Russia Offers Possible Compromise on Third Energy Package

The European Union's Third Energy Package, demanding the "unbundling" of energy production from energy distribution, had been headed for an impasse between Russia and the EU. As of December, however, it appeared that a Russian compromise may be finding traction.

The low point came in early October, when the European offices of Gazprom were subjected to anti-trust raids. The EU seized files to determine if Gazprom was engaged in anti-competitive practices. While the Russians may have been angered, they recognized they were in a confrontation from which there could be no winners. Russian President Dmitry Medvedev told Gazprom and the Russian Ministry of Energy to submit proposals on how to operate under European laws.

The results were a disaster: the Russian Energy Ministry proposed an intergovernmental agreement establishing a special legal regime for major international infrastructure projects. The EU rejected the proposal. Energy Minister Sergei Shmatko told the press, "Talks with the European Comission on the third energy package...have hit a dead end," according to Reuters. The Russians threatened to legally challenge the Third Energy Package in court, and to shift their energy business to the Far East.

In the end, however, despite the diplomatic setback, Russia continued to look for a compromise. "What does this mean? Nothing terrible," Shmatko continued. "All the obligations that the Russian Federation and Russian companies have taken on with regard to supplies of energy under long-term contracts will without doubt be fulfilled." He also said Russia is committed to being a stable and reliable supplier of energy to the EU, and maintenance and increase of supply natural gas transport capacity is a top Kremlin priority, according to Deutsche Presse-Agentur. In early December, Shmatko offered hope. "I would not rule out resolving a fair number of regulatory conflicts at the level of national regulators," he said according to Reuters. At the same time, top EU energy officials said the dispute between Russia and the EU could be worked out under existing law.

The nature of the possible compromise was finally revealed by Russian Ambassador to the EU Vladimir Chizhov. As reported by ITAR-Tass, the Ambassador suggested that the ownership of Gazprom-controlled projects such as Nord Stream and South Stream be reinterpreted, so that ownership and transportation of the gas had already been "unbundled." "South Stream does not fall under the Third Energy Package, because its owner will be not Gazprom, but an international consortium. That is, it will be under an independent operator," he said. "The same applies to Nord Stream, because its operator--Nord Stream AG--is a consortum registered in the Canton of Zug of the Swiss Confederation."

While the Third Energy Package problem may be solved, EU energy commissioner Gunther Oettinger is creating more problems with the Russians. Gazprom has been highly successful in negotiating bilateral agreements that have hurt other countries in their ability to negotiate with the Russians. Thus, the bilateral Russian-German agreement to build Nord Stream has left Poland vulnerable to energy cutoffs; the bilateral Russian-Turkish agreement to allow South Stream to use Turkish waters in the Black Sea could leave Ukraine vulnerable to the same pressure. To solve this problem, the European Commission approved in September an Oettinger proposal requiring national governments to notify the European commission of international energy negotiations. "The ...mechanism is set to strengthen the negotiating position of member states vis-a-vis third countries, while ensuring security of supply, proper functioning of the internal market and creating legal certainty for investment," said the commission.

Azerbaijan to Have its Own Gas Pipeline

Tired of Nabucco planning without implementation, Azerbaijan's Minister of Industry and Energy Natik Aliev and Turkish Energy Minister Taner Yildiz signed a memorandum in late December to build their own natural gas pipeline. The new project, entitled the Trans Anadolu pipeline, will upgrade existing Turkish pipelines to carry 16 billion cubic meters (bcm) of natural gas a year: 10 bcm throughput for the European market, and 6 bcm for domestic, Turkish consumption.
The pipeline will be 80 % owned by the State Oil Company of the Azerbaijani Republic (SOCAR). The remaining 20% will be divided between the two Turkish state-owned companies that control the pipelines: Petroleum Pipeline Corporation (BOTAS) and the Turkish Petroleum Corporation (TPAO.)
The question becomes, what will happen to Nabucco? Trans Anadolu will only deliver to Europe one third the capacity of the planned Nabucco pipeline, but it would deprive Nabucco of the Shah Deniz output that was essential to getting the project started. Gulmira Rzayeva, a research fellow at the Center for Strategic Studies, told Bloomberg, "Nabucco is impossible in the medium term because it is a costly project and needs more suppliers than Shah Deniz to be economically viable." RWE's Stefan Judisch said the new route "raises questions about access and financing."
The Turkish government says that this project is not necessarily an alternative to Nabucco, but could be a first step toward its ultimate completion. Given that Trans Anadolu can be built at a fraction ($9.2 billion) of Nabucco's cost (possibly as high as $20 billion), it remains to be seen if investors will be interested in spending the funds to complete the project(assuming additional feedstock can be found).

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.

Bulgaria Cancelling Burgas-Alexandropolis Pipeline

After 15 years of planning, the government of Bulgaria has announced it will cancel the Burgas-Alexandropolis Pipeline in the next twelve months, because it is no longer financially viable. The argument is a bit disingenuous, since the costs escalated while the Bulgarian government used environmental concerns to delay approval of the project.

The pipeline was supposed to allow Russian crude to reach the Mediterranean while bypassing the straits of the Bosphorus. Bulgarian Prime Minister Boyko Borisov came to power in 2009 promising to cancel the project which had been opposed by residents of the towns the pipeline would transit. He returned proposals three times for inadequately addressing environmental concerns. Other investors in the project recognized this as a delaying tactic. Transneft spokesman Igor Dyomin said, "The Bulgarian side has three times given negative conclusions on the ecology (of the pipeline project) with the suggestion that the project should be improved. The last time their arguments were totally facitious, and we have got the impression that they intend to play for time instead of working on the project," according to Business Insider. Borisov's ecological bluff was called in November 2011, however, when the Environment and Water Ministry approved the last environmental impact statement.

Bulgaria owed $8.2 million dollars to its partners in the project. As a result of their failure to pay, Russian pipeline operator Transneft announced in July that it was freezing its involvement in the project. "God save anyone from partners like our Bulgarian friends," commented Transneft chief exectuvie Nikolai Tokarev.

Bulgaria is apparently blaming Transneft's freeze for the pipeline problems, rather than its own instransience. The Sofia News Agency quoted Energy Minister Traicho Traikov after a cabinet meeting: "Bulgaria's partners in the pipeline deal accused it of delaying the project quite a long time. But now it turns out it is not Bulgaria, but the other countries, which are at fault and this is the reason why we decided to walk out of this agreement. It is not Bulgaria which should be criticized for failing to meet its commitments." Traikov is proposing the dissolution without penalty of the trilateral cooperation agreement among Russia, Bulgaria and Greece; or, Bulgaria will withdraw unilaterally from the agreement.

For Transneft's part, they are considering other options to transit Greece while bypassing Bulgaria.

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.