Pipeline politics favour Azerbaijan and Turkey in new round of old game


On Tuesday March 17 2015, Turkish President Recep Tayyip Erdogan played host to his counterparts from Azerbaijan and Georgia at the launch of a project many hope will have a game-changing impact on Europe’s energy market and the overall balance of power between Russia and the EU. The three leaders adopted a jubilant stance at the obligatory photo shoot, as well they might.
The project in question is TANAP, the 1,850km Trans Anatolian Natural Gas Pipeline that will act as a crucial link in the EU-backed, $40bn Southern Gas Corridor that in under four years’s time is scheduled to deliver gas from Azerbaijan’s vast offshore Shah Deniz field in the Caspian Sea to the industrial economies of Western Europe. At Turkey’s northwestern border, TANAP will link up with the Trans Adriatic Pipeline (TAP) that in turn will run across Greece and Albania, under the Adriatic Sea and onto the heel of Italy where it will join to the EU’s existing pipeline network. If plans to build a further pipeline under the Caspian Sea (the Trans Caspian Pipeline) also come to fruition, the corridor could end up giving Europe access to gas from both Turkmenistan and Iran as well.
 TANAP will initially carry 16 billion cubic metres (bcm) of gas from Shah Deniz each year, 6bn of which has already been  earmarked for the domestic Turkish market. That figure is set to rise to 23bn bcm by 2023 and to 31bn bcm by 2026.
Advocates of the Southern Gas Corridor claim that developing an alternative energy supply to Russia is vital for Europe’s long-term energy security and will introduce a much-needed element of competition. Its critics (led, not surprisingly, by Russia itself) argue that it is both politically motivated and economically unviable; but although both the Total and Statoil oil companies pulled out of TANAP in 2013 because of escalating costs, there is little question of the corridor’s potential to reshape the dynamics of Europe’s energy market. Russia currently sells more than 160 bcm of natural gas, so the corridor should increase supplies by around 20% in the space of decade.
Regardless of the motivation behind the corridor, the gas pipelines that will soon be zigzagging across the Eurasian land mass from Siberia and the Caspian Sea to Western Europe in one direction and China in the other have already become significant weapons in the renewed power struggle between Russia and Europe.

Caspian Sea by territorial waters

Cheaper, more efficient and less harmful to the environment than oil, global production of natural gas tripled between 1970 and 2010 as advances in technology made its extraction, processing and transportation commercially viable. Nearly 80% of the world’s total proven natural gas reserves are located in ten countries, with Russia topping  the list with around 25% of that total, followed by Iran, Qatar, Saudi Arabia, the US and Turkmenistan. Most of Turkmenistan’s proven gas reserves are located in the Amu Darya basin in the remote south-east of the country which will soon begin flowing through the country’s East-West Pipeline to its coast on the Caspian Sea. Turkmenistan also has substantial reserves in its Western Murgab South Caspian basin, across the waters of the Caspian Sea from Azerbaijan and the Shah Deniz field complex. 

Russia’s Pipelines
More than half of Russia’s gas reserves are located in Siberia which is the chief source of European gas and which is delivered by way of three major pipeline networks:

  • The 4,500km Trans-Siberian pipeline from Siberia’s Urengoy gas field to Uzhgorod in Western Ukraine. (Also known, with unintentional irony, as the Brotherhood Pipeline.)
  • The 2,084 km Yamal-Europe pipeline that runs through Belarus and Poland into Germany, which will eventually transport the huge reserves of gas that lie under the Arctic wastes of the Yamal Peninsula. (Despite its name it is currently only transporting gas from the Tyumen fields in Western Siberia).
  • The 1,224 km offshore Nord Stream pipeline from Vyborg on the Gulf of Finland, along the bed of the Baltic Sea directly – that is to say without passing through the so-called ‘transit countries’ of Belarus, Poland and Ukraine – to Greifswald in north–eastern Germany

Captive Markets
Russian gas accounts for somewhere between a third and one half of Europe’s entire natural gas consumption and between 7.5% to 11% of all the energy it uses; but that top-line figure conceals some major variances between countries like Spain and Ireland – who buy no Russian gas at all – and Poland, Ukraine, Belarus and the three Baltic states of Lithuania, Estonia and Latvia who are almost entirely reliant on deliveries from Russia’s duo of state-run companies, Gazprom and Transneft.
Gazprom also controls more than 60 subsidiaries in 23 EU member states including various infrastructure assets, sales organisations and joint ventures dedicated to the construction and management of natural gas pipelines and storage depots. The extra leverage that these operations gives Russia is the source of ongoing and increasing tension between Moscow and Brussels.

At the root of this tension is the conviction in the EU that Russia has consistently taken advantage of its near-monopoly status to dictate both pricing and contractual terms according to its financial needs and political agenda. While close ally and fellow founding member of the new Eurasian Economic Union trading bloc Belarus pays a mere $166 per 1,000 bcm, for instance, the tariffs imposed on Poland and Ukraine – $564 and $485 per 1,000 bcm respectively – are more or less triple that. Most former members of the Soviet bloc are similarly disadvantaged, with  the two exceptions of Kazakhstan and Uzbekistan who have their own hydrocarbon supplies that they export to Russia, China, and neighbouring Tajikistan and Kyrgyzstan.West European customers such as Germany and the UK who have access to other, cheaper sources of energy, tend to be found  towards the lower end of the spectrum.
Today’s tumbling oil prices have, paradoxically, only made matters worse for Russia’s Central and East European customers. With the Russian economy in crisis, major revenue generators like Gazprom are under extra pressure to bring in revenues, and are therefore in turn putting the squeeze on those countries that have no choice but to pay up to compensate for the loss of sales from those who can walk away.

Tied in 
The recent slump in oil prices also makes Russia’s widespread use of fixed-price contracts – which peg the sale against the price of oil at the time the contract was signed – seem particularly inequitable. Since the vast majority of these contracts are also for somewhere between 10 and 35 years, many of its customers are now paying well over the odds.
These contracts, which are legally binding and subject to international arbitration, also contain take-or-pay clauses that tend to oblige Russia’s countries to pay for more gas than they need. The Oxford Institute for Energy Studies has estimated, for instance, that European buyers are already committed to purchasing a total of more than 125bn bcm of gas from Gazprom in 2020 and around 70bn bcm in 2030.

Russia and the EU
The EU has been challenging Russia over both the pricing and terms of its contracts since 2002 when it began formal proceedings to investigate whether Gazprom was breaching EU completion law. At the time, Brussels was particularly exercised by Gazprom’s usage of ‘no resale’ clauses in supply contracts as well as unfair pricing arising from the linking of oil and gas prices in long-term contacts. Russia responded by issuing a blocking legislation, which introduced a default rule prohibiting Russian strategic firms, including Gazprom, to comply with any foreign measures or requests.
In 2009 the EU introduced the Third Energy Package and the requirement for ‘ownership unbundling’, which prohibits gas suppliers like Gazprom from also owning (and therefore controlling the resale and distribution) of the pipelines through which it is supplied.
While the then EC President Manual Barroso insisted that the legislation was not discriminatory and applied to Norway as much as Russia, President Vladimir Putin protested that the new package was tantamount to the ‘confiscation of property’.

The package has already significantly affected Russia’s plans to increase its European supply options, particularly its desire to build a southern version of the Nord Stream pipeline running under the Black Sea to the Balkans. This South Stream option was originally meant to hit dry land at the Bulgarian port and coastal resort of Varna before running through Serbia, Hungary, and Slovenia and from there onto Italy; but Russia abandoned the project in late 2014 after Brussels used the Third Energy Package to deny Gazprom the exemption it would have needed to operate the pipeline at full capacity.The EU’s latest attempt to weaken Gazprom’s control through the courts came in April 2015 when its new European Competition Commissioner Margrethe Vestager formally charged the Russian company of violating antitrust laws and abusing its monopoly position in eight countries, namely Estonia, Hungary, Bulgaria, Czech Republic, Latvia, Lithuania, Poland and Slovakia. 

EU Competition Commissioner Margrethe Vestage

Like Barroso before her, Vestager insisted that the move did not amount to discrimination against Russia as she had also filed a similar suit against Google, but in the current political climate, Putin probably remains unconvinced. This perception will doubtless have been reinforced by Brussels’ near-simultaneous decision to set up the European Energy Union in a bid to establish a single energy market and therefore to drive up its member states’ collective bargaining power.

Russian solder at Crimea’s Belbeck airport

As one of Russia’s largest customers whose pipelines transport over 50% of all the Russian gas sold in Western Europe, Ukraine has long been at the front line in the stand off between the EU and Moscow, and relationships with Russia were under strain well before the annexation of Crimea and the ongoing conflict in eastern Ukraine. Ever since the post-Soviet economic slump of the 1990s, the two countries have been behaving like a couple trapped by mutual dependence in an unhappy marriage.
For its part, Russia has needed Ukraine’s pipelines to secure gas sales in Western Europe, a crucial source of hard-currency income. Ukraine, meanwhile, has been almost entirely reliant on Russia for its energy supplies, which at times it has ill been able to afford.
For most of that decade, Russia supplied Ukraine with large-scale gas deliveries, which probably did not even cover the cost of delivery, prompting Gazprom to cut off supplies for non-payment on several occasions. Relations were further soured when Russia accused some of its Ukrainian customers of helping themselves to gas from the transit pipelines.
A desire to break this mutual dependence and to enable it to trade directly with its West European customers therefore  not just precedes but is just as important as any ideological pique the Kremlin may harbour against Kiev for favouring Brussels to Moscow.

Proposed route of the Turkish Stream pipeline

Turkish Stream
The latest twist in the saga concerns Russia’s reaction to the stalemate over the South Stream project. Earlier this month, Gazprom Deputy Chairman Alexei Miller announced that he had reached an agreement with Ankara for the construction of an alternative pipeline from Turkey’s Black Sea coast to its border with Greece. On the same day, and in a move that will have done nothing to improve the mood in Brussels, President Putin rang Greece’s cash-strapped Prime Minister Alexis Tsipras, reportedly offering to advance him a figure of around €5bn against future transit fees if he would allow Russia to build a pipeline up to its northern Balkan neighbours.

Nabucco pipeline route

Then there is Iran. With the prospect of Western trade sanctions being lifted on the increase, Tehran is now looking for new markets for its gas reserves. In recent weeks it has both indicated that it might consider buying into the TANAP project to give it access to Europe through the Southern Gas Corridor, and has also approached Bulgaria about reviving the Nabucco-West pipeline idea.
Eventually abandoned in favour of the Trans Adriatic route two years ago, the Nabucco pipeline would have followed a route from Azerbaijan and Iran to Austria via Romania and Hungary. Expelled from original Nabucco venture in 2006 for its nuclear ambitions, Iran may have received a more sympathetic welcome in Sofia this time around as Bulgaria is still smarting at the  loss of $600 million in annual transit fees from the now-defunct South Stream project

In May 2014, Russia and China signed a $400bn deal contracting Gazprom to deliver 30bcm to China for the next 30 years. The original start date for the project was set at May 2018 to give Russia time to build the 4,000k Power of Siberia pipeline down from Yakutia; but Gazprom Deputy Chairman Alexei Miller took the occasion of Chinese President Xin Jinping’s presence in Moscow for this May’s Victory Parade to announce that initial deliveries of 30bcm – this time from the Urengoy reserves that also feed the Trans Siberian pipeline.
While Moscow is insisting that this decision does not put the future of the Power of Siberia at risk, it does give Putin and Gazprom the option to quietly scrap a project with a $20bn price tag. Regardless of the delivery route, however, the agreement with Beijing can only strengthen Russia’s bargaining position by reducing its reliance on its European customer base (although it is being reported that China and Russia have yet to pin down a unit price for the gas.)

LNG tanker

75% of all natural gas is delivered by pipeline, but this system has two main disadvantages as  all Eurasia’s protagonists are only too  aware – the high cost of pipeline construction (especially for the offshore sections) and the interdependence it creates between customer and supplier. In the case of a problem upstream, the consumer cannot use the pipeline to import gas from other sources. The downside for the supplier comes when a customer cannot absorb all the volumes exported by the pipeline, forcing them to reduce production.
An increasingly popular alternative to pipeline delivery is Liquefied Natural Gas (LNG) when gas is cooled to approximately minus 162°C at atmospheric pressure and is then transported by special tankers. Although export terminals cost over $10bn to build, they can, on completion, supply natural to any regasification terminal anywhere in the world.

LNG Terminals in Europe

While Asia is currently the world’s largest LNG market, there are over 20 regasification terminals scattered around the coasts of Europe with a combined capacity of 207bn bcm a year. Another six terminals are either at the drawing board or under construction, including a floating terminal that will be berthed off Lithuania in Baltic Sea, and which has been expressly commissioned to reduce the country’s reliance on Russia (as has another one in Poland). The biggest drawback remains the price, with the unit cost of LNG standing at 25% more than for the pipeline equivalent.

Just how these ‘pipeline wars’ will pan out is, therefore, fraught with uncertainty, and it is by no means clear that the European consumer is going to end up with cheaper gas bills at the end of it all, nor if this will really break its dependence on Russia. With the EU seemingly determined to access their gas reserves, it seems certain that  firstly Azerbaijan and then  Turkmenistan (provided  the issue or trans-Caspian transportation can be resolved) are in for a cracking 21st  century.

Some analysts are comparing the current power struggle between Russia and Europe to the Great Game that was played out in the 19th century and that inally came to an end with the First World War. One of the outcomes of that conflagration was the ultimate disintegration of the Ottoman Empire, but it is, ironically, Turkey that now stands to gain most from the outbreak of pipeline diplomacy. Feted by one all as a gas conduit to Europe, it is looking forward to a future as an energy hub with its economy bolstered by some substantial transit fees from at least one pipeline network.
It was not just Azerbaijan’s President Ilham Aliyev that was looking  triumphant at that opening ceremony.

Steve Macvicar