November 14, 2008

Ignore the Bluster: Nord Stream is Inevitable

Vladimir Putin recently threatened to pull the plug on Nord Stream, the sub-sea pipeline that will transport gas from Russia to Germany via the Baltic Sea. However, this is nothing more than brinkmanship from Moscow's strongman, as Russia covets the political power that such a project will bring. Equally, the EU needs Nord Stream, particularly after the August invasion of Georgia.

At a meeting in Moscow with Finnish Prime Minister Matti Vanhanen on Wednesday, Russian Prime Minister Vladimir Putin suggested that if Europe does not show sufficient support for Nord Stream his country will pull out of the project. "Europe must decide whether it needs this pipeline or not. If you don't, we will build liquefaction plants and send gas to world markets, including to European markets. But it will be simply more expensive for you". Yet Mr Putin's comments sound hollow - it is extremely unlikely that Nord Stream will not be completed. Put simply, both Europe and Russia want Nord Stream to succeed.

EU gas demand is set to increase from 505 billion cubic meters (bcm) in 2007 to 642bcm by 2020 and Nord Stream is expected to meet around 25% of these additional import needs. Furthermore, the August invasion of Georgia has elevated the relative importance of Nord Stream by casting further doubt over the security of pipelines running through such an unstable region.

Russia also sees benefit in Nord Stream. The sub-sea pipeline will transport gas from the Shtokman field through the Baltic Sea, from Vyborg in Russia to Greifswald in Germany. In doing so, Russia cuts out the transit states of Poland, Ukraine and Belarus. As well as being financially gainful (since Gazprom will no longer pay tariffs when passing through these states) the pipeline will allow Moscow to turn off the gas delivered to these states on account of payment disputes (or indeed political disputes) without affecting Western European customers. That is important when gas is sold in the Ukraine for $179/1,000m3 but fetches in excess of $470/1,000m3 in Germany.

Mr Putin alluded to the dip in gas prices rendering Nord Stream economically unviable. This is also unfounded. To begin with, the price of oil (and concurrently the price of gas) is unlikely to fall much further in the absence of a major reserve discovery or technological breakthrough. Furthermore, the cooling in energy prices is having commensurate effects on the price of inputs used for constructing pipelines - especially steel. The price of steel has dropped from a high of $1,060 per short tonne in May to less than $900 today. This trend is expected to continue - BG Group has recently delayed the Karachaganak project in Kazakhstan, precisely because the firm expects input prices to fall even further in the near future.

It is no coincidence that Mr Putin chose to deliver these remarks two days before the Russia-EU summit, due to be held in Nice on Friday. In reality, Mr Putin's comments are born of purely political intentions - a thinly veiled attempt to strong-arm MEPs and independent member states' governments (particularly Finland and Sweden) into accepting the recently submitted Environmental Impact Assessment (EIA) of the project. Should the EIA stall, the project could well be held-up for another two years.

Such a delay would increase costs significantly at a difficult time for Gazprom. The credit crisis has forced the state energy firm to delay investments into Shtokman condensate projects, and a hold-up with Nord Stream is an additional headache that Mr Putin would very much like to avoid.