Russian Gas Stream or Dream?
February 2, 2015
Lately President Vladimir Putin of Russia has transformed what others saw as either his tactical nimbleness or dangerous unpredictability into performance art. Putin’s actions may not always achieve a positive result, however. The annexation of Crimea and expanding conflict in Donbas in Ukraine caused severe damage to the Russian economy and to the standard of living of average Russians. $50 billion worth of international goodwill intended to be generated by the Sochi Olympics was squandered in one throw of the dice.
The sense of adventure extends into the oil and gas sector, which generated half of Russia’s government revenue and two-thirds of export earnings – both of which will shrink considerably as a result of a (so far) 60% downward correction in oil prices since June of 2014. This has not discouraged Mr. Putin from shocking friends and foes alike.
On December 1, during a visit to Ankara, he abruptly cancelled Gazprom’s 63 billion cubic meters per year (bcma) South Stream gas pipeline project under the Black Sea, which he had strongly endorsed since 2006, to the apparent surprise of his European business partners and the governments in southeastern Europe that he cajoled and pressured in turn to support the project. South Stream is now supposed to be replaced by a similar undersea pipeline to Turkey instead of previously to Bulgaria.
At the time of the announcement, the new project had no name (later dubbed Turkish Stream), no route, and no agreed gas price for Turkey. Only a memorandum of understanding was signed between Russia and Turkey, the precise terms of which are only just being negotiated. Incomplete information was released after meetings in Ankara on January 27 between the two sides. To the amazement of European Commission’s new vice president for “Energy Union,” during his first official visit to Moscow on January 14, Russian officials asserted that it is up to the European Union to build pipelines to take Russian gas from Turkey to European markets when Gazprom abandons gas transit through Ukraine after 2019.
Such pronouncements raise more questions than provide answers. Given the limited information available, let us posit three distinct scenarios of possible course of action for Russia:
A. No pipeline
A pipeline system under the Black Sea is no longer affordable for Russia. South Stream was estimated to cost $40-50 billion. Now that its European partners are out, Gazprom would have to bear sole risk. What is more, Mr. Putin’s priority has now shifted to two gas pipelines to China, in which he is even more personally invested, having presided over signing ceremonies with Chinese president Xi Jinping in Shanghai last May and in Beijing in November. Building the first pipeline to China and developing two new gas fields to supply it are very costly. The crisis over Ukraine and tensions with the West mean China’s energy market and political support to balance against the West became even more important to Russia.
Turkey would quickly get over the disappointment of losing “Turkish Stream.” After all, it would not be the first time Russia failed to fulfill promises to build pipelines across Turkey. It did not follow through with the once-trumpeted Samsun-Ceyhan oil pipeline or the Bosporus bypass pipeline across Turkish Thrace. Mr. Putin’s strong relationship with President Recep Erdogan of Turkey would not suffer unduly. Meanwhile, Russia will still have muddied the waters for TANAP, a pipeline to be built to move gas from Azerbaijan that would compete with Russian gas in Turkey and southeastern Europe.
B. Blue Stream II
Russia could build a pipeline with a capacity of 14-16 bcma that parallels the existing Blue Stream system, which brings gas directly from Russia to Turkey across the Black Sea. This would equal the additional volume that currently transits through Ukraine and the Balkans before arriving in Turkey. Thus transit risk to the growing Turkish gas market will be eliminated entirely. The generally north-south route is already familiar to Gazprom and is shorter than an east-west route across the Black Sea. If market conditions permit, a second new line with similar capacity can be built, utilizing the internal Turkish pipeline system to deliver gas to the Balkans, which currently imports exclusively from Gazprom but again relies on transit across Ukraine.
Since heavy investments in the onshore pipeline and compressor stations inside Russia for South Stream are already complete, as well as the specialty pipe for the first line of South Stream purchased and delivered and the expensive barge to lay the pipe contracted and in place, most of the capital to build such a pipeline is sunk. The incremental investment is not as great. Gazprom would fend off competition from Azerbaijan and perhaps northern Iraq, eastern Mediterranean, and Iran in the future for the European gas market.
C. Son of South Stream
Russians are true to their word. A new pipeline route from Russia to western Turkey would be utilized to build first one line and then a second line, totaling 31 bcma in capacity—the original plan for South Stream. Gazprom had already ordered the pipe for the second South Stream line. Therefore, additional capital is already committed beyond what was mentioned under scenario B. This option is more expensive and would take longer, but it does not rely on the problematic internal Turkish pipeline system to move gas to the European market. Therefore, it is more reliable.
One day, if conditions are ripe, two more lines can be built to bring the system to the stated objective of 63 bcma in capacity and allow Gazprom to bypass Ukraine altogether, which has been Russia’s objective since the 2006 gas supply crisis. However, this would be financially risky. What creditworthy buyers would commit to purchase so much gas through a new and more expensive route? Unlike oil pipelines, long-haul gas pipelines are not financeable until creditworthy producers provide long-term ship-or-pay financial guarantees to use the pipeline and creditworthy buyers provide long-term take-or-pay financial guarantees to offtake gas from the pipeline.
It is difficult to imagine when such conditions would prevail in Europe, amidst a changing global gas market with more liquefied natural gas and spot trading, along with weakening Russian and Turkish economies. The idea that the European Union would build pipelines to take 50 bcma of gas from the Turkish border (after subtracting volumes for Turkey) displays either naiveté or disingenuousness.
Additionally, what happens to Gazprom’s existing contractual commitments to deliver gas to its European customers at agreed delivery points? Any new delivery point would also have to be agreed by both sides. Turkey barely has the gas storage capacity to handle its own supply logistics, never mind to serve as a “hub” for another 50 bcma of transit gas.
Under no circumstance can a new 63 bcma pipeline system be ready by 2019 when the current gas transit agreement between Russia and Ukraine expires. Gazprom would still have to rely on Ukraine to transit significant volumes of gas to its European customers. This presents a dilemma for both countries. Russia claims it wants to eliminate all Ukraine transit after 2019, but would be happy to sell gas to Ukraine under the right conditions. Ukraine claims it wants to eliminate all gas purchases from Russia, but would be happy to continue transiting gas from Russia to Europe. However, the reverse gas flows from Europe that Ukraine plans to rely on would not be available in the case of total cutoff of Russian gas flows.
In point of fact, both Russia and Ukraine need each other for gas supply and transit for the foreseeable future. And Europe needs both of them to cooperate. Mr. Putin the risk-taker just made his gambit in this new pipeline contest. How will the others respond?
Edward C. Chow is a senior fellow in the Energy and National Security Program of the Center for Strategic and International Studies in Washington DC.
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