The deal enables ENI to add further value to its recent acquisitions of Russian assets, Arctic Gas and Urengoil. However, Gazprom will be the big winner, gaining routes into southern Europe that avoid the traditionally problematic transit countries of eastern Europe. The deal also gives Gazprom the ability to compete with any new pipelines not controlled by Russia that threaten to bring gas from central Asia or the Middle East into Europe via Turkey.

Italy is Europe’s third-largest gas market behind the U.K. and Germany, and it imports some 86 percent of its gas, mainly from Algeria and Russia. Gazprom already supplies about 25 bcm of gas a year to Italy, its second-largest gas purchaser after Germany. However, ENI is Gazprom’s largest single gas purchaser, making it Europe’s largest gas company (by sales), with some 18 percent of the total market.

Just as the 55 bcm per year Nord Stream pipeline across the Baltic (agreed to in 2006 by Gazprom, E.ON, and BASF, and scheduled to be online by 2010) diminishes the leverage Ukraine, Poland, and Belarus currently enjoy in transiting Russian gas to Germany, so may the South Stream line reduce Turkey’s influence over Gazprom’s gas supplies to southern Europe. Therefore, its strategic significance should not be underestimated.

Sanctioning of the South Stream pipeline is also likely to significantly dent the potential markets and economics of the Nabucco pipeline project, a $6.2 billion plan led by Austria’s OMV. The Nabucco 3,300 kilometer gas pipeline, with a potential capacity of 30 bcm per year by 2020, is planned from the Caspian Sea and Azerbaijan through Turkey, Bulgaria, Romania, Hungary, and on to Austria. Scheduled for construction from 2008 to 2011, few believe it will be ready to proceed at that pace. The European Union gave the project its backing in 2006, as it is looking for any alternative to Russian gas.

The announcement of South Stream appears to have damaged the commercial case for Nabucco to the extent that financial commitments may now be difficult to secure.

Pipelines proposed for construction over the next few years will compete to bring additional gas supplies into Europe. The Russian-backed South Stream Line may undermine the E.U.-favored Nabucco line that could carry gas from outside of Russian control.

In May, Russia’s president Vladimir Putin and Gazprom chief Alexy Miller visited Austria, meeting with Wolfgang Ruttenstorfer, the head of OMV, to agree on further cooperation in the gas business, particularly in the expansion of its Central European Gas Hub at Baumgarten, Austria. Gazprom wants an equity stake in the hub, which is the major European gas entry point. OMV has imported Russian gas since 1968, and last September extended its supply agreements with Russia through 2027 by contracting some 150 bcm of gas for Austria. Linking South Stream into Baumgarten with Gazprom as an equity partner will likely further limit the Nabucco project’s ability to be independent of Gazprom.

Russia has been extraordinarily successful in picking off the major gas distribution companies in Europe, which has limited the E.U.’s ability to diversify its gas supplies. Furthermore, Gazprom has taken steps to tie up a significant portion of the gas in central Asia under long-term contracts, and is doing the same with infrastructure and export routes from Kazakhstan, Turkmenistan, and Uzbekistan. In the short term, selling on this Caspian gas may also enable Gazprom to delay investment in some of the expensive pipeline and field developments required in northern and central Russia, thereby allowing it to further delay the development of big fields like Shtokman and Kovykta.

However, in May 2007, Turkmenistan and Kazakhstan agreed to expand shipments though a new-build 20 bcma pipeline out of Central Asia via Russia, in a blow to concerted western European efforts to build alternative pipelines for central Asian and Middle Eastern gas that bypass Russia. Building the new pipeline and modernizing the old ones would allow Russia to purchase up to 80 bcm of gas from Turkmenistan, which is believed to hold some 2 tcm of proved gas reserves. The $1 billion pipeline project is planned to start in mid-2008, with deliveries reaching 20 bcma by 2012 and potentially building to 30 bcma. Once upgraded, the whole Caspian pipeline export system through Russia is anticipated to be capable of carrying some 90 bcm of gas. This agreement is a blow to China as well as the E.U., both of whom were hoping to secure access to substantial Caspian gas without Russia’s involvement.

Belarus Gas Network Now in Gazprom’s Hands

In May 2007 Belarus signed an agreement to hand over a 50 percent stake in its gas pipeline network, Beltransgaz, to Gazprom, a key part of the settlement to the January 2007 dispute between Minsk and Moscow that led to oil and gas supply disruptions into western Europe. This further increases Gazprom’s control over gas networks into the area. The Gazprom deal will eventually be worth some $2.5 billion to Belarus, but payment will come in stages: an immediate $625 million for a 12.5 percent stake in Beltransgaz, with the remaining 37.5 percent stake to be paid for as it is transferred to Gazprom’s control between 2008 and 2010.

At the same time that Russia tightens control over its gas, it’s also retaking control of the few production-sharing agreements ratified with international oil companies during the 1990s. Key examples are Gazprom’s takeover of Shell’s controlling interest at Sakhalin-2, and its takeover of BP’s controlling stake at Kovykta. Now it appears that Putin’s government is turning its attention to Exxon Mobil’s stake in Sakhalin-1. (See the related story on page 10.) Rosneft – the Russian state-controlled oil firm – is already a shareholder in Sakhalin-1 (along with Japan’s Sadeco and India’s Videsh). It remains to be seen whether this will help the foreign companies retain control of this asset or hinder them.

Collectively, these recent events demonstrate the carefully orchestrated and ruthless strategy Russia and Gazprom are pursuing to achieve the objectives both of expanding gas supply volumes and securing long-term control of strategic assets and infrastructure to inhibit competition.