With Russia and Turkey starting technical implementation of the Turkish Stream pipeline this week, the project might become another geopolitical trump card in the hands of the Kremlin in its negotiations with the EU.

Russian President Vladimir Putin, left, and his Turkish counterpart Recep Tayyip Erdogan speak to the media during a joint news conference at the new Presidential Palace in Turkey, Monday, on December 1, 2014. Photo: AP

The November 2014 decision by Gazprom, Russia’s largest gas company, to halt its South Stream project and replace it with a new project - Turkish Stream - came amidst another low in the Kremlin’s relations with the West. This stance – as well as Western sanctions on Russia and the falling price of oil – contributed to the deteriorating state of Russia-EU gas relations. As a result, this new project might be a new gamble by the Kremlin to apply geopolitical pressure on the EU.

Amidst the talks about the launch of the Turkish Stream, Gazprom was clear about its plans to stop Russian gas from flowing to Europe via Ukraine by 2020. This statement alone suggests that Gazprom is still very much focused on the European export market, and is willing to use all opportunities to push its European customers to recognize the importance of Russian gas supplies.

One of the leading Russian newspapers Kommersant writes that, “Gazprom is setting an ultimatum: Gas supplies through Ukraine will stop by 2020 and Europe has to arrange its transport options to receive its gas at a delivery point on the Turkish-Greek border.” This stance seems to indicate that the South Stream cancellation altogether could be just a mere bluff in Russia’s attempt to push Europe to revise its approach to the project from a regulatory perspective.

However, is that really the case?

The history of the South Stream project with all its regulatory problems - and now its replacement by an entirely new pipeline project - reveals the real logic and motives of the Russian authorities.

Understanding the motives behind the South Stream 

The South Stream project was announced in 2006. The official position of Gazprom, which initiated the project, is that the project was targeted at lowering the supply risks that appear in the flow of Russian gas supplies to Europe through Ukraine. Actually, it was the Kremlin’s response to the 2005-2006 Russia-Ukraine gas wars, an attempt to modify the Russian energy strategy.

Another explanation is that the project was meant to undermine the Nabucco pipeline, the once dead-in-the-water alternative to Russia’s South Stream, the gas pipeline from the Turkish-Bulgarian border to Austria. Nabucco is the main source for the Southern Gas Corridor, a priority infrastructure project for the development of the European gas market that was promoted through gas market liberalization legislation – namely, the Second Gas directive – and, at a later stage, the Third Energy Package.

Whichever motivation was true, European counterparts were ready to get on board for the South Stream project. The initial partner was the Italian company ENI. Later, ENI was joined by EdF (France) and Wintershall (Germany). Plus, a series of intergovernmental agreements were signed with the countries through which the onshore part of the pipeline would run.

One of the key problems that the project was facing was the regulatory regime in the EU. When realizing infrastructure projects in Europe, foreign companies have to adhere to the requirements of the Third Energy Package.

The provision most problematic to the South Stream project is the request that any pipeline operator provide third party access to transport capacity. Under this provision, 50 percent of transport capacity has to be available for third parties, while for the largest infrastructure projects, it is essential to be able to work at full capacity in order to generate maximum capital flows and ensure the quickest return of investment.

If only half of available capacity is used upon completion, the economics of the project are considerably less favorable compared to the initial calculations assuming full capacity functioning. One option could be an “exception regime “for a certain period of time for the new project, but such permission proved to be impossible to arrange for the South Stream despite the fact that the option of such exception was referred to as possible by the European Commission at the end of 2013. The Ukrainian standoff, combined with other geopolitical turmoil in 2014, played a role and affected Russia’s chances to gain an exception regime for the South Stream.

Is Turkish Stream a geopolitical bluff?

In this regard, it seems useful to address several issues that inevitably arise when discussing the change of Russia’s plans on its gas exports via the Black Sea through the Turkish Stream.

First of all, Turkish Stream is hardly likely to be any sort of bluff played by Gazprom in order to get out of a complicated situation in the European market, or to push its European counterparts to reconsider their approach to the initial South Stream. In reality, it looks rather like an attempt to, on the one hand, have a more financially reasonable project that can be used at full capacity once built. On the other hand, the sunk cost associated with the South Stream construction project (which had already started), as well as accompanying contracts, will not be purely crossed out.

Secondly, Russia is not risking its reputation as a reliable supplier by suggesting Europe to take gas from a new delivery point (not the border of Ukraine but the Turkey-Greece border). Russia risks its reputation only in the breach of contracts. If contracts are renegotiated accordingly, one cannot talk about any such risks.

Thirdly, there will likely be sufficient demand for the 63 billion cubic meters (bcm) of the Turkish Stream. This, despite the fact that some critics point out that 63 bcm of the new pipeline is too big for Turkey. Yet the Kremlin’s logic rests on the assumption that the capacity of the Turkish Stream is meant not only for Turkey but also for Europe, and in that regard, it takes into consideration the outlook of Russia’s exports to Europe.

However, the core of the logic remains the same - to have this new pipeline as an alternative to the Ukrainian route. Therefore, in the conditions of a civil war-like confrontation in Ukraine and the deteriorating state of the transport infrastructure, there might be demand for the gas that flows through the Turkish Stream.

Summing up the implications of the South Stream cancellation and the Turkish Stream launch, it is safe to say that the European regulation (which definitely posed a challenge for the South Stream) was not detrimental in reality.

The 2014 economic crisis in Russia is the ultimate reason for the project to be cancelled and the overall strategy to be revised. It has to be noted that the new strategy is actually welcomed as a “more logical commercial strategy,” as suggested by researchers from the Oxford Institute of Energy studies in their energy comment on the case of South Stream.

The cancellation of the project is definitive in that it signals that Russia is not ready to proceed with high-cost projects amidst uncertainties in its position in the European gas market or the intransigence of the European Commission in its policy toward new energy infrastructure projects.

The opinion of the author may not necessarily reflect the position of Russia Direct or its staff.