Putin's Pipeline Predicament

03/18/2015 04:41 pm ET | Updated May 18, 2015

By Michael Haltzel, co-authored by Antto Vihma, Senior Research Fellow at the Finnish Institute of International Affairs, and Michael Mehling, Executive Director of the Center for Energy and Environment Policy Research at MIT.

As Russia and Ukraine approach yet another confrontation over natural gas, the recent demise of Putin's flagship South Stream pipeline casts doubt on his strategic acumen.

In December 2014, Russian President Vladimir Putin surprised even Gazprom's close business partners by announcing that Russia would abandon the South Stream pipeline project. South Stream was Putin's strategic flagship project, a controversial pipeline through the Black Sea to South-Eastern Europe, and while its commercial profitability had always seemed questionable, few observers doubted that it would proceed.

Markets reacted to the news with a slight rise in Gazprom's stock, confirming the primarily strategic nature of the pipeline project. What the project reflects, instead, is a broader geoeconomic struggle between Russia and the EU in which economic means are used to advocate geopolitical goals.

In the aftermath of the Cold War in Europe in the 1990s, there was a widespread hope that liberalized commerce, especially in important strategic commodities such as natural gas, would become the cornerstone of a mutually beneficial and interdependent relationship between the two regional powers. As events unfolded, however, the natural gas trade evolved into a strategic playing field for power politics. Memories of the Russian cut-offs of gas to Ukraine in 2006 and 2009 are still fresh in the EU, heightening concern about energy security and attempts to utilize natural gas trade for political purposes.

For Russia, the decision to abandon South Stream comes at a considerable price: Gazprom's stranded investment is estimated to exceed $4.5 billion, not counting the significant political capital spent by the Russian president. Has Putin, described by some commentators as a master strategist after his nearly unopposed takeover of Crimea, overplayed his hand?

Russia had hoped to pursue several objectives with South Stream. First, the pipeline would have decreased the importance of Ukraine as a transit state and denied it leverage in Moscow. Second, Russia stood to increase its influence in the countries of Central and Eastern Europe, thereby weakening exposed EU member states and further undermining the EU's Eastern Neighborhood Policy with others. Third, the project would have effectively stymied competing plans to bring gas from Azerbaijan through Turkey into the EU market.

But it didn't happen. The West may still be searching for a common overall policy to confront Russian aggression in Ukraine, but in the energy arena Putin seems to have succeeded in unifying the objects of his policy. For some time, Brussels had unsuccessfully prodded Gazprom and its partners to comply with EU rules on energy markets and competition. Among the concerns it flagged were third party access to pipelines, unbundling of network ownership and gas supply, and the tariff structure for pipeline use. Yet Russia proceeded with its plans, apparently confident that it would be given the same generous waivers enjoyed by a previous pipeline project, Nord Stream.

And indeed, early in 2014, it still seemed likely that the European Commission would bow to pressure from several member states and afford Gazprom a range of exemptions from EU rules. When the Russian invasion of Ukraine began, however, the EU quickly tightened its stance on the question of South Stream. Ongoing negotiations about regulatory exemptions came to a complete standstill in March 2014.

Putin and Gazprom CEO Alexei Miller toured Austria, Bulgaria, Italy and Croatia to raise support for the project, signing lucrative new contracts with European construction companies and industrial suppliers. Brussels, however, countered with an unusually strong message to Bulgaria and Serbia: construction work was to cease immediately until all pending legal issues had been addressed. As the plot thickened, Gazprom was still shipping pipes to the Bulgarian coast as late as summer 2014. Among industry insiders, the prevailing assumption was that business would resume after a few weeks of hard talk between Brussels and the Kremlin, as it had so often in the past.

In the end, Putin seems to have underestimated the deep anxiety created by his aggression in Ukraine. Whereas European Union foreign policy had typically been weakened by a cacophony of voices from various member states, it was now able to harden its line in the negotiations over South Stream. The changing global energy context, including the precipitous drop in the price of oil, more liquefied natural gas, and spot trading, cannot fully account for the shift in positions on South Stream across Europe. After years of planning and significant investment, South Stream became a victim of Putin's Ukraine adventurism.

The last 15 years have shown, however, that Putin does not give up easily. Looking at the domestic and foreign policy difficulties of Turkish President Recep Tayyip Erdoğan, he sensed an opportunity to resuscitate his pipeline dream and concurrently increase his influence with a country of pivotal regional importance. While in Ankara in December 2014, Putin abruptly unveiled a new project, a second undersea pipeline from Russia to Turkey. For now, this project -- branded "Turkish Stream" -- is not much more than a blueprint. Both parties have signed a Memorandum of Understanding, and will negotiate prices and quantities in due course. But market analysts have expressed doubt about the prospects of gas exports to the EU via Turkey, which would require substantial investment in new infrastructure in Southeastern Europe by many of the same countries that are still smarting over the demise of South Stream. Turkey's own gas market is growing, but not nearly fast enough to accommodate gas imports on a scale comparable to what South Stream was intended to mobilize.

The geoeconomic wrangling over energy in Europe is far from over: it continues in negotiations between Brussels and the Kremlin, in national election campaigns in several EU member states, in corporate boardrooms, and in civil ligation across Europe. Although the ultimate outcome remains in doubt, the aura of Russian energy invincibility has been seriously compromised.

Michael Haltzel is Senior Fellow at the Center for Transatlantic Relations of Johns Hopkins University's School of Advanced International Studies and Visiting Senior Fellow at the Finnish Institute of International Affairs.

Antto Vihma is a Senior Research Fellow at the Finnish Institute of International Affairs.

Michael Mehling is the Executive Director of the Center for Energy and Environment Policy Research at MIT.