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Make your mind up time for Azerbaijan pipeline

D-day looms as pipeline suitors jostle for Shah Deniz riches

Azerbaijan is set to take a crucial decision in April over which planned pipeline will carry gas from the huge Shah Deniz gasfield to Europe. No-one outside the highest circles knows if the country is leaning towards the heavily EU-backed Nabucco project, or one of two smaller-scale pipelines and the race is too tight to call.

Pipelines rarely make the headlines, but this one will be different: at stake is whether the EU can truly diversify its pipeline gas imports away from Russia in the medium term, and whether the bloc's executive body, the European Commission, is capable of successfully pushing through projects deemed strategic to its interests.

The choice before Socar, Azerbaijan's national oil company, is between three not-yet-built pipelines: Nabucco, Interconnector Turkey-Greece-Italy (ITGI) and Trans-Adriatic Pipeline (Tap). All three are part of the Commission's attempt to open up its Southern Gas Corridor – a network of gas pipelines that it hopes will eventually deliver up to 120bn cubic metres a year (cm/y) of Caspian, Central Asian and Middle Eastern gas to Europe, without crossing Russian territory.

The Southern Gas Corridor became a strategic goal after Russia cut off gas supplies to Ukraine in winter 2006 over a price dispute, leaving large swathes of Europe shivering – Russia provides about a quarter of the gas consumed in the EU and about 80% of this transits pipelines across Ukraine.

The plans received a further shot in the arm when Russia cut off the gas again in early 2009, again in a price row with Ukraine. While the proportion of gas imported from Russia constitutes 18% of EU15 consumption, once newer member states are incorporated the figure rises to about 60%. Slovakia and some western Balkan countries are wholly dependent on Russian gas.

Russia offered its own solution to the problem: bypass troublesome Ukraine. Gazprom is building the Nord Stream gas pipeline, which should be operational in October and will eventually carry 55bn cm/y under the Baltic Sea direct to Germany. It is also pushing South Stream, a €24bn ($32.5bn) pipeline project to deliver up to 63bn cm/y of new supplies through southeast Europe from 2015.

But for Europeans such as Joschka Fischer, former German foreign minister and now an advisor for Nabucco, South Stream is no answer to Europe's energy-security needs. "South Stream is not a European project, it's a Russian project," he told Petroleum Economist in January.

Supporters of South Stream counter this by pointing out that half of the project belongs to European transit countries such as Bulgaria and Serbia, and that Italy's Eni is building the pipeline in a joint venture with Gazprom. "It's very much a joint Russian-EU project, but from a political perspective some might see it differently," sighs Marcel Kramer, head of South Stream.

Europe will certainly need more gas over the next few decades, but is unlikely to need the volumes promised by both South Stream and Nabucco – a combined 94bn cm/y. Industry body Eurogas says EU gas demand rose by 6-8% in 2010, from 410bn cm in 2009, but the continent is oversupplied, with IHS Global Insight estimating the overhang at around 110bn cm last year.

While demand will recover in the coming years, says Eurogas, growth could be 20% lower than previously expected. And with the possibility that large amounts of unconventional gas – shale gas, as well as coal-bed methane – will be produced in Poland and Ukraine, for example, analysts say Nabucco and South Stream are mutually exclusive projects.

The southern route

To open up the Southern Gas Corridor, Azerbaijan committed in January to make "substantial" volumes of gas available from the phase-two development of the 1.2 trillion cm Shah Deniz field, where a BP-led group plans to begin producing 16bn cm/y in 2017. Official comments suggest the amount will be 10bn cm/y, to be sold through a common policy agreed by the Shah Deniz consortium. To ensure impartiality in the bidding process, Socar has been mandated to handle all negotiations. The Shah Deniz group comprises BP (25.5%), Statoil (25.5%), Socar (10%), Lukoil (10%), Nico (10%), Total (10%) and TPAO (9%).

Although the Commission is ostensibly neutral on which project should open up its Southern Corridor, behind the scenes it is heavily lobbying for Nabucco – an ambitious project requiring more than 4,000 km of new infrastructure, at a cost of around €8bn. The problem for Nabucco is the very feature that its supporters tout as its main advantage: its 31bn cm/y capacity. With Azerbaijan offering only a limited volume of gas, at least initially, the consortium must find other suppliers.

There is talk that Iraq's northern Kurdistan region could start exporting gas and supply Nabucco. But as Jen Coolidge, executive director of CMX Caspian and Gulf Consultants, notes, Iraq's central government wants to meet domestic demand before exports can begin. "That doesn't discount the potential for small-scale, near-term volumes of perhaps 5bn cm/y ... but Commission talk of 15bn cm/y for Nabucco" is speculative in light of Iraq's electrification needs, she says.

That leaves Turkmenistan as Nabucco's potential saviour. Historically, Russia was the main offtaker of the country's gas, but Gazprom plans to buy just 11bn cm this year, compared with forecast supplies of 70bn cm/y under a 25-year co-operation agreement signed in 2003.

For Turkmenistan, this precipitous drop in exports has been disastrous for the economy. In the short term, China is providing some relief. In 2009, the country loaned Turkmenistan $3bn to develop the 14 trillion cm South Iolotan gasfield and last year approved a further $4bn to complete the first stage of development of the field. Exports to China began in 2009 and could rise to 30bn cm/y in 2012.

While Valery Yazev, president of the Russian Gas Society and deputy chairman of the country's parliament, claims "the gas in Turkmenistan will be China's gas," analysts say it looks increasingly that Turkmenistan's leadership is keen to supply Europe with the volumes it needs.

In January, Commission chief Jose Manuel Barosso and energy commissioner Günther Oettinger met President Gurbanguly Berdymukhammedov, who made positive noises about building a trans-Caspian pipeline to Azerbaijan – essential if the country is to supply Nabucco. "We are ready to provide gas to the countries of Europe," Berdymukhammedov said on state television. The most attractive option, he added, "from a commercial, financial and infrastructure point of view, is a pipeline under the Caspian Sea".

This newfound willingness to build a trans-Caspian pipeline stems from a deterioration in relations with Russia. In November, Turkmenistan and Azerbaijan agreed that they had the right to build offshore pipelines crossing their sectors of the Caspian Sea, ignoring pressure from Russia, which claims infrastructure cannot be built until the Caspian has an internationally accepted status (since the break-up of the Soviet Union, the sea's five littoral states – Azerbaijan, Russia, Kazakhstan, Turkmenistan and Iran – have all made competing claims over parts of it).

Russia also objects to a pipeline on environmental grounds. But this position is seen by some purely as a strategy to block Nabucco. "Russia objects on environmental grounds, but there are already plenty of pipelines on the seabed," says Coolidge. She adds: "If Russia can economically provide gas to Europe under the increasingly competitive conditions in the European gas market, it should have no trouble with a trans-Caspian pipeline."

Coolidge estimates Russia's decision to reduce imports means up to 30bn cm/y of gas is shut in at the Dauletabad field that could be made available to Nabucco. Malaysia's Petronas could also supply another 5bn-10bn from fields it is developing in the country. As Fischer stated: "With commitments from Azerbaijan, Turkmenistan and northern Iraq, there is enough gas" to fill Nabucco.

This has put the project's supporters in a confident mood. Fischer even told the January conference there was a possibility of rolling the three projects into one, with ITGI and Tap opening up the Southern Gas Corridor and Nabucco later providing the strategic element.

Indeed, there is little chance of Nabucco meeting its planned 2015 start-up date and it will probably be pushed back to 2017, when Shah Deniz phase-two gas becomes available. A Nabucco spokesman says that after receiving commitments of €4bn from multilateral lenders, the next step is to enter talks with commercial banks and export banks, with the aim of starting construction in 2012 and finishing it in 2015-16.

Representatives of ITGI and Tap did not acknowledge Fischer's offer, but instead spent their allotted time extolling the virtues of their own projects over Nabucco – they are cheaper, more cost-efficient, more flexible and more practical.

Think small

For ITGI, around 1,700 km of the overall 2,500 km of pipeline already exists. Missing is a 207 km offshore section – the Poseidon Pipeline – linking the Italian and Greek networks across the Ionian Sea, which is being built by the IGI Poseidon joint venture between Italy's Edison and Greece's Depa. This will have a capacity of 8bn cm/y and cost around $1.5bn, while the existing section of the pipeline between Turkey and Greece has a capacity of 12bn cm/y.

"We are ready today to buy Caspian gas," says IGI Poseidon chief Elio Ruggeri. "How can Europe rely on a project [Nabucco] without any political clearance?" The attractiveness of ITGI to Azerbaijan is that it could sell gas not only in the Greek and Italian markets, but also to Bulgaria and the western Balkans, says Aleksandra Jarosiewicz of the Centre for Eastern Studies.

The Tap project would also provide access to similar markets for Azerbaijan, but like ITGI shares the drawback of its reliance on Turkish infrastructure, which desperately needs modernisation – the cost of which is estimated to run into billions of dollars.

The $2bn Tap project, proposed by a consortium of Statoil, E.On and EGL, requires the shortest pipeline to be built – a 520 km section with a 10bn cm/y capacity, across Greece, Albania and the Adriatic Sea to Italy's southern Puglia region.

Tap is the only project to include a member of the Shah Deniz consortium in its shareholder structure, Statoil with a 42.5% stake. The leverage this gives Tap in the bidding process for Azerbaijan's gas is debatable, but analysts say that if Nabucco had included Socar among its shareholders from the beginning, neither Tap nor ITGI would probably made it off the drawing board. "Had [Nabucco] included Socar among its members from the start, we wouldn't be having this discussion, it would've been a done deal, you never would have seen competing projects," says Andrew Neff of IHS Global Insight.

Tap managing director Kjetil Tungland is confident. "Tap is in a strong position at this critical stage," he says. "Distance is money, so we need to use the shortest route and as much existing infrastructure as possible – Tap is the most cost-efficient project for the Southern Gas Corridor." Tap is tailor-made as a conduit for Shah Deniz gas, he adds – the producers have offered 10bn cm/y and Tap has a capacity of 10bn cm/y. And he counters Nabucco supporters' argument that Tap's capacity is limited: "Tap is flexible, capacity can easily be increased to 20bn cm/y by adding compression."

If that is the case – and some analysts take it with a pinch of salt – it could ultimately swing Socar's decision in Tap's favour. The project is feasible at the initial volumes of gas on offer and can be scaled up if Azerbaijan agrees to increase supplies.

The danger for Azerbaijan is that its gas is left in the ground after opting for a pipeline that eventually founders on its complexity and its vulnerability to the shifting sands of the global gas market. Recent years have seen the emergence of shale gas, a global supply glut and plunging prices. In just three years, says Neff, the fundamentals underpinning Nabucco have changed dramatically, pushing the project back several years. But ultimately, Neff believes Azerbaijan will back Nabucco.

So for Azerbaijan, too, just as much as the project consortia, the decision is crucial. As Tungland says: "The plot is set. The players are lined up. Let the games begin!"

EU Southern Energy Corridor pipeline projects

Nabucco – Route: Turkey-Greece-south and central Europe. Capacity: 32bn cm/y. Shareholders: Austria's OMV, Hungary's Mol, Romania's Transgaz, Bulgaria's Bulgargaz, Turkey's Botas and Germany's RWE. Each hold a 16.67% stake in the project.

Trans Adriatic Pipeline – Route: Greece-Albania-southern Italy. Capacity: 10bn cm/y. Shareholders: EGL of Switzerland, 42.5%, Norway's Statoil, 42.5%, Germany's E.On Ruhrgas, 15%.

Interconnector Turkey-Greece-Italy – Route: Turkey-Greece-Italy. Spur line to Bulgaria. Capacity: 12bn cm/y. Shareholders: Italy's Edison, Turkey's Botas, Depa of Greece.

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