Russia Abandons South Stream But Not Goal of Bypassing Ukraine

President Vladimir Putin's decision to drop the South Stream pipeline project is a blow but not an end to Russia's search for ways to get natural gas to Europe without going through Ukraine.

The Kremlin wants to find routes to bypass Ukraine to cement its position on the European market and reduce reliance for energy transit on a country with which relations are strained.

The new focus of attention, a proposed undersea pipeline to Turkey, is a costly alternative at a time of flagging European demand and competition from rival projects.

Some experts say Russia could have saved billions of dollars by continuing to ship gas through Ukraine and negotiating a new deal despite the crisis in relations between Moscow and Kiev.

"I don't believe that Ukraine should be bypassed at all," said Alexander Fak, an analyst from Sberbank CIB, who put the South Stream total costs at $50 billion. "It's easier to have an agreement with Ukraine."

Fak said it was still not certain exactly which route an alternative to South Stream would take. He also questioned the wisdom of Russian gas producer Gazprom trying to fund a pipeline under the Black Sea alone, rather than as part of a consortium as would have been case with South Stream, which Russia abandoned on Monday.

"They (Russia) will build the new undersea pipeline, though it's not clear where will it end up," he said. "Unfortunately, there is nothing in yesterday's news to indicate that the Gazprom-financed stretch would be curtailed."

Gazprom has already spent about 400 billion roubles ($7.8 billion) expanding its domestic pipeline network in preparation for delivering supplies via South Stream, which was to enter the European Union via Bulgaria.

But that cost may not have been wasted. Experts say the infrastructure could be used to carry gas to southern Europe along the bed of the Black Sea under a plan highlighted by Gazprom Chief Executive Officer Alexei Miller.

Miller said on Monday that Gazprom and Turkish energy firm Botas had signed a memorandum to build an undersea pipeline to Turkey with an annual capacity of 63 billion cubic metres (bcm)- on a par with South Stream's planned volumes. European gas demand, however, has fallen 7 percent this year.

"I'm sceptical about the need of 63 bcm. Who will buy it? Also, don't forget about the rival TAP project," Alexander Kornilov, an analyst with Alfa bank in Moscow, said.

Trans Adriatic Pipeline (TAP) aims to ship 16 bcm of gas a year from Azerbaijan's Shah Deniz II field in the Caspian Sea by the end of the decade to Turkey and on to Italy.

The Russian project would have a cheaper price at the EU point of sale - around $9 per million British thermal unit (mmBtu) compared with $11 per mmBtu for TAP.

Some analysts believe that Gazprom may not necessary build the pipeline with the 63 bcm capacity at one go.

"Gazprom's best option may be to start with a single 16 bcm link, which may be sufficient for consolidating Turkish flows bypassing Ukraine, before establishing a significant new market presence in the region with a number of highly touted gas infrastructure projects," Artyom Konchin from Otkritie Capital said.


By Vladimir Soldatkin,  additional reporting by Katya Golubkova in Moscow and Henning Gloystein in Singapore