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Scrapping South Stream Underscores Russia’s Weakness

Scrapping South Stream Underscores Russia’s Weakness

Russian President Vladimir Putin announced on December 1 the cancellation of the South Stream pipeline in a move that indicates Russia’s reach is declining in concert with the price of oil.

The South Stream project was designed to carry natural gas from Russia underneath the Black Sea and connect to Bulgaria. From there, it would travel through Serbia and several offshoots would reach Bosnia, Croatia, Hungary, Austria and Italy.

The 63 billion cubic meter (bcm) pipeline has been Moscow’s preferred route, and for years it has been locked in competition with other projects, such as the EU-backed Nabucco (since scrapped), and the Trans-Adriatic Pipeline (currently being planned), which would bring natural gas from Azerbaijan to Italy. Putin’s objective has been to sell Russian gas to the EU while bypassing Ukraine, through which half of Russia’s gas exports must travel.

Related: Russia In Weak Position For New Gas Deal With China

But the project has always been fraught with questionable economics and lackluster political support from the European Union. Aside from the annexation of Crimea and the ongoing crisis in Ukraine, which has ruined much of the EU-Russian relationship, the EU had legal objections to South Stream because Russia’s Gazprom insisted on owning both the pipeline and the gas that flowed through it. The EU refused to support the pipeline if other gas suppliers were not given access, a position that hardened after Russian took control of Crimea.

As a result, building the pipeline was always going to be difficult. But a combination of western sanctions, falling oil prices, and a collapsing Russian ruble put the nail in South Stream’s coffin. Russia announced it will likely enter a recession in the coming months. The ruble hit a record low in early December, and the Russian central bank will likely be forced to intervene to protect the currency from a further rout.

The chances of a Russian economic crisis are higher than many expect. For example, foreign exchange reserves are depleting. Russia lost $100 billion over the last year, and it may also be vastly overstating its level of remaining reserves, according to The Economist.

Amid these economic conditions, South Stream has looked increasingly unaffordable. South Stream would have likely needed natural gas prices in the range of $9.50 to $11.50 per million Btu, whereas EU spot prices for most of 2014 traded between $6 and $9 per million Btu. Proceeding with construction could have severely hurt Gazprom’s bottom line, already reeling from low oil-indexed natural gas prices.

Still the move came as a surprise – South Stream’s partners Bulgaria, Serbia, and Hungary were stunned on December 1, stating that they had not been notified before Putin appeared at a press conference unveiling his decision.

Companies hoping to profit from the construction were also left at the altar. German firm Salzgitter, which was slated to make pipes for the project, saw its shares drop 7.4 percent. Italian oil services company Saipem lost 10.8 percent. The involved companies are seeking clarification on whether or not the contract is completely off the table and some may seek compensation if they take a financial hit.

Related: Russia Expects Oil Price To Rise, But Not Enough To Balance Moscow’s Budget

The story may not be over yet. Putin announced the beneficiary of the EU’s obstinacy will be Turkey, who could be home to a major Russian natural gas pipeline. Putin even offered Turkey a discount on future natural gas deliveries, no doubt a move intended to be a rebuke to the EU.

Nevertheless, as a Reuters report notes, the ultimate construction of a South Stream-style pipeline to Turkey looks just as uncertain. For one, the discount would make a project that was economically questionable look even worse. Moreover, the pipeline capacity could far exceed Turkey’s annual natural gas demand, raising the question of whether the excess volumes would need to be diverted to Europe after all. If that were the case, the pipeline to Turkey hardly makes more sense than South Stream.

At this point, there are more questions than answers, but Russia seems to be flailing about. Putin’s decision to scrap a project he once heavily pushed underscores Russia’s floundering economic position.

By Nick Cunningham of Oilprice.com

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  • Daniel G on December 04 2014 said:
    Is Putin really this stupid? Looking at todays State of the Union address he gave it appears so.
    Step on your own dick and then blame the guy that made the shoes...
  • Stavros H on December 04 2014 said:
    This move by Putin is designed to do the following:

    1) Raise the middle finger to the EU.

    2) Block any other possible pipeline routes through Turkey. The Turks now have every interest to go along with this project for at least 3 reasons. a) They will get a discount. b) They will probably be reselling the Russian gas to the EU market for a premium. c) No western corporations fleecing them off.

    3) Leaves it to Greece and other Europeans, to either pay for expensive LNG gas to the Turks, or continue the pipeline.

    4) A high-profile project such as this one with a major NATO member (Turkey has the second biggest Army in NATO) underlines Russia's enduring geostrategic strength and sows even further discord and weakness on that anti-Russian alliance.

    A falling ruble and a falling oil price (even though very harmful for Russia) have nothing to do this. This is reaction from Russia to the EU's hostility and subservience to the US. These are long-term geopolitical moves to strengthen Russia position in the global energy market in the long run. Keep in mind that it is Russia that is diversifying her customer base (major supplier for Europe, China and Turkey, very possible deals with Japan, Korea and India pretty soon as well) while Europe is left stuck with falling gas production from the North Sea, the Netherlands and Norway. With Russia finding more and more customers for her gas, it is Europe that will find themselves into some very deep trouble. If they are to import LNG from the US, the cost would astronomical. First of all, LNG is far more expensive than Russian pipeline gas. Second, the infrastructure required for LNG to be imported does not yet exist and will cost several tens of billions of euros for it to put into place. No one can genuinely confirm that the US shale gas boom is sustainable. It seems likely that the quantities required for the EU to be supplied with US fracked natural gas will in all probability never be there.

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