Baku-Moscow Growing Closer on Energy

While the Baku-Novorossiysk pipeline remains out of commission, talks have resumed between Baku and Moscow on the future of the pipeline.  Russia claims the line is underutilized and therefore unprofitable; Azerbaijan claims they lose money when Russia mixes Azeri crude with the heavier, Ural blend.

On 8 July 2013, however, Transneft spokesman Igor Demin said commercial negotiations with the State Oil Company of Azerbaijan (SOCAR) had resumed.  In making the announcement, he underscored the issues dividing the two sides: "The issue of the quality of transit oil has not been rasied in negotiations yet, but discussion of the matter of Azeri light oil quality is hardly possible because of the small volume of transportation.  At that, oil can be carried by shipments to maintain the quality, but it will greatly increase the cost of its transportation."

Despite the controversy, talks on other forms of energy cooperation are progressing.  SOCAR President Rovnag Abdullayev and Rosneft President Igor Sechin met in June 2013 in Moscow and July in Baku to discuss long-term projects.  SOCAR issued a press release stating, "The presentation opened the possibility of expanding cooperation between the two companies in Azerbaijan and Russia and in third countries.  In particular, possibilities exist on ongoing and pending projects by the two companies."

One area of cooperation is the Absheron off-shore gas field, jointly owned (40% each) by SOCAR and the French company TOTAL.  Sechin has held recent talks with both parties about obtaining a stake in the project.

The new-found cooperation in energy reflects improving ties in other fields, as well.  In 2012, Azerbaijan ordered a billion dollars worth of weaponry from Russia, including 100 T-90C tanks, and truck-mounted multiple rocket launchers.  Previously, Azerbaijan purchased a $2 billion air defense system from Russia.

South Stream Moving Toward 2015 Completion

While the Western news outlets have been full of information on the Shah Deniz 2 consortium choosing the Trans Anatolian Pipeline (TAP) to deliver Caspian gas to southern Europe, Russia has quietly continued work on the rival South Stream pipeline.  The pipeline, which will cross the Turkish economic zone in the Black Sea, is scheduled to make landfall in Varna, Bulgaria.  After that, plans call for the line to split.  One spur will provide product to Russia's traditional client states in Central Europe; the other will challenge TAP by transiting Greece and ending in Italy.  Italy's biggest energy company, Eni SpA stated it expects to receive the first gas from South Stream by the end of 2015.

The key to the project is Bulgaria:  both the pipeline's landfall and the location of the split.  Bulgaria's Minister of Transport, Daniel Papazov, confirmed the project was a top priority of the government, and that everything was ready to begin construction.  "This project will be implemented very soon," he said.  According to a Gazprom spokesman, the company is ready to begin construction in Bulgaria by the end of 2013, with the first phase completed by 2015. Such planning is ambitious, as the project is already behind schedule.  Gazprom CEO Miller said, "The project has been implemented with certain delays from schedule...We are however certain that the deadlines for the start of construction will be met."  Bulgarian Minister of Economy and Energy confirmed Miller's statement:  "We will speed up work on South Stream as it is important to diversity our natural gas delivery routes and have direct deliveries from Russia without passing via third countries.  We need to have final detailed site development plan, environmental impact assessment and front end engineering design by the end of this year and apply for construction permit."

According to  Deputy Head of Project Management Alexander Syromyatin, the need for South Stream continues.  "South Stream is an answer to the increased demand in natural gas and will enable diversification of the Russian gas supply routes to the EU, decrease transit risks, guarantee stable gas supplies to Central and southern Europe and help improve the environment," he said.

The project has the support of the overwhelming majority of Bulgarians.  According to a survey conducted by World Thinks, 68% of Bulgarians support the project.  "Very few feel opposed or strongly opposed," said company director Ben Shimshon.  "Only 5% felt negative about it and the remainder were either unsure or undecided on how they feel."  Shimshon said the public supported the project primarily for the jobs it would create, with good gas prices in second place.  "The public are much more clear," he said, "that there will be economic benefits:  61%  of people agree that Bulgaria will benefit economically from the pipeline."

One reason support may be so high is that the project will not cost the Bulgarian taxpayer any money.  Gazprom CEO Miller confirmed that Russia was prepared to fully finance the construction of the Bulgarian section.  Russia would lend Bulgaria 3.1 billion euros (approximately 5 billion dollars) to be repaid with transit and gas transportation fees.  Bulgarian Economics Minister Dragomir Stoynev confirmed "The South Stream will be financed on a project principle--there will be no money of the Bulgarian taxpayers to be spent."

Not everyone agrees that the pipeline should go through Bulgaria, however.  Julian Lee, a senior energy analyst at the Center for Global Energy Studies in London, claims that Bulgaria does not need South Stream.  "Bulgaria will still have access to gas from Azerbaijan via TAP and the Interconnector Greece-Bulgaria," he said.  Lee is joined by the citizens of Varna, the city where the pipeline will land.  The townspeople are concerned about noise and air pollution from both the construction and the operation of the pipeline and compressor station, to be built less than one mile from the city's southern suburbs.  The entry point is supposed to be the Pasha Dere Beach, which is a protected area under the EU's Natura 2000 program.  However, the project's environmental impact statement lists a number of advantages for Varna, including 2500 new jobs, profits of 30 million euros for the port, and a local business boom with profits for all.(The job creation figure is suspect, since South Stream Bulgaria's CEO Georgi Gegov claims the construction phase will create 2500 jobs in the entire country, not just in Varna.  Once it is built, South Stream Bulgaria will need an addition 3500 jobs to service and supply the pipeline.

Russia also plans a branch of the pipeline to go to Macedonia.  Russian Prime Minister Dmitry Medvedev ordered the Russian energy and foreign affairs ministries to begin discussions with Macedonia for a feasibility study.  Assuming this study shows the viability of the spur, the two countries would establish a 50/50 joint venture to complete the project, although Russia would retain the right to use the pipeline's full capacity, according to a Russian draft agreement that was signed by both countries on July 23.

Serbia is also excited (73% public approval rating) about the pipeline.  Serbian Prime Minister Ivica Dacic said, "South Stream is the most important international project that Serbia is currently involved in and will be key to the country's economic development, ensuring job creation, and energy security for the region...Our objective is to ensure energy sector supply and develop our partnership with Russia."  The Serbian Minister of Energy predicted the pipeline would create at least 1,000 new jobs.

What is clear is that, with Central Europe mired in a recession, the lure of jobs is stronger than the fear of dependence on a Russian monopoly for energy supplies.

No Russian Gas for China Yet

In March 2013, Gazprom CEOAlexei Miller stated that an agreement with China on the pipeline gas deal that they have been negotiating since 2004 would be signed by June 2013.  "The parties plan to sign legally binding principal terms and conditions of the contract in June this year and sign the long-term contract by the end of the year," he said.  With that deadline now on the ash heap of history, Miller is now hopeful for a September contract.  "I think it can be said in September we could achieve the signing of the basic terms of the contract."

Gazprom's Export CEO Alexander Medvedev was not as optimistic.  He said Miller's statement was a hope, not a reality.  He said that Miller was engaged in wishful thinking, and that thinking made it so.  The issue has not changed over the decade:  Gazprom wants to charge China using a price linked to the European market; China has never accepted this, arguing they are a developing country that cannot afford such prices. China has also claimed that the transit distance between Russian fields and China is less than between the wells and Europe; accordingly, prices should be less.

Despite these issues, Russian President Vladimir Putin remains optimistic about the Asian market.  "We  are thinking about entering the promising market in the Asia-Pacific region.  We should find our niche here; we have every chance of doing that," he said.  "The Asia-Pacific region is developing rapidly.  Its consumption is growing rapidly, and Russia can play a prominent role."  Putin's remarks may be fulfilled with the newly signed Rosneft contract to deliver petroleum to China, but Gazprom's $68 billion pipeline project remains mired in the inability of the negotiators to move toward an accommodation.

Russia and China Sign Major Petroleum Deal

On 20 June 2013, Russia and China signed a deal worth $270 billion dollars.  Rosneft agreed to double its sale of petroleum to China by 300,000 bpd over the next 25 years (5 years prolongable,)  from 15 million tons to 30 million tons per year.  The agreement was signed by Rosneft chief executive Igor Sechin and China National Petroleum Corporation (CNPC) chief Zhou Jiping in the presence of Russian president Vladimir Putin.

An important part of the deal is a $60-$70 billion prepayment for the oil, alluded to by Putin at the announcement of the contract.  JP Morgan analysts said, "If confirmed, this would be a transformational event for the company's balance sheet:  Rosneft could even potentially be able to show a net cash position, though working capital would be negative.  The prepayment could minimize financing risks for the leveraged state-controlled oil company."

The increased petroleum flows began even before the contract signing.  Reuters reported on June 18 that Russia was increasing its oil supplies to China by 13 percent in July-September over the previous three month period.  With this increase, Asia as a whole was importing 17% of Russian oil exports.  According to Valery Nesterov, analyst from Sberbank CIB, "Russia has been losing its interest in Europe where oil consumption is stagnant.  It's looking increasingly to the East."

Then came the June 20 deal, in which China acquired the rights to buy from the world's largest gas station:  Russia.  According to Liao Na, Vice President of the energy consulting company, ICIS C1 Energy, the timing was right.  "The seller and the buyer both have strong willingness to reach the deal provided the price was comfortable for each of them.  It is good timing, considering current international oil prices."

It was originally announced that fuel for the deal was to come from East Siberia fields.   In the annual meeting with Rosneft shareholders, Sechin named two fields as the main source of the oil, Vankor and Verkhnechonsk, that are nearing peak output.

In fact, the oil is not coming from East Siberia, but is being diverted from fields that service the European market.  Igor Katsal, Transneft deputy vice president, told reporters, "We supplied those 800,000 mt to the west and now will redirect them to the east.  They won't be replaced in the western direction."  Transneft confirmed that at least half of the redirected crude will be produced at Samotlor in West Siberia.  Deputy Energy Minister Kirill Molodtsov confirmed Russia planned to increase oil exports from the Pacific.  "The balance between West and East will change," he told reporters.

The reason for the diversion is that Russia has promised large quantities to Asia.  In addition to the current flows of 750,000 bpd, Russia promises to send another 9.1 million mt per year to China after a CNPC-Rosneft joint refinery is completed in Tianjin.  These changes are taking place at a time that Russian domestic consumption of crude is also rising.

How the oil will be delivered physically is still undecided.  Transneft spokesman Igor Demin said that there has been no change in its contract with Rosneft.  As a result, although Transneft has adjusted its transit schedule to accommodate the larger oil flows through the East Siberia-Pacific Ocean (ESPO) pipeline, Demin said that shipments might soon be suspended because it will have fulfilled its obligations under existing contracts.

The eastern "black gold" rush is encouraging others to enter into the field.  Lukoil CEO Vagit Alekperov confirmed that they are increasing exploration in East Siberia.  Alexei Kokin, an oil and gas analyst at UralSib Financial Corporation, wrote, "Other Russian companies' experience probably convinced Lukoil that East Siberian projects can be attractive.  As a late entrant, Lukoil will be able to learn from the pioneers' mistakes and be more efficient."

Still a Future for Nabucco?

The vote is in, and the Shah Deniz 2 Consortium has chosen to link the Trans Anatolian Pipeline (TANAP) to the Trans Adriatic Pipeline (TAP) instead of Nabucco West.  Natural gas flowing from the Shah Deniz 2 field will feed the industries of Greece and Italy, instead of Austria and Central Europe.  Conventional wisdom is that the Nabucco project is dead.  "The Nabucco project is over for us," said Gerhard Roiss, CEO of OMV, the Austrian leader of the Nabucco consortium.

The funeral oration may be premature, however.  Nabucco has not disbanded.  Upon learning of its loss of the Shah Deniz 2 gas, Nabucco announced it was continuing to look for new sources for its project, justifying its continuation on the European energy market's need for diversification.  "We remain convinced that the Nabucco route offers the only possibility to answer these needs," the company said.  "Nabucco is confident of developing opportunities based on alternative gas sources."  Construction of the long-debated Trans Caspian Pipeline would bring gas toward Europe in quantities that far exceed TAP's projected initial capacity of 6 bcm per year.

One of the major members of the Shah Deniz 2 consortium, the State Oil Company of the Azerbaijan Republic (SOCAR), also has held out hope for a future Nabucco role.  Rovnag Abdullayev, president of SOCAR, noted that Shah Deniz 2 is not the only offshore gas field the company is developing.  As additional fields come on line, such as ACG Deep, Absheron, Umid and Shafag-Asiman, "We clearly see the Nabucco pipeline corridor as the natural market for our future volumes of gas...We expect that the ability of the southern corridor to bring new sources of supply to European markets will extend beyond the immediate areas transited by TAP."

The European Commission has also not totally abandoned its favorite pipeline project.  Despite statements welcoming the choice of TAP, the commission issued a statement holding out a lifeline to Nabucco.  "In principle, gas from the Caspian Sea could be delivered to the EU both to Baumgarten/Vienna (Nabucco West) or to Italy (TAP)," it said.

An open question remains:  will Europe need all this pipeline gas?  With TANAP/TAP poised to bring gas from the Caspian, North and South Stream scheduled to export Russian gas, the development of shale gas, LNG coming from Algeria...it may be that Nabucco's future will be hostage to the pending glut in natural gas supplies.

Shah Deniz Consortium choose Trans Adriatic Pipeline

After two years of deliberation, the Shah Deniz Consortium (BP, Statoil, Socar, Lukoil, Nico, Total ) has decided to connect the Trans Anatolian Pipeline (TANAP) to the proposed Trans Adriatic Pipeline (TAP), instead of the longer Nabucco West pipeline.  TAP will carry Caspian-origin natural gas through Greece and Albania to Italy.  Nabucco West had planned to carry the gas northward to Baumgarten, Austria.  Speaking on behalf of the consortium, BP's regional director Gordon Birrell made the announcement to journalists in Baku on June 28, 2013.

The decision appears to have been made based on a number of factors such as  lower construction costs because of a shorter pipeline route, and  higher gas prices in Southern Italy.  Andrew Neff, an analyst with the Moscow market research firm IHS, said that a tipping point may have been the State Oil Company of Azerbaijan (SOCAR)'s purchase one week earlier of a majority stake in the Greek gas company Desfa.  "This gives Azerbaijan a direct supply relationship with Greece," he commented.

The government of the United States welcomed the announcement.  A statement issued by the US State Department called the choice "another important step in the process of advancing Europe's energy security and promoting competition in the supply of energy resources."  European Commission President Jose Manuel Barroso also expressed pleasure.  "This is a shared success for Europe and a milestone in strengthening the energy security of our Union," he stated.

Western support has little to do with the amount of gas that will be delivered to Europe.  At 6 bcm per year, TAP will only carry about 1% of European gas consumption.  The financial rating company Fitch Ratings commented that the limited capacity meant TAP would probably not contribute any downward pressure on gas prices.

Rather, the importance of TAP, and the TANAP line to which it will be connected, is that it challenges Russia's hold on natural gas exports to Europe.  US Heritage Foundation analyst Ariel Cohen called TAP an achievement, especially for Azerbaijan.  "This is the first gas pipeline from the former Soviet Union that is not controlled by Russia," he said.  "This is a precedent and a model for Europe to get gas by pipelines from the Caspian region or from other regions without the Russian control."

A country that will benefit substantially from the new pipeline is economically beleaguered Greece.  Prime Minister Antonis Samaras said the decision to use his nation as a transit zone was a vote of confidence in his country.  Samaras issued a statement that TAP would invest 1.5 billion euros (approximately $2 billion dollars) in Greece to construct the pipeline, would generate 2,000 direct jobs, and an additional 10,000 jobs in companies that would be supporting the project.  "After the TAP announcement, the 'disaster scenarios' for Greece and its exit from the euro definitely stop," he said.