The downgrading of the planned $40 billion pipeline, designed to detour Ukraine and flood southern and western Europe with gas, comes as Western nations impose economic sanctions on Russia to punish it for its stance over Ukraine.
"It`s useful infrastructure, but maybe it`s no longer in the list of priorities," Italian Industry Minister Federica Guidi told a news conference in Rome, signalling a policy U-turn given Italy`s once key role in facilitating the project.
"Even if on the one hand it helps diversify transit (of gas), on the other hand there is a problem with the supplier," Guidi said.
The European Union has sought for years to reduce its reliance on Russian gas imports, and Moscow`s annexation of Ukraine`s Crimea region in March combined with its support for rebels in eastern Ukraine has focused minds further.
Italy, whose state-owned oil producer Eni has set aside 600 million euros ($750 million) to bankroll the project, would be one of the countries supplied by the pipeline, while its oil services arm Saipem has lucrative deals to install the pipe`s offshore section.
But with Italian markets over-supplied amid declining gas and power demand caused by a contracting economy, South Stream`s appeal has waned -- especially as Italy will be the landing point for supplies of Azerbaijan Caspian gas from 2020.
The Gazprom-led South Stream pipeline has exposed cracks in EU strategy as countries such as Hungary, Austria, Serbia and Bulgaria among others see it as a solution to supply disruptions via Ukraine, as happened in 2006 and 2009.
Hungary on Wednesday said it aimed to start building its stretch of the line next year despite opposition from Brussels and Washington, who say the project will entrench Moscow`s energy stranglehold on Europe.
Russian energy industry sources say Gazprom is also losing patience with Europe`s political manoeuvring and, after signing two major gas supply deals with China in recent months, is re-focusing on its strategic sales pivot to Asia.
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