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Russian President Vladimir Putin announced Monday that Russia will be cancelling its $40 billion South Stream gas pipeline project. Mr. Putin cited unwillingness from European countries as the main reason for shutting down the project saying: “[the project’s cancellation] is the decision of our European friends. They are, in the end, customers. It is their choice.”

Falling oil prices and stalling European demand also contributed to undermining the economic viability of the project. South Stream would need to be marketed at an equivalent of $9.50-$11.50 per mmBtu, including a 30% export duty, estimates have shown. The average European spot gas prices have ranged between $6-$9 per mmBtu this year, reports Reuters.

The announcement to cancel the pipeline, which was set to supply 63 billion cubic meters (2.2 trillion cubic feet) of gas a year to Europe, has caused mixed reactions among the countries that would have received gas from the project. Serbia’s Prime Minister Aleksandar Vucic was quoted as saying that the project would have absolutely benefited his country, The Moscow Times reports.

Though it became politically toxic after the crisis in Ukraine, the pipeline made sense for countries such as Serbia, Bulgaria and Hungary because it offered a supply of gas that did not pass through Ukraine, making it less vulnerable to supply disruptions. For those countries, South Stream would have been an insurance policy against supply cuts, like the ones that took place in January 2009, when a pricing dispute stopped gas transiting Ukraine, leaving those countries with fuel shortages in sub-zero winter temperatures.

E.U. members, such as Brussels, saw the project differently. The Ukraine conflict led to Brussels freezing its approval process for the pipeline over fears that it would force the E.U. to rely too heavily on Russia to supply its energy demand. South Stream would have supplied over 10% of European demand, which already receives nearly a third of its gas from Russia.

Russia’s Plans for the Future

President Putin announced his decision to put an end to the South Stream project while in Turkey with Gazprom’s (ticker: OGZPY) chief executive, Alexei Miller, where Putin also proposed building a gas pipeline to Turkey instead, offering the country a gas discount.

South Stream

Source: Gazprom
Alexei Miller signing an already finished portion of South Stream

Turkey has taken advantage of increased East-West tensions by increasing exports of food to Russia, reports the New York Times. “Sanctions on Russia have let Russia impose its own prohibitions on imports from the E.U., and Turkey is trying to take advantage of this gap by becoming a more significant exporter,” said Sinan Ulgen, a Turkish former diplomat and a scholar at Carnegie Europe, a foreign policy group based in Brussels.

Turkey imports about 60% of its natural gas from Russia, and now stands to be the biggest beneficiary of the cancellation of South Stream. Putin said Russia would build a smaller pipeline to Turkey, instead of finishing South Stream, to transport Russian gas through Turkey to a hub near the Greek border. Putin said that this hub could be used to supply Southern Europe if there is demand, too, reports the Wall Street Journal.

Moscow also agreed to increase gas exports to Turkey via the existing Blue Stream pipeline to 19 billion cubic meters (671.1 billion cubic feet) – an increase of 3 billion cubic meters (approximately 106 billion cubic feet), or almost 20%. The rise in volume is complemented by  a 6% discount to the Turkish market starting the first of next year.

Some feel that this is nothing more than a political ploy from the Kremlin in order to win support of those E.U. members in favor of the pipeline, however. “The alternative to Turkey is even more doubtful than the direct option to Europe,” a financial adviser who has dealt with the matter told Reuters on the condition of anonymity. “Even if it went to Turkey, most of its gas would end up in Europe, so it begs the question, why introduce a transit risk instead of attempting to solve Russia-E.U. differences and run it directly to Europe as initially planned?”

Europe’s Path Forward

The focus in many states is now turning to what could fill the supply gap left by South Stream. The most viable Western-backed option, the Nabucco pipeline, which would bring gas from the Caspian Sea through Turkey to Bulgaria and on to Austria, was shelved in part because there was not enough demand to justify building it in addition to South Stream. Now that South Stream seems so unlikely to be completed, Nabucco may have another chance.

A solution currently under review proposes to link up Slovakia’s gas hub, which is supplied by a variety of sources, to the Balkans by running a pipeline across the south-western corner of Ukraine and through Romania and Bulgaria.

Another proposal being considered is to build a liquefied natural gas plant on the Croatian island of Krk. Tankers carrying Qatari, Algerian or eventually U.S. gas would unload there, and the gas could be shipped on to Hungary and the rest of the Balkans.

A third option is the Trans-Adriatic Pipeline (TAP). Like Nabucco, it is intended to bring gas from Azerbaijan’s Caspian Sea through Turkey and on to Europe.

Kristalina Georgieva, the European Budget Commissioner, said on Tuesday that the E.U. would speed up work to help provide more energy security for south-eastern Europe, including by financing gas connectors between Bulgaria, Romania and Greece, reports The Moscow Times.

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Important disclosures: The information provided herein is believed to be reliable; however, EnerCom, Inc. makes no representation or warranty as to its completeness or accuracy. EnerCom’s conclusions are based upon information gathered from sources deemed to be reliable. This note is not intended as an offer or solicitation for the purchase or sale of any security or financial instrument of any company mentioned in this note. This note was prepared for general circulation and does not provide investment recommendations specific to individual investors. All readers of the note must make their own investment decisions based upon their specific investment objectives and financial situation utilizing their own financial advisors as they deem necessary. Investors should consider a company’s entire financial and operational structure in making any investment decisions. Past performance of any company discussed in this note should not be taken as an indication or guarantee of future results. EnerCom is a multi-disciplined management consulting services firm that regularly intends to seek business, or currently may be undertaking business, with companies covered on Oil & Gas 360®, and thereby seeks to receive compensation from these companies for its services. In addition, EnerCom, or its principals or employees, may have an economic interest in any of these companies. As a result, readers of EnerCom’s Oil & Gas 360® should be aware that the firm may have a conflict of interest that could affect the objectivity of this note. EnerCom, or its principals or employees, may have an economic interest in any of the companies covered in this report or on Oil & Gas 360®. As a result, readers of EnerCom’s reports or Oil & Gas 360® should be aware that the firm may have a conflict of interest that could affect the objectivity of this report.