Two Pipelines Running in One DirectionFollowing the autumn 2012 agreement made between Russia and East European countries on the construction of the South Stream gas pipeline and the more recent withdrawal of one of the main investors from the Nabucco pipeline project, German energy giant RWE, the implementation of the Nabucco pipeline has been postponed for an indefinite time. However, as the key principle of economics suggests, monopolization and price increases stimulate desires to find substitutes, which is something that has already occurred in the natural gas market.
In December 2012, the Russian energy giant Gazprom inaugurated the construction of the South Stream. This project, envisaging building a gas pipeline under the Black Sea (from the Black Sea shore in Russia to Bulgaria) and then on land to Austria, will enable Russia to ship up to 63 billion cubic meters of natural gas per year to Europe, circumventing Ukraine and Poland in the process.
The South Stream project is yet another step by Russia to remove problematic transit countries (Poland and Ukraine) from its energy supply route to Europe. The first step, known as the Nord Stream pipeline, operating under the Baltic Sea from Russia to Germany, was completed two years ago to provide Gazprom with the ability to export a throughput of 55 billion cubic meters of natural gas per year.
With the dropout of German company RWE, Russia’s aggressive politics and the passivity of gas-supplying countries, the future of the Nabucco gas pipeline project, designed to carry natural gas from Caspian Sea countries to Europe via Georgia and Turkey, has been called into question.
Natural Gas – Europe’s Weakness
During the past few years, Europe has consumed between 550 to 600 billion cubic meters of natural gas per year, almost half of which has been imported. According to last year’s data, 28.7 percent of Europe’s total gas consumption (excluding CIS countries) was met by Gazprom, which provided Europe with more natural gas than any other single source.
Various international organizations and companies have predicted an increase in the European import of natural gas and the need to find additional sources of supply is obvious. This need becomes even more urgent considering two important aspects:
• Natural gas extraction in Europe is decreasing (in particular, if no decision is taken on the extraction of shale gas, the current rate of gas extraction in Europe will probably halve within the next 15 to 20 years).
• In 2011 Germany, Europe’s largest natural gas consumer, made the decision to replace its nuclear power plants, which generate 23 percent of Germany’s electricity, with other power generation plants by 2022. Some of these additional plants would rely on gas turbines.
According to the prognosis of the International Energy Agency, by 2025, Europe will need to increase the import of natural gas by 450 million cubic meters. Russia plans to supply at least half of that volume.
It is an acknowledged fact that for Russia natural gas is not only responsible for 12 percent of its Gross Domestic Product, but that it also serves as a quite powerful weapon in its foreign policy arsenal. Gazprom meets between 70 to 100 percent of the natural gas demand of many European countries (for example, Hungary, Slovakia, Finland, Bulgaria, Austria, Poland and the Czech Republic). The Nabucco project, designed to bypass Russia to supply Caspian natural gas to Europe, was especially important for East European countries as half of the throughput of this pipeline was intended for them. The implementation of the Nabucco pipeline would give these countries significant commercial and political capital in negotiating with Russia over the price of natural gas as well as in various political issues.
Moreover, Russia deems it important to teach a lesson to “disobedient” countries such as Ukraine and Poland. More than 80 percent of the 155 billion cubic meters of natural gas that Europe receives from Russia reaches Europe via Ukraine, while the remaining 20 percent goes there via Belarus. In 2011, Belarus yielded to Russia and agreed to join the customs union of the Eurasian Union in return for the price of natural gas not increasing. The construction of the Nord Stream rendered Belarus less important as a natural gas transit country for at least the next five to ten years and it was therefore not difficult to force it “agree” to these conditions. Besides Russia and Belarus, only Kazakhstan has expressed readiness to join the customs union. In building the South Stream pipeline Russia strives to achieve two goals: to undermine economic motivation for the implementation of the Nabucco project and to weaken Ukraine’s transit role in a manner analogous to as occurred with Belarus. By interrupting the natural gas supply to Ukraine and Poland, Russia will stillbe able to fulfill its contractual obligations to supply gas to Europe but will also be able to be bolder in its demands that Ukraine join the customs union as well as yield to other political issues.
Moreover, by building the South Stream and blocking Nabucco, Russia will be able to influence not only the prices of the gas supply to Europe but also the supply of natural gas from the Caspian Sea countries (Turkmenistan, Azerbaijan, Kazakhstan and Uzbekistan) to Europe. This is especially significant considering that these countries, in contrast to Persian Gulf countries (which can ship liquefied natural gas in tankers to European terminals), have no other means of supplying natural gas but the pipeline.
Nabucco vs. South Stream
Several projects were proposed for carrying natural gas from the East to Europe but none of them are so economically viable as the Nabucco and South Stream projects. Nabucco was an idea born out of the interests of the European Union and the United States, whereas the South Stream is a project created and supported by Russia’s political leadership.
Judging the two projects on economic and technical parameters, Nabucco is the more interesting. However, considering Europe’s increasing demand for the import of natural gas, the implementation of South Stream does not exclude the need for Nabucco, though the former will still cause the postponement of the latter for about six to eight years because of the lack of economic incentives.
The main advantages of Nabucco compared to the South Stream are:
• It will alleviate the dependence of East European countries on Russia;
• The project is open to several transit suppliers thus ensuring competition and consequently, protecting customers from monopolistic pricing;
• It will encourage the exploration of new gas fields because Europe is the most expensive market for the sale of natural gas;
• It will encourage the construction of the proposed Trans-Caspian Gas Pipeline which will open routes for the large natural gas resources of Turkmenistan, Uzbekistan and Kazakhstan to European markets, bypassing Russia and increasing the political independence of these countries
• It is technically easier to implement, its exploitation will be relatively cheaper and its economic parameters are better. Consequently, its transit tariff would be about 40 or 50 percent less than that of the South Stream (according to preliminary calculations the transportation of 1,000 cubic meters per 100 kilometers will cost 1.8 USD in the case of Nabucco and 3.5 USD in the case of the South Stream).
Despite the above noted advantages, Nabucco also has a number of quite significant disadvantages. These, in fact, have led to the current situation where the construction of the South Stream is underway (although some formalities, such as conducting an environmental impact assessment, have yet to be finalized) whereas the fate of Nabucco remains unclear.
1. Contracts from natural gas supplying countries/companies are not in place and financing the project without guaranteed contracts on energy resources is unimaginable. Even though Azerbaijan expressed its readiness to ensure half of the throughput of the Nabucco pipeline, conflicts with Iran, Russia’s blocking of the Trans-Caspian pipeline project and ambiguity about licenses and contracts for the extraction of natural gas in Iraq, have all raised doubts that the pipeline will not be used to its full capacity and that investors might not receive the economic benefits envisaged.
2. Investors have not assumed liability for the project (probably because of the problems noted in the above point), allowing them to withdraw their participation at any time. A clear example of this happening is the action of German company RWE, which announced its decision to withdraw about two months ago.. If the natural gas crises of 2006 and 2009 taught Europe anything, it was the need to diversify gas supplies. However, in spite of the economic and political exigency, the decision making process for 27 different participants has proved to be far less effective than the decision making process of just one participant.
4. Even though the implementation of Nabucco alleviates Europe’s dependence on Russia, it increases the dependence on Turkey. The increase in Turkey’s regional influence and its negative attitude towards Europe, which emerged as a result of opposition to Turkey’s EU membership, has caused an additional headache for Europe. The growth of Turkey’s economy at a time when the fiscal situation in some EU member states is distressing has further left Europeans wary of Turkey’s revival and unsure whether it is desirable to give Turkey additional leverage.
How Will Nabucco’s Impediments Affect Georgia?
For Georgia the effects of starting the construction of the South Stream and the ambiguous future of Nabucco will be more of a political than economic nature. In the event of Nabucco being implemented, Georgia will receive a certain volume of cheap gas in return for transit, investments worth several hundred million US dollars will be made (which would positively affect Georgia’s budget and current account balance) and new jobs for at least several hundred people will be created. Yet the political effects of the Nabucco project will be much more impressive. These will include greater integration in Trans-Caspian projects, a further strengthening of regional influence and higher motivation for Europe to support Georgia’s Euro-Atlantic integration.
The postponement of the Nabucco project gives Russia a big political advantage at the detriment of all those countries which the pipeline will cross and supply. This will provide Russia with more leverage when negotiating controversial political issues indirectly related to the project. That will only happen if the current status quo is maintained and Nabucco is not implemented.
Alternatives and Risks
At first blush, both pipelines serve one and the same purpose and the increase in gas consumption by Europe may put the need for the Nabucco project back on the agenda after South Stream resources have been exhausted. However, recent achievements made in the extraction and transportation of natural gas may create problems for the South Stream as well.
Since 2005, the world has actively started extracting shale gas. This extraction has been carried out on an especially large scale in the USA, making the country the largest gas producer in the world according to the last year’s data. At the same time, the price on natural gas has dropped significantly and today natural gas in the USA is almost 3.5 times cheaper than in Europe. This tendency will lead to a situation where 1) within several years the USA will become a natural gas exporter; 2) natural gas originally intended for the USA, which is shipped in liquefied form from the Persian Gulf and North Africa, will be redirected to Europe (this process has already partially started); 3) Europe itself will start the extraction of shale gas. Especially significant is the fact that potential resources of shale gas within Europe have been observed in countries that most heavily depend on Russia’s energy resources – Poland, Hungary, Slovakia, Germany, the Baltic States, Romania, Bulgaria and Ukraine.
Moreover, even though pipelines are the cheapest way of transporting natural gas today, technological developments have made the liquefaction of natural gas and its transportation by sea tankers cheaper. These developments mean that the natural gas market of Europe will have greater liquidity and both Gazprom’s influence and the price it offers will decrease. The big difference in gas prices between various world regions creates a precondition for turning the liquefaction of natural gas and its transportation by sea tankers into a profitable business. In future, Europe will decrease its import of gas and nothing may be left of either the South Stream or Nabucco but debts owed to international consortiums. As the former Saudi Arabian oil minister Sheikh Ahmed Zaki Yamani famously once said: “The Stone Age didn't end because we ran out of stones. It ended because people invented alternatives.”