Putin’s Pipeline Bypassing Ukraine at Risk Amid Conflict: Energy

Aug 14, 2014 12:56 pm ET

Aug. 14 (Bloomberg) -- Vladimir Putin’s dream of a new pipeline to deliver Russian natural gas to the European Union without passing through Ukraine is fading amid escalating tit- for-tat economic sanctions.

The $46 billion South Stream project, spearheaded by OAO Gazprom, is on hold and will probably remain in limbo for years as Russia continues to foment armed conflict in eastern Ukraine and the EU retaliates with bans, Eurasia Group said.

That means the war-torn country will remain a key transit point for about half of Gazprom’s shipments to Europe, according to the New York-based risk research group. The EU previously had mixed positions on South Stream. With Russian troops massing near the Ukraine border, the bloc now has little choice but to stand united in opposition.

“There’s no way Europe is going to put South Stream negotiations back on the table now, given the larger geopolitical context of the Ukraine crisis,” Emily Stromquist, a Eurasia analyst in London, said in an interview. “That, combined with a number of regulatory disputes about the pipeline and gas deliveries will push back the timeline a number of years.”

The proposed 2,446-kilometer (1,520-mile) pipeline would run under the Black Sea and enter the EU in Bulgaria. That would end Gazprom’s dependence on the Ukrainian gas-transit system.

While the European Commission had previously voiced concerns that the project was violating the bloc’s open-access laws, some EU members, particularly in the south, had openly supported it. That’s shifting as Putin’s support for armed separatists in eastern Ukraine and retaliatory bans on European goods strengthens the 28-nation bloc’s resolve to halt the project.

Political Leverage

“Politically it’s very difficult for the Commission to support South Stream as this might be seen as depriving Ukraine of its leverage toward Russia,” Katja Yafimava, a senior analyst at Oxford Institute for Energy Studies, said in an interview. “But equally, it’s very difficult for the EC to block South Stream as long as it can’t ensure security of supply for its south east Europe members by other means.”

The commission declined to comment directly on the pipeline’s prospects, and said in an e-mail that all new energy infrastructure investments must adhere to the bloc’s laws.

Gas Disputes

Ukraine and Russia have a long history of disputes over gas prices and debt. In 2009, all Russian gas flows through Ukraine were halted for 13 days, leaving southeastern Europe without gas supplies. While Russia has diversified the routes it uses to get gas to the EU, Gazprom still shipped 89 billion cubic meters through Ukraine last year, about 55 percent of its total exports to Europe.

With an eventual capacity of 63 billion cubic meters a year, South Stream, remains a crucial part of Russia’s dream to eliminate Ukraine as a transport country.

Gazprom had initially expected to bring South Stream online by the end of 2015 with an initial annual capacity of 15.75 billion cubic meters. Gazprom officials could not be reached for comment.

Companies on both sides of the Black Sea are unhappy. Gazprom has spent about $3.1 billion on Russia’s domestic network to prepare for South Stream, and plans to invest at least another $18.4 billion.

Gazprom shares gained 0.3 percent to close at 131.4 rubles in Moscow trading today.

European Partners

In Europe, Italy’s Saipem SpA has signed a 2 billion-euro contract ($2.68-billion) to install the first subsea line. Electricite de France SA, Germany’s Wintershall AG and Italy’s Eni SpA all own minority stakes in the offshore segment of the project and have billions of dollars at stake in future profits.

Gazprom owns 50 percent of the 930-kilometer undersea section, estimated to cost about 10 billion euros. The onshore sections in Europe, to be developed by Gazprom with local utilities, would cost about 6 billion euros, the Russian company estimates.

Saipem and EDF have said the project remains on schedule, and Wintershall anticipates no immediate impact on its business.

“We can’t say how the sanctions will ultimately affect the business climate, which could have a mid-to-long-term impact on our activities,” Wintershall spokeswoman Anna Bungarten said in an Aug. 6 e-mailed message.

‘Top Agenda’

Given the value of the South Stream project to Russia, the EU may use it to gain leverage in negotiations over deliveries of Russian gas to Ukraine, Eurasia’s Stromquist said.

“The project is on the very top of the agenda, both for President Putin and for Gazprom,” she said. “It’s an important political tool for Europe, particularly in terms of restarting the gas talks with Ukraine.”

Some nations, including Bulgaria, were betting on South Stream to dramatically improve the security of their supplies. They halted construction only under intense pressure from Brussels and the U.S.

The Bulgarian government acceded only after it turned out that the construction deal had been awarded to OAO Stroytransgaz, a Russian company controlled by Putin ally Gennady Timchenko, who is on the U.S. sanctions list.

“Those countries are highly dependent on the Ukrainian route,” Yafimava said. “Especially in the Balkans, they suffered very badly during the 2009 gas crisis. For them the concern isn’t dependence on Russian gas, it’s the insecure transit through Ukraine.”