South Stream's winding road to Baumgarten

A parallel with Nord Stream

Word has it that at a closed meeting between Russian Prime Minister Putin and foreign Russia experts, organised by the Valdai discussion club in September of 2010, Putin was asked about the viability of South Stream. In his reaction Putin drew a parallel with Nord Stream, stating that despite all the difficulties Nord Stream had encountered in the run up to its construction, it was now actually under construction. He assured all of those present at the discussion that South Stream would be constructed at a similar pace. To recall, it took Nord Stream almost ten years from the date its shareholders announced a joint feasibility study, to the day when the first pipes landed on the Baltic seabed. What made the case for Nord Stream stronger and eventually speeded up its realisation was the bringing on board of strong European partners, initially German, but later on French and Dutch companies joined the ranks. Just as with Nord Stream, South Stream's success, it seems, will partially depend on the extent that strong European partners will be involved.

Together South Stream's 'founding fathers', Gazprom and Italian ENI, in 2007 established the company South Stream AG, each holding a 50% share, based in Switzerland. It is worth mentioning that South Stream AG only refers to the offshore section of the pipeline in the Black Sea. For the onshore pipeline Gazprom has founded joint ventures with national partners in each separate transit country. It took another three years before before Gazprom and ENI officially agreed to open the door for a another strong European partner, Electricité de France (EdF). In June 2010, all three companies signed a joint memorandum, which set out a roadmap for the French company to join the project. Then it was believed that EdF would become a shareholder before the end of 2010. However, the three sides still have not been able to agree on the terms of entry. According to one of the younger statements by Gazprom CEO Alexey Miller, intense negotiations are being conducted and there is hope a deal will be reached before the end of 2011. Some Russian media reports have in the past suggested that the main obstacle for EdF to enter the project, has been ENI's unwillingness to cede part of its 50% share to EdF. Gazprom has from an early stage on made clear that it would hold on to its 50% share. Alexey Miller has reiterated on several occasions that Gazprom does not intend to cede any of its 50% share.

Old friends

Some time after the MoU with EdF had been signed, reports of a new, preferably German, partner emerged in the press. The advantages of a German partner for South Stream were evident. Besides sharing the costs, involving a strong German energy company would provide the project with more momentum and more backing from the EU. The first German energy company that seemed to have caught Gazprom's eye in this respect was Rheinisch-Westfälisches Elektrizitätswerk (RWE). Although it was never officially confirmed by either of the two, the EEO learned that Gazprom had approached RWE about possible participation in South Stream with the latter turning down the offer. Some might characterise it as a staunch move to try to involve one of Nabucco's strongest shareholders into the  project. It was therefore not surprising that RWE showed no interest in South Stream, as its involvement could have been interpreted as a psychological defeat to Nabucco. On the other hand, by opting for RWE Gazprom might have tried to diversify its partnerships in Germany. Historically, Gazprom's cooperation with German energy companies was mainly limited to Wintershall and E.On. The MoU on joint gas-to-power projects in Germany that was signed mid-July between Gazprom and RWE, sparked a similar discussion. RWE again seemed to be well aware of the message that an MoU with Gazprom was sending out and its press service was quick to state that the MoU would not affect RWE's participation in Nabucco. 

After RWE had seemingly turned down the offer to join South Stream, the autumn of 2010 brought rumours about the possible participation of BASF's subsidiary Wintershall. The two companies were no strangers to one another. Over the past two decades Gazprom and Wintershall developed a strong partnership through their German joint venture (JV) Wingas. The Wingas JV proved to be very successful during this period and gained a share of almost 20% on the German gas market. Both companies also have another JV, Swiss based Wintershall Erdgas Handelshaus (WIEE), which also operates on the Bulgarian and Romanian markets. Through South Stream, Wintershall would have the opportunity to increase its share on the promising South East European market, beyond Bulgaria and Romania. It should also be noted that cooperation between both companies is not limited to European downstream. Together with Gazprom, Wintershall takes part in a Russian upstream project through their JV Achimgaz. Moreover, BASF is a shareholder in the Nord Stream pipeline. Both companies have many more shared interests throughout the whole gas value chain. So, Wintershall's participation in South Stream would seem to be a logical broadening of cooperation with Gazprom.

More became known about the alleged talks with Wintershall in a report by Russian daily Kommersant from autumn 2010. An anonymous source, apparently familiar with the talks between Gazprom and Wintershall stated that Wintershall was offered a share equal to what was offered to EdF, i.e. 10-20%. After a relative period of silence, on the first day of spring 2011, Gazprom and Wintershall then finally signed the MoU, which anticipates Wintershall's participation in South Stream's offshore pipeline. The MoU notes that Wintershall should enter the South Stream consortium before the end of the year with a 15% share. Gazprom CEO Alexey Miller, who signed the MoU on behalf of Gazprom, stressed that Gazprom would maintain its 50% share, which reportedly enjoyed the approval of the other South Stream partners.

What is not unimportant is that Wintershall's participation in South Stream seems to have the full support of the Kremlin. The signing ceremony of the MoU took place at the Russian Prime Minister Putin's residence in Novo-Ogarevo, where usually only the world's political leaders are received. In a comment to the press, Putin characterised Wintershall's entry into South Stream as a very important step, taking into account the events evolving on the international energy markets. Therefore, Putin noted, the signing of the MoU should be regarded as a sign of stability. Also in light of the German decision to phase out nuclear power, a strong German partner seems even more logical. As a result of this decision, during the visit of Russian President Medvedev to Germany in July of this year, a discussion was prompted, mainly by the Russian side, about expanding Nord Stream with a third or a fourth string. It is not unthinkable that South Stream, in light of the German situation, could become in addition to Nord Stream, a complementary supply route to Germany. The states of Bavaria and Baden Württemberg, together Germany's economic and industrial backbone, will require alternatives to nuclear power. Possibly, new opportunities could open up in Southern Germany, close to South Stream's final destination, Baumgarten.

Sebastian Sass, Head of EU and Regulatory Affairs at South Stream, confirms the importance of European partners, "In general it is very welcome to have a broad European shareholder base. For us especially, who perceive ourselves as a genuine European-Russian JV. Having major European companies from different parts of Europe emphasises that. So that is of course very welcome." With Wintershall joining South Stream, the project will undoubtedly gain a strong European partner. But more importantly, as was stressed by ENI CEO Paolo Scaroni in an interview with the Wall Street Journal on 18 March 2011, South Stream needs the EU's backing for the project. Three companies from three major EU countries will surely have an positive affect on South Stream's lobby with the EU. Meanwhile, in both the home countries of Wintershall and ENI, Germany and Italy respectively, the fate of nuclear energy seems to be sealed. As a result, the role of gas in these countries will increase, including Russian gas. It should be noted that final agreements on EdF's and Wintershall's participation in South Stream are still under discussion.

Source: South Stream AG

If from the moment of its announcement, South Stream was mainly regarded as a Russian driven project, by now it has gradually turned into a Russian-European project with strong European partners ready to join the consortium. The appointment of a new European executive director, former CEO of Dutch Gasunie, Dutchman Marcel Kramer, in October 2010, seemed symbolic in this respect and further contributed to European image of South Stream. Commenting on the appointment of Mr. Kramer as executive director in a comment to the press, Gazprom CEO Alexey Miller explained that the reasons for appointing Kramer were his "experience in working at major international energy companies and international institutes related to oil and gas".

It was under Kramer that the call for an equal treatment of all major European pipeline projects, also known as "a clear level playing field", by the EU was put forward. In practice this means equal standards and requirements for all pipeline projects, regardless of their origin. In part this call seemed to be directed against the EU's 3rd Energy Package. On the other hand, the Ukrainian crisis of January 2009 has not yet faded from the EU's collective memory and spurred the EU's diversification policy. Gazprom is still dealing with the impact of the Ukrainian crisis on the reputation and reliability of Russian gas. Paradoxically, South Stream, whose raison d'être is partially to increase the EU's energy security by means of diversifying supply routes, is not perceived as such by all of the EU member states. This seems to be one of South Stream's 'weak spots', which most of its critics tend to stress. As is often the case with many other Russian projects, most of the criticism concentrates on the allegedly political nature of South Stream, aimed at undermining Nabucco and increasing Russian leverage over Ukraine, South Eastern Europe (SEE) and the EU.

Although most of the criticism directed at South Stream as being merely a political project seems unfounded, the mere scale of the South Stream undeniably gives it a (geo-)political dimension. It is therefore not surprising that Russia's political leadership is lobbying for the business interests of its largest state controlled company. This has on occasion seems to have affected the work of South Stream AG. Statements about South Stream, issued by the Kremlin, seemed to have overtaken the company at times. An illustration of this was a statement by Russian Prime Minister Putin in April of this year, in which he proposed the idea of substituting South Stream's offshore pipeline with LNG carriers. At the Flame energy conference in Amsterdam, in early May 2011, when asked by media about the possibility of LNG shipments within the framework of South Stream, Marcel Kramer dismissed the idea and suggested the issue had been blown up by the media. However, as shown further below, Russian Prime Minister Putin mentioned, at least on two occasions, LNG shipments as a possibility.

What is wrong with Ukraine?

After the Ukrainian gas crisis of January 2009, the case for South Stream grew stronger and efforts towards its realisation were stepped up. Although the newly elected Ukrainian government was much more cooperative towards Russia, it made no secret out of the fact that it would like to see the South Stream project terminated. The country's Energy Minister's, Yuri Boyko, assessments of South Stream have varied from going against Ukraine's national interests and the project being political rather than commercial, to being a threat to Ukraine's national security. Except for the fear of losing an important source of income derived from transit revenues, the Ukrainian government fears that once South Stream is on stream, Ukraine's gas transit system (GTS) will lose its value as a bargaining tool in its political and economic dialogue with Russia.

With the complete construction of South Stream's all four strings, the loss in transit volumes for Ukraine could turn out to be quite severe, some experts believe. Mostly Ukrainian experts believe that transit volumes could be reduced by as much as 50%, which approximately equals South Stream's planned capacity of 63 BCM/year. Well aware of the likelihood of such a scenario, Ukraine has therefore stepped up its efforts to promote its GTS as a more economical and affordable alternative. Recently, it announced and officially initiated the modernisation of parts of its GTS, partially with EU funding. Ukrainian government officials have repeatedly argued that with a full scale modernisation the current transit capacity of around 120 BCM/year could be expanded to up to 200 BCM/year, while the costs for modernising the GTS are estimated at $ 2 bln. It should be noted that figures of up to $ 4 bln have also been mentioned. In an interview, which Ukrainian President Viktor Yanukovich gave in May of last year, he stated that the modernisation of the GTS would save South Stream investors around $ 19 bln. Regardless of the fact whether the figures put forward by Ukraine are actually correct or not, the message is clear. Or as Ukrainian Foreign Minister, Konstantin Grishenko, put it during an official visit to London on 7 September 2010, "we don't seen any need for the construction of South Stream. It's an expensive and unnecessary project for which it is not too late to still be terminated."

On the other hand, the Ukrainian gas crisis also displayed to what level losses for Gazprom, as a supplier, can run up to when transit is disrupted. As a result of the Ukrainian gas crisis, Gazprom suffered losses of around € 2 bln in missed revenues, according to a statement by Gazprom's official representative, Sergey Kupriyanov, late December 2010. Kupriyanov characterised South Stream as an economically motivated project and pointed out that with South Stream such financial losses can be prevented. The debate concerning the perceived high costs of South Stream should, at least from the supplier's point of view, be regarded from this perspective. In other words, although a costly project, South Stream will provide Gazprom with a guarantee to supply gas to Europe at all times. By mainly relying on the Ukrainian GTS, Gazprom apparently believes that it does not dispose of this guarantee.

Nevertheless, there seems to be one major condition on which, at least the Russian government is prepared to offer some concessions to Ukraine. In April 2010, during a meeting between Russian Prime Minister Putin and his Ukrainian counterpart, Nikolay Azarov, Putin proposed the merger of Gazprom and Naftogaz. However, this proposal was received with little enthusiasm by Ukraine. In the unlikely case of a merger or asset swap, Gazprom would become a shareholder in the Ukrainian GTS. Within this context, Russian officials, including the press secretary of premier Putin, did not exclude the possibility of revising the required transport capacity of South Stream. More than a year later and with gas prices on the rise, Ukraine is still not prepared to take such a course. In a recent interview with the EEO, Ukraine's Ambassador to Turkey, Sergiy Korsunky, stated that although he is not personally involved, he knows the situation is very difficult. "Ukraine will do everything to bring a revision of the contract to Gazprom's attention. However, it will not agree on a merger of Naftogaz with Gazprom.", Korsunky told EEO.

Ukraine does not regard the merger of Naftogaz with Gazprom as an option. Instead it plans to restructure Naftogaz into three separate companies. Source: RIA Novosti

One of the main concerns of the Russian side remains to what extent the political climate in Ukraine will remain stable and turn against Russia, after Yanukovich' presidential term expires, as it did under former President Yushchenko. In this regard, Russia's concerns seem justified, considering the Ukrainian tendency to constantly renegotiate its contracts. At least from the perspective of Russia, Ukraine's political instability and unpredictability remains a concern. Therefore, it sees the South Stream project as an investment in the stability of supply, circumventing an unpredictable Ukraine. The announcement by Ukrainian Prime Minister, Nikolay Azarov, on 2 Septmeber, to liquidate Ukraine's national gas company Naftogaz, is a more recent proof of this tendency, since a liquidation of Naftogaz will force a revision of the existing gas contract with Gazprom.

Sebastian Sass explains that the main aim of South Stream is to invest in the diversification of routes. As for the volumes, "it is a possible scenario to have about two thirds to one third, between rerouted gas and additional supplies. That is a possible scenario, that shows to you the emphasis there is for the diversification of routes improving energy security, but also allowing capacity for some additional supply. Of course, it makes sense to have more routes for all that Russian gas that is being delivered through existing routes. For example, Ukraine, at the moment, is a transit country for 70-80% of Russian gas to the EU. But it is not about an individual country, it is about improving security of supply by diversifying routes.

Recent developments this summer have shown that disagreement over gas prices between Russia and Ukraine is not something of the past. Ukraine claims that the price it pays is too high. In the 4th quarter of 2011, it is expected to pay a price of almost $ 400 per 1,000 CM. After unsatisfactory negotiations with the Russian President Medvedev mid August in Sochi, both the Ukrainian President Yanukovich and his Prime Minister Azarov did not excluded the option of having the gas contract with Gazprom declared invalid through court. Plans to liquidate Naftogaz suggest that Ukraine has set out a determined course to achieve a revision of its contract. Such remarks are reminiscent of the times running up to the January 2009 gas crisis. With the winter ahead both sides seem to drifting apart rather than coming closer towards a mutually acceptable compromise. Although a possible supply disruption through Ukraine would obviously strengthen the case for alternative supply routes, including South Stream, it is not something that would be welcomed by South Stream itself. Sebastian Sass tells why: "Anyone that is doing business in gas cannot welcome any event that is problematic for the industry as a whole. Any disruptions that we have seen in the past are not being welcomed by anybody. But for us the case is clear, it is not worth putting all your eggs in one basket. Diversification as such, is a declared policy objective of the EU. We are aiming at providing one important part of the solution to make energy supplies more secure. It is not about circumventing certain countries or replacing other routes completely. It's about diversifying."

Why not South Stream light?

However, bypassing Ukraine in order to diversify exports does not require the construction of a gas pipeline all the way to Baumgarten. It would be sufficient to construct a shorter and less costly pipeline. Mikhail Korchemkin, executive director at East European Gas Analysis (EEGA), calls it South Stream 'light'. According to Korchemkin, in order to bypass Ukraine it would be sufficient to connect the offshore part of South Stream with a pipeline running from Romania to Slovakia, via Hungary. From there the gas could be fed into the existing pipelines. Such a pipeline would exclude Bulgaria, Serbia, Slovenia and Austria as South Stream transit countries. Similarly, South Stream's southern leg would be deemed unnecessary by feeding into the existing Trans-Balkan pipeline. Thus, eliminating the need for a pipeline to Italy via Greece. 

When asked whether the South Stream ‘light’ version has been considered, Sebastian Sass responds: "I have not heard very much about that before. I cannot say too much about it, because I have not studied such a proposal. But what I can say is that there is no discussion among our shareholders or project partners on South Stream 'light', because they are actually quite happy with the real South Stream. There are a number of route options on the table, but that is all within the range of route options that you have seen discussed or that have been portrayed in the map of the presentation from the 25th of May. We see no reason to go for South Stream ‘light’, when our original plans are actually very feasible and our project partners are very committed to that."

It could lead us to believe that South Stream is about more than just diversifying supply routes. It seems that it is also about expanding the market shares of South Stream shareholders in SEE, not just of Gazprom, but also of potential partners, such as Wintershall. As several leading consultancies agree, the gas markets of SEE, though still relatively small in volumes, are expected to grow even quicker than those in West and Central Europe. The SEE gas markets seem to offer an attractive growth potential to those that can succeed to acquire a share in it. In this sense, we are witnessing a competition for market shares as well.

Dealing with the EU: the 3rd Energy Package or a separate regulatory framework?

In dealing with the EU, South Stream has obviously tried to illustrate the importance of the pipeline. Also in light of events in Japan, the Middle East and North Africa (MENA), Gazprom was quick to recognise the consequences of the 'Arab Spring' and Japan's nuclear catastrophe. During a high profile visit to Brussels on 24 February, led by Russian Prime Minister Putin, Gazprom CEO Alexey Miller stated that global developments are making the South Stream project more "urgent, needed and very contemporary". A month later, in Slovenia's capital of Ljubljana, Miller added a new dimension to this. He referred to the events in Japan and MENA as drivers for new plans to build gas fired power plants within the framework of South Stream. Although South Stream's advantages and potential for the EU seem to be evident, the EU's 3rd Energy Package remains a major stumbling block.

On 25 May of this year, South Stream organised an event in Brussels in order to present itself more extensively to the EU. According to Sass, the event was satisfactory, "I think the presentation of the 25th of May in Brussels to EU decision makers, which saw a lot of participation from the European Commission, was actually very positive in many ways. Also the participation from the Commission side was very high level. Of course, we had Commissioner Oettinger, Director General Philip Lowe was there and a number of important decision makers. To us that expressed a high degree of interest and also a constructive approach to the project."

Many observers, however, agree that the EU's 3rd Energy Package in its current form could thwart much of the onshore part of South Stream. But according to Sass, there is quite some unclarity still around how exactly the 3rd package, the 3rd gas directive, will be applied, "That is not unusual, because first of all the 3rd gas directive is fairly new. It is not implemented yet in our route countries. South Stream is an extraordinary project and it is also rather new. Clearly, there is room for interpretation. South Stream is obviously a bit of an exceptional project in the sense that it is coming outside from the internal market, outside EU jurisdiction. Parts of it are running through international waters, then going into the EU, but also crossing non-EU countries. It is running through so many different jurisdictions but it is still one integrated project."

It is not surprising therefore that South Stream would like to see a comprehensive solution for its project, as Sass explains: "We perceive ourselves as an integrated project. It's one pipeline and it cannot be chopped into little pieces. It needs a predictable legal framework and a profitable commercial rationale." At the South Stream presentation, organised on 25 May in Brussels, a separate EU-Russia agreement was proposed as a pragmatic solution. Sass tells EEO: "Such a comprehensive framework between the EU and Russia, of course depending on the content, would be a very good avenue to move forward. Surely, it could be more predictable than having many procedures in many countries. Yes, we very much support that both parties continue working on this. Our understanding is that both parties have expressed interest in this."

At least one of South Stream's EU transit countries, Bulgaria, believes the EU is willing to make an exemption for South Stream. In a statement to the press on 13 July of this year, Bulgarian Energy Minister Traycho Traykov expressed his confidence that the South Stream gas pipeline will be granted a derogation by the European Commission on third-party access requirements. But as is shown below Bulgaria has not always proved itself to be a reliable partner.

IGAs not always a guarantee

Although an EU-Russia agreement is regarded as a desirable way by South Stream to find a pragmatic solution, IGAs between Russia and transit countries nevertheless seem to play a vital role in bringing South Stream about. However, as the case with Bulgaria showed, an IGA does not always provide a guarantee. In the summer of 2009, the freshly elected Bulgarian government, under Prime Minister Boyko Borissov, suspended all energy agreements reached by the previous government, including those on South Stream. As a consequence, negotiations had to start all over again. Even more recent developments showed that Russian - Bulgarian energy relations have still not entered smooth waters. On 21 July 2011, Russian company Atomstroyexport announced that it would go to court with a claim against state company Bulgarian Energy Holding for unpaid services provided to the Belene nuclear power plant, amounting € 58 mln. Soon another sign suggesting that Russian-Bulgarian energy relations were suffering from tensions followed. On 27 July, the Bulgarian authorities withdrew the operating license of the country's largest oil refinery, located in Burgas. The refinery, which belongs to private oil company Lukoil and supplies most of the Bulgarian market with petroleum products. Reportedly, the withdrawal of the license had been motivated by the fact that the Burgas refinery no longer complied with the license regulations. On 1 August, however, a Bulgarian court ruled that the withdrawal was without foundation. Though it seemed that South Stream was kept outside of this sudden deterioration of Russian-Bulgarian energy relations, it is not unthinkable that in case of a further deterioration it might again be affected, as it was in 2009.

Asked whether South Stream takes into account the political instability in SEE or a possible IGA annulment due to a change of government, Sass answers: "Of course, IGAs provide you an additional assurance or government endorsement with the countries that you deal with. An investment like ours, however, is planned for many many decades ahead. Of course, we can only have the approach, right from the start, that it is a project good enough to endure changes in political environments. Most pipeline projects of our kind rely on IGAs. Nabucco has them for example. In the end what will count for us is complying with the criteria from the applicable legislation to get the permit to build the pipeline. We are convinced the case is good enough and then the project will go ahead. We cannot make it dependent on political influences which may be very short lived. It has to endure many decades."

In an unlikely scenario, whereby Bulgaria would decide to withdraw from the project, South Stream still seems to have an alternative it can fall back to, Bulgaria's neighbour Romania. After Bulgaria's newly elected government suspended all previously signed energy agreements with Russia, in the summer of 2009, including South Stream, Gazprom soon turned for talks to Romania. Bulgaria sought a revision of the terms in the agreements and obviously wanted to get more out of the deal for itself, including a lower price for Russian gas. Reportedly Romania, a gas producing country itself, was considered an attractive alternative, amongst others because of its underground gas storage (UGS) potential. According to Sass, the route through Romania is still under consideration, but the base case continues to be Bulgaria. South Stream does not seem to have a real preference for either of the countries, "It is premature to say whether we have a preference. The preference that we will have, will come out with the integrated FS. That is exactly what is under review currently. And it will be commercial and technical criteria that will decide which route is most feasible. But it does not have to be a solution of either-or, there is also a discussion on the combination of those. That is still under review.", Sass explains.

Russian Prime Minister Vladimir Putin and Bulgarian Prime Minister Boyko Borissov attend the signing of the Shareholders’ Agreement for the joint project company South Stream Bulgaria AD. Source: RIA Novosti.

As for Romania, it has clearly displayed interest in participating in South Stream, as a visit by Alexey Miller to Bucharest, in September 2010, proved. Both sides agreed to conduct a feasibility study on a possible route for South Stream through Romania. To this aim an expert working group was established. Then it was suggested that an intergovernmental agreement with Romania could be signed already in the first quarter of 2011 if the outcome of the feasibility study was positive. To what extent Gazprom was seriously interested in the Romanian alternative or was just trying to exert pressure on Bulgaria remains unclear. However, after several rounds of talks between Gazprom and its Romanian partners, the Bulgarian side was ready to sit around the table again. Eventually, by late October 2010, the Bulgarian Energy Holding and Gazprom signed an agreement on a joint feasibility study for the Bulgarian stretch of South Stream. Before the end of the year, a joint project company, South Stream Bulgaria AD, had been registered. Both Gazprom and the Bulgarian Energy Holding now have a 50% share in the joint project company.

Serbia: a special case

The only non-EU country that South Stream will transit onshore is Serbia. However, this is not the only thing that makes Serbia different from the remaining chain of transit countries. For all the onshore stretches Gazprom has established separate joint project companies with each corresponding national partner, based on a 50% share each. In Serbia, however, Gazprom holds a 51% share in the Serbian joint project company. Another conspicuous observation is that Serbia is paying the highest price for Russian gas in Europe. Altogether it seems that Gazprom enjoys a special status in Serbia. On its turn Serbia seems to play a central role in the onshore part of South Stream, amongst other hosting a strategic UGS at Banatski Dvor, in Northern Serbia.

Djordje Padejski, a freelance journalist from Serbia, who published an extensive article on Gazprom's dealings with Serbia, told EEO about the background of these relations. Padejski notes, "what is characterising for the deals between Serbia and Gazprom, is that they are being concluded at some political level and that they lack transparency. Although there is no proof of it, there are signs that the outcome of the deals between Serbia and Gazprom were rather the result of personal interest of Serbian politicians involved in it." Also when it comes to diversifying energy sources Serbia seems to be different, "in contrast to all its neighbouring countries, Serbia is not pursuing a policy of diversifying its gas supplies and remains solely dependent on Russian gas. Other countries are investing in alternative sources of energy, but this is not the case in Serbia", Padejski says.

Negotiations on the Serbian part of South Stream seemed to have played a central role in relations between Serbia and Gazprom in recent years. Padejski clarifies, "Gazprom used typical 'carrot' tactics by promising South Stream to run through Serbia as a mean to obtain a majority control over important parts of Serbia's energy sector. Initially, Serbia was promised South Stream in return for giving Gazprom a majority share in Jugorosgas, the mediating company responsible for the sale of Russian gas to Serbia's national gas company, Srbijagas." "However, a new demand then followed shortly", Padejski continues, "the message was that if Serbia still wanted to join South Stream, it should allow the sale of 51% of Serbia's National Oil Company (NIS) to Gazprom Neft, which it did in January 2008. In the same fashion Gazprom subsequently demanded a majority share in the Undergroud Gas Storage (UGS) Banatski Dvor, which it also received."

Was the take over of Serbian National Oil Company (NIS) by Gazprom Neft part of the South Stream deal with Serbia?

An independent consultant, close to negotiations between Serbia and Gazprom on South Stream, that wished to stay anonymous, told EEO that Serbia still has not received any guarantees in return for the concessions it made. It has been promised South Stream, but neither transit tariffs nor future gas prices have been agreed upon so far. Nevertheless, officially Serbian authorities seem to be content with the situation. Former Serbian Energy Minister, Petar Shkundrich, who is now the Prime Minister's advisor on energy, uses every opportunity to stress the financial advantages South Stream would bring about for Serbia, such as creating new jobs and generating transit revenues into the state budget. For now cooperation between the two seems stable, but it remains to be seen whether cooperation will continue along the same lines. At a meeting, on 20 April, between the heads of Gazprom and Srbijagas, Alexey Miller and Dushan Bajatovich respectively, discussed the prolongation of the existing gas contract. In a joint statement it was stressed that the further development of Russian-Serbian gas cooperation should be mutually beneficial and take into account the long term strategic interests of both sides. Perhaps Serbia is realising that previous cooperation has not been that "mutually beneficial" in the end as it might have wished for.

Turkey - the last hurdle?

With all of the IGAs signed with the transit countries, the integrated feasibility study due by the end of September and the final investment decision before the end of 2012, Turkey's approval of South Stream passing through its territorial waters in the Black Sea remains an unresolved issue. In order to bypass Ukrainian waters, the offshore pipeline will have to go through Turkish waters. The Russian side had anticipated Turkey to give its approval before the end of 2010, as was more or less agreed between the two countries in August 2009. However, Turkey still has not given its approval. According to Sergiy Korsunky, who is Ukraine's ambassador to Turkey and keeps close track of South Stream, the main reason behind this is that South Stream has still not provided Turkish authorities with the integrated feasibility study, which was supposed to have happened a year ago. "Turkey will base its decision on the integrated feasibility study, which is supposed to be presented by the end of September.", Korsunskiy says.

Earlier this year, the issue seemed to surface just a week before Turkish Premier Tayip Erdogan was due to visit Moscow. On 9 March, Russian Premier Putin issued a directive to the Energy Ministry to look into the possibility of including an LNG plant within the framework of the South Stream project. Putin suggested that the plant would be located on Russia's Black Sea shore. Commenting on the outcome of Erdogan's visit to Moscow, Russian Deputy Prime Minister, Igor Sechin, also mentioned the idea of an LNG solution being part of the South Stream project. According to Sechin, Moscow was studying the ways of lowering the project's costs. Therefore the LNG solution could serve as a complimentary solution or as an alternative. Putin's press secretary, Dmitriy Peskov, commented similarly on the issue. In general, Peskov's message was that in case South Stream would encounter insurmountable obstacles in the course of the project's realisation, the LNG solution could become a 'complete' alternative to the pipeline version.

South Stream at least does not seem to consider LNG as an option. Sass tells EEO: "It is surely not part of our feasibility study or any other option that South Stream is looking at. We have seen there has been a discussion on possibilities to send gas by LNG. As far as I understand it has been an initiative to look at additional possibilities on top of South Stream, not something that would replace our project. There is a very clear commitment for our project to go ahead. And LNG as part of the South Stream Black Sea crossing is not in the cards. That will not exclude that somebody else is having such plans and is going forward with them, but that would be another project."

Nevertheless, the sudden upheaval over substituting South Stream's offshore pipeline with an LNG solution was the first time that Moscow publicly called into question the future of South Stream's offshore pipeline. It was most likely Turkey's reluctance to grant South Stream the permission to cross its economic waters that provoked the Kremlin's response. So far, Turkey has only given South Stream permission to conduct geological and seismic research in the respective through which South Stream should cross. The Russian side seems frustrated, since it was under the impression that it had reached a 'package deal' with Turkey, including the construction of the Samsun-Ceyhan oil pipeline at the cost of the Russian preferred Burgas-Alexandroupolis oil pipeline. In return Russia also offered the construction of the first Turkish nuclear power plant by Rosatom at favourable conditions. Sergiy Korsunsky characterises the 'package' deal as rumours, something which is unlikely to materialise, "Russia will in any case build a NPP in Turkey, since the project is of considerable economic interest to Russia." As for the Samsun-Ceyhan project, it has not made any progress what so ever, according to Korsunky. "The Turkish government is unable to proceed with the project, since Russian oil companies have not shown any commitment to the project yet. It will take at least one more year of negotiations before concrete steps will be taken regarding the Samsun-Ceyhan oil pipeline.", Korsunky told EEO.

Considering Ankara's newly found and steadily growing self confidence as an emerging regional power and energy hub, a policy shaped under its Foreign Minister Ahmet Davutoglu, it is not unlikely that Turkey will turn out to be a bigger diplomatic hurdle for Russia than previously assumed. In a world of rising energy prices, Turkey is in a strong position to negotiate for itself a lower price for Russian gas under more favourable contract conditions. Meanwhile, experts agree that the LNG solution for South Stream seems as an unlikely alternative. Russia has too much at stake to terminate the South Stream project, in particular the IGAs signed with the South Stream transit countries. Therefore, another round of tough negotiations between Russia and Turkey could well lay ahead. "In the end", Korsunsky believes, "although Turkey prefers Nabucco over South Stream, it will not say "no" to South Stream if the project meets the standards."

Possibly, a new chapter has been opened thanks to new Turkish plans for the construction of the 'Istanbul channel'. Turkey's Premier Erdogan announced the plans in late April, stating that the channel should be ready by 2023, coinciding with the celebration of the hundred year existence of the Turkish state. The aim of the 'Istanbul channel' is to reduce tanker traffic through the Bosporus.  Although such a channel is still more than a decade away, it could possibly open up the Mediterranean markets for Russian and Caspian LNG, provided the channel can take Q-Flex and Q-Max class LNG tankers. Ultimately, the channel could serve as a way to integrate the Black Sea and Mediterranean markets. The 'Istanbul channel' would also be in the interest of Ukraine, which could receive access to the global LNG markets. In general, plans for the 'Istanbul channel' seem to fit perfectly within Ankara's policy to become a regional hub for hydrocarbons.

Background 

On 23 June 2007, Gazprom and ENI signed a first MoU on South Stream. 
Later, in January 2008, South Stream AG was registered in 
Switzerland. South Stream AG is responsible for the offshore part of the pipeline. Both Gazprom and ENI hold a 50% in South Stream AG. French EdF and German Wintershall have each signed an MoU with Gazprom and ENI on joining the project. The integrated feasibility study, including the final route, is expected
 to be presented by the end of September. South Stream estimates the costs for the offshore section at approx. € 10 billion and the onshore part at around € 5
 billion. The ultimate costs will become clear when to final route is 
determined.

The offshore part of South Stream will run from the Russian 
compressor station Beregovaya to the Bulgarian coastal town of Varna. The preliminary onshore route splits into two 
directions after reaching Bulgaria. After passing through Greece and crossing the Adriatic, the southern twig ends in Italy. The northern twig continues through Serbia and Hungary ending at Austrian Baumgarten. There are also plans for a separate twig to split off to Croatia. In Hungary a separate pipeline continues to Slovenia ending at the Italian entry point of Traviso. The planned 
capacity of South Stream is 63 BCM / year, consisting of four separate 15,75 BCM strings. The first string is scheduled to be constructed by December 2015, with the fourth being completed by the end of 2018. The onshore part of South Stream will be implemented in each national
 section by a national South Stream company, which have already been established.