Ukraine: Why buy when you can rent?

Ukraine and Russia may be on the verge of a compromise that grants Gazprom control over the Ukrainian pipeline system, while allowing President Viktor Yanukovych to keep his promise not to sell the asset to the Russians.  Ukraine may grant Gazprom use of the pipelines on a long-term lease.

In a live television program "Dialogue with the Nation," that was aired in February 2013, President Yanukovych floated the idea of renting out the pipeline system.  He continued to complain about the high price the country was paying Gazprom for natural gas under the "take or pay" contract negotiated by former Premier Yulia Tymoshenko, but rejected Gazprom's condition for lowering the price:  sale of the pipeline system.  Yanukovych was stuck between a rock and a hard place, however, in that he also rejected an International Monetary Fund (IMF) demand that Ukraine raise domestic gas prices before qualifying for a $15 billion loan.

Yanukovych traveled to Russia on March 4, and met Russian President Vladimir Putin for several hours.  At the conclusion, the news agency Unian reported the two sides were close to a deal in which the price of gas would be lowered from $430 per thousand cubic meters (tcm) to $260 per tcm, in return for which Gazprom and Naftogaz Ukrayiny would form a joint venture that would rent the pipeline system.

No formal announcement was made, however, because the two sides remain divided on including the European Union in the joint venture.  Ukraine supports a European presence, while the Russians would prefer a bilateral arrangement.  In May, Ukrainian Energy Minister Eduard Stavytsky and EU Energy Commissioner Guenther Oettinger discussed a potential trilateral arrangement.  ""Ukraine is really trying to consider its geopolitical situation and to establish a gas hub, so we will be able to do spot purchases in central Europe," Stavytsky told reporters.  He estimated it would take $550 million to modernize the Ukrainian infrastructure.  Oettinger said he believed EU firms were willing to buy the ageing system.

The two sides have been skirmishing over the pipeline for sometime.  Ukraine has unilaterally reduced the importation of Russian gas, and in November 2012 began to import gas from Hungary to take its place.  Russia retaliated by presenting Ukraine with a bill for $7 billion for gas Ukraine was obligated to purchase.  Russia has also threatened to build a second Yamal pipeline to divert gas deliveries from the Ukrainian route.

Alexei Miller, head of Gazprom, said he was not worried about Ukrainian attempts to purchase gas from Europe on the spot market, because the spot price was rising.  "The price for Russian gas, which is being supplied to Ukraine, is significantly lower than the spot price, which has settled in continental Europe," he told reporters.  "Ukraine will not be able to bear the spot prices."

In late April 2013, the Ukrainian government introduced a bill in parliament that would allow the sale or lease of Naftogaz.  Kommersant reported Ukrainian authorities were prepared to allow Gazprom to control the main gas pipeline, while the Ukrainian East European fuel and energy company (VETEK) would run local gas distribution.  Valery Yazev, Russian State Duma first deputy for natural resources, predicted a compromise might be found.  Faced with a new arrangement with lower fuel prices, or losing the Ukrainian contract entirely, Yazev predicted Russia would reduce the gas price to $260-$280 per tcm.

In anticipation of a deal being struck, accountants performed an appraisal of the gas network, and valued it at between $26 and $29 billion.  Ukraine is ready to go the the altar, but is still waiting for a bridegroom.

China Russia Energy Cooperation Moving Slowly

You would think that the most natural thing in the world would be for a large energy producer to partner with a large energy consumer, but in the case of China and Russia logic does not always prevail. The Washington Post quotes a Western energy executive who said, "They look like the perfect partners, but this is a marriage made in hell." He added the two sides were so afraid of being outdone by the other that negotiations tend toward all-or-nothing combat. The issue, whether discussing gas or crude oil, is the relationship between price and transportation distance.

In the case of oil, in October 2008 Russia and China signed an agreement in which the China Development Bank lent Transneft the funds to build an extension of the East Siberia-Pacific Ocean (ESPO) so that Russian crude could be delivered to the Chinese city of Daqing. The loan was to be repaid by supplying China with 300,000 barrels per day of crude for twenty years. Everything appeared on track, and on December 31, 2010, the first Russian oil crossed the Chinese border.

In April, Transneft reported that it was losing $20 million a month in the oil deliveries, because China had unilaterally decided that they were paying too much and reduced payments. Russia threatened to take the Chinese National Petroleum Corporation (CNPC) to the London Arbitration Court. China wanted a discount, because the oil they were purchasing traveled less than oil destined for Japan. according to Transneft spokesman Igor Dyomin, "There is no price difference for oil companies as to where they enter ESPO and where they exit...Russia is long out of socialism--we want fair market pricing."

Chinese Foreign Ministry spokesman Hong Lei was sanguine about the dispute. Reuters reported his comments that, "As for some concrete problems encountered during cooperation, we believe both sides can fully resolve this in a positive way via friendly negotiations and on a mutually beneficial, win-win basis."

Some progress was made in late May 2011, when China paid about three-fourths of the money the Russians claimed they were owed. Shortly thereafter, China resumed discounting its payments. After talks in early June, a Russian Energy Ministry spokesman said that the pricing formula would remain unchanged. "The price formula will be kept unchanged, we have agreed on that and China is ready to make payments according to it," quoted RIA Novosti. The Russians were overly optimistic, however. "They actually went back to the level of negotations which we had prior to the signing of the contract," Pravda quoted Transneft officials.

A Russian source stated anonymously that if the Chinese did not pay for the oil in full, that the dispute would go to the arbitration court, and that Transneft was prepared to repay its 20 year loan ahead of schedule, according to oilprice.com. With the loan repaid, Transneft could cease oil deliveries. China then moved the dispute from the state-owned company level, to the governmental level.

Russia's Deputy Prime Minister, Igor Sechin, tried to calm the situation. He said he did not see any problems that could not be solved, and that not all opportunities had been exhausted, according to RIA Novosti. Finally, in October, Premiers Wen Jia Bao and Vladimir Putin jointly announced a breakthrough. "The two countries agreed on crude oil prices and decided to actively push forward cooperation on oil and gas," China Daily quoted Wen. No details of the agreement were released but anonymous sources told oilprice.com that Russia, who had claimed China was underpaying by $3 per barrel, had agreed to a $1.50 discount.

At least a compromise had been reached. Natural gas is a different story. Currently, China consumes about 150 billion cubic meters (bcm) of natural gas per annum, approximately 4% of its energy mix. This amount is expected to double by 2020, according to a report in the People's Daily. Russia and China signed an agreement in 2006 to build two natural gas pipelines. Russia would then send 70 billion cubic meters annually to China. In 2011, despite numerous positive remarks by both Chinese and Russian officials, there is no pipeline construction.

Denis Borisov, an oil analyst at the Bank of Moscow, believes that Russia badly needs a gas deal with China, to diversity its exports away from saturated European gas markets. "Talks may last long but the gas deal won't be sacrificed..I think gas cooperation is a top priority for Russia," he told Reuters. This optimism was echoed by a Chinese source close to the Chinese-Russian talks,. "Our positions have gotten closer," he said about the possibility of a Chinese loan to build the pipeline.

In April, Chinese President Hu Jintao met with Dmitry Medvedev in the Chinese resort town of Sanya. The leaders announced they would pursue cooperation on major energy projects, such as the west natural gas pipeline from West Siberia to China, according to the Xinhua news agency. Despite the positive pronouncements, Interfax China reported that Gazprom and CNPC were involved in tough negotiations over price that did not appear to be progressing.

Everything looked better in May. Russian Deputy Prime Minister Igor Sechin reported that, after many years of fruitless negotiations, Russia and China had coordinated the key terms of a long-term gas contract. "We are considering two gas supply routes for the next 30 years. The western route will provide China with 30 bcm of gas, the eastern one with 38 billion,' he said. He also said there would be no problem with financing, according to the Voice of Russia. Sechin cautioned, however, that the two sides had not reached a final agreement on price--leaving that detail to Gazprom and CNPC, according to Russiaprofile.org. Chinese Assistant Foreign Minister Cheng Guoping was pleased: "Personally, I'm confident that if progress is smooth, then it's quite likely that in the near future..both sides will achieve a major breakthrough in cooperating over natural gas," he told a news conference. Xing Guangcheng, an expert on Russian studies at the Chinese Academy of Social Sciences, commented, "The deal is not an ordinary project between just two companies. It is a project of bilateral strategic importance, and it needs the determination of the leadership from both sides," according to China Daily.

It was not to be. President Medvedev announced that documents were being finalized, and Premier Hu Juntao said both sides ere willing to push forward, but price remained a stumbling block. "We are not going to sign anything this time," Medvedev concluded the negotiations, according to New Europe. Russian Energy Minister Sergei Shmatko commented, "This is not some simple bazaar deal; we can't hurry on this."

The disagreement was outlined in China Daily. Andrew Neff, an analyst who specializes in Russia and the Commonwealth of Independent States at IHS Global Insight, explained the Russian position: "Gazprom is focused on achieving a price agreement in line with that of its long-term, oil-indexed contracts for pipeline supplies to its European customers." But China disagreed. Pang Changwei, Director of the Institute for International Oil Politics at China University of Petroleum said it was unrealistic to base the price on the European market because the distance between China and Russia was much less than that between Russia and Western Europe. He reasoned that because transportation costs should be lower, so should the price. It was the same Chinese argument that disrupted oil deliveries through ESPO.

Some analysts believe that Russia has no intention to actually build a gas line, and that the lengthy negotiations are a ruse. RusEnergy partner Mikhail Krutikhin opined that clearly no gas agreement would be reached. "Russia is trying to scare Europe with threats of redirecting its gas to China, but China is not ready to pay $220-$230 per 1,000 cubic meters," he said according to Nezavisimaya Gazeta. Robert Cutler cited a Chinese press leak that the two sides were as much as $100 per thousand cubic meters apart on price.

In the end, price differences could be negotiated, but the heart of the matter is a lack of trust between the two sides. "China looks very seductive, but" said former Russian deputy energy minister Vladimir Milov. "there is a deep lack of trust behind the facade," quoted the Washington Post. This lack of trust could be generated by geopolitical rivalry between the two sides, according to analyst Alexandros Petersen. The Chinese officially reject such an analysis as an "inaccurate Western perspective," but Petersen quotes a Sinopec analyst saying, "Our interests and the interests of our government are to see stable governments in the region...The result is soft geopolitical competition between China and Russia. And it is spreading."

All that's left is to see what is more important: access to energy, price or geopolitics.

Russia on Top in Ukranian Energy Dispute

In 2011, Ukraine was faced with a combination challenges: former Prime Minister Yulia Tymoshenko had saddled the country with a long term contract committing the country to paying $400 per thousand cubic meters on a "take or pay" basis; the government was in a dispute over its share of revenues for gas passing through the country to Europe; it was threatened by the creation of alternate pipelines that would remove its importance to the European energy grid; its sovereign control over its energy assets were threatened. As 2012 arrives, it appears that Ukraine is losing on all counts.

Until three months ago, 80% of all Russian natural gas exported to Europe flowed through the Ukrainian pipeline system. This vital energy artery was initially constructed by the Soviet Union. Through age, use and lack of proper maintenance, the pipeline faces obsolescence. Ukraine has long wanted to renovate the pipeline, but has lacked the funds. In June, Ukrainian President Viktor Yanukovych invited Russia and the European Union to finance the renovations, in return for price concessions. Naftogaz officials estimated the cost of renovations would be $3.5 billion, a bargain compared to the $11 billion Nord Stream project or $21.5 billion South Stream project. Faced with a lack of Russian interest, in July Ukrainian Prime Miniter Mykola Azarov announced it was beginning to upgrade its pipeline system itself. The European Bank for Reconstruction and Development (EBRD and the European Investment Bank (EIB) signed memorandums commiting 300 million Euros to Naftogaz for the upgrade.

Meanwhile, Prime Minister Azarov demanded that Russia release it from the 2009 gas contract. When Tymoshenko signed the contract, she was hailed as a hero because it promised that Russia could not cut the gas supply to Ukraine as it had only months before. In 2011, however, as the cost of natural gas plummeted around the globe, the contract was perceived as a criminal conspiracy to defraud the Ukraine and Tymoshenko was jailed.

Russia hinted that the contract could be renegotiated, but only if Ukraine joined in a customs union with Russia and Belarus. Alternatively, Gazprom's leader Alexei Miller offered to lower prices if Naftogaz merged with the larger Gazprom. Azarov feared either option would destroy the country's soveriegnty and refused.

To cancel the contract, Azarov announced he would disband Naftogaz. "Naftogaz as a company will cease to exist. There will be a liquidation period. Some time later, after all necessary formalities are taken care of, entirely new companies will begin to operate on the market. As a result, all existing agreements will be revised," Ria Novosti quoted Azarov as saying.

Yanukovich also threatened to take Russia to the Stockholm Arbitration Panel to get the contract voided. This action appeared to be an empty threat, however, as within a week Ukranian Foreign Minister Kotyantyn Gryschchenko was stating he wanted to find a solution without going to the court. "There is one group of people which is always interested in court action--lawyers," he said. "We should probably do everything possible to make their life easier and find a natural decision in the bilateral format."

In September, Russia turned up the heat by formally opening the Nord Stream pipeline. This route goes under the Baltic Sea directly to Germany, and avoids transiting Ukraine or other countries. Ukraine's transit revenues are expected to decline. Vitaliy Lukyanenko, spokesman for Prime Minister Azarov, demanded that Russia and Europe make its plans known. "Since Russia is building pipelines bypassing Ukraine, Ukraine wants to get a clear answer, whether Russia intends further to use the Ukrainian gas transport system...And from Europe, Ukraine wants to know its plans regarding the Ukrainian gas transportation route," quoted the Kyiv Post.

The Ukranian government took a deep breath, and analyzed what was going on. Why would Russia refuse to cooperate to repair an inexpensive route for their gas shipments, and insisting to pay tens of billions more for alternative routes (one of which has yet to be built)? Given the fact that the Russians had offered deals in return for the Custom Union or other connections to Russia, they concluded that they were not involved in an economic contest, but a political one.

According to Voice of America, in August President Yanukovych announced Ukraine would join the European Union in ten years. This goal is suppoted by 70% of Ukrainians, according to Viktor Chumak, director of the Ukrainian Public Policy Institute. Oleg Voloshyn of the Foreign Ministry said that Ukraine aspired to be a member of the European Union, and Russia was attempting to force Kyiv into the customs union, instead. Gazprom leader Miller also hinted that Russian plans to build the South Stream pipeline might be a pressure tactic against the Ukrainians. "South Stream has always been linked to Ukraine," he said.

Faced with a looming shutoff of gas from Russia, Yanukovych turned to Turkmenistan. Russia had stopped buying Turkmen gas in April 2009, so there was a mutuality of interests in the connection. Turkmen gas would not free Ukraine from Russian dependency, however, as the pipelines between Turkmenistan and Ukraine passed through Russian territory. In October, Prime Minister Azarov relented, and agreed to join the CIS Free Trade Zone. Azarov said that once the agreement goes into effect, Turkmen gas would be able to transit Russia within six months.

The Ukrainians then renewed its proposal for a pipeline consortium consisting of Naftogaz, Gazprom and the EU to repair the pipeline network. According to Reuters, Gazprom chief Alexi Miller met in December with Ukrainian Energy Minister Yuriy Boiko and removed the EU from the equation. New estimates, however, place the cost of repair at $20 billion. Combined with the domestic price reductions that Ukraine is demanding ($9 billion annually), the negotiations have bogged down again. Russia has returned to its previous position that it might finance pipeline upgrades, but only if the Naftogaz pipeline system becomes part of Gazprom.

Negotiations between the two sides begin again on January 15. Ukraine has been seriously weakened in its strategy. It has acquiesced to a Free Trade Zone, thereby threatening its chance at a European orientation; it has been unable to obtain a break in the price of gas it will use domestically despite its legal threats; it has moved toward creating an energy consortium that will allow Gazprom to eventually take over control of the pipeline system; Nord Stream is completed and South Stream continues to progress in its planning. Russia continues to get top dollar for its gas, and is slowly pressuring Ukraine to accept all its demands to keep that country within Russia's shadow.

Azeris and Turks Pursue Independent Course

While the major energy consortiums wait for Baku to decide among the Nabucco, TAP, ITGI, and BP proposals for the Shah Deniz 2 gas deposits, Azerbaijan and Turkey have moved on their own. The two countries have decided to build on the South East European Pipeline (SEEP) proposal, and upgrade existing pipelines through Turkey. This new pipeline proposal, called the Trans-Anatolian Gas Pipeline, will carry 16 billion cubic meters (bcm) of natural gas per year. This represents the 6 bcm Turkey consumes domestically, and a 10 bcm throughput to Europe, according to Robert Cutler of the Central Asia-Caucasus Institute.

Turkey and Azerbaijan signed an agreement on October 25 to allow the 10 bcm to transit Anatolia. At the time, most analysts thought this was a prelude to Baku's accepting one of the existing Southern Corridor plans. The proposed owner of the pipeline, SOCAR, had a different idea. Rovnag Abdullaev, SOCAR president, announced on October 27 the two countries would build the Trans Anatolian Gas Pipeline. This announcement was ignored until late November, however, when Abdullaev repeated it at the Third Black Sea Energy and Economic Forum, according to an article by Cutler in the Asia Times.

The same article reports that Turkish officials estimate the cost of the TAGP will be 5-6 billion dollars. This would be a significant savings over Europe's preferred Nabucco route, estimated between 10-19 billion dollars.
The TAGP is a clear alternative to other Southern Corridor proposals, but does not necessarily foreclose being incorporated into a larger project at a later date. Turkish Minister of Energy and Natural Resources Taner Yildiz said the TAGP would reduce the cost of the larger proposals, while casting doubt that they would ever be built. "The implementation of such projects as Nabucco, ITGI and TAP seemed doubtful," the Asia Times quotes.
Azerbaijani Foreign Minister Elmar Mammadyarov disagreed. At a Washington DC conference in October, he said the Azerbaijani-Turkish transit agreement meant the Southern Corridor was one step closer to being launched," according to UPI.

Turkey Diversifying Natural Gas Suppliers

Turkey has begun taking steps to diversity its natural gas sources. Currently, 65% of natural gas in the country comes from Russia, and it is expensive. The state energy company Botas has been the partner in a number of "take or pay" delivery contracts, in which Turkey agrees to pay for the gas whether it is used or not. As a result, it is paying $2.64 billion dollars for 3.6 billion cubic meters (bcm) of gas that it has not used from Russa, and 55 million cubic meters (mcm) it has not used from Azerbaijan over the past three years, according to the Turkish newspapr Haberturk as reported by Bloomberg.

To reduce the payments, Turkey demanded a price reduction of 15-20% from the Russian gas giant, Gazprom. The Russians did not take the Turkish demand seriously, and Botas terminated the contract that brings 6 bcm of natural gas to Istanbul via the Balkans. This placed in play the delivery of 15% of Turkey's energy needs.

To compensate, Gazprom has offered to sell private companies the gas that was originally destined for Botas. Gazprom Chairman Alexander Medvedev said, "We expect that demand from our customers in the industry and trade sectors will continue...We are ready to supply the same amount of gas to private companies, which then supply the final consumers in the Turkish market," according to Today's Zaman. This is a reversal of Gazprom's previous position that Gazprom deliveries were governed by intergovernmental agreements and could not be expanded to include private buyers, according to Today's Zaman.

The price dispute between Turkey and Russia has put other projects in jeopardy. Konstantin Simonov, from the General Directorate of the National Energy Foundation, charges that the Samsun-Ceyhan oil pipeline and the South Stream projects are interrelated with the natural gas deliveries, according to the Turkish Weekly.

Siminov may be correct. When discussing the cancellation of the Botas contract, Turkish Minister of Energy and Natural Resources Taner Yildiz discussed South Stream, which still lacks permission to transit Turkish waters in the Black Sea. The minister said that Turkish permission would be granted when Russia delivers documents Ankara has requested. "There are no problems in this respect," he said. Turkey's strategic relationship with Russia would not be affected "by a few contracts," according to euractiv.com.

According to Siminov, Russia has frozen the Samsun-Ceyhan oil pipeline until it receives the South Stream approval. This oil pipeline is of great importance to Turkey, as an effort to divert oil shipments away from the congested Bosphorus Straits. But the pipeline would be costly. Russian estimates are that it would cost three times as much to ship oil via the pipeline than to send the oil through the straits, according to Hurriyet Daily News. To compensate, the Russian oil pipeline Transneft has demanded tax exemptions for Russian companies that work on the line. Transneft President Nilolai Tokarev said "It is necessary to set up tax privileges to guarantee that the oil transportation tariff on the route is competitive on the tariffs in the Black Sea straits."

New developments are anticipated, as Prime Ministers Erdogan and Putin held telephone discussions in October to discuss the resumption of the Russian gas supply to Istanbul, according to ITAR-TASS. The discussions also covered the Samsun-Ceyhan oil pipline, and plans to build a nuclear power plant in Turkey. So: South Stream appears dependent on resolving the natural gas dispute, and Samsun-Ceyhan appears dependent on South Stream.

Will Russia Attack in the Caspian?

With the future delivery route of Turkmenistan's supplies of natural gas at stake, some analysts are predicting that Russia is turning up the heat. Using language not heard since the Russia-Georgia conflict of 2008, a number of influential Russian spokesman are calling for force to prevent the construction of the Trans Caspian Pipeline (TCP).

The TCP has been in discussion for years. It would connect the eastern and western coasts of the Caspian Sea, thereby allowing Turkmen gas to feed the Nabucco pipeline.

The European Union has declared the TCP to be a matter of community interest. In September, the 27 members of the European Commission adopted a mandate to negotiate a legally-binding treaty among the EU, Azerbaijan and Turmenistan to build the pipeline. "Europe is now speaking with one voice," said EU Energy Commissioner Oettinger. "The trans-Caspian pipeline is a major project in the Southern Corridor to bring new sources of gas to Europe. We have the intention of achieving this as soon as possible," according to the Associated Press.

Russian reaction was immediate. Foreign Ministry spokesman Alexander Lukashevich said that only the five countries bordering on the Caspian had the right to settle isues regarding use of the inland body of water. He said any accidents on the proposed pipeline would impact all five littoral nations. "It is evident that laying down the trans-Caspian pipeline in a confined basin with high seismic activity and a tectonic seabed is exactly one of those questions," he said according to the same AP article. The ministry issued an official statement stating the European decision "ignores the current international, legal and geopolitical situation in the Caspian Basin," and warned that attempts to intervene would complicate the situation and negatively affect talks on the status of the Caspian Sea.

Azerbaijan, who would be the recipient of the gas piped through the TCP, decided to refrain from comment on the European initiative. Rovnag Abdullayev, president of the State Oil Company of the Azerbaijan Republic, said "The Trans-Caspian Gas Pipeline Project is not ours. This is a project designed by Turkmenistan and the European Union. Based on the European Energy Charter, we are an open transit country and infrastructure, which they (the EU and Turkmenistan) are going to build, is a matter for the two parties."

Lately, what should be considered a diplomatic tussle over whether the Caspian is a small inland sea or a large lake has the smell of gunpowder about it. The head of the Russian "Fund for National Energy Security," Konstantin Simonov, hints at war when he said, "Only the experience of the August war in Georgia is deterring Ashgabat today," according to EurasiaNet. According to noted commentator on the Caspian, Vladimir Socor, Siminov was quite explicit: "Ashgabat understands that the situation would be the same as it was in Georgia in August 2008. Back then they promised to protect Georgia, some kind of guarantees. And how did that end...Does Turkmenistan want the same thing to happen in the Caspian?" Simonov also said that "using force is the only possible response if diplomacy fails to stop the trans-Caspian project." EurasiaNet also quotes Siminov: "the reaction can be very hard up to some sort of military conflict in the Caspian Sea. Is Turkmenistan ready for this? I have great doubts in this regard."

Socor also quotes Mikhail Aleksandrov, department chief at the Russian government-sponsored "Institute on the CIS Countries." Aleksandrov also drew upon the Georgian analogy: "Russia would have to act in the manner of its operation to compel Georgia to peace...It may even be through air strikes, if they do not understand any other way." The vice-chairman of the Duma, Russian Gas Society president Valery Yazev, noted that Turkmenistan has no military protection in the Caspian, and that it risks a "Libyan scenario" by joining the trans-Caspian project.

Turkmenistan has condemned such bellicose talk from its northern neighbor. The foreign ministry released a statement that said, "A normal, civilized process of collaboration between sovereign and equal parties on the energy market is taking place...This, however, causes an inappropriate response from certain officials and mass media in Russia." Turkmen President Berdymukhamedov said European-directed pipelines are "among the most important goals of Turkemnstan's energy policy," that such pipelines would be actively developed, and that he supported the building of the TCP, in principle.

What is at stake? Petro-wealth. In November 2011 the firm of Gaffney, Cline and Associates released the results of the second phase of its audit of Turkmen gas reserves. Turkmen Vice Premier Baymyrat Hojamuhammedov released the results: the country owns 71.21 billion tons of natural gas, 50% more than previously expected. The firm stated that the South Yolotan gas field is the world's second-largest, with an estimated total of 26.2 trillion cubic meters. The estimates were immediately disputed by Gazprom deputy CEO Medvedev, who said there was no serious study or research report to back up the audit results.

There are two sides to the dispute: Russia and Iran claim that the Caspian is actually a very large lake (a body of water from which there is no egress). If they are correct, then all the states around the lake have equal rights to the use of the water. By contrast, Azerbaijan and Turkmenistan believe the water is an inland sea--in which case each state would control the waters off its coast. If the Russian/Iranian view is correct, then they have a veto over the construction of the TCP; if the Azerbaijani/Turkmen view is correct, then any two states can do what they want within their own territorial waters. The fifth littoral state, Kazakhstan, has stayed away from the conflict, but officials there say that Kazakhstan will not cooperate with the TCP until the Caspian legal status is resolved.

To strengthen their hand in the dispute, Iran and Russia agreed in September to set up a joint energy committee to expand cooperation between the two states, according to the Tehran Times. At the same time, they announced their opposition to the TCP due to environmental concerns, protection of marine resources and preventing pollution.

Such claims are considered ludicrous by people who have observed Russia's own practices. It has built its own pipelines in the Black Sea (Blue Stream) and the Baltic Sea (Nordstream) with little comment on the environment. In fact, all five littoral states have undertaken offshore exploration and development without seeking permission from the others, according to Robert M. Cutler.

Some legal experts believe that a pipeline can be constructed while the final status of the Caspian is still being negotiated. Jerome Pons, the Charge d'Affaires of the EU Delegation to Azerbaijan, told Today.Az that "The on-going negotiation on the legal status of the Caspian has not precluded the construction and operation of (other) oil and gas pipelines...In the Caspian Sea, the on-going negotiation between the littoral states over the last years on the legal status of the Caspian has in fact not precluded the construction and operation of oil and gas pipelines." Brigitte Bichler, senior project manager for Nabucco at the Austrian energy group OMV said the TCP was "legally feasible." This view was supported by US State Department advisor for Eurasian energy Daniel Stein, who said no country had "veto power" over a Turkmen-Azeri pipeline agreement, according to Reuters.

The country that may influence this dispute the most may be "none of the above." As China buys more gas from Turkmenistan, their influence over Turkmen pipeline planning will continue to grow. According to a Chinese diplomat, "Beijing does not want Turkmenistan to build a pipeline to the European Union, get a different gas price on the European market and then increase it for China...Beijing will do its best to make sure the Transcaspian pipeline project is not developed," according to Rianovosti.

US Policy for Russia and Central Asia

Richard Morningstar recently spoke before the US House Foreign Affairs Committee, and outlined United States policy toward Russia and Central Asia, reports the Asia Times. Morningstar reaffirmed that "Europe is our partner on any number of global issues from Afghanistan to Libya to the Middle East, from human rights to free trade." As a result, the United States intends to be deeply involved in Europe's energy security. In that regard, the US will work for Europe's "diverse energy mix" in regards to supply, transportation routes, and types of energy.

Morningstar then made the following points:

1. The US will encourage Central Asian and Caspian countries to find new routes to market;


2. The US will push for the privatization of the energy sector;


3. The US remains as committed to the Southern energy corridor as it was under presidents Clinton and Bush, and will promote all three possible routes (Nabucco, ITGI and TPA) as possibilities;


4. Turkmenistan can be a major supplier of gas to Europe through the Southern Energy Corridor;


5. The Baltics should be integrated into the European energy market so it is not as vulnerable to Russian pressure;


6. The US will challenge Russia's efforts to monopolize Ukraine's energy sector;


7. European countries should not negotiate energy deals unilaterally with Russia, but should negotiate together as a single energy market;


8. Europe should consider shale gas as an alternative to Russian natural gas; and,


9. Europe should not allow Gazprom to penetrate the European retail market.

Morningstar's message places US interests in the region clearly in opposition to Russia's. Diversity in energy sources, new Caspian energy routes, the Southern gas corridor, etc. all are designed to limit Russian energy dominance of the Eurasian land mass. What was missing from Morningstar's testimony, however, were plans on how the United States was going to implement the goals he outlined. Implementation will require more attention to the region than the current US administration has given it, to date. While the Ambassador can claim that the commitment to the Southern corridor is as strong today as previously, the last two presidents at least had ambassadors appointed to all the countries in the area--something President Obama has not done after three years in office.

Kyiv Pulling Away from Moscow

When Viktor Yanukovych was elected President of the Ukraine, Western officials decried the end of the Orange Revolution. Yanukovych had been supported by the Kremlin, and one of his first acts was to extend Russian basing rights for the Black Sea fleet at Sevastapol. Moscow had purchased the extension by reducing the price of natural gas for 2010 by $3 billion. In the competition for control of the "near abroad," Ukraine had slid back into the pro-Moscow column.

National interests are more enduring than Presidential administrations, however. Russian attempts to control Ukraine's politics by manipulating energy supplies have pushed Yanukovych into a more independent course.

Under the administration of the Western-leaning Viktor Yushchenko, Gazprom cut off supplies to the Ukraine on 1 January 2006. Charges flew about official corruption, bribes, Ukrainian stealing of gas supplies, and pricing irregularities. European countries downstream complained that their gas supplies were also being affected, and Gazprom resumed deliveries the following day.

In March 2008, Russia reduced gas flows to Ukraine by 50% in another pricing dispute. Gas supplies were returned to normal before European powers could complain, but the incident underlined that Gazprom's tactics in 2006 were not an isolated incident.

The biggest supply interruption came in January 2009. In Europe, the cancellation of gas deliveries for several days led to increased support for the Nabucco pipeline; in Ukraine, the supply interruption helped convince voters that their energy supplies could only be insured by the election of a pro-Moscow candidate to the presidency--Yanukovych. Despite the election of Yanukovych, however, Moscow has threatened to build the South Stream pipeline to supply Europe without passing through Ukranian territory. This would leave Ukranian gas supplies hostage to Gazprom's whims, since future supply interruptions to Kiev would not have an effect on European countries.

Disputes with Moscow were not limited to natural gas. The Odessa Brody oil pipeline was designed for a South-North flow, supplying Central Europe with Central Asian oil. The pipeline was built without any guarantee as to who would fill the pipeline. Finally, Russian oil companies agreed to fill the line but only if the flow were reversed and used to bring Russian oil to the world market. A line that had been built to add to European energy independence was instead an instrument of increasing energy dependence.

Recently, as previously reported in this blog, Moscow and Minsk have had a number of policy disputes--including the price of oil deliveries to Belarus. Taking advantage of the situation, Venezuela stepped in and agreed to supply Belarus with four million tons of oil a year for two years. The oil would be transported via the Odessa Brody pipeline, with the direction of flow reversed to its originally-planned direction.

At the World Economic Forum in Davos, Yanukovych attacked the Kremlin for its efforts to make Ukraine dependent for its energy needs. He said that Russian plans to build natural gas pipelines directly to Europe were politically motivated, not economically. He then signed agreements with Azerbaijan to use the Odessa Brody pipeline to ship Caspian oil to Europe (1.5 to 3 million tons per year), and to provide natural gas to Ukraine.

Yanukovych attacked the South Stream project, pointing out it would cost $25 billion dollars. He said that upgrading the current pipeline through Ukraine would only cost $5 billion. "If this is a way to exert pressure...serious questions arise about how we should build our relations." http://www.themoscowtimes.com/business/article/yanukovych-seals-gas-deal-with-baku/429999.html

Moscow obtained a great prize in extending its lease on the Sebastapol base, but the Ukranian Supreme Court may yet declare the agreement contrary to the Ukranian constitution which forbids foreign bases on Ukranian soil. There are no indications that such a judicial decision is even being contemplated, but Moscow's heavy-handed energy policies is putting its recent gains in influence in jeopardy. Ukraine's position remains in flux as its president confronts the demands of Ukrainian national security interests.

Dr. James J. Coyle is available to speak to your organization or at your event. Please contact him at jimcoyle@verizon.net.

Ukrainian Tightrope

The Ukraine is engaged in an extremely difficult high wire act: balancing a desire to remain on friendly terms with its neighbor, Russia, while trying to maintain energy independence by developing alternative sources for its natural gas.

Our story begins in January 2009 when the Russian government-owned company, Gazprom, cut off all gas supplies to Ukraine. Gazprom claimed there was a price dispute; Ukrainian nationalists claimed it was an attempt to influence upcoming presidential elections. Regardless of the reasons, Ukraine's then-Prime Minister, Yulia Tymoshenko, ordered the seizure of Russian gas that was in the pipeline traversing the country. In June 2010, an arbitration commission in Sweden ruled that the seizure had been illegal, and ordered Ukraine to pay $192 million, and return 12.1 bcm of gas to the Russians. The Ukrainian government is negotiating how to pay back the money and gas, without running short this heating season ("Ukraine Returns Disputed Gas to RosUkrEnergo", Eurasia Daily Monitor 7/156, August 12, 2010).

Ukraine feels embattled between the court case, and the possibility that the Russians will launch the South Stream pipeline project, which would bypass Ukrainian territory. If South Stream were completed, then Ukrainian Energy Minister Yuriy Boyko believes Russia might halve the amount of gas transiting the Ukraine. (www.oilandgaseurasia.com/news/p/0/news/8545, 02 September 2009). Ukrainian President Yanukovych promised that price disputes with Russia would never result in cutting off supplies to Europe (www.oilandgaseurasia.com/news/p/0/news/8699, 14 September 2009), an assertion clearly not true given the events of January 2009.

To keep South Stream from becoming a reality, the government in Kyiv has begun a public relations campaign against the project. They argue that the cost of the project ($20-30 billion) will be passed on to Europe through higher gas prices, that the source of the gas would remain Gazprom and is therefore not a diversification, that the acidity of the Black Sea could eat through the pipeline and cause explosions, and that the Ukraine can be a better route if the current pipeline were upgraded with European support. ("Ukrainian Government Can Call the Bluff On Gazporm's South Stream Project," Eurasia Daily Monitor 7/169, 21 September 2010).

In late October, Russian President Vladimir Putin visited Ukraine for discussions about a possible merger of Ukrainian pipeline company Naftogaz with Gazprom. The Ukraine had previously ruled out such a merger, but had left open the possibility of a joint venture. ("Kiev to Talk Gas Venture During Putin Visit", The Moscow Times, 26 October 2010). The two sides failed to reach an agreement.

In the event of another Russian gas shutdown, Ukraine is looking for alternative sources of energy. First Deputy Prime Minister Andrey Klyuyev issued a press release stating that the country would construct a regasification terminal over the next 12-18 months. The price tag would be $1 billion (www.oilandgaseurasia.com/news/p/0/news/8958, 04 October 2010). Construction will begin in 2015,and the terminal will have a capacity of 5 billion cubmic meters, rising to 10 bcm in late 2016. This would represent 20% of Ukraine's gas imports. Project head Petro Moroshnikov said construction was designed to reduce dependence on Russian gas imports. Moroshnikov added that the most attractive source for the gas appeared to be Azerbaijan. In addition, the Russian-US consortium, TNK-BP, will invest another $1-2 billion over 25 years to discover gas trapped in Ukrainian shale, according to German Khan. (Reuters: "Ukraine Plans LNG Terminal to Diversify," The Moscow Times, 03 November 2010).

Ukraine is also trying to solidify its position as a reliable transportation link for Central Asian oil. Kazakhstan had been pumping 6 million tons of oil a year through Ukraine, but they discontinued using the country in January 2010 over a tariff dispute. In September, however, President Yanukovych announced a new agreement whereby Kazakhstan would pump 8 million tons a year to Europe (www.oilandgaseurasia.com/news/p/0/news/8728, 16 September 2010). The government has also approved a test-pumping of Venezuelan oil through the Odessa-Brody pipeline. If Venezuela were to become a steady supplier, it would mean reversing the flow of the pipeline to the original South-North orientation--contrary to the wishes of the Russians.

Venezuela's supplies would be mingled with Central Asian. President Ilham Aliyev said that in the future, oil from states situated on the eastern coast of the Caspian Sea could be supplied to Ukraine, via Azerbaijan. Aliyev said this would create another reliable energy corridor connecting the Caspian with Europe. Aliyev added that Azerbaijan was already providing the Ukraine with a million tons of oil per year ("Azerbaijan to increase Oil Supplies to Ukraine," Hurriyet Daily News, 28 October 2010).

The threat of Venezuelan and Azeri oil deliveries appears to be having an effect on Russia. During Prime Minister Vladimir Putin's late October 2010 visit to Kyiv, the two sides initialed an agreement in which Russia would ship 25 million tons of oil over 5 years. ("Moscow, Kiev in Oil Deal," The Moscow times, 28 October 2010). In addition, Iran is interested in becoming an oil supplier to Ukraine (www.oilandgaseurasia.com/news/p/0/news/9379).

Ukraine remains vulnerable to Russian manipulation, and will become even more so with the construction of South Stream. Independent suppliers, such as Azerbaijan and the countries of the eastern Caspian, offers Ukraine the best hope of remaining energy neutral in the years to come.

Dr. James J. Coyle is available to speak to your organization or at your event. Please contact him at jimcoyle@verizon.net.

AGRI Jeopardizes Nabucco

Seeking to maintain its economic independence from Russia, while giving Europe an independent source of natural gas, the government of Azerbaijan has agreed to a feasibility study to send liquified natural gas (LNG) to Europe via ship. The new agreement establishes the Azerbaijan-Georgia-Romania Interconnector (AGRI.)

The signing of the Baku agreement on September 14, 2010 does not promise the launch of this new LNG route, however. Despite voluminous press coverage marking the agreement, the three leaders (Ilham Aliyev of Azerbaijan, Mikheil Saakashvili of Georgia, and Traian Basecu of Romania) have only agreed to the creation of a joint working group and a series of feasibility studies. Should the project be approved, the equity share for each country will be 33 percent (www.today.az/news/business/73413.html)

The project, as envisioned, will ship 7 to 20 billion cubic meters of gas annually to Romania. Once in Central Europe, Romania can then use its existing pipeline structure to either use the gas itself or sending it on to the rest of Europe. What is unique about AGRI is that the proposal does not rely on pipelines through Russia or Turkey: rather, the gas will be piped to Kulevi in Georgia, where it will be converted to LNG at the oil export terminal there (owned by the State Oil Company of the Azerbaijan Republic, or SOCAR). It will then be shipped across the Black sea by boat, and offloaded at a planned re-gasification plant in Constanta, Romania. The preliminary cost estimates for the project range from 1.2 to 4.5 billion Euros. (Oil and Gas Eurasia No. 9, September 2010, Baku Summit Launches Breakthrough LNG Project) Romanian President Basescu believes that with these costs, AGRI is more cost effective than the Nabucco project (Eurasia Daily Monitor 7167, September 17, 2010, Black Sea LNG Project: A Spoke in Nabucco's Wheels?) to which Romania is already committed. Azerbaijani President Aliyev predicts the project will take approximately 20 months to complete (www.today.az/news/business/73558.html)

Others have also expressed interest in cooperating, such as Hungary and Ukraine. Yuriy Boyko, the Ukrainian Fuel and Energy Minister, said their country would be interested in building an LNG terminal near Odessa for the importation of 10 billion cubic meters of gas per year. The cost of the Odessa terminal would be $3 billion, but Boyko believes that AGRI could save Kiev at least $60 per thousand cubic meters over the cost of imported Russian gas (ibid).

The new project is in direct competition with Nabucco for Azerbaijani gas. As Vladir Socor points out, Nabucco "The AGRI project, if pursued seriously, can undermine Nabucco by reducing the volumes of Azserbaijani gas available to that pipeline project. Azerbaijan's existing output level (reported at 23.5 bcm in 2009, anticipated at 28 bcm in 2010), its internal consumption (10 to 11 bcm per year in 2009-2010), and its export commitments (some 8 bcm to Turkey and Georgia combined), do not seem to leave sufficient gas volumes to support both Nabucco's first state (at 8 to 10 bcm per year) and the LNG project at the same time." (Eurasia Daily Monitor 7/165, September 15, 2010, Black Sea LNG Project Draws on Gas from Azerbaijan).

Despite problems for Nabucco, AGRI appears to meet the needs of everyone involved. For Azerbaijan's part, the construction of AGRI represents further diversification of delivery systems to ensure the country can continue to service its markets. Azerbaijani President Ilham Aliyev said diversifying transportation routes was a key priority in Azerbaijan's energy policy, and he noted that there were already seven pipelines in Azerbaijan which transport the country's oil and gas in different directions. Georgian President Saakasvili stressed the importance of EU countries such as Hungary joining the project. Romanian President Basecu is pleased with the planned investments in infrastructure in his country (www.today.az/news/politics/73465.html ).

Europe also benefits by the new pipeline, in that it meets previously stated goals to diversity their gas suppliers away from Gazprom; at the same time, it also diversifies its source of natural gas away from Turkey. As the AK Party solidifies its hold on that country through constitutional changes, secular Europe might now have a way to access Central Asian gas without depending on pipeline routes through a potentially hostile country.

Dr. James J. Coyle is available to speak to your organization or at your event. Please contact him at jimcoyle@verizon.net.

Chinese Demand for Central Asian Energy

In December 2009, the Central Asia-China (Turkmenistan to China) natural gas pipeline opened. This gave China the ability to import natural gas from Turkmenistan, Uzbekistan and Kazakstan. The new natural gas pipline connects with the Chinese West-East pipeline, meaning Turkmen gas can reach Pacific coastal cities such as Shanghai and Hong Kong. To give the reader an idea of scale, the CA-C cost $7.3 billion to construct, and is 1,833 km (1100 miles) long. The West-East pipeline is over 4,500 km (2,800 miles) long, making the combined network the longest in the world. The CA-C line was partially financed by the China Development Bank, who invest $6.7 billion to build the portion of the line that transversed Kazakhstan (Hurriyet Daily News, 28 December 2009). Predictions are that the CA-C will reach its full capacity of 40 billion cubic meters by 2012-2013 (Reuters, March 11, 2010). Turkmen President Gurbanguly Berdymukhammedov is requesting that China increase its $3 billion loan for the development of the South Yolotan gas field (oilprice.com, 24 August 2010), which would favor the gas flowing East to China rather than to Europe.

This is part of a longterm Chinese strategy to lock up energy sources around the globe. As the second largest energy consumer behind the United States, China needs to be certain it will have the energy to continue its breakneck economic growth. This has led to deals with Angola, Sudan, Iran, Venezuela, etc. It has also led to some strange bedfellows: earlier in 2009 China loaned Russian oil firms $25 billion in return for a 20 year supply of crude oil (Hurriyet Daily News, 21 December 2009). Russia is also building a $25 billion link across East Siberia to bring oil to China (The St. Petersburg Times, 24 August 2010). Russian Premier Vladmir Putin has officially launched the Russian section of the Eastern Siberia-Pacific Ocean pipeline. "The implementation of this project is a crucial task for Russia and our Chinese friends," he said. "It means stabilization of supplies and energy balance for China, and for us it creats entry to new challenging markets, in this particular case, to the growing market of China." Putin promised to deliver 30 million tons of oil to China, and (in case of expansion to the Asia-Pacific region) 50 million tons. Despite Putin's optimistic projections, only 15 million tons of crude have been delivered through the pipeline this year. (Oil & Gas Eurasia No. 7, July-August 2010).

Over 100 Chinese state-owned companies operate in Iran, and many of the contracts are in the oil and gas sector. According to Christina Lin of the Jamestown Foundation, In 2008 the China National Petroleum Corporation (CNPC) and the National Iranian Oil Corporation (NIOC) signed a $1.76 billion deal to develop the North Azadegan oil field, $8.2 billion deals in 2009 to develop the South Pars Gas field, a $3 billion deal to expand refineries, and a $4 billion deal to expand Iranian oil production. China is also selling gasoline to Iran, despite US sanctions against the country ("The Caspian Sea: China's Silk Road Strategy Converges with Damascus," www.jamestown.org , 19 August 2010 =).

Dr. James J. Coyle is available to speak to your organization or at your event. Please contact him at jimcoyle@verizon.net.

Eurasian Energy Moving East

While this blog has covered Eurasian energy movements to Europe, one cannot forget that Asia also needs oil and gas from Russia, the Caucasus and Central Asian Countries. Platts reports that Chinese oil demand for the first six months of 2010 was 210.81 metric tons, an average of 8.54 million barrels per day. This represents a 13% jump in demand over the same time period in 2009. Demand in natural gas also continues to rise.
To meet China's demands, Kazakhstan opened in July 2009 the first phase of its oil pipeline to China. As for natural gas, in December 2009 Chinese president Hu Jintao met with Turkmen president to inaugerate a Trans Asian gas pipeline. The Washington Post reports the pipeline will cost $6.7 billion to build, and will link with China's West-East gas pipeline. The pipeline is designed to meet half of China's gas needs. Russia has promised to meet the other half of China's gas needs, with two new pipelines from Siberia. In addition, Russian Premier Vladimir Putin recently relaunched the proposed Eastern Siberia-Pacific Ocean oil pipeline.
Not all reports demonstrate increased Chinese demand for energy, however. Eurasia Oil and Gas reports that China's imports of Iranian crude oil fell by almost a third in the first half of 2010.

Dr. James J. Coyle is available to speak to your organization or at your event. Please contact him at jimcoyle@verizon.net.