South Stream and the Capturing of the State

01.09.2016

RiskMonitor pubished its paper on the South Stream and state capture. The paper is the result of a case study of South Stream as the a proxy for state capture through large energy projects. The report is part of the project ENCAPTURE: Countering State Capture in the Energy Sector with the support of the Think Tank Fund and the Balcan Trust for Democracy

By: Atanas Georgiev, Galya Alexandrova, Ilin Stanev, Julian Popov, Matus Misik, Sanja Tepavcevic
 and Vladimir Medovic


E X E C UT I VE   S U M M A R Y

The report looks at the South Stream Gas Pipeline Project (SSGPP) as an avatar of the phenomena of State Capture.

The South Stream is a gas pipeline project that had to link Russia and the European market via the Black Sea, with Bulgaria as its entry point into European Union territory. The maximum planed capacity of the pipeline was 63 cubic meters per year. Initially the cost of the project was estimated at 15,5 billion euro but with time this sum has grown to over 35 billion euro. While on a visit to Turkey in December 2014, Russian president Vladimir Putin declared that the project is going to be ceased.

There are different interpretations for the discontinuation of South Stream. For some (including the Russian government) the project was stopped due to Bulgaria abandoning its economic interest and succumbing to pressure by the European Commission. For others, the reasons for ceasing the project are financial – the growing cost, low gas and oil prices, and the impossibility for the project to be financed. This report studies the history of the project and the stakeholders’ attempts to enforce political influence upon the decisions related to its development.

The analysis focuses on the SSGPP from the perspective of the state capture concept. State capture is perceived as a special form of corruption, in which private interests overtake state functions without damaging the wholeness of state institutions structure-wise. The phenomenon entails seizing state mechanisms from within and retailoring them in order to serve alternate purposes. In this way, the state’s resources are not subject to ordinary theft. On the contrary, they are highly valued, for they frame the criminal entrepreneur’s investment field. The Bulgarian section of the South Stream pipeline has grown drastically, which arouses some of the most serious suspicions that state functions in this case have been captured.

Furthermore, the report examines the history of the project and pinpoints the steps, which ultimately have turned it into an instrument for state capture. The bilateral agreement between Bulgaria and Russia of 2008, which serves as a general framework for the development of South Stream, includes drastic violations of European law. These violations are the first steps in the emergence of an environment, which will later accommodate the capture of key government functions within the project.
 
While the negotiations between Russia and Bulgaria about South Stream were underway the European Commission (EC) made it clear that the project will likely not be in correspondence with European requirements. However, the EC could not sanction Bulgaria at this point, since the actual development of the project had not yet commenced. The Russian side at the same time ensured the Bulgarian side that the signed bilateral agreement will not be susceptible to EC regulations.

Following this false start, the project takes up its own path, in which gas negotiations are perceived more and more as an opportunity for on-the-side profits. The Bulgarian side remains hopeful that “Gazprom” will reach an agreement with the EC, however, the probability of the project becoming finished is at this point questionable.

Parallel to this, the history of South Stream has another, more practical side. The high gas prices in 2012 also play a role in the government’s stance regarding South Stream. Since Bulgaria is almost solely dependent on one gas supplier (Russia), the Bulgarian gas infrastructure does not permit diversification of gas supply and Bulgaria does not have access to the free gas market.

Lowering gas prices almost always rests on negotiations with the supplier, in which the supplier has a disproportionately strong position.

The expectations that the lower consumption of gas in this period (contributed mostly to the economic crisis at the time) is temporary and consumption will eventually rise, foster enthusiasm for the gas pipeline not only in Bulgaria but throughout the whole region as well. Private firms and governments alike expect that the project will be justified economically and energy-wise. The data since suggests that the drop in the gas demand has deeper roots and is not solely a consequence of the crisis, but is rather a result of structural changes in the European economy.

Down the line two more factors have influenced the outcome of the project. One is the annexation of Crimea, which subjects economic relations with Russia to a very strict regime of supervision. The other is the expected liberalization of American gas export, which will likely lead to further diversification of European gas supply.

In November 2014, the Italian government discretely announced that South Stream is no longer a priority for Italy. Soon after, a similar position is expressed by Austria. Without strong interest by Italy and Austria, and subjected to heavy control from the EC, South Stream becomes increasingly vulnerable. During a visit to Turkey, on December 1st 2014, Vladimir Putin announces the suspension of the project. He adds in his announcement that Bulgaria has lost its sovereignty.




Behind this demonstration is a more complexed picture. It has to do as much with the changed economic and energy environment – low gas and oil prices, spiral increase of the project cost and low gas demand – as it has to do with the Bulgarian government’s failure to control the negotiation process and the relevant financial transactions. The crisis in Ukraine no doubt has played a role in the outcome of the project as well.

The report follows the end of the project as well as the consequences of that end. Special attention is given to the South Stream project from a business perspective and its probable place within Bulgaria’s and South Eastern Europe’s energy infrastructure. In this context, it is clear that the project might have been justified, given high levels of gas consumption in the EU, limited alternative suppliers, higher gas prices and a more transparent negotiation and collective involvement by all affected countries. It seems obvious that the involvement of the EC at an early stage of the negotiations would limit the risk of their failure.

Such a justification for South Stream, however, is not obvious and unconditional. Rather what is obvious is that throughout its existence, the project has been influenced by forces, which are not only corrupt and defy economic logic but have attempted – and at times succeeded – to capture key state functions.
The report also looks at the development of the project and its political influence in neighboring countries, affected by the possible realization of South Stream. Serbia’s case is especially interesting given that the contract for South Stream is signed at a point in time where Serbia is counting on Russia in opposing Kosovo’s independence. This situation puts Serbia in a very weak position. Here there is no case of state capture in the sense of the Bulgarian experience. It is quite apparent, however, what role the energy infrastructure could have when its development is used as a political tool in international negotiations.

The report’s conclusion is that the South Stream project demonstrates the risks of state capture through large infrastructure projects. The South Stream partially succeeds to realize this risk. Studying this case can be invaluable in uncovering the mechanisms of achieving state capture, as well as in discovering systemic measures that could prevent it.

You can read the full report (in Bulgarian) here

            
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