South Stream is the latest Russian gas pipeline offensive into Europe. This joint project from Russian giant Gazprom and its Italian peer Eni prompted international analysts to wonder if it would trigger the demise of its direct rival, Nabucco. Certainly, the two projects will test each other’s viability, if only because their Balkan routes coincide and they are targeting the same volume of gas from similar sources.

The European Union has expressed grave concerns about Gazprom’s daunting offensive, leading to a spat between the two sides. Russia’s English-language newspaper Moscow Times, for example, saw the new EU energy strategy to detach energy generation from energy distribution assets as a direct attack on Gazprom. In another sign of EU concerns, it refused to give South Stream a priority project status, one that Nabucco enjoys. This counter-attack follows Gazprom’s aggressive, and hitherto successful, attempts to buy various energy infrastructure assets allowing it to vertically integrate its operations in Europe, just like it has done at home.

At the beginning of the year, Gazprom bought a substantive slice of the Baumgarten Austria-based hub, the third-largest gas trading platform in Europe, from Austria’s OMV. It’s also slated to build Blue Stream and Nord Stream, the pipelines which are to reach out to Europe as alternatives to the existing routes. With South Stream, Gazprom is making a decisive thrust, adding not only a new pipeline but also underground storage in countries partnering the project.

The EU has clearly suffered a setback in its bid to counter Russia’s domination of the European energy market. The Russian project has acquired momentum and will likely outpace Nabucco soon. As The Sofia Echo has already reported, Russia signed agreements with the Bulgarian and Serbian governments in the first two months of 2008 alone. In early March, Hungary also became a partner, just months after Gazprom and Eni struck the founding agreement on the South Stream project.

If the pace is sustained, the South Stream project managers are likely to turn the first sod faster than Nabucco despite its projected cost exceeding twice that of its rival. The figures tell the story: the provisional cost of 3300km Nabucco is estimated at five billion euro, while that of South Stream’s 900km is 10 billion euro.

South Stream’s higher cost, despite the smaller length, stems from the fact that much of the pipeline will be laid on the Black Sea bed.

Parameters of the agreement
The section of South Stream crossing Bulgaria will be Gazprom’s first foreign gas pipeline asset.

The South Stream agreement, signed by the governments of Bulgaria and Russia on January 18, appears to enjoy total governmental support. The deal contains no concrete parameters except for the pipeline’s annual capacity of 31 billion cu m. More stipulations will be specified once the parties complete the project’s feasibility study. The investment is expected to see a return within 15 years.

The agreement allows the formation of a company in which the Bulgarian and Russian sides will own a joint 50 per cent stake. The Russian side held out for a 51 per cent stake in the company until the very last moment but Bulgaria insisted on strict parity so as to have an equal say during important decisions. Parties to the agreement will have to provide capital commensurate with their share. The parties will not be expected to provide state guarantees and will be encouraged to seek funds using the project finance principle, which draws on a complex financial structure using debt and equity.

The Russian side is obliged to procure the necessary gas supplies for the project. Both parties are seeking a trans-European energy network status for South Stream, so as to enjoy the prerogatives of such projects.

Bulgaria also negotiated the “transport or pay” principle once the pipeline becomes operational, stipulating that the Russians will have to pay indemnities if their side is not filled to capacity. Once construction works start, priority will be given to Bulgarian and Russian companies during contract-awarding procedures as well as in the supply of material and technical resources and the procurement of machinery and equipment for the construction and management of the pipeline.

The contract also stipulates that the two countries will ensure that all specialists, materials, technical supplies and machinery necessary to build and operate the pipeline will enjoy facilitated access. Bulgaria will also ensure that once the route of the pipeline is defined, all plots falling within the route will be expropriated and land rights bought by the company.

The company will also enjoy tax concessions. All materials and equipment imported for construction purposes will not have to be set aside as collateral provided that, on completion, they are re-exported abroad. Procedures for refunding VAT payable for materials, services and works necessary for the construction and management of the pipeline will also be streamlined.

The project also enjoys fixed taxation levels, adhering to existing tax rates in Bulgaria and Russia at the time of the deal. All subsequent changes to financial legislation will be disregarded.

In addition, parties have stipulated a special clause to ensure fast implementation. The feasibility study must take no longer than 18 months and construction should start no later than 24 days after the study’s completion. The contract is valid for 30 years and can be subsequently extended every five years.

Local experts see the contract as advantageous for Bulgaria despite Bulgaria relinquishing partial control over its infrastructure. Nevertheless, the South Stream project is set to cost about 300 million euro a year in transit fees.