The Nabucco consortium strongly supported by the European Commission in the name of EU energy security interests is going ahead. It decided on February 2010 to order the steel to forge the 3000 km future pipe. Such a strong determination is striking because there is only room for one transit pipe-line and the rival project lead by Gazprom, namely South Stream, has much better chances to win the competitive battle because there will be gas to fill it and money to finance it, which is not the case of Nabucco.
The issue of gas corridor diversification has become increasingly important in the late 2000s setting up many projects driven by political aspirations to reduce dependence on Russian gas. By helping diversification of gas import sources, the European Union has developed a determined foreign policy which is supposed to help European markets to reach Caspian gas and Middle East gas through pipes-lines. Since 2006 it intensively promotes the Nabucco project to help reaching gas resources of Azerbaidjan, Kazkhstan, Turkmenistan, and possibly Iran, Iraq and Egypt. “Nabucco was the first attempt at forging a common energy policy to reduce its dependence on Russian gas. The basis of Nabucco is to bring gas to Europe from new suppliers”, underlined the EU energy Commissioner A. Pielbags in 2007
Foundations of this project are indeed mainly political, because it aims to overcome the Russian gas import monopoly on the Central and Eastern European markets, the risk of which being rapidly compared to transit risk, clearly shown through the successive 2006 and 2009 Ukrainian-Russian gas crises.
Russia has been able to respond to this challenge in two ways, downstream by launching the competing project South Stream which could ship Caspian and Russian gas to the same markets and also to other ones in Southern Europe (Serbia, Slovenia and Italy); and upstream by contracting directly with Turkmenistan to remove all the available gas of the Western Turkmen fields.
Competition theory can be used to throw light on the probable outcome of the competition between the Nabucco project and the SouthStream project. Indeed, it can be viewed as a competition between two firms to buy inputs from the same sources, to transform them in a same product and to sell this product on the same set of geographic markets. The peculiarity of the competition is that these two firms have to decide an investment in a large-scale and indivisible equipment and they also have the option to ex-ante contract with input producers before building it. There are two levels of competition between the two firms, upstream for accessing to Caspian sources or other sources, and downstream for accessing to markets in Central and Southern Europe. That means that competitors will have to anticipate what they will lose if they install their equipment or do not install it, while the situation upstream or downstream could change in their disfavor.
As any imperfect competition game with entry, the dominant player has the possibility to deter entry in three ways: first overinvesting (in a pure economic competition, in fact the “SouthStream firm” assimilated to Russia does not need this costly undersea pipeline to export its gas towards Europe given the existing pipes, but, as being the incumbent, it could decide to invest in order to deter the “Nabucco firm” to invest), second obliging entrant to overinvest and increase its costs (Nabucco would need to link its entry with an investment in the €8-billion TCP to be connected to the main source in East Caspian) and third taking control of the main input source (here by buying all the available Turkmen gas). In this strategic game, the two players have to anticipate their gains and their losses in relation to the likely strategies planned by the other player. We consider the different advantages of the two projects in the point of view of accessing to markets downstream first and second of accessing to sources and finally linking competition downstream and upstream.
Downstream Nabucco has some few advantages on South Stream. Namely its shareholders (onthe long distance, the Turkish section) are the historic companies in Bulgaria, Romania, Hungary and Austria (which would use half of Nabucco capacity for transporting gas to their own markets), the remaining capacity would be for gas trade on the Baugmarten hub at the Austrian frontier with German market. This could be considered as an advantage on South Stream which has not a so clear position on the downstream markets for accessing to national markets. Local gas companies and their governments accept to finance half of the cost of the national sections on the Northern part in Bulgaria and Hungary, but they are not investors on the main part of South Stream under the Black Sea. It is partly compensated by positive development on the downstream branch of South Stream in Serbia and Slovenia. New outlets could be found on the Italian market, in particular with the entry of EDF which controls the third of Italian gas supplier. The main game seems in fact to set upstream. For the access to gas sources, as said above in the storyline, the likely sources available to fill up Nabucco pipe on an horizon compatible with the investment cost recovery period are Azerbadjian and Turkmenistan. It has quickly appeared that Azerbadjian will not have enough gas in the next fifteen years to contract quantities with European buyers that will fill Nabucco at least up to 20 Bcm/y, the level necessary for the fixed cost recovery. Turkmen gas became the only solution for filling Nabucco and making it profitable.
Second upstream resources must not be preempted by an agreement with Russia, and indirectly by the SouthStream project. This Nabucco competitor benefits from the Gazprom ability to control multiple sources of supply, as well as in the Russia’s “Near Foreign”. For gaining agreement with Turkmenistan, Gazprom accepts to change its trade relations withand to pay to Turkmen gas company at the European price. Present attempts from the “Nabucco coalition” to create alternatives to initially hoped-for Turkmen gas quantity in the framework of the so-called Caspian Development Corporation (CDC) is not a credible enterprise on the time scale of the cost recovery period of the project, all the more so that even if new Turkmen gas fields should be developed by the CDC, the gas to be transported to European markets would need the TransCaspian Pipeline (TCP) installation beside Nabucco realization; Finally we consider the game between the two competitors in its vertical dimension including upstream gas access and investment decision in the large upfront cost equipment in relation to their respective competitor anticipated strategy. For the Nabucco coalition it will cost a great amount if it is built without contractual gas, because no quantity will be available during the 2010s at the exception of some Azeri gas. This situation will be the same even if South Stream is not built because all the Turkmen gas which is accessible in the next 15 to 20 years for the European markets is contractualized with Gazprom. It is not because Nabucco will be installed that the advantage of gas source diversification as well as the gas transit risk reduction will be gained for the partners, through lack of gas to fill it in the near and long term. Symmetrically for the South Stream coalition led by Russia/ Gazprom, there would be no cost in relation to the commitment to buy Turkmen gas for controlling the sales of Eastern Caspian gas to Europe, if the pipeline is not built. Indeed Turkmen gas sold to Gazprom could find other outlets and other corridors to reach the European markets, in particular South Stream if it is realised.
If we come back to geopolitics and give up strict economics paradigm, the non realization of South Stream should have an opportunity cost for Russia which would then loose an opportunity to reduce the Ukrainian transit risk, as well as for the buyers of gas transported by South Stream. If the latter will be costly to build, in particular for Russia and Gazprom which are heavily constrained by the financial crisis and sales reduction on the European market in 2009-2010, the economic value of transit risk reduction could be seen as justifying the investment. Alliances with large European “deep pocket” companies (ENI, EDF) should then help to overcome the financial obstacle.
Dominique Finon, CNRS senior researcher, CIRED and Gis LARSEN
For further developments on this issue, see “The limits of the EU direct foreign gas policy. Autopsy of the (soon) stillborn Southern corridor Nabucco”.