Trans Adriatic Pipeline Takes the Lead

With only weeks to go before the Shah Deniz consortium chooses which route will bring Caspian gas to Europe, the Trans Adriatic Pipeline (TAP) has taken a commanding lead.  The decision is supposed to be made by the end of June, according to the director of the State Oil Company of the Azerbaijan Republic (SOCAR) Rovnag Abdullayev.  "At present, the work is under way to choose a route of transporting Azerbaijani gas to Europe," he told Trend.  "The final decision will be made at the end of the month."

TAP has a number of advantages over Nabucco-West, its rival for the fuel that is scheduled to be delivered to the western border of Turkey by the Trans Anatolian Pipeline (TANAP).

• It is shorter.  TAP will extend 800 km, while Nabucco West will stretch 1300 km.
• It is cheaper to build.  Because of the shorter distance covered, TAP is estimated to cost $500 million less. 
• It has political support along the route.  Greece, Albania, Croatia, Montenegro and Bosnia-Herzegovina all support construction.  The Baltic countries hope to gain access to the line through an  Ionian Adriatic Pipeline.
• Azerbaijan stated in February they prefer TAP.  One possible reason is that TAP will not cross directly through former Eastern bloc countries, and Azerbaijan might want to avoid antagonizing Russia.
• Europe has approved TAP.  In May, the European Commission granted TAP the Third Party Access exemption, giving TAP permission to offer capacity for export of gas for the next 25 years.  Previously, the Europeans had given their backing to the Nabucco project.
• TAP will strengthen the Greek economy by providing transit revenues to the beleaguered nation.
• Israel could use TAP to ship its new-found gas to Europe.  Valeria Termini, vice president of the Council of European Energy Regulators, has held talks with senior Israeli officials on the project, according to Platts.

Despite all the advantages to the TAP route, there is still backing in some quarters for the Nabucco-West route to Austria. "Both have advantages and disadvantages," said Gulmira Rzayeva of the Azerbaijani Center for Strategic Studies.

Russian Energy Flows Move East

In a move with major geopolitical ramifications, Russia is diverting increasing amounts of energy from the European market to the Asian.  Economically, it makes sense that Russia would want to be less dependent on the stagnating European economies, and the growing economies of Asia are a strong alternative.  "Russia has been losing its interest in Europe where oil consumption is stagnant.  It's looking increasingly to the East," said energy analyst Valery Nesterov.

The East Siberia-Pacific Ocean (ESPO) pipeline, originally opened with a branch line to Daqing (15 million tons delivered in 2012) has now expanded.  In January 2013 ESPO 2 opened to the Pacific Ocean.  ESPO oil flows are scheduled to increase from 30 million tons in 2012 to 80 million tons.   Bloomsberg estimates that in February 2013, Russia sent 1.1 million tons (22 percent of total oil exports)  in an easterly direction, up from 18 percent in October 2012.  By 2015, when ESPO reaches full capacity, Russia is scheduled to send 25 percent of its crude exports to eastern markets.

In addition to ESPO, which traverses only Russian territory, there is the possibility that Russia could sell additional oil to China via Kazakhstan.  Kazakh Energy Minister Sauat Mynbayev reported he was in negotiation with Russia to begin the sales as early as 2014.  The oil would reach China via the Kazakh Atasu-Alashankou pipeline. (Russia shipped oil to China through this pipeline until 2010.)   Kazakhstan would deliver 7 million tons of oil to China, and Russia would give Kazakhstan an equal amount in a "swap operation."  Such a move would be opposed by the Russian pipeline operator Transneft, who believes they would lose $1.5 billion in transshipment revenue.  Transneft CEO Nikolay Tokarev opined that the deliveries could proceed if the the lost revenue was compensated in the budget.

In March 2013, Rosneft and the China National Petroleum Corporation (CNPC) signed an agreement to increase oil exports to China.  In return for the agreement, China reportedly agreed to make an advance payment of $8-10 billion.  In addition, China Development Bank agreed to extend an additional credit line of $2 billion to Rosneft for the duration of the contract.  Russian Energy Minister Aleksandr Novak implied the delivery would be via the Kazakh swap mechanism.  No date was given for the signing of the contract.

As for natural gas, the situation is more complicated.  Russia already has agreements to send China 68 billion cubic meters (bcm) annually.  Deliveries have not begun, however, because of an inability to agree on price.  In March 2013, Gazprom and CNPC signed another memorandum of understanding in which the Russian company agreed to supply 38 bcm per year for 30 years, beginning in 2018. Price remains an issue.  Gazprom chairman of the board Viktor Zubkov was optimistic that an agreement could be reached by June, and hoped the price could be pegged to the cost of oil.  He admitted, however, that "the Chinese side probably believed there were other parameters that prices could be pegged to."  

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.

Rocky Road to Yamal 2

Polish Prime Minister Donald Tusk has asserted his control over Polish infrastructure projects, by firing state officials who signed a memorandum with Gazprom without his knowledge.  The Yamal - Europe 2 gas pipeline has been on the planning books for twenty years, and and had been almost forgotten.  In the midst of Russia's latest quarrel with Ukraine over transit rights, however, Russian President Vladmir Putin revived the dormant proposal on April 3.  Putin requested Gazprom CEO Alexei Miller to take another look at the proposal, despite no additional gas supplies available to fill the pipeline.

Miller quoted a market analysis that Gazprom could transport 15 billion cubic meters of gas to Hungary and Slovakia.  He proposed construction could begin in 2018-19 after the completion of the South Stream project.  Polish Treasury Minister Mikolaj Budzanowski dismissed the possibility out of hand.  "I approach media speculation regarding a second branch of the Yamal gas pipeline with great caution, because the consent for such a project should depend on the price of the raw materials and its suppliers," he said.  "The European Union does not need more supplies of natural gas from Russia," he told Polish radio.  A separate report quotes Budzanowski in even stronger terms.  "No one, except for the Polish company and the Polish government is entitled to make decisions about transit via the Polish territory.  That's why we would like to tactfully remind that we are not going to build a new gas transportation network to Poland or the European Union on instructions from anyone, especially from Gazprom."

Polish Minister of the Economy Janusz Piechocinski recognized that the new pipeline's sole purpose was to divert gas from the pipeline that transits Ukraine, putting more pressure on that state to accept Russian demands to pay more for gas.  He said Poland should be "very careful" about getting involved in the spat over the gas price.  These cautions were echoed by Polish Prime Minister Donald Tusk.  "Poland won't participate in these political contests.  For us, gas isn't a tool to conduct politics and we very much want, in agreement with European Union laws, to keep gas issues free of politics."

With the major Polish officials all opposed to the new pipeline, it came as a shock to all when Gazprom announced that it had signed a memorandum of understanding with Miroslaw Dobrut, CEO of Polish pipeline operator Europol Gaz.  "The document envisages the implementation of the Yamal-Europe 2 project through  Poland," the Russian company stated in a press release.  It envisioned the completion of a feasibility study in six months.

The Prime Minister was furious that such an agreement could be signed without his approval.  Grazyna Piotrowska-Oliwa, head of PGNIG SA (part owner of Europol Gaz) immediately tried to backtrack.  She said Gazprom was exaggerating the significance of the memorandum, which was merely an agreement to evaluate the project.  "Nobody knows what the result of the analysis will be, whether it's going to be profitable at all," she said in a television interview.  "The memorandum does not include a decision to build the pipeline and is not a legally binding agreement or pledge to conclude any agreements or contracts."

The dominoes quickly fell.  On Friday, April 19, Prime Minister Tusk fired Economics Minister Budzanowski for failing to monitor the activities of the state-owned PGNIG.  "In my view, the oversight function was not fully implemented," he said.  Budzanowski was replaced by Wlodzimierz Karpinski, whom the Prime Minister warned about needed personnel changes in the gas  company. Ten days later, PGNIG's board let go CEO Piotrowska-Oliwa and her deputy, Radowslaw Dudzinski.

In the face of such insubordination, the Polish government was not satisfied with the personnel changes.  In June, the Treasury introduced a proposal to change the statutes under which PGNIG operates.  Under the new plan, PGNIG's management board would be required to report on any agreements with foreign entities.

The Yamal - Europe 1 pipeline was originally conceived in 1994, and began operating in 1999.  It is the main pipeline for Gazprom's Eastern European clients (Western Europe gets its gas from the Ukrainian pipeline and, more recently, Nord Stream.)  It stretches over 2,000 kilometers over Belarus and Poland.  In Poland, the pipeline is owned by Europol Gaz, which in turn is owned jointly by Gazprom and by the Polish state-controlled gas company PGNIG SA (48% each.)   Yamal - Europe 2 was proposed in 2008, but in 20009 the Russian then-president Dmitry Medvedev postponed the project, citing inadequacy of supply to meet all the Gazprom agreements with the EU.  If completed, Yamal 2 will have a 15 bcm capacity.

While Prime Minister Tusk may not have been happy with the way Yamal 2 was resurrected, there are signs that planning for the project is continuing.  Russian Ambassador to Belarus Alexander Surikov has confirmed that the feasibility study proposed in the memorandum of understanding is continuing, and will be completed by November 2013.  "Poland has confirmed its willingness to have an additional 15 billion cubic meters of gas," he said. "All these issues will be resolved...in November."

Possible Political Implications of Russian decision to cancel Baku-Novorossiysk pipeline agreement

Russia is terminating the Northern Route Export Pipeline, running from Baku, Azerbaijan to Novorossiysk, Russia.  This oil pipeline, which stretches 1,330 kilometers (830 miles) at one time was considered an important national interest for both countries.  Today, it is considered a pipeline to be filled only if the economic conditions warrant it.

In 1994, when the government of Azerbaijan signed the "Contract of the Century" with Western oil companies to exploit offshore energy deposits, the United States opposed any proposal that would give Russia control over the export route.  But in February 1995, at a confidential meeting with the heads of the State Oil Company of the Azerbaijan Republic (SOCAR) and the Azerbaijan International Operating Company (AIOC, a BP-led consortium), President Heydar Aliyev directed early oil to be exported via the northern route.  According to the former President of the AIOC, "There were to be no situations created by Baku that would actively alienate President Aliyev's political allies in Moscow...Preparatory work could also start on WER (Baku to Ceyhan), but not brought into full effect until such time as Russian contracts had been signed.  For President Aliyev it was in Azerbaijani national interests to be aligned with but not subordinate to a cooperative Russia."  (Adams, Terry D.  "Baku Oil Diplomacy and 'Early Oil,' 1994-1998: an external perspective," in Azerbaijan in Global Politics:  Crafting Foreign Policy.  Baku:  Azerbaijan Diplomatic Academy, 2009, 242-243).

One reason that this pipeline route was important was the same reason that the original consortium included the Russian oil company Lukoil; namely, to avoid a Russian challenge to Azerbaijan's right to take oil from the contested waters of the Caspian.  The strategy worked:  in May 1995 Russian Energy Minister Yuri Shafranik proposed that the flow be reversed in the pipeline which had previously brought Russian crude to Azerbaijan to be refined.  In February 1996 the intergovernmental agreement was approved.  AIOC would ship oil across the border into Russia, from where the Russian pipeline company Transneft would take it to the Black Sea port of Novorossiysk.  There, it would be mixed with Russian "Ural light"-blend oil for sale on the international market.

The original agreement called for 5 million tons (approximately 35 million bbls) of oil to go through the pipeline annually.  The pipeline could carry up to 10 million tons, so the agreement only called for the pipeline to be 50% full.  In fact, however, the quantities shipped were far less than that.  Azerbaijan averaged 2.5 million tons per year, with the quantity decreasing in recent years:  2.2 million tons in 2010, 2.06 million tons in 2011, 1.99 million tons in 2012.

Because of these decreased flows, discussion about discontinuing the export through this line has been around for at least a decade, according to Azerbaijan's Ambassador to Russia Polad Bulbuloglu.  In 2007, SOCAR took over from AIOC as the operator of the Azerbaijani side of the pipeline.  Almost immediately, SOCAR President Rovnag Abdullayev announced a continuation of the use of the pipeline, but at reduced levels.  SOCAR cited the loss of revenues from the mixing with Ural light as the reason (Ural light sells for approximately $4 per barrel less than the higher quality Azerbaijani crude).

In August 2008, possibly as a signal of their unhappiness, Transneft notified SOCAR of a temporary suspension of the transportation of Azerbaijan's oil, supposedly because of repair work on the pipeline. This was followed in May 2009 by a Russian proposal to alter the original transit agreement.  According to Russian Minister of Industry and Energy Sergey Shmatko, the agreement had become "old."  Shmatko wanted to see the quantity increased from the average 2.5 million tons per year to the originally conceived 5 million tons.  "It is necessary to make changes in the agreement and the draft of the revised agreement was sent to Azerbaijan.  We expect a response," said the minister.  Apparently, they did not get one as the oil volumes continued to drift downward.

In September 2012, SOCAR announced they were holding negotiations with the Russians as to how much oil would be transported through the pipeline.  SOCAR estimated the volume would be 1.6 million tons, a 20% drop from the already low level of 1.99 million.  The decrease was soon confirmed:  in January-March 2013, SOCAL exported 411,339 tons through the pipeline, a drop of 85,548 tons from the same time a year ago.  The volume decreased an additional 2.8% in April.

Faced with the declining volumes, and with Transneft already losing an estimated $50 million annually on pipeline maintenance, Russian Prime Minister Dmitri Medvedev signed a decree on May 5, 2013 terminating the arrangement.  The Russians did not give any advance notice of the action, although the termination was legal.  The original intergovernmental agreement stated either side could cancel the arrangement with six months notice, and Russia agreed to honor the current agreement until the beginning of 2014.  Transneft spokesman Igor Demin stated the agreement was being cancelled because Azerbaijan had not honored the terms as to the quantity being shipped. He added that the shipments could be resumed in 2014 if a new agreement were negotiated.  "From January (2014) we will calculate the tariff based on real rates," he said.

Azerbaijan also chose to look at the issue from an economic viewpoint.  "There will be no problem with oil exports," said SOCAR's leader Abdullayev.  "We have the Baku-Tiblisi-Ceyhan route, Baku-Supsa and a railway."  Abdullayev said he was ready to enter into negotiations with Transneft.  "The company will continue oil deliveries in case of economic suitability of new (contract) conditions for SOCAR.  In case of economic unsuitability, deliveries won't be implemented."  A separate report quotes Abdullayev saying, "This is a commercial decision and the matter has moved from the political perspective to the economic.  The State Oil Company understands the decision of the Russian side."

Both sides have gone out of their way to make the decision appear divorced from politics.  Russian Foreign Minister Sergei Lavrov announced the talks had already begun.  "Our respective energy agencies and companies are working on preparing a new intergovernmental agreement which will reflect current realities."  Similarly, the deputy chief of Azerbaijan's presidential administration, Novruz Mammadov, concurred that "the transportation of oil at the moment is simply not profitable to both parties in terms of economic and commercial viability..we accept the decision of the Russian Federation as perfectly normal."

SOCAR's Abdullayev is reviewing all options for the pipeline including the establishment of an oil quality bank in Novorossiysk, using the pipeline to transport oil from a third party, or even reversing the pipeline to its original orientation.  "Economic efficiency of all possible options may be considered," he said.  "There is enough time."

While economic considerations must play into the decision making, one is forced to ask:  Why now?  After all, the mixing with Ural light was included in 1995 in the original draft of the intergovernmental agreement.  And Azerbaijan has never sent more than 3 million tons through the pipeline since they began the northerly flow in 1996.  The conclusion, despite protests from both sides, is that Russia continues to ratchet up the pressure on Azerbaijan.

Russia has long tried to force Azerbaijan into a customs union or security treaty.  It has opposed Azerbaijan's claims to its territory in the Caspian (pending an all-party conference), supported Armenia against Azerbaijan over Nagorno Karabakh, and announced construction of the South Stream pipeline to choke any attempt for Azerbaijan to ship its gas to Europe independently.  When the Russian lease ended on the Gabala radar station in Azerbaijan and Azerbaijan demanded an increase in rent, Russia refused to renew the lease.  Instead, it announced it was increasing its troop presence in Armenia.  The cancellation of the Baku-Novorossiysk intergovernmental agreement appears to be yet another move to bring Baku back under Moscow's control.