The ambitious, €15 billion ($20.5 billion) South Stream project – which could deliver Russian gas to Austria and Europe by 2015 - took a step closer to reality on Friday, after a shareholder agreement for the offshore section of the pipeline was signed between Gazprom, Eni, EDF and Wintershall.
In my preliminary research paper – The Economics of the South Stream pipeline in the context of Russo-Ukrainian gas bargaining, I analysed the profitability of South Stream investment in the context of Russo-Ukrainian gas negotiations. South Stream, if realised, would allow Gazprom to completely bypass Ukraine. The project has received much publicity since its inception in 2007 and gained substantial support after the January 2009 gas dispute between Russia and Ukraine.
Policy literature is rather ambiguous regarding the South Stream project. Security of supply and competition with the EU-backed southern gas corridor reasoning concerning motivation behind South Stream investment saturates both expert analysis and media commentary. Despite its importance, limited efforts have been invested in rigorously analysing the economic rationale of Gazprom’s investment in South Stream in a systematic way.
South Stream’s project sponsors argue that the major objective of the pipeline is meeting the additional demand for natural gas in Europe while eliminating transit risks. Policy literature on South Stream also suggests that risks of transit disruptions through Ukraine may justify South Stream investment. However, based on my preliminary findings, it was shown that risks of transit interruptions through Ukraine do not justify the construction of the South Stream pipeline because under all transit disruption scenarios analysed in the paper the economic value of South Stream is negative.
Concerning natural gas demand as a factor that justify Gazprom’s investment in South Stream, it was found that the economic value of this investment would be positive ($1.1 billion over 25 years) only when demand in Europe grows at more than 2% per year until 2030. By 2030, natural gas consumption in EU27 is projected to grow at an annual growth rate of +0.7%, according to data by the International Energy Agency (IEA).
Most importantly, only in case Ukraine increases its transit fee considerably (e.g., to the level of around $5 per thousand cubic metres per 100 km, according to www.eparvda.com.ua), the economic value of South Stream investment would vary between $1 and 10 billion, depending on assumed demand growth rate in Europe. Ukraine’s demand for “economically” justifiable transit fees and/or lower import prices makes South Stream investment profitable and Ukraine risks being completely bypassed.
One of the most interesting results from the research shows that South Stream investment, as an insurance against Ukraine’s future bargaining over higher transit fees or lower import prices, has far greater economic value than its value as an insurance against transit interruptions and/or its value as a demand-driven project. The expert analysis and media commentary concerning Gazprom’s investment in South Stream miss this important dimension; that is, Gazprom’s bypass strategy towards Ukraine is not so much about meeting future gas demand in Europe while eliminating transit risks through Ukraine. This strategy is about eliminating Ukraine’s transit monopoly while preserving Gazprom’s own ability to extract monopoly rent from Ukraine’s gas market without risking its gas supplies to Europe.
Ukraine is a net importer of natural gas and gets all its imports (roughly 50 bcm/y) from Russia.
EU gas demand must grow by 2% per year for South Stream to be profitable
The ambitious, €15 billion ($20.5 billion) South Stream project – which could deliver Russian gas to Austria and Europe by 2015 - took a step closer to reality on Friday, after a shareholder agreement for the offshore section of the pipeline was signed between Gazprom, Eni, EDF and Wintershall.
In my preliminary research paper – The Economics of the South Stream pipeline in the context of Russo-Ukrainian gas bargaining, I analysed the profitability of South Stream investment in the context of Russo-Ukrainian gas negotiations. South Stream, if realised, would allow Gazprom to completely bypass Ukraine. The project has received much publicity since its inception in 2007 and gained substantial support after the January 2009 gas dispute between Russia and Ukraine.
Policy literature is rather ambiguous regarding the South Stream project. Security of supply and competition with the EU-backed southern gas corridor reasoning concerning motivation behind South Stream investment saturates both expert analysis and media commentary. Despite its importance, limited efforts have been invested in rigorously analysing the economic rationale of Gazprom’s investment in South Stream in a systematic way.
South Stream’s project sponsors argue that the major objective of the pipeline is meeting the additional demand for natural gas in Europe while eliminating transit risks. Policy literature on South Stream also suggests that risks of transit disruptions through Ukraine may justify South Stream investment. However, based on my preliminary findings, it was shown that risks of transit interruptions through Ukraine do not justify the construction of the South Stream pipeline because under all transit disruption scenarios analysed in the paper the economic value of South Stream is negative.
Concerning natural gas demand as a factor that justify Gazprom’s investment in South Stream, it was found that the economic value of this investment would be positive ($1.1 billion over 25 years) only when demand in Europe grows at more than 2% per year until 2030. By 2030, natural gas consumption in EU27 is projected to grow at an annual growth rate of +0.7%, according to data by the International Energy Agency (IEA).
Most importantly, only in case Ukraine increases its transit fee considerably (e.g., to the level of around $5 per thousand cubic metres per 100 km, according to www.eparvda.com.ua), the economic value of South Stream investment would vary between $1 and 10 billion, depending on assumed demand growth rate in Europe. Ukraine’s demand for “economically” justifiable transit fees and/or lower import prices makes South Stream investment profitable and Ukraine risks being completely bypassed.
One of the most interesting results from the research shows that South Stream investment, as an insurance against Ukraine’s future bargaining over higher transit fees or lower import prices, has far greater economic value than its value as an insurance against transit interruptions and/or its value as a demand-driven project. The expert analysis and media commentary concerning Gazprom’s investment in South Stream miss this important dimension; that is, Gazprom’s bypass strategy towards Ukraine is not so much about meeting future gas demand in Europe while eliminating transit risks through Ukraine. This strategy is about eliminating Ukraine’s transit monopoly while preserving Gazprom’s own ability to extract monopoly rent from Ukraine’s gas market without risking its gas supplies to Europe.
Ukraine is a net importer of natural gas and gets all its imports (roughly 50 bcm/y) from Russia.