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Nov 6, 2012 | 11:30 GMT

Russia: Bypassing Croatia with the South Stream Pipeline

Russia: Bypassing Croatia with the South Stream Pipeline
THIERRY CHARLIER/AFP/GettyImages
Summary

Russia's decision to bypass Croatia as a transit state for the South Stream natural gas pipeline is not entirely surprising. Croatia has been very active in planning the construction of an import terminal for liquefied natural gas on its shores, a project that would bolster its energy independence from Russia and possibly transform Croatia into a Balkan energy hub. Gazprom's decision to bypass Croatia in favor of landlocked Hungary allows the Russian energy giant to maintain its leverage over the transit states along its strategic pipeline routes to Europe.

Croatian President Ivo Josipovic and Gazprom Deputy CEO Alexander Medvedev independently verified Gazprom's choice Nov. 5. Days earlier, on Oct. 31, Hungary approved a final investment in the project and gave the South Stream pipeline the status of a project of national significance. In response to Gazprom's decision, Croatia will focus its efforts exclusively on building its own LNG import terminal, as evidenced by Josipovic's upcoming trip to Qatar, the world's largest LNG exporter.

Russia is moving quickly to lock in the route for the South Stream project, which would bypass Ukraine and connect Russia's southern natural gas fields directly to southern and Central Europe. Gazprom wants to avoid facing an additional legal battle with the European Union by completing all investment agreements and breaking ground on the project before certain provisions of the European Union's Third Energy Package take effect in March 2013.

Planned South Stream Route

South Stream map

Determining the last transit state for Russian natural gas before arriving to Italian or Austrian natural gas distribution centers is a matter of great strategic significance for Russia, which had considered both Hungary and Croatia for the role. Between 2007 and 2011, the Hungarian government was one of the most active in Central Europe in trying to counter Russia's growing influence in the region, particularly regarding Moscow's dominance of local energy assets. Despite Croatia's efforts to diversify its energy supplies away from Russia, Moscow had considered the country as an alternative transit state for South Stream if Hungary could not be used. However, the European financial and political crisis mollified Hungary's attitude toward Russia and weakened Budapest's unconditional alignment with the European Union.

Motives Behind the Choice

Hungary is suffering from one of the most severe economic downturns on the Continent and is engaged in acrimonious negotiations with the European Union and International Monetary Fund for a bailout. The European Union is using Hungary's weakened position to demand reforms to some of Budapest's most controversial policies, which Brussels says are undemocratic. Although Budapest remains wary of direct Russian control of Hungarian assets, it also sees South Stream as a financial and political opportunity. Investment and transit revenues from the project could boost Hungary's economy, and renewed discourse with Moscow could be used as leverage with the International Monetary Fund and European Union. The final investment decision by the South Stream consortium and Hungarian representatives indicates Hungary's commitment to the project.

Having secured Hungary as its last transit state to the large Western European markets, Moscow has no need to use Croatia as a backup plan. Croatia's inclusion in the South Stream project was always problematic for Russia. Zagreb has gone further than any other country on Russia's potential pipeline route to distance itself from its dependence on piped natural gas. Croatia has been pursuing several avenues to build the first LNG import terminal in the Balkans outside of Greece, largely because of its close relationship with the European Union and its economic preeminence in the region. An LNG terminal would give Zagreb a measure of independence from Russia, which currently supplies 96 percent of Croatia's natural gas imports. This possibility troubled Moscow, which traditionally has kept its transit states dependent on its energy supplies as a way of maintaining leverage should a transit state do anything that jeopardizes the smooth operation of Russia's natural gas pipelines.

With Hungary's participation in the South Stream project secured, Gazprom has been clear about ending its engagement with Croatia over the pipeline. Josipovic expressed some regret about the loss, but Croatia still has the most positive energy security outlook in the Balkans.

Croatia's Focus on LNG

Josipovic's upcoming visit to Qatar will serve as an attempt to rekindle Qatari interest in investing in Croatia's LNG import capability. Although the Croatian natural gas market is limited — the country's annual natural gas consumption is 3.2 billion cubic meters — Qatar has considered the Balkan state as a possible stepping stone to other Balkan markets that currently depend entirely on Russian natural gas.

However, global economic constraints likely will prevent Croatia from becoming a regional player in the short term, especially since Zagreb's priority is to diversify its own energy supply rather than become a regional hub. With Gazprom's decision on the South Stream project, Croatia lost its biggest source of leverage in upcoming natural gas price renegotiations with Russia, making the need to obtain alternative sources of the commodity much more pressing.

In May, Croatia accelerated its efforts to build an import terminal by sidetracking the perpetually delayed and very expensive Adria LNG project, which would have a capacity of 15 billion cubic meters per year, and commissioning a feasibility study for a smaller (6 billion cubic meters per year) and cheaper terminal. The smaller project would be commensurate with Croatian and EU budgets and is likely to be fast-tracked, especially since South Stream is due to break ground by the end of the year, rekindling Europe's concerns about energy security in its periphery.

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