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Southern Gas Corridor project defies sceptics

Azeri gas will be flowing into Europe via a new route by the summer

When the first gas flows through the Turkish stage of the Southern Gas Corridor (SGC) pipeline network this July, Europe will have made a symbolic and important step towards its goal of loosening its dependence on Russian gas.

The amount of gas involved is relatively small—just 10bn cubic meters sourced from Azerbaijan's Shah Deniz II field, compared to the 194bn cm of Russian gas that went Europe's way in 2017. At one point in its gestation there were plans to pump up to 60bn cm of gas through the SGC—an amount that really would have shaken up market shares in Europe.

Nevertheless, the SGC has a strategic value to Europe that outweighs the volumes involved. EU officials say the SGC is as much about displacing coal-fired power generation in central and southeast Europe as offsetting Russian dominance. But this is the first non-Russian gas pipeline to Europe since the Medgaz link from Algeria to Spain completed in 2008 and is highly significant for that reason.

The EU has bridled at perceived overcharging by Russian state gas monopoly Gazprom of customers in central and eastern European countries. By introducing a rival and growing long-term alternative gas supply source from the Caspian, it hopes market pressure will erode Gazprom's capacity to dictate prices—as well as bolstering European energy security.

Europe's determination to see the SGC to fruition, just five years after the final investment decision, reflects the readiness of the main European lending bodies—the European Bank for Reconstruction and Development (EBRD) and the European Investment Bank (EIB)—to commit substantial loan packages. The project's total cost is put at $40bn, of which about $28bn is capital investment required to produce the gas and transport it to the Georgia-Turkey border.

From there, additional pipeline systems will deliver 6bn cm a year of gas to Turkey and a further 10bn cm of gas to markets in Europe. Overall, Shah Deniz gas will travel 3,500km through one of the biggest ever energy infrastructure projects. Comprising three linked pipelines—the Trans-Adriatic Pipeline (TAP) from Albania to Italy, the South Caucasus Pipeline through Georgia and the Trans-Anatolian Pipeline (TANAP) through Turkey—it forms one of the EU's "priority projects".

Financing controversy

But the scheme has also courted controversy, particularly for its financing. Criticism has focused on Azerbaijan's lack of commitment to the highest levels of transparency—an issue highlighted in the country's March 2017 withdrawal from the Extractive Industries Transparency Initiative (EITI), following its earlier suspension (see box below). Human rights campaigners have highlighted other issues in Azerbaijan, including attacks on civil society groups.

Despite initial concerns that this might lead to it being ineligible for funding from international institutions, the flow of finances has not halted. In October 2017, the EBRD approved a $500m loan for Tanap, and in February of this year, the EIB approved a €1.5bn ($1.86bn) loan for the TAP component. EBRD officials have hinted at more funding being made available, with one quoted as saying that the bank plans to allocate loans worth up to €1.2bn for TAP this year.

'The EBRD's participation is a signal that investors believe in this project'—Stanislav Pritchin

The TAP link has also been identified as a particular concern by environmental campaigners. One, CEE Bankwatch, has countered EU claims that the TAP project will lower the continent's emissions by reducing dependence on coal-fired power generation. It suggested the SGC's overall environmental impact would actually be as damaging as coal, largely because of fugitive emissions of uncombusted methane and other leaks.

These criticisms have done nothing to dim European appetite for the pipeline project. Stanislav Pritchin, a Russia specialist at think tank Chatham House, points out that while the Azeri gas is limited in volume, it will nonetheless make a strategic impact in key eastern European markets that have hitherto been dependent on Russian gas. In Bulgaria for example, the plan is for Azeri gas to supply a third of its 3bn cm annual consumption.

Turkey will also benefit from its separate allocation of gas from Azerbaijan. "Although Turkey's main gas supplier is Gazprom, 6bn cm/y of Azeri gas will have a significant impact there too," says Pritchin. Some 28.6bn cm of the 55.2bn cm of gas imported into Turkey in 2017 came from Russia, according to Turkish government data.

Could SGC carry Russian gas?

Despite the rationale behind the project, there is a chance that Russian gas could find its way into the SGC. Such an ambition has been voiced by high-ranking Gazprom officials, and could be possible because of the auction system employed that gives equal access to the SGC for all potential suppliers. If TAP infrastructure could be freed up for Gazprom supply, it would widen the Russian giant's supply options to the European market.

This is still considered a low probability outcome by some. Under the development plan, the capacity of TAP could double, to 20bn cm, if a supplier provides sufficient volume. But one analyst said there was no indication that Gazprom gas would be that supplier, and that the Russian firm will more likely send gas to the separate Turkstream pipeline project to feed Russian gas into the Turkish gas network, when that is completed in late 2019.

For Azerbaijan, July 2018 will be a landmark in its evolution into a major gas supplier to Europe. State-owned oil company Socar is now mulling developing new gasfields that could end up joining the Shah Deniz gas in the corridor.

The SGC project developers have defied sceptics who thought it might never happen, and it is coming in on time and within the budget. Baku has also shown it can tap external funding sources, despite criticism on human rights and transparency issues. "The EBRD’s participation is a signal that investors believe in this project and are ready to support it," says Pritchin. "At the beginning, Azerbaijan wanted to construct this project using money from its national oil fund. Now it has external funding, it can speed things up."

EBRD defends financial support for Azerbaijan pipeline

Financing for the Southern Gas corridor (SGC) pipeline network was thrown into question in early 2017 when Azerbaijan quit the Extractive Industries Transparency Initiative (EITI), following criticism from human rights groups over a crackdown on civil society groups. However, European institutions, including the European Bank for Reconstruction and Development (EBRD), were not deterred from providing finance.

In October 2016, the board of EITI—an anti-corruption watchdog for a coalition of countries—concluded that, while Azerbaijan had made "meaningful progress in implementing the 2016 EITI Standard", it had not made "satisfactory progress on civil society engagement". In the following March, the board said Azerbaijan had made further progress, but that more work was required. At that point, the country withdrew from the initiative.

Membership of EITI was considered a key asset in terms of improving the image of the country's oil and gas sector, so leaving was a risk. It looked possible that Azerbaijan would be deemed ineligible for future loans by the World Bank and other international institutions as a result.

Why then is the EBRD providing loans to the SGC, a project which will benefit Azerbaijan to a large extent? The EBRD itself says the projects it finances must be designed and operated in compliance with good international practices relating to sustainable development, and it has a specific mandate to promote democracy.

Francis Malige, the bank's managing director for eastern Europe and the Caucasus, told Petroleum Economist that standards similar to those of EITI had been applied to the project, despite Azerbaijan's withdrawal from the initiative.

The Southern Gas Corridor stretches over 3,500km - Source: Petroleum Economist

"It's a project that is strategic for Europe's energy security. We have worked in Azerbaijan for the past 25 years. It's not a perfect situation there, but we believe we have better influence by actually engaging rather than not engaging," said Malige. "That is our policy in this country in general, and also as far as this project is concerned."

He contended that the EBRD could add significant value to the SGC through continued engagement.

"We are not the EITI, right? We have our own standards when it comes to environmental and social policies and transparency of revenues," he said. "From that standpoint, we actually welcome the fact that, when Azerbaijan decided to exit EITI, they announced they would keep implementing the transparency standards that come with EITI membership."

Malige pointed out that Azerbaijan created its own version of the EITI and invited in outside observers, such as the EBRD and several dozen non-governmental organisations, to monitor developments. "Azerbaijan is clearly practicing a degree of transparency with regards to its use of oil revenues," he said.

So, does Europe's strategic need for diverse gas supply sources ultimately trump human rights or environmental considerations?

"I wouldn't put it that way," Malige said. "It's a really important project for Azerbaijan. And we have not lowered our standards in order to make sure that we are comfortable with the way the project is run and the way the project will operate."

Oil and gas only make up a part of the EBRD's overall support for Azerbaijan. "We think that strong dialogue with the authorities across the spectrum of the economy helps us be more relevant when it comes to Azerbaijan's long-term objective to build an economy that is less dependent on oil and gas," Malige said.

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