russia's pipeline plan

BUDAPEST -- During the Cold War, the balance of power was measured in nuclear warheads. Now a new kind of contest is playing out. The battlefield is Europe's energy market. The objective is pipeline proliferation. And Russia is winning. http://louis2j2sheehan2esquire2.blogspot.com

Europe is witnessing a race between two mammoth pipeline projects that would bring natural gas to the Continent from the Caspian and beyond. One of the plans -- hatched in Europe, championed by Washington and named for a Verdi opera -- has been hobbled by bureaucracy. The other, backed by the Kremlin, is rolling ahead with a speed and success that has surprised and frustrated the West. The outcome could shape energy supplies, and political influence, in Europe for decades to come.

KREMLIN RULES

• The Race: Europe is seeking to build a pipeline to help ease the Continent's dependence on Russian gas. Moscow has proposed a pipeline of its own.

• The Playing Field: The European project has bogged down in red tape. The Russian plan, backed by full Kremlin firepower, has raced ahead.

• The Impact: A Kremlin-backed pipeline would increase Russia's leverage over Europe as its natural-gas needs are expected to soar.

The European Union has been desperate to reduce its dependence on Russian fuel ever since Moscow turned off the gas tap to Ukraine two years ago in a pricing dispute, disrupting supplies to Western Europe in the middle of winter. The EU's proposed solution was the Nabucco pipeline, which would pump gas from Central Asia and the Caucasus without going through Russia.

But earlier this year, in the last few months of his presidency, Vladimir Putin mounted a diplomatic push on behalf of the Kremlin's own proposed pipeline, called South Stream. Moscow enlisted the support of former Eastern European satellites through which the new supply route would pass -- including Hungary, which had been a signatory to the rival Nabucco plan.

South Stream's triumphant march through Europe attests to the potency of Mr. Putin's brand of state-directed capitalism. The Kremlin and its gas monopoly, OAO Gazprom, negotiated swiftly and ruthlessly. That contrasts with the European approach: Seeking consensus and hewing to laws meant to foster competition, Nabucco's backers provided Moscow ample time to capture the lead.

"The Russians were just much faster," says Abel Garamhegyi, a senior official at Hungary's Economics Ministry.

Soaring crude prices have catapulted Russia, holder of the world's biggest natural-gas reserves, to the status of energy superpower. http://louis2j2sheehan2esquire2.blogspot.com

Gazprom already provides just under a quarter of the EU's gas. With the bloc's gas demand expected to climb, consulting firm Wood Mackenzie projects the Russian share to rise to one-third. http://louis2j2sheehan2esquire2.blogspot.com

Increased Leverage

In Western capitals already worried by Gazprom's dominance, some fear that additional pipelines will let Russia increase its leverage over its biggest customers. "This is all about Gazprom, a state-run monopoly, exerting monopoly pressure to restrict competition," says Matt Bryza, U.S. deputy assistant secretary of state for European and Eurasian Affairs, who has led the losing battle to fend off South Stream. "The Russians want to maintain our allies' dependence on Gazprom so as to keep gas prices high."

With its gas supplies in hand, Gazprom expects to finish a feasibility study for South Stream by the end of this year, arrange financing and launch the pipeline in late 2013. The Nabucco consortium says its groundwork in Europe is nearly complete and it expects to start building in 2010 and begin pumping gas as early as 2012.

But Nabucco's future is murky, and upcoming decisions by several key countries could determine its fate. The consortium's negotiating position is in danger of being weakened by Gazprom, which has recently offered to pay Azerbaijan and Central Asian producers market rates for their gas. That puts the squeeze on Nabucco, which will be forced to fight harder to win supply deals and may find it difficult to secure financing for construction.

Nabucco was supposed to help Europe diversify its supply. In 2002, five gas-transportation companies -- from Turkey, Bulgaria, Hungary, Romania and Austria -- dreamed up a plan for a 2,046-mile, $7.7 billion pipeline that would bring gas from the Caspian Basin and the Middle East through Turkey to a European gas hub near Vienna. The consortium ordered a feasibility study and met in Vienna two years later to approve it. To celebrate, the partners went to see Nabucco, the Verdi opera.

They were impressed by the exotic tale of Nebuchadnezzar, king of Babylon -- present-day Iraq, which they expected to provide some of the pipeline's gas. So, they adopted Nabucco as the project's name.

When President Putin heard about it, he was dismissive. "He said you can only build a pipeline if you have gas to fill it," Janos Veres, the Hungarian finance minister, recalls Mr. Putin saying at a Kremlin lunch in 2005.

He had a point. The companies building Nabucco don't themselves extract natural gas. The EU's antimonopoly rules forbid gas producers from building and owning the infrastructure to transport their fuel. Pinning down the gas to fill Nabucco has proved hard.

In 2006, the European project gained a powerful backer. The Bush administration, alarmed by the Ukrainian gas cutoff, threw its weight behind Nabucco.

Driving the new policy was Mr. Bryza, a career foreign-service officer who has been a linchpin of U.S. energy policy in the Caspian for a decade. He was a key architect of the pipeline that ships crude from Azerbaijan to the Turkish Mediterranean. Named Baku-Tbilisi-Ceyhan, or BTC, it was the first non-Russian export route for Caspian oil.

Early on, Mr. Bryza identified Azerbaijan as the main potential source for Nabucco gas. He began courting Ilham Aliyev, the Caspian state's authoritarian leader. The two had worked closely on BTC and enjoy a "warm relationship," Mr. Bryza says. Some of Mr. Aliyev's ministers attended Mr. Bryza's wedding in Istanbul last year. http://louis2j2sheehan2esquire2.blogspot.com

Mr. Bryza encouraged Mr. Aliyev to open up his vast gas reserves to fill Nabucco. He says the Azeri president was unsure there would be enough demand in Europe to justify the vast investments needed. Mr. Aliyev wanted clear signals from the often-divided Europeans that they were committed to buying his gas.

The Russians, meanwhile, began considering a rival plan. Their inspiration was Blue Stream, a costly pipeline Gazprom had built with the Italian energy giant ENI SpA that pumped Russian gas to Turkey along the bottom of the Black Sea.

In November 2005, when Russian, Turkish and Italian leaders gathered in the Turkish port of Samsun to inaugurate the line, Mr. Putin boasted that it was just the start. "The Russians said, 'Why don't we build another one across the Black Sea directly to Bulgaria?'" says Paolo Scaroni, ENI's chief executive.

In January 2007, Italian Prime Minister Romano Prodi visited Mr. Putin at his residence in the Black Sea resort of Sochi. Over lunch, they agreed to set up a working group to look into the new supply route.

Putin 'Knows Everything'

Just five months later, at a ceremony in Rome, ENI and Gazprom bosses inked the deal to build a $15 billion pipeline that would carry gas 558 miles under the Black Sea from Russia to Europe. It would finish up at Baumgarten, the same Austrian hub as Nabucco. South Stream was born.

The mastermind of the project was Mr. Putin. "He knows everything about the price of gas," says Mr. Scaroni. "I wish European politicians knew as much about gas as Putin does."

The EU's top energy official, Andris Piebalgs, welcomed the plan, saying it wouldn't pose a threat to Nabucco. The EU's own figures show that the combined capacity of South Stream and Nabucco will fall far short of the bloc's expected increase in demand over the next decade or so.

"There's plenty of room for both," says Alexander Medvedev, the head of Gazprom's export business.

Russia also argued that new pipelines would, if anything, improve Europe's energy security. Gazprom was worried about the condition of pipelines crossing Ukraine and frustrated by spats with Kiev over unpaid bills and transit fees. The same arguments had led Moscow to initiate a new pipeline from Russia to Germany under the Baltic Sea, also avoiding Ukraine, called Nord Stream.

But Nabucco and South Stream began bumping up against each other.

In June 2007, the Bush administration saw an opportunity to reassure Mr. Aliyev of Nabucco's viability. At a summit of Black Sea states in Istanbul, a meeting was arranged between the Azeri leader and the Greek prime minister, Costas Karamanlis. The U.S. side hoped the Greeks would persuade the Azeris that there was a European market for their gas.

But Mr. Karamanlis snubbed the Azeri, huddling instead with Mr. Putin. Afterwards, he announced that Greece was backing South Stream. U.S. officials were deflated.

A Greek government official said Greece also supports alternatives to Russia, such as gas supplies from Algeria and through Turkey. "But we have to make sure we secure all our necessary future supplies," he said.

Countries Flip-Flopping

Other countries were also flip-flopping. By 2007 Hungary, one of Nabucco's initial backers, was worrying that the project wasn't commercially viable and that Azerbaijan, the main source of the gas, wasn't a democracy.

Last spring, U.S. diplomats went to work on the Hungarians to persuade them of the wisdom of diversifying gas suppliers. Hungary swung back to Nabucco. At a conference in Hungary in September 2007, Prime Minister Ferencz Gyurcsany pledged his "total support" for the project. "Our job is to find gas resources independent of Russia," he said.

Russia struck back. Mr. Putin and his senior aides began moving through Eastern Europe, wooing local leaders and signing deals. Within weeks, Russia had recruited Bulgaria and Serbia as transit countries for South Stream. Gazprom acquired half of a key gas-trading hub in Austria.

The talks didn't always go smoothly. Negotiations with Greece were overshadowed by the issue of its existing long-term supply agreements with Gazprom. The Russian gas giant threatened not to extend the contracts, which expire in 2016, unless Athens allowed Gazprom to sell its gas directly on the Greek retail market. "As soon as this issue is resolved, the supply contracts will be extended," Gazprom's Mr. Medvedev says.

Russia began to press Hungary, now the missing link in South Stream's route. On Feb. 22, Russian and Hungarian officials gathered in Russia's Energy Ministry in downtown Moscow to hammer out a transit accord. Gazprom wanted to take a 51% stake in the joint venture operating the Hungarian branch of the pipeline and win tax breaks. But such incentives would go against EU rules. Hungary balked.

After the talks broke down, Mr. Veres, the Hungarian finance minister, set off for his flight home. On the road to the airport, as his car sat in traffic so heavy that it caused him to miss his flight, he says he received a call from Russia's ambassador to Hungary. The envoy told him that Dmitry Medvedev, then Russia's deputy prime minister, would come to Hungary the following Monday to resume the South Stream talks.

Such high-level trips normally take weeks to plan; the Hungarians had two days' notice. Russia's political clock was ticking. Presidential elections were scheduled for the following Sunday in which Dmitry Medvedev, Mr. Putin's handpicked successor, was widely expected to win. "It's clear they wanted to close this deal before the elections," says Mr. Veres. "It's a prestigious project for them."

Within a few hours of his arrival, Mr. Medvedev had given in to Hungary's key demands. Ownership of the pipeline joint venture would be split 50-50. There were no promises on taxes. Russia also agreed to let Hungary have access to the gas in the pipeline and stockpile it in underground storage tanks on Hungarian soil.

Signing Ceremony

"We knew that if we didn't agree, they'd investigate other routes," said Mr. Garamhegyi of Hungary's Economics Ministry. No pipeline meant no lucrative transit fees for Hungary.

Four days later, Mr. Gyurcsany, the Hungarian prime minister, flew to Moscow for the signing ceremony.

In Hungary, the deal caused a firestorm. "Instead of reducing our energy dependence on Russia, they're increasing it," said Zsolt Nemeth, a lawmaker in the opposition Fidesz party.

The U.S. was furious. "Moscow has responded to the advance of the Nabucco project by exerting pressure on Hungary and its neighbors to strike a quick deal on South Stream," Dan Fried, U.S. assistant secretary of state, wrote in a Hungarian newspaper. "This is not the right time to have our attention diverted by a pipeline...which will be used by a monopoly to stifle competition."

Waiting on the EU

But Hungary was frustrated by Nabucco's slow pace. In February, Mr. Garamhegyi prepared a draft agreement on the Nabucco project and handed it to EU ambassadors. Three months later, he was still waiting for most of them to respond.

"I'm a former businessman, and this is not the way to do business," he says.

Russia is pressing its advantage. In May, the Nabucco company announced that spiraling steel and energy prices had pushed costs for the project up 58% from initial projections, to $12 billion.

Earlier this month, Gazprom offered to buy Azerbaijan's gas on long-term contracts at market rates. Such a deal would destroy any advantage the Nabucco buyers would have over Gazprom in competing for Central Asian and Caucasian gas. Azerbaijan has yet to respond.

Gazprom's Alexander Medvedev criticizes the U.S. for opposing its pipeline plans. "Resisting South Stream and Nord Stream is condemning Europe to energy famine," he says. "How will you then sate that hunger? We have a proverb: You can't feed nightingales with fairy tales."