrastructure under the Third Package as it currently stands, it’s really quite challenging. It’s a strict regulated environment with third party access, with unbundling, with tariffs, methodologies approved by regulators like the 'enter-exit methodology' for tariffs and its booking capacity, only through auctions (existing capacity). It is important to stress here that the regulatory framework is still under development, particularly as it concerns new and implemented capacities so it is hard to comment on something that doesn't exist."

As she understood it, the Third Package was creating a regulatory framework for new and implementable capacity to create an “open season” procedure for very complex projects and projects which cannot really be built; according to her, Russia had suggested coordinated open season procedures, but other suppliers of gas in Europe were not so interested because they did not face problems like the challenge of booking capacity across a number of borders.

An exemption from the Third Energy Package, she explained, could relieve the project from various provisions, most importantly unbundling tariffs and third party access. To do this, she said the project needed to apply for an exemption, national regulators needed to approve it and the European Commission would need to approve it at the very end. She pointed out, “South Stream has not applied for an exemption and it did undermine its case by taking an FID (final investment decision) last year.”

Several big projects had received exemptions, she said, like TAP and Nabucco, from third party access, tariffs and also unbundling for the entire project, as well as third party access for an initial capacity of 10 BCM. “So if South Stream actually had applied for exemption before taking an FID, it would have been very difficult to refuse an exemption given that projects such as TAP and Nabucco got it, because they are off comparable magnitudes,” she explained, adding that South Stream had a strong case.

An exemption had been given to Opal, an onshore extension of Nord Stream. “Initially it was granted 100% exemption, then it was devised down to 50% and as we know there have been negotiations for nearly 2 years, so no decision on this.”

Nord Stream, she pointed out, had been constructed long before the Third Package, in a much different environment, so it wasn't a template for South Stream. Of the latter, she said: “The project promoters have been warned that the Third Package is actually happening.”

“Even if South Stream applied to the list of the EU's Projects of Common Interest, it would have to fit in the list of priority corridors, but it is very difficult to see how it would fit. Although there is a provision of Southern Gas Corridor, but I would argue that the regulation hasn't been drafted in mind with having something like South Stream. In any event, as we know South Stream is not on the list, and the next list for Projects of Common Interests will be available in 2015, but by that time, South Stream would arrive to the Bulgarian shore and deliver first gas – so it's a little bit too late for that,” she explained.

Another possibility was intergovernmental agreements. “Even if they are in place, they provide a project of national interest status, but if they are not compliant with the Third Package (as none of them are), then some sort of compromise negotiation and difficult procedures would have to be accomplished. So it is not really the only framework in which a project of such magnitude could be based.”

Another possibility for South Stream would be to make a room for it in the 3rd Package, according to Ms. Yafimava, who reported: “Talks between the Gas Advisory Council and the Commission are taking place on that matter, but even if it happens, it will take longer than 2015. A regulatory framework is possible that could be a project of mutual interest with a supportive regulatory environment, but the criteria should be well thought through.”

She concluded by saying that Ukraine had been a reliable gas transit corridor over the last two decades, even after the 2009 crisis. “However, if any transit interference occurs this winter, it only strengthen Gazprom’s justification for South Stream as a transit avoidance corridor.”