Why is it a big surprise to Brussels that Russia will stop gas transit via Ukraine?

It is better for comparison to start with considering surprises caused by natural disasters. Perhaps this is what it is the most difficult to predict and to prevent. As you may know, all over the world considerable resources are spent on current monitoring and assessment of the impact of various natural hazards on energy markets, from a sharp drop in temperature in winter to a catastrophic earthquake and tsunami that could radically change the concept of energy development of entire countries. So as it happened in Japan after the Fukushima nuclear disaster.

However, it is not always possible to avoid the consequences. In January severe storms in the North Sea caused a nasty surprise - three major gas fields were shutdown facing a high danger of short circuit in power supply. Statoil was forced to stop production at the largest gas field Troll, which accounts for 60% of all gas on the Norwegian shelf. Production outages triggered by bad weather resulted in a sharp drop of about 40 percent in Norway's gas exports. Obviously, it is impossible to foresee these kind of surprises.

Nowadays in the 21st Century climate change and political tensions are having significant implications on the energy market. Nevertheless, often the events taking place in this area, firstly, are not always, and, secondly, are not so straightforward perceived by everybody as something extraordinary. In general, there is a common opinion now that it is hard to find any big surprise for us.

Arguably, the cancellation of the South Stream gas pipeline project became a real sensation. Many observers and experts noticed that President Vladimir Putin's decision to abandon the South Stream announced on December 1 actually stumped politicians in Brussels. There were no clear comments of the EU leaders even on the next day. The arguments appeared later that Russia allegedly was required to negotiate for many weeks in order to denounce the interstate agreements on the construction of the pipeline. Although for everyone who had ever followed just a bit of the South Stream project development, it was obvious that because of a growing political pressure from Brussels and Washington Bulgaria would never give permission for the construction, and therefore further implementation of the project would be impossible.

Maybe then, for somebody it was a real surprise. However, interpreting the well-known saying "Sawing off the branch they're sitting," we can point out that in this case the surprise was that partly sawed off branch collapsed at UNPREDICTABLE TIME, but it was not the fact of the collapse itself.

In other words, it is unlikely a surprise that the project, which had been "sawed off" so diligently for several years, collapsed. Europe should be much more surprised if the project somehow would hold out under such conditions, should not it?

If we reject unserious versions trying to explain the expression of surprise in the reaction of European politicians, then it remains only to assume that they expressed an outwards demonstrative amazement. And indeed there was no surprise to those who deliberately and openly led the situation with the South Stream project to such an outcome.

It is in the past already, in the history of the EU's relations with Russia, where in the future a separate chapter will be devoted to the unfulfilled South Stream project. It would make sense for all of us to see the hidden intrigue of this past story in order to recognize correctly what real and, especially, what alleged surprises further await the European energy market. After all, there will be still other causes yielding new surprises.

The EU looked like very much surprised again when the Russian Gazprom announced its intention to redirect in the near future its natural gas transit, which goes to Europe via Ukraine. The Vice President of the European Commission, in charge of Energy Union Maroš Šefčovič was informed about it during a one-day visit to Moscow on January 14. At the meeting the head of Gazprom Alexey Miller said: "The project (South Stream – ed.) is closed. The gas pipeline Turkish Stream is the only route by which can be supplied 63 bcm of Russian gas going now while in transit through Ukraine. No other options. Our European partners informed of this, and now their task is to create necessary infrastructure from the border of Turkey and Greece".

Maroš Šefčovič commented that he was “very surprised” by Alexey Miller’s statement, adding that such a decision could have a negative impact on Russia's reputation as a reliable supplier of gas.
However, underlining the reliability of Russian gas supplies, Maroš Šefčovič perhaps unintentionally got directly to the point. That is it because Russia has already explained not once that the decision to build the South Stream pipeline bypassing Ukraine induced by the necessity to ensure security of gas supplies to Europe. After its cancellation, Russia again found the other route around Ukraine as "Turkish stream."

Obviously there is the only one reason in this case - it is a non-decreasing political and economic instability in Ukraine, which, unfortunately, the EU could not take under international control up to now. And many of us in Europe doubt that it hardly ever would be possible.
It is appropriate to recall how the supplies of natural gas to Europe were completely shut off twice in 2006 and 2009 because of a pricing dispute between Russia's Gazprom and Ukrainian gas monopoly Naftogaz.

First serious dispute began in March 2005 over the price of natural gas supplied and the cost of transit. Russia claimed Ukraine was not paying for gas. At the same time Ukraine siphoned off gas from the transit pipelines which was intended to be exported to the EU. Ukrainian officials at first denied the accusation, but later admitted that transit gas was used for domestic needs. When the negotiations came to a standstill on January 1, 2006 Russia cut off all gas supplies passing through Ukraine and only on January 4, 2006 Russia and Ukraine reached a preliminary agreement, and the supplies to Europe were restored.

The second shut down of gas transit to Europe via Ukraine happened in the most severe period of winter in 2009 and lasted for nearly two weeks. Because of the gas supply disruptions through Ukraine in 2009 Slovakia and a number of Balkan countries had to impose severe restrictions in gas consumption, many industrial enterprises stood still and electricity power supply was disconnected as well.

Now under a catastrophic mismanagement of the country and resumption of massive hostilities in the South-East of Ukraine, neither any Kiev's promises nor encouraging words from Brussels cannot reassure in the reliability of the Ukrainian gas transit route to Europe, it does not matter who will be trying to prove it.

Now let's imagine that in 2019 Russia will fulfill its intention not to renew the transit agreement with Ukraine and also will offer the EU to receive gas from other routes, primarily by the planned Turkish stream pipeline. It's hardly possible to allege that the construction of Turkish Stream pipeline can result in reducing the security of supply in the EU or will somehow influence negatively on reputation of Russian gas supplier. It shouldn't be surprising that now Russia itself as a reliable supplier openly suggests taking into account in advance these future gas route changes.

Ultimately, it comes as no surprise for Europe, but instead there will be the challenging task that should encourage the EU to implement the European energy security strategy with consideration of new southern routes of gas imports to the EU to be opened in the near future.

As it is correctly noted in the comments published by The Economist, with all its disadvantages a perennial contention over the construction of the South Stream, as well as the recent turn of events in the direction of the Turkish stream can positively affect the integration within the European energy sector. And besides, Russia's energy policy has actually given an additional impulse to accelerate the development of the project of the Energy Union.

However, the question then arises: whether all the countries in Europe are ready for such a development?

Why is it unlikely possible for Bulgaria to become a testing ground for the newly created Energy Union?

In the middle of the 20th century Sir Winston Churchill had already called the Balkans as "Europe's soft underbelly". Since then, unfortunately, little has changed, and these unflattering comparisons were already used countless times. Again, there is an article in such an authoritative source of international news as "Financial Times" under the same title:” The Balkans are the soft underbelly of Europe”. This time an old unpleasant epithet is applied to the Balkans in the article of Bulgarian political scientist.

Even so, it is doubtful whether the majority of the Balkan countries agree with this characteristic. As for Bulgaria, the political scientist is right saying so about his own country. Unfortunately, Bulgaria has turned out the weakest link in the chain of partner countries, which have taken a consistent position for several years pursuing their national interests in strengthening its own, emphasize once more, its own energy security by means of participation in the South Stream project.

Bulgaria experienced the most intense political pressure. There was no other partner country taking part in the South Stream project implementation visited by so many high-ranking policy makers from Brussels and Washington. Ultimately, Bulgaria did not sustained, turned backwards under that political pressure and blocked the South Stream pipeline by not issuing construction permits. Since then, the opponents of the South Stream pipeline are pleased to repeat that the cancellation of its construction reducing Moscow's influence.

But the problem is that this so-called "influence reduction" did not move the Balkan countries any closer to solving pressing economic issues, which require a drastic improvement in energy supply. The Bulgarian political scientist called the Balkans just a "EU's backyard" in his article in FT. Nevertheless, it should not mean that EU citizens living there do not need modern and stable lighting and heating, environmentally friendly transport, etc., do they?

Almost nobody conceals now in Europe that Russia's refusal to construct the South Stream gas pipeline came as a total surprise. As if the EU did not do its utmost to slow the commencement of its construction until the very last day apparently not expecting it really can happen. An awareness about what had really happened appeared only when Russian President Vladimir Putin stated about cancellation of the South Stream gas pipeline. Before that neither in Sofia nor in other European capitals, obviously, such a scenario was not considered.

That is why the Prime Minister of Bulgaria Boyko Borisov had urgently to leave for Brussels to consult with the European Commission Vice President Maroš Šefčovič. The Prime Minister brought to Brussels a proposal to build a gas hub in Bulgaria, which could be a part of the infrastructure necessary for implementation of plans for creating the Energy Union.

Meanwhile, there are still doubts that the idea of this gas hub originally belonged to Bulgaria since before that the country's leadership did not demonstrate enough initiative often proving appropriateness of Churchill's characteristic with regard to the Balkans mentioned above. However, it does not matter who invented the idea of constructing a gas hub in Bulgaria. Another thing is much more important. This idea resulted from the necessity of providing the society with convincing arguments that, despite the problems with the South Stream pipeline, there are some alternative projects for energy development and, therefore, the loss is not so great.

But there is an understanding as well as more or less concealed annoyance in the majority of the Balkan countries that in fact they will encounter a significant loss of future benefits because the project cancellation postpones real opportunities of increase in energy consumption by several years.

Meanwhile it is necessary to consider not only energy problems, but also missed out huge investment gains. Russian Gazprom invested in the Nord Stream pipeline through the Baltic Sea, and it was supposed to be with the South Stream as well.

Joint project companies were created for implementation of onshore part of the South Stream pipeline in all countries - partners of Central and South East Europe. For example, South Stream Bulgaria is a joint-venture company established to manage the project in Bulgaria, owned equally by Russia's Gazprom and the state-run Bulgarian Energy Holding (BEH). In August last year South Stream Bulgaria joint venture raised its capital to 397.6 million Levs (about 200 million Euro).
Having abandoned the South Stream project Gazprom stopped investing into development of the EU gas transportation infrastructure. More importantly, this decision marked the beginning of radical changes in the strategy of the Russian company, which before was primarily focused on gas deliveries to the countries of end users in the European market.

In this regard, the head of Gazprom Alexei Miller stated after the talks in Moscow with the European Commission Vice President Maroš Šefčovič on 14 January that the new Gazprom strategy in Europe would be built in compliance with EU plans for creation the Energy Union that envisage centralizing purchases of Russian gas. In this regard, Gazprom intends now to construct new pipelines for delivering gas up to Europe's borders only.

Especially it concerns a new gas pipeline Turkish Stream announced simultaneously with the cancellation of the South Stream, which is considered as its direct successor. The new pipeline to Turkey will have an annual capacity of 63 bcm and will include a gas hub on the Turkish-Greek border specially constructed for customers in Southern Europe.

It turns out that Russian Gazprom purposely changed the new gas transmission infrastructure to make it consistent with the model of the future Energy Union, which has become one of the top priorities of the new European Commission team. The European Commission Vice President Maroš Šefčovič said it is expected that the concept of Energy Union is to be presented in February 2015. The Concept of Energy Union will include infrastructure projects aimed at building a single internal energy market.

However the question is whether the gas hub proposed by Bulgaria is included in the Concept of Energy Union? Probably not, and in future Bulgaria will be receiving gas from the Turkish gas valve since an opportunity of taking a position of the major Balkan hub on the South East border of Europe was missed forever. Because without the South Stream there is no gas in Bulgaria to distribute and to transit. "Gas hub does not make sense without Russian gas, "- said the former Bulgaria’s President Georgi Parvanov on the construction in Bulgaria a gas distribution hub instead of the South Stream pipeline.

Obviously, the chances to build a gas hub in Bulgaria on the EU money are very weak. Furthermore, there will be no financial support from Washington as it became clear after US Secretary of State John Kerry's visit to Sofia, when he announced plans just to send the top US energy official and no more.

Therefore, Bulgaria is unlikely to become a testing ground for the implementation of a new model of the Energy Union, acting as a gas intake and transit facility for the EU gas imports. Now Bulgaria is offered another role clearly defined in the article of well-known American edition «Foreign Policy» on January 16 under the title: "Bulgaria Is the New Battleground in Fighting Russian Energy".

No wonder as far as Bulgaria has served against its own energy interests and now the country will be getting so called anti-gas bastion rather than a gas hub.

Why does it happen that actually the fight against real energy projects, which are capable to strengthening energy security, is presented as an undeniable option? 
Why did it suspend improving the quality of life especially by means of achieving for that a required level of energy consumption in EU countries?

Is there anybody who would be willing to invest in the Ukraine’s gas transportation system? Moreover, why is there actually no one at all?

Popular opinion has been spread for a long time, especially among European politicians, that the pipelines "Nord Stream" and "South Stream" had the only one goal - to punish Ukraine depriving this country of gas transit business. Of course, this point of view primarily reflects the Ukraine's interest in retaining of its transit revenues. This is a fact that now it is one of the few stable sources of foreign currency earnings, which are very severely lacking on urgent needs of the Ukrainian dented economy.

As well as everywhere in the energy sector now Ukraine is experiencing an acute shortage of funds for purchasing gas. Therefore, no wonder if the amounts received from Russia for gas transit services are paid back to the Russian company “Gazprom” for new gas deliveries. According to Ukrainian sources, in September 2014 Russia paid for the transit of gas 68 million USD and about 70 million USD in October. These, in terms of gas contracts relatively small amounts were included in 387 million USD that on 5 December the Ukrainian company “Naftogaz” transferred to “Gazprom” as an advance payment for the supply of 1 bcm of gas from Russia. Recently on December 31 "Gazprom" received 150 million USD from Ukraine’s "Naftogaz" as an advance payment for Russian gas supplies in January 2015.

At first thought, usage of transit revenues for gas purchase seems to be a common practice, and perhaps Ukraine has to be just satisfied with this possibility. However, if you look at this situation from our side taking into account EU countries' interests as importers of Russian gas transported through the Ukraine’s gas transportation system (GTS), the attitude towards this practice should be quite the opposite, because it is bad for Europe and even very bad!

The main problem here is that, as is widely common in energy sector, the calculation of gas transit tariffs is based on operating and investment costs. That means that revenues obtained from gas transit payments mostly should be directed to ensuring proper maintenance and technical condition of the Ukraine’s GTS.

Meanwhile, actually in Ukraine such basic requirements have been ignored for many years. It had taken place already at a time of the previous Ukraine's governments. And even more so under the pressure of severe fiscal deficit now nobody cares to use this transit money for its intended purpose of GTS maintenance. Ultimately, the Ukraine’s GTS keeps operating although a service lifetime stipulated by the technical regulations for the majority of pipes and equipment have been completely exhausted long time ago.

An excessive deterioration of the Ukraine's GTS caused an increase in number of technical accidents. Last summer there were two gas explosions in the Poltava region on the largest pipeline "Urengoy - Pomary - Uzhgorod", which pumps Russian gas to Europe. Later in autumn an accidental depressurization put out of order the pipeline “Brotherhood” in the Transcarpathian region on the section “Valley – Uzhgorod – Border”. It is not difficult to figure out that in all cases the main reason appeared an out-of-limit technical deterioration and lack of funding for necessary modernization.

The pipeline accident in the Poltava region apparently made the Ukraine's government pay attention to the pressing problem of deteriorating the GTS condition. As a result, last summer the Ukraine's government officially announced the beginning of a radical modernization of the GTS at its own expense, which, according to preliminary estimates of Ukrainian experts, would amount to 5.3 billion USD for 5-7 years.
Since there is no money in the country in August the Verkhovna Rada (the Ukrainian Parliament) at the third attempt adopted the law on modernization and operation of the GTS. It launched a procedure of attracting investors to the Ukraine’s GTS, where the state will own its share in a control package, and another 49% can be distributed only among an operator company or several companies from Europe or America.

However, so far the expectations of reconstructing the Ukraine's GTS by means of foreign investors have not been met at all. The Ukraine's Government attempts of attracting foreign companies and, in particular, the negotiations with Chevron, Statoil and other companies have not yielded any result yet. There are several reasons for a failure.

First of all, it is necessary to realize that, in spite of the Minsk Agreement, Ukraine is still teetering on the brink of the renewal of hostilities which have already massively undermined the Ukrainian economy. Meanwhile artillery strikes and civilian casualties take place up to now.

In addition the US Congress passed the "Ukraine Freedom Support Act" on December 13 that would allow 350 million USD in lethal and non-lethal military assistance to Ukraine from 2015 to 2017. It should be quite clear to everybody that even promises of supplies for military use instead of private investments will not contribute to the stabilization of peace in Ukraine. Under such circumstances it is unlikely possible to find investors who would dare to invest heavily in a multi-billion project that should be fulfilled near half-ceased battlegrounds. Do they?

Besides that, we have to recognize a critical weakness in functional structure of the Ukraine’s GTS, which I described almost half a year ago in the end of June. It consists in the fact that the infrastructure of the Ukrainian transit pipelines simultaneously are in permanent and total use for meeting the needs of internal gas consumers in Ukraine. Direct access of local Ukrainian consumers to transit pipelines as well as an insufficient administrative control and corruption that all together make it easy to carry out an unauthorized gas offtake. Or by other words it means stealing a transit gas partly instigated by a severe energy shortage in the country.

Practically it will not change anything if European or American companies become co-owners of the Ukraine’s GTS. In such circumstances, they are unlikely to be able to ensure that Russian gas intended for Europe will not be pumped out on the territory of Ukraine. But in that case why should investors sustain such financial and image risks?

Finally, we need clearly to understand the consequences of recent events - namely, Russia's action of canceling the South Stream pipeline construction. Simultaneously Russia and Turkey completed an agreement on the construction of the other gas pipeline with the same capacity of 63 bcm, which is now called the Turkish stream.

The announcement that the South Stream would be halted caused a surge of enthusiasm in Ukraine. Ukrainian Prime Minister Yatsenyuk again repeatedly called foreign companies to invest in the Ukraine’s GTS. But at the same time almost nobody paid attention to the fact that, as well as the South Stream, the Turkish stream will provide a new route for gas supplies to Europe bypassing Ukraine. Therefore, redirection of the Russian gas pipeline to Turkey means only one thing: Ukraine will lose a status of gas transit country for the foreseeable future.

Nevertheless, the transit agreement between Russia and Ukraine will be valid for another five years until 2019. As long as there are no companies willing to invest in the Ukraine's GTS neither in Europe nor in the US, the financial burden of its preservation from a complete collapse rests on the EU itself. While politicians in Brussels and Washington go on talking about gas dependence on Russia, as you can see, the real threat to our security of gas supplies is much closer. It is right behind the EU borders and has a name that is known as "the Ukraine's gas transportation system."

An indirect recognition of this fact is that the EBRD extended a loan for modernization of the Ukraine's GTS in December. But the allocated amounts are much less than those required according to the calculations in Ukraine. It is 200 million USD intended only for the reconstruction of the Urengoy - Pomary - Uzhgorod pipeline.

Generally speaking now when the Ukrainian economy is sinking into deep trouble, this loan would be like "a drop in the bucket."

Obviously Europe launched its loan initiative too late spinning out almost until a middle of winter! Now Ukrainian media covers so-called rolling power cuts occurring every day in all the cities, which, by the way, a few of us in Europe can imagine. And what is more there was a nuclear power plant accident in Zaporozhye, which resulted in shutting down one of its generating blocks. Ukraine purchases coal from a far South Africa and negotiates about coal shipments even from Australia. Ukraine's government approved temporary electricity import from Russia.

It is paramount for European security of gas supplies that due to acute shortage of energy from the very beginning of winter Ukraine started increasingly pumping out gas of underground gas storages (UGS). There are 12 UGS in Ukraine with a total active capacity of 31 bcm. According to the Gas Storage Europe Association (GSE) data in 2014, the maximum filling volume of the Ukraine's UGS was recorded on October 19 and accounted for 16.759 bcm. As of January 10, 2015 this volume dropped by 37% to 10.615 bcm. Furthermore, from 5 to 6 bcm out of 16.5 bcm is a so-called inactive gas that in principle cannot be used at all.

As a matter of fact Ukraine does not have to use much of its storage volumes for the domestic consumption because these UGS facilities perform an important role of buffer stocks in the gas transit system, ensuring security of stable supplies to meet peak increases in gas consumption in Europe especially during a cold spell in January and February. Meanwhile, the Ukraine’s UGS now filled only to 33.51%.

For refilling the Ukraine’s UGS, it is necessary to import gas from Russia. But evidently Ukraine has no money for that. Instead, there is a multi-billion unpaid gas debt to Russia, which Ukraine hoped to pay off with the financial assistance of the European Commission.

In such a tense situation, why are our European politicians in Brussels and in other European capitals still urging to the accompaniment from Washington that Europe should cope with its gas supply without Russia? Why did the EU refuse a new gas pipeline to supply Russian gas bypassing the decrepit the Ukraine’s GTS? And ultimately why is Ukraine going to squeeze further out the EU to finance its GTS while, as we see, it is of no interest to investors?