Likelihood of friction between Serbia and Russia over Serbian NOC and gas supply deals

Economic recovery and FDI (Foreign direct investment) diversification improve the negotiating position of Serbia. Early indications of growth in the Serbian economy in the first quarter of 2013 are likely to bring new momentum to the relationship between the Serbian and Russian governments over the Serbian national oil company NIS.

(c) Romania-Insider.com
Sold to Gazprom in 2007 under the previous center-left government led by Democratic Party of Serbia and President Boris Tadic, the terms of the sale have been publicly and politically disputed. The initial privatization process starting in 2007, 51 per cent of NIS shares were sold to Gazprom Neft for €400 million and an additional €550 million in investments until 2012. A 22 per cent net income rise of NIS amounted to €461 million in 2012 raised further public pressure over sale terms and Gazprom investments in NIS.

Before mid-2012, Serbian international and economic relations were heavily focused on Russia due to Democratic Party of Serbia’s leadership strong ties to Russian political leadership. However, since the parliamentary and presidential elections in May of 2012 brought major political change with the Serbian Progressive Party claiming victory in both elections, the Serbian government has aggressively pursued attracting foreign direct investments from alternative destinations, primarily Western Europe and the Middle East. Exports from FIAT’s factory in Kragujevac, Serbia started in late 2012 and are estimated to reach between €1.1 and 1.3 billion in 2013. Further progress was made with the sale of the Serbian national airline JAT, a constant heavy loss-producing entity, to Etihad of Abu Dhabi in exchange for investments in the company as well as large-scale investments from the UAE-based company Al Dahra in Serbian agricultural production and other UAE investments in tourism. Negotiations are under way for the construction of a semiconductor plant by the UAE-based Mubadala.

With exports rising by an proximate 21 per cent, industrial output growth early forecasts for first quarter of 2013 at 5,2 per cent and estimates of GDP growth around 1,5 percent for the same quarter, Serbia’s negotiating position towards Russia is improving for issues of notable investment decrease in NIS and stagnant negotiations over the NIS-associated south stream section. The improved economic situation makes Serbian government pressure for renegotiation of investment terms for NIS with Russia very likely in the nearby future. High unemployment and particularly rising energy costs are further factors that impact political pressure on the current government to consider Gazprom’s supply contracts and investments into NIS.

Serbia and Kosovo growing towards one another

Completion of Kosovo talks and likely start of preliminary EU accession negotiations
generate positive impact on Russian interest for reviewing economic and political ties with Serbia The change in direction over Kosovo talks by the key political factor, Serbian Vice-Prime Minister,

The costs of extensive internal corruption issues persist as Gazprom struggles to keep its long-term supply contract pricing in place
Minister of Defense and head of the Serbian Progressive Party Aleksandar Vucic proved to be the key step in finding an agreement in the Kosovo talks, recently finalized between Serbian Prime Minister Ivica Dacic and Kosovo Prime Minister Hashim Thaci with moderation by EU top diplomat Catherine Ashton. After Vucic agreed to support a deal between Serbia and Kosovo, the agreement was formulated as an accord on normalization of relations and was reached within days as intensive brokerage by Ashton and reinsuring messages over start of preliminary EU negotiations from the European Commission were channeled to the Serbian government.

After the initial agreement over Kosovo was reached, the European Commission recommended the start of EU membership talks upon Serbia’s relinquishing of military and police control over northern Kosovo, likely to take place on July 1 when the neighboring Croatia is set to enter the EU. The rapprochement with EU and Kosovo, initially not anticipated due to a hard line election platform over Kosovo by the Progressive Party, is another new factor in Serbian-Russian relations. The visit of Prime Minister Dacic to Russia in early April and the meeting with Prime Minister Dmitry Medvedev was the initial step in the increased attention of Russian government to rekindle the relationship with the Serbian government. However, importance of the meeting with Medvedev is relative as likelihood of his dismissal as Prime Minister will increase substantially should the country continue down the negative economic trajectory.

Yet neither investments into NIS development nor the start of south stream constructions were settled as internal Kremlin relations mandated that a meeting as well as agreement over Gazprom-NIS, the south stream development and other Russian-Serbian investments will have to be done at the highest level, with President Vladimir Putin meeting his Serbian counterpart, President Tomislav Nikolic – the second person in the Serbian Progressive Party hierarchy.

Russian interests increase

Mounting issues with and in Gazprom are likely to accelerate the resolution of friction over Russian gas and oil investments in Serbia. The reduction in supply from Gazprom’s ageing gas fields in Russia as well as an EU probe into Gazprom’s anti-competitive policies are slowing down the development of the $21 billion south stream pipeline after last year’s renewed initiative with signing of section construction agreements in Bulgaria, Serbia, Hungary and Croatia.

The US shale boom is another obstacle to Gazprom’s gas exports to Europe, with falling prices and price cuts from Gazprom affecting long term export prospects to Western and Central Europe, where Gazprom holds a 25 per cent of the gas market

It is likely that President Putin’s cabinet will push for realization of agreed terms
yet derives 40 per cent of its revenues from this geography. A $1 drop per 1 MMBtu in Europe is expected to further reduce Gazprom’s profit by almost 8 per cent. The costs of extensive internal corruption issues persist as Gazprom struggles to keep its long-term supply contract pricing in place. The European Commission antitrust probe review of Gazprom’s dominant position in the Central and Eastern European market and the impact on competition is another risk for Gazprom. If Gazprom loses the case against the EC, potential fine estimates range up to $14 billion.

All these factors, in short, contribute to the increasing importance Gazprom will attribute to maintaining its position in the Serbian gas market, both through the construction of the South Stream pipeline and NIS investments. The connection between NIS, construction of the south stream section and current Russian gas-supply is largely in public perception rather than material. Rising utility costs and increasingly publicized high prices of Russian gas-supply deals in Serbia, at $420 per thousand cubic meters in March of 2013, were behind late-March Gazprom’s CEO Alexery Miller’s announcement that gas prices for Serbia will be reduced to around $380 per thousand cubic meters.

While NIS engages in gas exploration and production, it supplies only 15 per cent of Serbia’s gas demands. However, persisting of sub-priced initial sale of NIS to Gazprom adds on to pressures for reduced gas prices and/or Gazprom’s investments into NIS. Finally, the political and economic importance of south stream construction is multiple – in addition to the direct foreign investments, the supply costs for Gazprom’s gas to Serbia are raised by passage through Hungary between 25 and 40 dollars per thousand cubic meters, something that the construction of the south stream pipeline would reduce in the long term as Serbia expands plans for construction of gas power plants.

Conclusion

As implied during Prime Minister Dacic’s visit and considering internal Russian hierarchy over international energy sector relations, concrete agreements will formally have to be made between President Putin and Nikolic. The meeting took place shortly after, in May, when President Nikolic joined by Vice Prime Minister Vucic met with President Putin over the alliance. After the meeting, it is likely that President Putin’s cabinet will push for realization of agreed terms as soon as possible with Serbia’s EU accession negotiation start date approaching fast with July 1. The beginning of construction of the South Stream pipeline will either be fast forwarded, providing ample evidence that the broader project is likely to be realized in the near future, or, if delayed, it will provide indication of where the project will head over the coming years. In any case, Serbia’s internal issues with Russia and Gazprom will be an indicator on the more general direction the two will be taking in the near future.

Luka Oreskovic is a researcher and associate of the Institute for Quantitative Social Science at Harvard University and a columnist or contributor to the Financial Times, the Economist, Moscow Times and Huffington Post.