Pipe politics: What next, now that Austria backs Putin’s South Stream plan?

As the ink dries on yesterday’s deal between Austria and Russia to push ahead with the controversial South Stream pipeline, an expert in Russian politics tells GCR why this is not about selling gas.

Vladimir Putin, the president of Russia, yesterday made a state visit to Austria to try to build political support for the $40bn South Stream gas pipeline project, and in the process to widen the split within Europe over whether to go ahead with the scheme.

During the visit, which was made at the invitation of Austrian President Heinz Fischer, Austria’s energy company OMV and Russia’s Gazprom signed a deal for the Austrian section of the line. Gerhard Roiss, the general director of OMV, said South Stream would "ensure energy security for Europe, particularly for Austria".

South Stream is being opposed by the US, some member states of the EU and the European Commission. The US embassy in Vienna issued a statement yesterday saying transatlantic unity had been essential in "discouraging further Russian aggression" in the Ukraine, and that the Austrians "should consider carefully whether today’s events contribute to that effort".

Fischer told journalists at a press conference, "Nobody can explain to me – and I can’t explain to the Austrian people – why a pipeline that crosses EU and Nato countries can’t go 50km into Austria." Putin suggested that the US had an economic motive in opposing the deal. He said "our American friends want to supply Europe with gas themselves. They do everything to derail this contract".

Putin and Fischer emphasised Russia and Austria’s close business ties, with Putin calling Austria an "important and reliable" partner. In 1968, Austria became the first western European country to sign a long-term gas supply deals with Moscow, and Russia is Austria’s third-biggest non-EU trading partner after the US and Switzerland. Fischer said he opposed sanctions against Moscow, but also told Putin that Moscow’s annexation of Crimea violated international law. 

The commercial case

Adnan Vatansever, a senior lecturer at the Russian Institute of King’s College London, told GCR that the combination of political and commercial difficulties had made South Stream increasingly hard to justify.

He said: "If the supplier were driven purely by profit it would have a hard time justifying this project. The European market for gas has been stagnating for some time and is expected to grow very slowly in the future, and the cost of South Stream looks like being much higher than $40bn because of the low level of efficiency of Russia’s pipeline industry, which has something to do with the lower level of transparency. And at present the pipeline network has about twice the capacity that is actually needed."

Our American friends want to supply Europe with gas themselves. They do everything to derail this contract– Vladimir Putin

He said it would be more sensible for Russia to arrive at a political agreement with the Ukraine in order to ensure the viability of the existing pipeline that travels over Ukrainian territory. "It’s clear that Russia, Europe and Ukraine have a common interest in continuing to transit through the Ukraine," he said, "and it would be more sensible than building an extremely expensive pipeline to a market that is not growing significantly."

It would appear, however, that the main driver behind the new pipeline is political, not commercial. If it is built, South Stream will take Russian gas under Turkish territorial waters in the Black Sea, through Bulgaria, Serbia and Slovenia to Austria.

At present, Russia provides a quarter of the natural gas consumed in the EU, and about 80% of that travels across Ukrainian soil. South Stream would bypass the Ukraine, and therefore make it possible for Russia to cut off that country’s gas without also halting supplies to Europe. Russia is particularly keen to avoid suspending supplies to friendly countries such as Bulgaria, which are dependent on Russian energy. 

Russia has used the gas weapon in its previous dispute with the Ukraine; in 2006 it halted supplies entirely after a bitter row over Kiev’s debts to Gazprom, and claims that the Ukraine was siphoning off gas intended for downstream countries. It was probably not a coincidence that the idea of the pipeline was proposed in 2007. Gazprom doubled the price of Kiev’s gas after the ejection of pro-Russian president Viktor Yanukovych in February. The Ukraine’s arrears presently stand at something like $4.5bn.

The US and northern Europe are anxious to prevent South Stream being built because of the increased leverage it would give Russia over the Ukraine. The European commission has objected on the grounds that the pipeline does not meet EU law because it does not allow third-party access, because Gazprom owns the pipeline and the gas, contrary to EU rules on separating infrastructure and operating companies, and because the contract in Bulgaria was given to South Stream Bulgaria in violation of EU competition rules. 

A further problem with that contract arose last month when it was disclosed that construction would be carried out by Stroytransgaz, a company controlled by Gennady Timchenko, who is among the Russian allies of Putin who have been individually sanctioned by the EU and the US.  

The weak point 

The West scored an important victory last month when it cajoled Bulgaria into suspending its work on the line. Prime Minister Plamen Oresharski made the announcement following criticism from the EU and a meeting with US senators. He said after the meeting: "I have ordered work to be stopped. We will decide on further developments following consultations with Brussels."

When and if it is competed, the pipeline will be stretch for 2,500km (Gazprom)

Ekaterina Shumitskaya, a researcher at the Russian Academy of Sciences, told Pravda TV that Bulgaria was the political weak point in pipeline. She said if the EU continued to pressurise that country, work would probably move to Turkey. She said: "Government circles in Turkey have already indicated their willingness. Austria will not succumb to the pressure as they understand the benefits and Austrian diplomats and officials know how to talk to Brussels, and Austria does not depend on loans from development funds as Bulgaria does. On 3 June, all loans to Bulgaria from the EU were suspended."

Vatansever was sceptical that the Turkish option would work. He said: "There is already a pipeline to Turkey, the Blue Stream, and even if it went through there it would still have to enter Europe in Bulgaria or Greece."

Russia’s ITAR-TASS agency yesterday quoted Alexander Novak, Russia’s energy minister, as saying the construction of South Stream in Bulgaria would soon be resolved. He said: "The Bulgaria issue is of a working nature, it is being discussed, resolved between companies who established a joint venture company on the project and are conducting further operations to choose contractors." He added that he hoped "everything will be okay and the project will be implemented in strict accordance with the schedule".

The companies with a commercial stake in the scheme are Italy’s ENI, Électricité de France, and Germany’s Wintershall. The vehicle formed to carry out the work, South Stream Transport, is 50% owned by Gazprom; ENI owns 20% of the shares and the other two firms own 15% each. 

The dispute over South Stream has split the member states of the EU, with southern countries – who stand to benefit from the scheme – generally in favour and northern countries opposed. Federica Guidi, Italy’s economic development minister, said: "Italy will continue to support South Stream, which is among strategically important infrastructure projects. South Stream further strengthens the existing gas supply network."  

How will it turn out?

The outcome of the South Stream battle may have far reaching consequences for all the contestants. The EU, with its control over Bulgaria and its backing from the US, seems to be in the stronger bargaining position at the moment but, as Dr Vatansever points out, it will only take a cold winter to put Russia in the driving seat. 

"The EU is talking about diversifying its gas supply, but it’s not something that can be accomplished in a short period of time," he said. "If there is a cold winter then you end up paying much higher prices for liquid natural gas or you have to get as much as possible from Russia."

The political split between the southern states and the EU’s central institution may also have consequences down the line, particularly in those countries such as Bulgaria that feel bruised by their treatment by Brussels. The Ukraine may also have to seek compromise with Russia, and may also have to reorganise its internal market. Vatansever says the gas industry is heavily subsidised, which means that Ukraine’s Naftogas has constantly either to seek government bail-outs or run up debts to Gazprom.

"It’s very hard to predict what will happen in the pipeline business. Some of lines survive, some of them you talk for 10 years and nothing turns up," Vatansever said. "It does seem that Russia is very dedicated to finalising the project. If the politics become more positive then there is more chance it will be done, but there are a lot of political issues that are going to remain on the agenda to do with the EU’s competition law and network rules.

"It’s not going to be completed by next year. Typically with pipeline projects the targets are very ambitious. The only exception is a pipeline between Turkmenistan to China, but that’s often the case with projects where the Chinese are involved – they are usually accomplished much faster." 

South Stream: some facts

If and when it is completed, South Stream will have a total length of 2,506km, making it the seventh longest in the world. It will run from Nizhny Novgorod, about 400km east of Moscow, to the Russkaya compressor plant near the Caucasus port of Krasnodar, and from there it will run about 2km below the surface of the Black Sea to the Bulgarian port of Varna, a distance of about 900km.  The annual design capacity is 63 billion cubic meters, delivered by 10 compressor stations which will require 1,516 MW (enough to power about 500,000 homes).  According to the original schedule, the first supplies of gas via the gas pipeline are due in late 2015.