Russia’s ‘South Stream’ is Closed, but Nothing has Changed

Russian President Vladimir Putin announced on 1 December during his official visit to Turkey that Russia had postponed the ambitious South Stream gas pipeline project. This would have delivered Russian gas to Southern Europe, bypassing Ukrainian territory. The next day, CEO of Gazprom Alexey Miller went further and announced that the ‘project is closed’. Russia has seemingly abandoned its aspirations to increase supplies to Europe. Russia presented the move as part of the country’s decisive pivot towards Asia, which has already been demonstrated by the monumental gas deal that Russia signed with China in May 2014 and the recent discussions for more deals to come. Numerous comments appeared in Russian media describing the decision as evidence of Russia’s final decision to abandon the European market. Indeed, never before has a Russian project been cancelled at such an advanced stage: Gazprom had invested approximately $4.5 billion into the South Stream project and had stored 300,000 tons of pipes  in preparation for the pipeline’s sea-leg construction this December.

In reality, nothing much has changed. Shortly after Vladimir Putin announced the cancellation of South Stream, he announced that Russia had signed a memorandum of understanding with Turkish company Botas for the construction of an alternative pipeline. The announced capacity of the proposed pipeline matches that of South Stream, at 63 billion cubic metres (bcm) per annum. This, like South Stream, would also cross the Black Sea, advance to the Turkish-Greek border and continue to the Baumgarten gas hub in Austria. The difference is that this pipeline would cut out problematic European Union (EU) partners who were originally part of South Stream. Bulgaria halted work on the South Stream gas pipeline in June 2014 after the EU Commission demanded an investigation into whether the project violated EU competition rules as part of the third energy package. Putin warned as early as May that if the European Union would not cease obstructing the project, Russia might ‘consider other variants – via countries which are not EU members’.

Turkey’s Bargaining Power

The terms of the Turkish deal are still vague. Purportedly, Turkey would absorb 14 bcm for domestic consumption and export the rest. However, Turkey pays a high price for importing Russian gas, about $418 per 1,000 cubic metres, and is looking to negotiate on this. Russia offered a 6 per cent discount as part of the initial negotiations, but Turkey is rumoured to be pushing for 15 per cent. If price concessions cannot be agreed, Turkey has expressed its desire to resell all of the 63 bcm of gas delivered by the proposed pipeline to Europe itself, instead of acting as a transit country. This would deviate from Gazprom’s usual policy and represent a serious concession to Turkey. In the meantime, Turkish officials have made it clear that the prospective Russian project is of secondary importance to the EU-sponsored Southern Gas Corridor. It seems likely that, as with the monumental gas deal that Russia struck with China in May 2014, Russia will be forced to grant certain concessions to Turkey.

Russia’s Pipeline Politics

This surprising announcement appears to be part of a political ploy in which gas supply, once again, is the main lever. It is a strategy that bears all the hallmarks of Vladimir Putin’s tactics over the last few months. First, Putin criticised the EU for its reluctance to proceed with the project, which, to Putin’s domestic audience, absolves Russia from any blame in cancelling it. Putin has also made comments that reinforce his European ‘divide and conquer’ approach. Referencing sovereignty seems risky given Russia’s recent activity in Ukraine, but Putin specifically blamed the EU Commission for blocking Bulgaria’s participation, stating ’if Bulgaria is deprived of the possibility of behaving like a sovereign state, let them demand the money for the lost profit from the European Commission’. Russia is playing hard geopolitics with Europe, trying to isolate members and weaken the bloc’s resolve to punish Russia for its actions in Ukraine. This could backfire, given that the future benefits of South Stream had formed part of the reasoning behind some Central and Eastern European EU member states’ opposition to sanctions against Russia.

The emergence of discussions over a Russo-Turkish gas deal at this time is evidence that Russia will not, and cannot, abandon the European gas market. Russia instead wants to supply Europe through a system which the EU – rather than Gazprom itself – funds the construction of the pipeline network to distribute Russian gas from Turkey. This is all the more pressing now, given Russia’s weakening economic position. Russia does not wish to waste limited resources, particularly if such an investment does not go towards a network exclusively owned by Gazprom. Hence the cancellation of South Stream and alternative Turkish deal maintains Russia’s prospective share of the European gas market, albeit through a different, less problematic route; it saves Russia money at a time it certainly needs to; and simultaneously represents a dramatic snub to Europe.

The decision to cancel South Stream in favour of an alternative project with Turkey is a risky one. Turkey is pushing for a significant discount, and allowing it to resell Russian gas would deviate from traditional Gazprom agreements. This would thus increase Turkey’s leverage in any future agreements. Turkey is a stronger negotiating partner than Ukraine. Russia may succeed in excluding European countries in favour of Turkey for a potentially lucrative project. Nevertheless, this may work in Europe’s favour by removing an obstacle to more consolidated support behind a united European energy policy, in which diversification away from Russia will be key.