End of the Pipe Dream
Russia’s decision to abandon the ambitious South Stream deal has forced energy giant Gazprom to alter its business model in Europe and transformed the political and energy dynamics of the region
Russia’s recent announcement to cancel the South Stream project has come as a shock to the oil and gas industry, with experts left wondering whether the decision that was made public in Ankara in early December was motivated by politics or pure economics. South Stream, an offshore Black Sea pipeline with a projected annual capacity of 63 billion cubic metres per annum (bcma), was conceived with the objective of circumventing Ukraine to bring Russian gas to the new markets in South East Europe.
To begin with, the project’s rationale was heavily influenced by a political motive that was backed by a number of financial calculations. On the commercial side, South Stream would have allowed Gazprom, the Russian energy giant that set up the project, to save up to $2.5 billion-$3 billion a year in transit fees paid to Ukraine. Gazprom could have injected this money into its own pipeline project. Ukraine’s transit fee is not economical by any standards; in the fourth quarter of 2013 it reached $3 per 1,000 cubic metres per 100 kilometres. A shipment of 1,000 cubic metres of Russian gas via Ukraine cost Gazprom $37 at the time.
Cutting ties
The termination of the project, however, is explained by a combination of economic challenges and regulatory hurdles. The onshore part of the South Stream was subject to the third-party access (TPA) clause imposed by the EU Third Energy Package. Moscow’s attempts to get a full regulatory waiver by removing South Stream from the purview of EU legislation faced fierce opposition in Brussels. In the best case scenario, the project would have got only 50 per cent TPA exemption, which was not sufficient to guarantee economic feasibility of the South Stream pipeline.
The situation looks quite bleak on the other side as well. Currently, the EU gas market hardly offers any incentives to investors and energy suppliers. It is over-regulated, oversupplied and often unprofitable to operate in, especially in the power generation sector. Internal gas consumption is unlikely to grow fast in the near future as well. Natural gas consumption in the EU has decreased for the third consecutive year — total demand was down by 1.4 per cent in 2013, following the 10 per cent and 2 per cent decline in 2011 and 2012, respectively.
The International Energy Agency estimates that natural gas consumption in Europe will not go back to the 2010 levels for the next 17–18 years. Lower spot prices and downward pressure on oil-linked longterm contracts do not offer much promise for external gas suppliers. Therefore, present market conditions, coupled with often-excessive subsidies for renewables, make the immediate future for gas in Europe rather uncertain.
Fighting the odds
Low oil prices and sanctions create additional challenges for Gazprom. Though the company is not on the EU and US sanctions lists, getting cheap financing for South Stream would have been problematic in the present circumstances. The company’s funds and budget support is always a possible solution, but not in the present economic and political circumstances. Money is becoming scarce in Russia and is immediately required for more significant projects such as the Power of Siberia.
The end of South Stream will undoubtedly lead to tectonic shifts in Russian energy policy both within the country and overseas. Firstly, there are clear signs that Gazprom might soon change its business model in Europe. While it is determined to cut its dependence on Ukraine’s transit advantage by building the Turkish Stream, the company is no longer enthusiastic about European downstream and is ready to sell gas volume reserves for the South Stream at the EU-Turkey border — a development that was unthinkable only two years ago.
Last November, Gazprom created a commodity exchange department after organised trading began on the St Petersburg International Mercantile Exchange in October. The new department is likely to lead to a new shift in Gazprom’s export paradigm — part of the gas volumes for European consumers might be sold in the spot market within Russia, initially to reduce Ukraine-related transit risks. In the future, EU companies would potentially have to buy gas in Russia and organise transit logistics themselves. Although that does not mean an immediate termination of long-term contracts, these procedures will open a new spot-oriented era in Gazprom’s export policy.
Finally, these changes will lead to further erosion of the single export gas channel. Partial liberalisation of LNG exports in December 2013 was only a first step and new measures will follow soon. Attempts by the oil company Rosneft to get access to Power of Siberia and open-season TPA proposals are bringing a wind of change in Russia’s gas sector. This is an opportunity not to be missed by other energy giants in Russia.
Danila Bochkarev is a Senior Fellow at the EastWest Institute in Brussels
This article was originally published in Oil Journal, LUKOIL Overseas’ official English-language newspaper: http://lukoil-overseas.com/press-centre/oiljournal/