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With Turkish Stream, Gazprom Faces Major Obstacles

6 MINS READJul 9, 2015 | 22:05 GMT
Flags of Turkey, Russia and Italy hang on the Blue Stream natural gas pipeline in Samsun, Turkey. (MUSTAFA OZER/AFP/Getty Images)
(MUSTAFA OZER/AFP/Getty Images)
Flags of Turkey, Russia and Italy hang on the Blue Stream natural gas pipeline in Samsun, Turkey.
Summary

For the second time this week, Russian energy firm Gazprom has announced the suspension of a contract to construct its planned Turkish Stream pipeline. First, on July 6, the company asked pipeline suppliers to suspend deliveries. Then it canceled a contract July 9 with Italian oil and natural gas contractor Saipem. The developments follow the passing of a June 29 negotiating deadline in talks over natural gas discounts between Turkey and Gazprom. The setbacks highlight the difficulty that Gazprom has had implementing the Turkish Stream project on schedule — and foreshadow future complications. Gazprom had planned to begin construction on the first phase of the pipeline, which involved Saipem. The completed first phase of the pipeline was then set to enter service by the end of 2016. With the latest cancellations and delayed talks with Turkey, that start date is now likely to be delayed.

Gazprom originally awarded Eni subsidiary Saipem the contract to lay the underwater pipelines for the first phase of the South Stream project in 2014. But South Stream was canceled in December 2014 and quickly replaced by Turkish Stream. The new pipeline project will unfold in four phases and ultimately consist of four parallel underwater pipelines across the Black Sea with a capacity to transport 63 billion cubic meters of natural gas each year. With the switchover from South Stream to Turkish Stream, Gazprom had hoped to migrate the contracts from one to the other without difficulty.

At the beginning of May, Gazprom officially asked Saipem to resume activities to prepare for the construction of an underwater pipeline across the Black Sea. However, the Italian company never confirmed that it was going to follow through with Gazprom's wishes. The lack of a response was not surprising. Numerous legal, technical, logistical and engineering issues made it difficult to migrate the contract to a different project with a different route, length and cost structure. Gazprom and Saipem had been negotiating for some time to resolve these issues.

At the same time, Gazprom has been negotiating with Turkey to finalize an agreement on Turkish Stream, formulating a memorandum of understanding in early June. But Turkey has been reluctant to finalize an agreement. One sticking point has been Ankara's request that Gazprom provide a natural gas discount to Turkish state-owned pipeline company BOTAS. On June 29, a six-month window closed for these negotiations, which stalled over disagreements on the size of this discount. No deal was made and hence there is no final agreement between Turkey and Gazprom. 

Gazprom's talks with both Saipem and Turkey broke down this past week partly because of the July 6 announcement of the suspension of pipeline equipment deliveries. In spite of this, Greek Energy Minister Panagiotis Lafazanis presented plans July 9 for the Southern European Pipeline, which would cost 2.2 billion euros ($2.27 billion) and carry 47 billion cubic meters of natural gas from Turkish Stream into Europe. This Greek proposal is a result of Russia's manipulation of tense ongoing negotiations with the European Union. The European Union is trying to lessen its reliance on Russian natural gas and instead supports the Trans-Adriatic Pipeline from Azerbaijan through Greece to Italy.

Russia would like to move ahead with Turkish Stream as quickly as possible. Gazprom's options to accelerate the schedule, however, are becoming increasingly limited — it will have to find new suppliers and contractors while negotiating with Turkey. Gazprom can now pursue one of several strategies. The first and most likely of these is to negotiate with other potential contractors to award a new pipeline-building contract tailored to Turkish Stream's specifications. This would likely delay construction beyond 2016 and into 2017, if not further. Alternatively, if Gazprom can quickly bridge the gap between Saipem and itself, it may be able to put the project back on schedule. But given how quickly negotiations fall apart and the fact that it was Gazprom that broke the contract, it likely points to significant disagreements between the two that will not be quickly resolved.

Gazprom's other option is to continue its attempts to migrate South Stream contracts to Turkish Stream. It has done so already for several of these and could do so for others. To overcome the Saipem obstacle, Gazprom could substitute a 2014 South Stream contract with Swiss-based Allseas Group, for example. Of course, doing so comes with all the same complications that Gazprom faced with transferring the Saipem contract.

In addition to Turkey's stalling and the breakdown of relations with Saipem, there are additional obstacles to the project. The first (and possibly second) phase of Turkish Stream will be to sell natural gas to the Turkish and Greek markets. Russia and Gazprom's end goal, however, is for the final two or three phases to allow them to bypass Ukraine. This will be difficult. Gazprom typically opts for long-term contracts of 20-25 years with specific terms about the delivery of natural gas, including the route. For many Central European customers, the delivery point is either Velke Kapusany between Ukraine and Slovakia or the Central European Gas Hub at Baumgarten on the Austrian-Slovak border.

Gazprom will likely try to use Turkish Stream to fulfill some of these contracts. However, the company has set 2019 as the year for final deliveries through Ukraine. Switching over to Turkish Stream would mean modifying the contracts or finding alternative routes to delivery points.

Neither of these would be easy. Modifying contracts would force Gazprom to make concessions. This is what happened with Nord Stream, and Gazprom had to negotiate with Czech natural gas transmission operator RWE Transgas to move the delivery point from Velke Kapusany to Lanzhot on the border of Slovakia and the Czech Republic. The second option, to build new routes, is challenging because EU legislation has made building additional pipelines and establishing different routes more difficult. This is largely because of the unbundling clause of the Third Energy Package, which forbids natural gas suppliers and buyers from owning transmission mechanisms, such as pipelines, in the same market.

In the past Gazprom had tried to skirt these concerns in places such as Bulgaria, where it has more political pull, but even that fell through and led to the cancellation of South Stream. Gazprom has since moved away from challenging these regulations and must now partner with other companies to build lines. This was a challenge for Gazprom during Nord Stream, though in that case the pipeline was given Trans-European Network status at Germany's behest so it could bypass certain regulations. Turkish Stream, like South Stream, will not be accorded this status and will have to deal with the long process of negotiating with private companies.

With Turkish Stream and the recently announced Nord Stream 2 project, Gazprom has sent a clear message to Europe that in the future the company will not be abjectly dependent on Ukraine to send natural gas west. Instead, Gazprom will have multiple routes to choose from, increasing its negotiating power against the European Union, which has been trying to dismantle the company's near-monopoly. However, Gazprom is quickly realizing that the negotiation process, both at the political and commercial levels, is going to be slow and painful.

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