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Nabucco and South Stream - The Race Heats Up, CU Issue 34, May 25, 2009

The world of international pipelines usually moves at a glacial pace. So this week’s developments were, by the standards of the industry, dramatic. On May 17 a gas deal was signed by Austria’s OMV and Hungary’s MOL with local partners in the Kurdish part of Iraq which could have – and, conceivably, may still – save the troubled Nabucco pipeline. But hopes were crushed the following day as officials in Baghdad insisted that the central government would block any unapproved export deals. Meanwhile on May 15 Russia secured support from Italy, Greece, Serbia and Bulgaria for its South Stream pipeline, Nabucco’s competitor (BBC News, May 15). And on May 22, the Russian Energy Ministry stated with confidence that South Stream would be built before Nabucco.

Although there is a hint of triumphalism about this statement, it is hard to disagree. The problems with Nabucco are well attested – lack of reliable supplies, Turkish obstinacy over cost, and a lack of united effort by the EU – and the Iraqi deal may have been its final hope (Eurasianet, May 19). OMV and MOL, both members of the Nabucco consortium, signed an agreement with Dana Gas and Crescent Petroleum, two UAE-based companies, to invest $8 billion in the development and infrastructure of gas fields in Iraqi Kurdistan (Dana Gas Press Release, May 18). By 2014, Nabucco’s estimated start date, the Iraqi gas fields could be producing 3 billion cubic feet a day, the volume which Nabucco is intended to carry to Europe.

The agreement is undermined by wrangling between the Kurdish Regional Government (KRG) and the central government in Baghdad. The lack of a federal hydrocarbons law has made the issue of exporting oil and gas from the autonomous Kurdish region extremely contentious, which illustrates that the real risk for investors in Iraq these days is not violence – although this is still clearly a problem – but the unsettled political and legal climate. The Oil Minister, Hussain al-Shahristani, stated bluntly that gas exports would not be allowed without Baghdad’s approval: unlikely, since there is no agreement on how the profits of exports would be shared. Baghdad is desperate for extra revenue and will not allow the KRG to take sole control of such a lucrative export deal.

So whilst the central government and the KRG argue, the said agreement will remain stuck in limbo and Nabucco will remain without a supplier. The fact that hopes have come to rest on Iraq, a country which has only recently and tentatively emerged from a savage civil war, speaks volumes about the problems facing the project.

In the meantime, South Stream proceeds apace, demonstrating once again that Moscow’s willingness to back its energy giant Gazprom to the hilt, even in projects with questionable commercial logic, earns dividends (this willingness also makes Russian criticism of Nabucco as “no more than a political undertaking” rather hollows). South Stream will cross the Black Sea to Bulgaria, from there branching north – through Serbia, Slovenia and Hungary into Austria – and south, through Greece and into Italy. It is due to be finished in 2015, a year after Nabucco, although the completion date of that project is likely to be pushed further and further back.

Gazprom’s commercial flexibility was on clear display at the May 15 meeting. It backed away from its earlier insistence that South Stream used Bulgaria’s existing pipelines, to save costs (or to increase the logistical difficulties for Nabucco, which would also run through the country), and conceded ground to Italy’s ENI, which demanded to sell gas to transit countries on the route (Reuters, May 15). Although technical work has yet to begin, all the agreements are more or less in place. Austria and Slovenia are expected to sign up in June.

In another bold move, Russia has requested that the European Commission grant South Stream priority status (Upstream Online, May 22), which would probably steal the momentum once and for all from Nabucco. There is a sense of pessimism in the EU over its relationship with Russia at the moment, as a disappointing EU-Russia summit on May 22 made plain. The meeting in Khabarovsk ended with fears of a new ‘gas war’ between Russia and Ukraine as Moscow cast doubts on Kiev’s ability to pay its debts (BBC News, May 22). Although unspoken, the underlying message – that diversifying Europe’s gas supplies as soon as possible is the only way to secure energy security – is unmistakeable. Russia also refused to ratify the Energy Charter, which would force greater transparency and accessibility in Russia’s energy industry, and instead called for the treaty to be replaced. The EU is unwilling to cave in to Moscow’s demands, but is equally unwilling to create even more problems in the moribund ‘strategic partnership’.

The next move in the ongoing energy race? It may take some time to become obvious, but it seems likely that Europe will quietly accept South Stream and begin to cool down support of Nabucco. The project is unlikely to die entirely; partly because that would be a blatant sign of capitulation to Moscow and partly because it is hard to see the EU gathering the collective will to do anything so decisive. The sign to watch is whether or not the Commission grants South Stream priority status.

Of course, if Iraq’s politicians can set aside their differences and miraculously pass a federal oil and gas law, then Nabucco is back in the running. But – and this is far less commonly realised - this could seriously undermine the rationale for the European penetration of the Caspian region which, although driven by energy, was intended to link those states with the West, provide a geopolitical alternative to Russia and settle the region’s security problems. Without the incentive to invest political capital in bringing the Caspian’s hydrocarbons to market through the Southern Corridor, the EU may allow the Caucasus and Central Asia to fall back into the Russian sphere of influence. Expansionists in Brussels should hope that South Stream fails.

This hope may yet be fulfilled by the pressures of the market. Gazprom announced on May 22 that its gas production in 2009 could be cut by up to 18%, due to the global recession and weakening demand. In such a climate, even the Kremlin may think twice before throwing €24 billion into South Stream.

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