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.
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.
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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