Russia blames EU for South Stream axing but rising costs amid falling energy prices real culprits

By bne IntelliNews December 2, 2014

Graham Stack in Berlin -


President Vladimir Putin announced that Gazprom would abandon its much-hyped $30bn South Stream gas pipeline project, which by running from Russia to Bulgaria under the Black Sea was designed to bypass Ukraine, thus reducing Russian dependence on Ukraine for transit of up to 80% of its gas exports to Europe. 

Putin cited opposition from the EU as the reason for cancelling it, which he said had pressurised Bulgaria, the country of entry for the pipeline from the Black Sea, into backing out of the project. With Russia in a standoff with the West over its meddling in Ukraine's civil war, the project was effectively on the ropes ever since the start of pro-Europe protests in Kyiv a year ago that led to the overthrow of the pro-Russian government.

However, a European source told Interfax that blaming the EU was just an excuse for abandoning an economically unfeasible venture amid declining hydrocarbon prices. "It costs a pretty penny to build the South Stream, and its construction has become economically unfeasible as oil and gas prices are going down," the source was quoted as saying.

Gazprom CEO Alexei Miller said that the decision was irreversible.

The cancellation takes place as construction of an initial section of the pipeline had been completed and work was due to start on the underwater phase. "There's no point in us building a pipeline to the coast of Bulgaria only for it to stop there because work is blocked in Bulgaria," Putin observed.

Gazprom had so far invested $4.7bn in the project, mostly in its Russian debottlenecking pipeline system that would enable it to pump larger gas volumes towards the Black Sea, according to analysts. The total cost of South Stream was put at just under $30bn.

New deal

Putin and Gazprom CEO Miller were on a visit to Turkey when they announced the decision. This allowed them to put a brave face on the climbdown, since they then revealed that the pipeline section already built in Russia would now be used to launch a new southward pipeline, running under the Black Sea to Turkey.

Gazprom signed a memorandum with Turkish energy group Botas to build this new pipeline to Turkey to transport 63bn cubic metres a year (cm/y), of which 14bn cm/y would be sold on the Turkish market and the rest delivered to a transfer point at the Greek border, from where it will flow to the EU.

Gazprom also said that the existing Blue Stream pipeline that takes Russian gas to Turkey might be expanded by 3bn cm/y capacity up to 19bn cm.  Such an increase in gas exports to Turkey via Blue Stream would add $500mn-600mn to Gazprom’s earnings, only around 1%, according to analysts at Moscow brokerage UralSib.

But considering that Gazprom already has the Blue Stream trans-Black Sea pipeline to Turkey, it is not clear why Russia should now be building a new and expensive pipeline, especially one that does not even sideline transit countries between Russia and the EU, as South Stream was intended to do.

"Though Gazprom’s capex on the new project may potentially be lower, the endeavor still leaves many questions, among them being: Who exactly will consume the 49bn cm of Russian gas if the pipeline ends at the Turkey-Greece border, at the same time that competition from the Southern Gas Corridor and Azerbaijan gas aggravates the potential risk of the pipeline being underutilized?" Alfa Bank's Alexander Kornilov asked.

Nevertheless, analysts were largely relieved that Gazprom had given up on the South Stream project, believing that the EU had done Russia a secret favour by blocking what was increasingly seen as a white elephant. "We have long been skeptical on South Stream as a costly new route to reach markets already served by Gazprom," analysts at VTB Capital wrote.

But analysts were also apprehensive over the immediate fallout of the cancellation for Gazprom shareholders, believing that the Russian gas company would have to write off some of the $4.7bn preparatory South Stream investment, thereby slashing 2014 and possibly 2015 dividends. Energy Minister Aleksandr Novak said the question would be handled separately.

This is the second mega-project that Gazprom has had to abandoned over the last two years due to cost considerations. In 2012, Gazprom finally laid to rest plans to develop the giant Shtokman gas field in the Barents Sea, valued at over $40bn, as the price of liquefied natural gas fell on global markets due to the shale gas revolution in the US. In 2013, Gazprom announced that it would not reconsider the Shtokman project before 2019. 

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