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    The Price of Gazprom’s Pipelines: Analysis

Summary

Gazprom is facing a dilemma: how does it prioritise its export pipeline projects now that Poland has jammed a spoke in the wheel of its favoured Nord Stream 2?

by: John Roberts

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The Price of Gazprom’s Pipelines: Analysis

Gazprom is facing a dilemma: how does it prioritise its external pipeline projects now that Poland has jammed a spoke in the wheel of its favoured Nord Stream 2 project? At present the Russian energy giant is simultaneously seeking to develop three major new pipelines to connect Russia to the outside world. Nord Stream 2 was clearly the most favoured project, since it had managed to secure the participation of five western companies who were due to take a half share between them in the projected 55bn m³/yr project, and thus carry half of its estimated $10bn cost. 

What the Poles have done in ruling that there cannot be a single company embracing both Gazprom and the five shareholders without severe repercussions for the western companies' subsidiaries in Poland is to force Gazprom to contemplate having to finance the project on its own. Yet Gazprom is confronting financial problems and still has to proceed with its $38bn project to develop a system capable of delivering gas to China and eventually, Japan, via a Pacific coast LNG project. Progress has been slow, but since Russia has yet to conclude actual contracts for the sale of gas to China, this may not matter too much. 

At the same time, it is also deeply engaged in reviving the Turkish Stream project, originally conceived as a 63bn m³/yr project, with close to 50bn m³/yr transitted across Turkey to the European Union via Greece.

At this stage, the best bet as to what will actually happen – as opposed to what Gazprom might intend – is that one string of Turkish Stream will be built fairly quickly and that Gazprom will strive and probably succeed in laying at least one string of Nord Stream 2 as well.

Nord Stream 1, landfall at Greifswald (Credit: Nord Stream AG)

The commercial logic behind this is that the line pipe for at least one 15.75bn m³/yr string of Turkish Stream has already been delivered while delivery of line pipe for Nord Stream 2 is due to start next month. Other binding contracts have been placed with third party suppliers for the provision of other goods and services as well. In addition, the systems required to deliver gas to the Russian terminals for the two pipelines are already well under way.

However, Gazprom is still in the middle of completing its massive $12bn “Southern Corridor” project to connect Russia’s Unified Gas System (UGS) to the Russkaya terminal on the Black Sea coast at Anapa – originally intended to feed the aborted South Stream pipeline, and currently intended for its Turkish Stream replacement – and delays so far make it unclear as to whether the system has the ability to deliver much more than the gas for the first string.

Much more work will have to be done to feed a 63bn m³/yr system, and, given Gazprom’s current financial constraints, it seems unlikely it will be in a position to ensure that its southern corridor will be able to deliver such a volume to Anapa soon. 

One US analyst, Edward Chow, of the Washington-based Centre for Strategic and International Studies, told NGE: “It doesn’t cost Gazprom much to construct one pipe for Turkish Stream given the capital already sunk in South Stream; so the more NS2 is delayed, the more likely they will start on Turkish Stream.”

Politics in the driving seat

In political terms, from Moscow’s perspective, the rationale for constructing both Nord Stream 2 and Turkish Stream remains as strong as ever. Nord Stream 2, together with the original 57bn m³/yr Nordstream line, remains the most important component in Russia’s strategy of eventually being able to deliver almost all its gas to customers in the European Union without relying on transit across Ukraine, a policy which has already seen Russian gas distribution via Ukraine fall from 128.5bn m³/yr in 2006 to 62bn m³/yr in 2014.   

Likewise, the first string of any Turkish Stream system would serve to ensure that Russian gas deliveries to Turkey, Greece and Bulgaria would not have to transit Ukraine. Gazprom said in 2015 that it would be terminating all transit across Ukraine once current arrangements ended in 2019, but subsequently acknowledged that it will still have to rely on Ukraine to transit some 15-20bn m³/yr to European customers for a number of years thereafter.

Gazprom has always proved flexible in adapting its policy to changing circumstances. In 2015 all eyes were on Russia's president, Vladimir Putin, when he visited Beijing on 3 September and he was expected to announce at least significant progress in the ten-year-old saga of Russian gas sales to China, if not an actual contract. But while he made no significant progress on this complex issue, he did trigger a major surprise the following day when, during a visit to Vladivostok, Gazprom announced it had reached agreement with the five western companies to develop Nord Stream 2.

These five companies – Engie, Gazprom, OMV, Shell, Uniper and Wintershall – will now have to decide just what they are going to do with regard to the project. Gazprom has said that they “will continue their close cooperation and their mutual efforts towards the strengthening of the European gas supply” and that the withdrawal of the company’s application for merger clearance in Poland “does not affect implementation of the project, which continues as planned.”

However, there are important financial repercussions. Nord Stream 2 was developed as a project that would rely on equity to cover 30% of its costs and on financing for the rest. This means that Gazprom’s own direct contribution to the project, if it is to be built in full, will have to double to around $3bn while the lack of western partners will make it much harder to raise the $7bn on capital markets, particularly at a time when Russia remains under extensive international sanctions as a result of its seizure of Crimea from Ukraine in February 2014.     

It is just possible that the western companies may wind up securing the best of both worlds. They want to be on good terms with Russia, not least because they either have significant investments or investment projects within Russia, or are major importers of Russian gas, or a combination of these. For them, paying their share of Nord Stream 2 could be regarded as the price they have to pay to guarantee their relationship. But it may turn out that, for no fault of their own, they may not be permitted to pay such a price. This would save them money at a time of considerable financial constraint whilst landing Gazprom with the problem of working out just how to cope with the prospective loss of western investment.

 

John Roberts, Chief Analyst