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Gazprom holds the cards

Gazprom becoming a world leader in gas acquisition

THE South Caucasus Pipeline (SCP) came on stream last month, opening Central Asia's gas reserves to European consumers and reducing the continent's dependence on imported Russian gas. It is a development that could eventually transform the balance of Europe's energy relationship with Russia, writes Derek Brower.

At least that is what Europe hopes. SCP is one of the flagship projects of the Baku Initiative, a "dialogue" the EU set up in 2004 with energy-producing and -transit countries in the Caucasus and Central Asia. Although the pipeline will supply just 8.6bn cubic metres a year (cm/y) in its first phase, total capacity will be 20bn cm/y, says BP, the technical operator of the consortium developing the Shah Deniz Caspian gasfields that will fill it (see box).
A spokesman for Andris Piebalgs, the EU energy commissioner, said last month that the pipeline would be a "welcome new supply route for Europe, which will help to diversify the continent's sources [of energy]". However, notwithstanding EU enthusiasm for Caspian and Central Asian gas imports, there are two problems.

The first, as ever, is infrastructure. The long-term ambition of Turkmenistan and Kazakhstan is to pump their gas to Europe through SCP, which follows the same route as the Baku-Tbilisi-Ceyhan (BTC) oil pipeline (see map). And additional supplies from these two producers would increase deliveries to a level that would start to have a significant effect on Europe's attempts to diversify its supply base.

However, BP says the consortium developing Shah Deniz has had no negotiations with Turkmenistan or Kazakhstan about using its infrastructure for exports (although the Shah Deniz partners are not ruling it out). Encouragingly for the EU, there are signs that this co-operation could receive impetus at the political level. In January, Azerbaijan's prime minister, Artur Rasizade, told his Kazakhstani counterpart, Danial Akhmetov, that his government would support Kazakhstan's ambition to export gas thorough SCP.

Barriers to TCP

That, however, would require a new pipeline from Kazakhstan to Azerbaijan. Kazakhstan has proposed to build the Trans-Caspian Gas Pipeline (TCP) from Turkmenbashi to Baku, where it would link with SCP (see Map 1). Last year, the government approved an oil version of the project and said it would be on stream by 2010. However, this looks unlikely – there has been little progress since. In addition, the technical difficulties involved in building any submarine line, especially one that lies on the bed of the world's fourth-deepest lake, are another formidable barrier.

However, Turkmenistan is also eager for that export route to open. The country has bold export plans and is particularly keen to break Russian gas monopoly Gazprom's stranglehold over the routes that take its gas to markets. The country has already negotiated a potential export project with China. But while those plans depend on China's gas market growing sufficiently (PE 12/06 p12), Turkmenistan knows westbound exports to Europe would tap a market whose demand is in no danger of slowing down (see box) – provided it can find a direct export route that avoids Russia.

And Europe, of course, has backed the pipeline, which could eventually transit up to 30bn cm/y, according to Azerbaijan. Piebalgs endorsed the TCP in a visit to Kazakhstan last summer and officials in Brussels tell Petroleum Economist that the line would be crucial to the continent's diversification strategy. The US has also begun lobbying governments in the Caspian region to develop TCP.

Baku, which would do nicely from the line's transit fees, has, in turn, put pressure on the EU to make its backing of the project more tangible – by, for example, instructing its investment banks to provide financial support. In March, President Ilham Aliev claimed TCP would "ensure Europe's energy security and protect it from Russian monopolism". He added: "Europe has understood that it is naive to place all its hopes on Russian gas. The events of recent months, when Russia has, in effect, demonstrated its status as a monopolist, indicate that prices will rise further."

However, this brings up the second problem: the transit countries. The European Commission has been twitchy about its reliance on transit countries between producers in Central Asia and markets in Europe ever since the so-called gas war between producer country Russia and transit country Ukraine at the beginning of 2006.

Central to Europe's strategy for these countries is its Neighbourhood Policy. Established in 2004, this aims to increase integration between the EU and "its immediate neighbours by land or sea". The policy includes a number of tangible benefits for potential partners, including trade agreements and preferential investment terms from EU banks. There are other less tangible benefits – not least the promise that participants may one day join the EU.

Yet events on the ground continue to undermine the EU's efforts to secure its energy supplies through the soft politics of the Neighbourhood Policy. As Petroleum Economist recently revealed (PE 11/06 p20), Gazprom seems to have muscled in on the EU's much-vaunted Nabucco pipeline project.

Gazprom believes it has rendered that pipeline redundant (see article, opposite). And now the company is pursuing a policy that aims to ensure any transit countries between Central Asian producers and European markets remain firmly within the Kremlin's sphere of influence.

What is the South Caucasus Pipeline?

STARTING from the Sangachal terminal near Baku, the South Caucasus Pipeline (SCP) could eventually be a crucial source of energy for Europe. Production from the Caspian Sea's Shah Deniz gasfields, which lie some 70 km southeast of Baku, will be 9bn-10bn cubic metres a year (cm/y) of natural gas and 37,000 barrels a day of condensates in its first phase, which should last until around 2010, says Statoil, one of the developers.

Shah Deniz is estimated to hold 50bn-100bn cm of gas reserves. Those volumes will supply Turkey's Botas with 6.5bn cm/y once the production plateau is reached. Azerbaijan, which imports gas from Russia at present, could take 1.5bn cm/y and Georgia is likely to buy another 0.8bn cm/y. However, as production from Shah Deniz increases, so will the capacity of the line, which will expand to 20bn cm/y in its second phase. The route of the pipeline follows much of that established by the Baku-Tbilisi-Ceyhan, crossing Azerbaijan (442 km) and Georgia (248 km) before reaching Turkey. SCP terminates in Erzurum, in the east of the country.

Construction began in 2004 and was finished in May 2006. BP, the technical operator of the Shah Deniz consortium, said last month that the pipeline had been filled with associated gas and commissioned up to the Turkish border. It said the group is now awaiting the official start-up of Shah Deniz project.

Once the gas is in Turkey, it could feed the Nabucco pipeline, a project the EU hopes will help the continent diversify its source of energy away from Russia. If it is built, Nabucco could also take Middle Eastern gas, although it seems increasingly likely that Russian gas will also help to fill the line.

Ambitious gas exporters

Having brought SCP on stream, Central Asia's other ambitious gas exporters, Turkmenistan and Kazakhstan, hope the Trans-Caspian Pipeline (TCP) will eventually link up with SCP. But analysts doubt TCP will go ahead (see main article). In addition, BP says plans to take gas from Turkmenistan and Kazakhstan are "not part of the Shah Deniz consortium's thinking at present".

However, an official from Norway's Statoil, the company managing the consortium's gas sales, says the company would "not rule out that we could have capacity at some stage for other gas".


An offer you can't refuse

Furthermore, while the EU's Neighbourhood Policy offers few immediate benefits to these countries – or to the EU itself – Russia's strategy has been to make offers that these countries cannot refuse.

Turkmenistan, for example, is unable to sell its gas without Russian co-operation. Ukraine is the main transit country for Turkmenistani gas, but Russia now has control over Ukrainian gas flows through RusUkrEnergo, a Gazprom-managed joint venture between Russia, Ukrainian and other, more opaque, interests. As a result, Gazprom sells its own gas to Europe and keeps Turkmenistan's gas to meet growing internal demand in Russia where, of course, prices are much lower. Lacking in transparency and fundamentally insecure though that arrangement appears to Europeans, neither Moscow nor Kiev are of a mind to change it.

Meanwhile, having seen SCP gas come to market, Russia is now trying to gain control over other export routes. Russia believes it has the power to prevent TCP; Iran does too. According to both countries' governments, infrastructure developments affecting the Caspian Sea must be unanimously agreed by all five of its littoral states. Neither is likely to approve the line, which would hand a competitor of both countries a means of monetising gas in their target markets. TCP would also result in an increase in the price of the gas Russia buys from Turkmenistan, given that Turkmenistan would have a competitor willing to take it.

Kazakhstan, Azerbaijan and Turkmenistan, the other littoral countries, all claim that individual states have the right to take unilateral decisions about the Sea, which they claim is divided by maritime boundaries into five sovereign sectors. The dispute could eventually be resolved by international arbitration. But, suggests Richard Giragosian, an analyst at Janes' Defence, one of the carrots that the US may hold in front of Iran in its efforts to involve that country in stabilising Iraq is the promise to support its argument over the Caspian.

That would kill TCP before Russia has the opportunity to raise objections on environmental grounds. The country's special envoy on Caspian issues, Alexander Golovin, claims the environmental impact of the line would "pose a serious, dangerous risk to the prosperity of the entire region". And, just in case no-one accepts that logic, Russia has already announced plans to build up its Caspian Sea naval fleet.

Keeping Iran out

Iran and Russia joining forces to control exports to Europe is the EU's worst nightmare, given that Europe still also hopes to import Iranian gas, ideally through the proposed Nabucco pipeline. However, the reality is darker: Russia's complicated relations with Iran, particularly evident in its apparent ambivalence to the country's nuclear plans, involve a strong motivation on Moscow's part to keep Iranian gas out of Europe.

That policy is evident in Armenia. Although its domestic market is small, Armenia's location as a potential export route for Iranian gas has drawn increasing attention from Moscow and its state-owned companies. President Vladimir Putin said during a recent visit to Moscow by Armenia's President Robert Kocharian that Russian investment in Armenia had not yet been sufficient – a fact he described as both "strange and shameful".

Putin was being modest. Indeed, local observers say that every time Kocharian visits Moscow, another chunk of his country's economy is sold to Russia. The latest visit, at the end of October, preceded an agreement by a Russian mobile-phone company to buy Armenia's telecommunications monopoly. Another deal saw Russia's Vneshtorgbank announce that it would buy from Mikhail Baghdasarov, a local oligarch, the remaining 30% of shares in Armenia's Savings Bank that it does not already own. In September, UES, Russia's state-owned power monopoly, completed its acquisition of Armenia's electricity sector.

Gazprom, however, has been even busier. It recently bought unit five of the Hrazdan power plant for around $250m and said it would spend $180m finishing construction. That deal struck many observers as bizarre, given the sums involved, the small market it will serve and that the plant was incomplete. Some of this will be used to subsidise gas prices in Armenia. Nominally, these have been doubled by Gazrpom from $54/'000 to $110/'000.

Gazprom takes control ...

Additionally, Gazprom now controls Armenia's gas sector and is effectively selling the gas to itself, having recently increased its stake in ArmRosGazprom, from 45% to 58%. Armenia's stake is now 32%, while Gazprom's former affiliate, Itera, owns the remaining 10%.

Gazprom has also stifled Iranian attempts to make inroads into the Armenian market, preserving Russia's de facto monopoly on gas transit. As Petroleum Economist went to press last month, a new pipeline from Iran to Armenia was due to come on stream. Initially, throughput would amount to up to 1.1bn cm/y, rising to 5bn cm/y when new compression stations are built.

However, this pipeline will not supply Hrazdan, as was originally envisaged in an agreement between Iran and Armenia in 2004. According to well-placed sources, Gazprom strengthened its position by persuading Armenia to ensure the new line would have a diameter sufficient only to meet local demand – 700 mm, as opposed to 1,400 mm. As a result, Iran cannot, in future, use the line for exports through Armenia and beyond. Ukraine and Georgia had both talked about taking Iranian gas through Armenia, but those plans are now dead.

And it is not just Armenia that is suddenly winning Moscow's favour. Weaker-than-expected gas demand in Turkey has seen the country develop less as a consumer than as a hub for Caspian and Middle Eastern oil and gas exports to Europe. That makes control over its energy sector a much-valued prize.

And while domestic and European politics continue to impede the country's path to EU membership, the country stands to benefit from better ties with Russia. Analysts say this will give Turkey greater bargaining power with the EU and the US, with which the country's relationship has not been easy – particularly over the issues of Cyprus and Iraq.

... in Turkey too

Russia has played on that. Before November's Nato summit in Latvia, Moscow invited a Turkish delegation to visit Gazprom and the foreign ministry. Russia's deputy foreign minister, Alexander Grushko, told the delegation that the two countries' "relations in the fuel and energy sector play a crucial part in our co-operation". He also reiterated Moscow's backing for Iraq's territorial integrity – a reference designed to assure the Turkish of the Kremlin's support over the Kurdish question. Gazprom, for its part, went as far as to claim that it would help Turkey build a liquefied natural gas export plant in the country.

It is more likely, however, that Gazprom will help Turkey build more pipeline infrastructure, with the aim of increasing the country's ability to transit Russian gas to Europe. That would achieve the combined goals of increasing Russian sales to its main markets in the EU, as well undermining Nabucco and other trans-Turkey export routes.

Igor Torbakov, an analyst at the Jamestown Foundation's Eurasia Daily Monitor, says Gazprom has already endorsed plans to begin feasibility studies of new pipelines in Turkey. One pipeline would cross the country from east to west; a second would run from north to south. For Gazprom, the slow growth of domestic demand in Turkey has been a blessing. Although it means that the Blue Stream project has been underused since it came on stream, that spare capacity now means Gazprom has a head-start in the battle to secure onward transit markets and to exert influence over Turkey itself.

Turkey: got broke, became broker

TURKEY'S emergence as a transport hub for energy coming out of the Middle East and Central Asia and into Europe and the West is an accident. Not long ago, Botas, the state-owned gas pipeline company, was predicting demand for natural gas would be 53.8bn cm/y in 2005, and rise quickly thereafter, to 85bn cm/y by 2015. Predictions for a rapid rise in gas-fired power generation saw exporters rush to sign long-term contracts with the country.

Botas got it wrong. In 2001, the economy crashed amid a poorly planned price deregulation. Turkey, which had signed for more gas than it needed, went broke, as its stock exchange lost around half of its value amid a banking crisis, the lira collapsed, inflation soared to 68%, real GNP fell, and Ankara racked up some $20bn in debts to the International Monetary Fund. Botas, understandably, revised its demand figure for 2005 to 25.5bn cm/y.

Rising value

But the unneeded import capacity now turns out to be a boon for Turkey. Its progress towards EU membership may be slow, but the country's value to Europe is growing. Turkey has become Europe's gas broker. Upstream developers are keen to add a host of other infrastructure projects to the country (see Table 1).

That leaves the country in a strong position. Its own supplies of natural gas should be secure and its strategic importance to Europe is increasing with every new cubic metre of transit capacity.

It also leaves the suppliers to Turkey in a strong position, given that they can now sell their gas to Europe. Gazprom's $3.2bn Blue Stream pipeline, for example, which crosses the Black Sea to Turkey, has had its problems – not least when Turkey shut down the line because it did not need the gas. But from 2010, Blue Stream will be able to supply Turkey with half of its 16bn cm/y of capacity and send the rest to Europe through Turkey's gas network. Officially, Turkey and Gazprom say incremental supplies through Blue Stream will be met by rising Turkish demand. However, Gazprom also says Blue Stream could help fill Nabucco.

Meanwhile, Iran is in a similar situation to Gazprom. A contract signed in 2002 commits Iran to supply Turkey with 14bn cm/y of gas through a pipeline from Tabriz to Ankara. Maximum capacity could eventually be some 25bn cm/y. However, Iran's exports have rarely exceeded 4bn cm/y since the line came on stream. That leaves substantial spare capacity for any export projects to Europe through the same route – should Turkey and Iran ever agree on a price for the gas and if Iran ever expands its internal network to bring gas from the Mideast Gulf to export points in northern Iran.



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