A MEETING IN MOSCOW Prime Minister Jadranka Kosor with Russian Prime Minister Vladimir Putin at last week's Croatian-Russian meeting in Moscow at which the South Stream deal was signedThe signing of the contract on the participation in the construction of the Russian South Stream is the biggest foreign policy success to date in Croatian Prime Minister Jadranka Kosor's tenure. With the deal Croatian Government has created the key prerequisites for the secure supply of natural gas over the coming twenty years, which can be considered the basic foundation of the long-term economic development of the country.

On the other hand, the deal marks the definite end of a ten-year period of poor bilateral relations between Russia and Croatia, that is to say it portends more intensive economic cooperation in the future. Croatia now has the perspective of becoming an important Russian partner among the countries of the European Union and thereby reap great economic and political benefit. The cornerstone of the future cooperation will certainly be major energy projects, a sector in which Russia wishes to retain its dominant role in South East Europe.

For years Croatia rejected Russian proposals on energy cooperation, and only started negotiating on the South Stream after Russia had already hammered out deals with all of the other countries in the region. Considering that the South Stream is conceived as a natural gas pipeline that will transport Russian natural gas from the Bulgarian Black Sea coast to Central European countries, Russia practically secured the entire conceived route through deals with Bulgaria, Serbia, Hungary and Slovenia. In these circumstances the position of Croatian negotiators was significantly weakened. Russia was in a position to extract numerous concessions in the negotiations with Croatia, especially as the negotiations on the South Stream were linked to the talks on a new contract on the supply of natural gas from Russian state-owned Gazprom.

The existing contract with Gazprom expires at the end of the year, and not concluding a new contract would put Croatia into a situation in which in the coming year it would face uncertainty in the supply of natural gas. As a result there was a danger that in its negotiations with Russia Croatia would hold an inferior position and in the end strike an exceedingly unfavourable deal.

This, however, do not happen. Croatia concluded the deal with Russia on the South Stream project at very favourable terms, significantly better than those of some of the countries that got on board the project earlier, such as, for example, Serbia. And it is precisely on this account that the South Stream can be considered a framework in the scope of which future partnership relations between Croatia and Russia have be traced. Insofar it is clear that the significance of the deal on South Stream largely exceeds the scope of the natural gas pipeline itself, and energy consultant Jasminko Umicevic feels that the final outcome is a significant success of all those involved in the negotiations.

"In its negotiations with Russia Croatia did not hold many aces, and it can therefore be concluded that the result is more than satisfactory. And while the public at large has yet to be presented with all of the details of the contract, just the fact that there will be 50-50 co-ownership of the part of the pipeline that will pass through Croatia is evidence that Croatia did better in the negotiations than some other countries. It is evident that the enormous efforts of the Prime Minister and Croatian Government's team of negotiators, led by Economy Minister Duro Popijac, these past months have paid off, and it appears that in the end Croatia did not have to concede to any of the contentious Russian demands that had allegedly been mentioned during earlier rounds of talks."

The two chief conditions that Russian officials mentioned were majority ownership of the natural gas pipeline and Croatia's abandoning the idea of building a liquefied natural gas (LNG) terminal at the Omisalj location on the island of Krk. These Russian demands, never officially confirmed, were very unfavourable for the Croatian side. The Russians wanted the ownership stakes to be distributed 51-49 in favour of Gazprom. That would have meant that Croatia would have had to cover half of the construction costs for the construction of the 350-kilometre natural gas pipeline from the border with Serbia to the border with Slovenia, and would in the process gain almost no rights in running it. Serbia agreed to such an arrangement, and some experts now say that Serbia's government will have no chance of influencing the operation of the natural gas pipeline, not even on transit prices, as a result of which Serbia could wind up without planned revenues in the millions. In the end the Russian demand was sidestepped by Croatia, so that a firm in which Russian Gazprom and Croatian Plinacro will hold equal ownership stakes will carry out the construction and management of the natural gas pipeline in Croatia.

The other alleged unfavourable demand from the Russian side was that Croatia back out of the construction of an LNG terminal on the island of Krk. LNG terminals are practically the only alternative routes for the supply of natural gas European countries have at their disposal, as natural gas from Northern Africa, the Middle East and Asia is transported by ship via them to Europe. For years Russia has used its influence to, as much as possible, retard the development of these facilities, especially in the countries of South East Europe.

The Omisalj project is in fact one such endeavour, with the leading roles played by major European energy companies - Austria's OMV, Germany's E.ON Ruhrgas and France's Total, joined by a consortium of Croatian companies and a stake held by Slovenia's Geoplin. The construction of this facility is very significant for Croatia as it would create a new, alternative supply route for natural gas, secure supply and by that alone reduce the dependency on Russia. As a result it is possible that one of the goals of the negotiations with Croatia for Russian officials was the possibility that Croatia abandon the LNG terminal.
In the end, however, they backed down on the demand, and there are no obstacles now to intensifying the realisation of the project so that it could be put into operation by the end of 2015. This is important because on the basis of the agreement on the LNG terminal a new Russian energy policy towards Croatia can be discerned. It is, namely, quite likely that Russia will in the future no longer seek of Croatia that it abandon competing energy projects, under the condition that it give equal support to Russian projects.

And so Croatia has effectively gained key support to participate in the future in any new energy project, including the Nabucco natural gas pipeline project, which is favoured by the countries of the European Union and the USA, and which is envisaged to supply natural gas from the Caspian Sea area to Europe via Turkey. For years Nabucco and South Stream have been considered competitor projects, and participation in one as being automatically exclusive of the other. Geopolitical relations have changed significantly in the meantime and some countries, like Hungary, have succeeded in striking deals to participate in both projects. Now Croatia is numbered among these countries, and through the deal with Russia Croatia has gained the possibility of becoming a junction of regional energy routes.

That means that Croatian institutions will in the future participate much more actively in developing Russian energy projects than they have to date. The first among a number of such projects should be the new version of the Druzba Adria oil pipeline. This project was hatched back in the time of the Racan administration, when a bilateral agreement was signed on an oil pipeline that would link the Russian city of Samara and Omisalj. Based on the deal the Janaf pipeline was to have been integrated with the transport systems of Russia, Ukraine, Belarus, Hungary and Slovakia to enable Russia oil to be delivered to the island of Krk and loaded there onto tankers. The pipeline's initial capacity was to have been five million tonnes a year, and in time to grow to a maximum 15 million.

ANTE MARKOV, head of Janaf Croatia was guaranteed compensation for transit amounting to several tens of millions of dollars, but the project very quickly met with negative public reaction. The project was slammed as being of poor profitability and the fact that the increased tanker traffic in the Adriatic Sea would increase the possibility of ecological damage. In these circumstances Racan's administration stopped the project, and with the coming of Ivo Sanader to power it was definitely rejected.

Only a few Croatian politicians, such as former President Stjepan Mesic, warned that abandoning Druzba Adria could permanently hurt relations with Russia and lead to catastrophic consequences to Croatia's national interests. This evaluation has been largely borne out, but it appears that the project could now be revived, in a somewhat revised incarnation. The top man at Janaf, Ante Markov, has for some time now led negotiations with representatives of Russian state-owned oil company Gazpromneft on creating an Adriatic spot market, an oil exchange of sorts, where international buyers could take delivery of oil immediately upon concluding a transaction. Seeing through that project would significantly improve the profitability of the original Druzba Adria.

It is, therefore, to be expected that the signing of a new deal on Druzba Adria will follow quickly on the heels of the signing of the South Stream deal, and the long-term contract on the supply of natural gas from Gazprom. And while the details of this deal are as yet unknown, off the record the story is that Gazprom has agreed to increase Croatia's import quotas, which was also one of the chief topics on the negotiating table. The increase of these quotas by over a billion cubic metres a year, to 2.5 billion, has been sought from the head of the Russian negotiating team, Russian Minister for Emergency Situations Sergey Shoygu, even back when the talks were being led by former Deputy Prime Minister Damir Polancec early last year in Moscow. Shoygu allegedly energetically rejected the demand saying that Russia currently lacked the capacity to meet the request. Given the enormous quantities of natural gas that Russia produces and exports the answer seemed unconvincing, but it clearly bears witness to the intractable position the Russian side had assumed at the start of the talks.It is clear then that the signing of the deal is a success, especially if the speculation that the increases in deliveries over the coming several years will see exports to Croatia reach the desired 2.5 billion cubic metres. And so, besides the construction of the LNG terminal, Croatia has practically secured sufficient quantities of natural gas for the coming two decades and created the basic prerequisites for industrial and economic growth in that period.

Nevertheless, speculation concerning the future route of the South Stream natural gas pipeline should be seen in light of these Russian concessions to Croatia. After the deal was signed some of the domestic media, and several energy experts, judged it as very negative, saying that Croatia would not be on the trunk route of the natural gas pipeline, and that it will as a result, lose the possibility of earning millions from transit fees. It is presumed that the main route of the natural gas pipeline would be built from Bulgaria and travel via Serbia, Hungary, Austria and Slovenia to Italy. That would mean that Croatia would only be joined to the South Stream by a branch and would in fact not have the possibility of reaping profits from the transit of natural gas.

And while the possibility is there, it is by no means certain. Far from it, the final route of the South Stream will not be defined until a feasibility study is drafted, announced for late 2010, and some experts feel that, for various political reasons, it will practically not be known until the actual start of construction. As a result the conviction in the Croatian national leadership is that further diplomatic activity could secure the passage of the trunk section of South Stream through Croatia. And even if that does not pan out, the branch connection to South Stream will for Croatia mean the resolution of one of the major goals of its energy policy, and that is to create new routes of supply. As a result the issue of exclusivity on which Russia insisted in its negotiations with the other countries participating in the project seems much more important than the issue of the route of the trunk natural gas pipeline itself. At issue is a provision that stipulates that in the future infrastructure constructed in the frame of the South Stream can only be used for the transport of Russian natural gas. A few countries, like Slovenia, succeeded in the negotiations to avoid the provision, and it remains unknown if Croatian negotiators succeeded in doing the same.

For now the provision would not have any practical effect as there are no serious competitors in the region to Russia when it comes to the supply of natural gas, but in the future Croatia could find itself in the situation of not having the necessary infrastructure for the supply of natural gas, and be unable to use existing facilities because of Russian exclusivity rights. But even that possible problem does not significantly overshadow the positive effects Croatia's accession to the South Stream project will have, and the biggest unknown surrounding the entire project is now the date of its realisation.
Irrespective of the ever greater number of countries that have struck deals with Russia on the construction of the South Stream, the realisation of the project is now in many regards much more uncertain than it was a few yeas ago. Some domestic energy experts have already warned of the danger, and there are very concrete reasons behind their claims. Europe, Russia, and the entire world have seen significant geopolitical and economic changes from June of 2007 when the natural gas pipeline construction project was first officially presented.

Dmitry Medvedev and Sergey Shoygu, the Russian President and the Minister for Emergency Situations The South Stream and North Stream natural gas pipelines were conceived above all as major geopolitical projects. Their aim was to increase the deliveries of natural gas to Central Europe, especially to major markets like Germany and Italy, and in the process to isolate those countries that were for political reasons inclined to obstructing the supply. The North Stream was, as a result, targeted to supplying North West and Central Europe, bypassing the Baltic states and Poland, while the South Stream was to have supplied South East Europe, bypassing the natural gas pipeline running through Ukraine.

In short, the idea to build the South Stream was a direct consequence of the problems Russia had with the frequent blockades of the Ukrainian natural gas pipeline. In power in the country was pro-western President Viktor Yushchenko, Ukraine aspired to cooperation with NATO and publicly expressed its ambition to join the European Union. In the situation the intention of the Russian leadership to build a new natural gas pipeline to reduce the geostrategic importance of Ukraine was entirely logical, and to significantly reduce Ukrainian revenues from the transit of natural gas, a key economic resource in that country.

The situation has changed in the meantime. The new Ukrainian President is Viktor Janukovych, a pro-Russian politician, who will almost certainly stop the trend of opening Ukraine to western influence. With Janukovych in government the Russian position towards Ukraine will change significantly, and there could even be a partnership of sorts in the making. It is possible that Janukovych will not launch blockades of the natural gas pipeline in the future, and Russia will not have an interest in reducing Ukrainian revenues from the transit. Most of the money goes anyways to Western European countries, and it is likely that in the future Russia could encourage a hike in transit costs, well aware that it would in this fashion help its ally Janukovych stay in power.

On the other hand, when the South Stream project was created, the global price of oil was hovering around its record 147 dollars a barrel, and there were forecasts that the price of oil could peak out at over 200 dollars. As the price of natural gas is related to the price of oil, Russia was reaping enormous profits on the production of natural gas, and with prices that high and a significant growth in global demand, all projects to develop new finds and the construction of new infrastructure appeared cost effective.

And then the world was hit by a global economic recession. The drop in industrial production provoked a sharp drop in energy consumption, including a drop in the need for natural gas. The cost of oil and natural gas is now almost half what it was in mid 2007 when the South Stream project was presented, and consumption has dropped in Europe by about 8 percent.

In these circumstances it is a big question whether a company, even a giant like Gazprom, can afford to embark upon a 25 billion dollar investment without a clear perspective of cost effectiveness. The Russian natural gas business, Gazprom above all, is currently seeing a significant stagnation. If the period of lowered economic activity at the global level, i.e. a reduced demand for natural gas, persists, Gazprom and other Russian companies will probably be forced to slow down or temporarily delay a significant number of large-scale projects.

Given the new geopolitical relations and in the context of better relations between Russia and Ukraine, one of these projects could easily turn out to be the South Stream natural gas pipeline. The creators of Croatia's energy strategy should bear this fact in mind. Croatia cannot realistically influence whether and when the South Stream will be built. By signing a deal it has secured its participation when that happens, and that is without a doubt a success. Now the Croatian national leadership must, with equal intensity, continue to develop all other projects that could in the future secure Croatia's long-term energy stability.