The South Stream and Nabucco Pipeline: the former is designed to increase Russia’s energy dominance in Europe, and the latter is designed to offset it. Russia would like to maintain and strengthen its economic leverage as a supplier of oil to Europe, hence, its support of the South Stream. The EU is eager to diversify its source of oil supply, hence, its backing of the Nabucco project. Enter Serbia, a proposed South Stream transit country.

First, we need a proper framework of the negotiations that have taken place between Serbia and Russia to better realize the economic impact the South Stream has on Serbia.

September 9th, 2008 was the day that saw the Serbian Parliament’s ratification of a key deal with Gazprom over the purchase of a majority stake in the state-owned oil monopoly, Petroleum Industry of Serbia (NIS). This ratification calls for a negotiated price by the end of 2008.

Prior to the parliament ratification of the deal, Prime-Minister Vojislav Kostunica and President Boris Tadic signed an agreement with Gazprom for EUR 400 million, 51% stake in NIS and EUR 500 million more in future investments for the modernization of NIS until 2012. One of the key bargaining chips of the Russian side was its strong diplomatic opposition to Kosovo’s unilateral declaration of independence from Serbia, and Serbia’s becoming a transit country in the proposed South Stream pipeline.

However, after conducting an analysis of the fair market (intrinsic) value of NIS at 100% equity, it was determined to be 2.2 billion Euros by Deloitte & Touche, which was far more than the deal struck between Kostunica-Tadic and Gazprom. Now, to compensate, Serbian media is reporting that the Russians are being challenged by Serbia’s recently elected pro-Western government: to invest an additional EUR 500 million by buying an additional 19.5 percent stake in NIS. With these new challenges from Serbia’s pro-Western government, Gazprom may or may not choose to go along with the agreement. Gazprom is hopeful in reaching an agreement with Serbia because it would mean Gazprom’s first total market control outside its borders.

The Serbian negotiating position, therefore, is that all three contracts (construction of the South Stream pipeline, completion of the natural gas storage facility in Banatski Dvor, and the NIS sale) should be treated as one package.

According to the Deloitte report, NIS was ranked 20th out of the 500 largest companies of Central Europe. NIS would also provide Gazprom’s first refineries outside of Serbia. With a network of about 500 gas stations allocated in Serbia (including Kosovo), as well as in Bosnia and Herzegovina and Montenegro, Serbia’s oil monopoly is strategically significant in the supply of neighboring regions as well.

As oil becomes increasingly scarce and general demand for it is inelastic in the short to medium term, there is a trend of increasing profitability as well in the commodity. NIS posted a EUR 95 million in profit for the first half of the year, 50% higher compared to the whole of last year’s result.

With these facts we can begin to analyze the economic impact of Gazprom’s potential purchase for the majority stake in NIS and future South Stream pipeline operations in the Republic of Serbia.

It is clear that the relationship undertaken between NIS and Gazprom would be one of collusion. By purchasing a majority of NIS, Gazprom will acquire key Serbian infrastructure. Such infrastructure would include two oil refineries: one in Novi Sad and one in Pancevo. Coincidentally, the planned South Stream pipeline route is geographically close to these two refineries, which would keep transportation costs of oil low.

When completed and fully operational, the pipeline would make Serbia an energy hub in the region. Assuming the Serbian government continues favorable relations with Russia, the Serbian market would be viewed as a favored costumer, especially in unnerving times of excess demand (oil shortage). All else equal, having a stable inflow of cheap energy will translate to faster economic growth for the country as well. A particular stimulus to this growth could be the transit fees Serbia earns from neighboring countries joining in on the project. Serbia will earn revenue on every cubic centimeter of oil that passes through its jurisdiction.

The NIS purchase and construction of the South Stream would keep Serbia under an oil monopoly, as well as monopolize central and southeastern Europe, provided the alternative Nabucco pipeline does not get built. The sale of NIS and construction of the South Stream is also the beginning of the Eurasian oil cartel, which is based in Moscow. In doing this, it would also allow positive growth in Gazprom’s Western European market share as well. With European economics becoming more dependent on Russia, conditions are also obviously favorable for price discrimination in national markets.

Depending on the politics of the current time, Gazprom and a colluding firm such as NIS could set prices above marginal cost and set output below the efficient level, reducing supply. This would lead to Gazprom’s and NIS’s profit maximization. Gazprom and NIS can maximize profits by fixing prices at a higher level, especially if the political circumstances provoke this. As a result, the profits between the two would be split. However, this could always backfire on Serbia, with the disadvantage being that any moves in contrast to perceived Russian interests could lead to direct negative consequences in the Serbian market for oil.

Therefore, I find the Serbian negotiating position to be for the most part positive. One must keep in mind the advantages and sensitivities this brings to the Serbian state when considering such propositions. One can be sure the selling of NIS and the building of the South Stream pipeline will result in an increase in Serbian strategic political and economic influence. The extent of this increase in influence will largely depend on domestic Serbian factors, from the composition and leadership of future Serbian governments to the views of Serbia’s citizens. The Republic of Serbia will be the only ex-Yugoslav country to have the South Stream pipeline and by immediately developing the NIS-Gazprom relationship, will continue to be an increasingly important economic market and political player in the region.

In these decisive times for the Serbian state, it is ever more important that Serbia master the benefits of its relationship with both East and West, as did Yugoslavia. With the building of the South Stream and sale of NIS, Serbia can take different approaches toward its future relations with global power centers. The government, representative of the people, can take a pro-Western, pro-Eastern (Russia), or carefully balanced approach. With the building of this pipeline and the sale of NIS, Serbia can choose to exercise a more balanced, well-thought out approach to its future. Serbia will have greater leverage with its relations with the EU since part of EU country’s oil supplies are going to be coming from Serbia. At the same time, working together with EU countries will give Serbia a foundation to offset other potential Russian monopolies that want to come in and offset Serbian industry. Therefore, a healthy equilibrium can be found in where imports and exports are well diversified. Thus an elected, progressive Serbian government can attain what is best for Serbia while keeping Serbia as independent and self-sustaining as possible.

Serbianna