Russian Federation President Vladimir Putin announced on Monday that Russia was cancelling the controversial South Stream natural gas pipeline project. The surprise announcement comes only weeks before the planned start of the underwater part of the project. The USD 40 billion pipeline would have transported Russian natural gas to central and southern Europe via the Black Sea, Bulgaria, Serbia and Hungary starting in 2015.
At a joint press conference held with Turkish President Recep Tyyip Erdogan on Monday, Putin announced that Russia would “compensate” for the project’s cancellation by building a gas distribution network in Turkey. He accused the EU of obstructing the project and, in so doing, harming its own economic interests. He also accused the EU of exercising undue pressure on Bulgaria by withholding its approval of the pipeline construction. “If Bulgaria has been stripped of the ability to behave like a sovereign nation, then it should demand the EC compensate it for lost profits,” suggested Putin.
The European Commission has repeatedly stated that the pipeline, which was to be entirely built owned by Russia, would be incompatible with EU law which says the owner of the pipeline transporting the gas cannot be the same as the owner of the gas. In June this year Bulgaria’s government resigned after its prime minister, succumbing to EC pressure, announced the country was suspending construction of the South Stream pipeline.
Hungary reacts to the news
Hungarian Foreign Minister Péter Szíjjártó, who is in Brussels at a meeting of NATO foreign ministers on Tuesday, reacted to the news by saying that Russia had every right to make such a decision:
“We must look for other opportunities in the interest of ensuring Hungary’s energy supply security. Prominent among those opportunities is the supply of gas by Azerbaijan to Centeral Europe via the southern corridor. At the same time, this is just one of many opportunities. And while this has been accorded a large role, we have to look into other opportunities for solving Hungary’s energy security in the long run.”
Russia’s decision to cancel South Stream is a giant setback for Prime Minister Viktor Orbán who staked considerable personal and national prestige on the project being built despite EC opposition. Recently parliament even passed legislation that would have cleared the way for Russian companies to build the pipeline despite the current economic sanctions.
In March 2013 Hungarian state-owned energy company MVM Zrt. vastly overpaid to acquire German energy giant E.ON’s wholly owned Hungarian subsidiary, E.ON Hungaria Zrt.. E.ON Hungaria Zrt. consisted of two business units: E.ON Storage, and gas storage company) and E.ON Trade, a gas importer and wholeseller. The transaction reportedly took place at Viktor Orbán’s insistence over the objections of of MVM’s directors and even members of his own cabinet.
At the time the only plausible explanation for the decision to pay €875 million for a company valued the previous year at €380 million, was that it would somehow enable Hungary to play a key role in the future storage and distribution of Russian natural gas in central Europe once the South Stream pipeline was completed.
Apart from the price, few details of the E.ON transaction were made public. It was not until July 2014 that Hungary’s highest court ordered details of the transaction be released. On the basis of the original declaration of intent signed by Orbán himself on November 28, 2012, the final sales agreement of March 12, 2013 and other documents released in July, MVM appears have overpaid for the subsidiary by as much as €1.675 billion ($2.2 billion), taking into account the company having a potential net worth of minus €800 million.
Unable to fathom why Orbán would pay such an enormous premium for E.ON Hungaria in light of falling natural gas prices and a glut of gas storage facilities in Europe, Hungarian economist Mária Zita Petschnig speculated that corruption must have been involved. Petschnig told ATV she could not understand why the government went through with the deal even after learning of hundreds of millions of euros in potential liabilities arising from E.ON Trade’s business activities.
Skeletons in the closet
The contract between E.ON Trade and Gazprom, which expires in 2015, fixes the price and quantity of gas to be purchased on an annual basis irrespective of fluctuations in world market prices or domestic demand. The contract reportedly provides for E.ON Trade to pay a penalty equal to 50 percent of the value of the gas it fails to take delivery of in a given year.
After signing the declaration of intent, government examiners reportedly learned that instead of paying penalties per the contract, E.ON avoided paying them immediately by agreeing to purchase correspondingly more gas in the future. Presumably this did not happen as the 2013-2014 winter was unseasonably warm.
Current world market gas prices are 30 percent lower than those contained in the Gazprom agreement. This means E.ON Trade can only meet its legal obligation to Gazprom by either purchasing (at an elevated price) significantly more gas than it can reasonably expect to resell, or paying a 50 percent penalty after gas for which it contracted but did not take delivery. Either way, the total cost of the transaction to Hungarian taxpayers is likely to exceed the purchase price by several hundred million euros.
Critics point out that at a time when a third of Hungarians live in poverty and the country is struggling to keep its debt to under 80 percent of GDP, Hungary could ill afford to pay €875 million for a company having a potential net worth of minus €800 million.
Exit Russia, enter Azerbaijan
Recently Hungary concluded a strategic cooperation agreement with energy-rich Azerbaijan which, to everyone’s surprise, provides for the construction of a USD 45 billion pipeline that will bring Azeri gas to Hungary. The timing of the agreement suggests to some observers that, upon learning of Putin’s plans to cancel South Stream, Orbán went to Baku to negotiate a deal (on paper at least) that would enable him to save political face, having arguably squandered €875 million of Hungarian taxpayer money.
It remains to be seen whether anything comes of the $45 billion pipeline project announced during the President of Azerbaijan’s recent visit to Budapest, and how much Orbán’s latest grandiose scheme will end up costing Hungarian taxpayers.