Russia Looking for an Exit?

Published by the Atlantic Council on September 24, 2015. To access the original article, click here.

As Russia increases its support for beleaguered Syrian President Bashar al-Assad, rebels in eastern Ukraine have observed a ceasefire since September 1. The second Minsk ceasefire agreement, signed in February, had been repeatedly violated. But things have changed. Some separatist leaders have left the area, returning to posh jobs in Moscow. Former Donetsk Prime Minister Alexander Borodai has resumed his consulting career in the Russian capital, and former Luhansk Prime Minister Marat Bashirov chairs the government relations committee at the Russian Managers Association.

Russian reporting on Ukraine has also decreased. Two of its star war reporters have been sent to Syria. On September 6, Dmitry Kiselyov's two-and-half hour program—Rossiya 1's flagship weekly news program—was different: known for his fiery rhetoric against the government in Kyiv, the host "was uncharacteristically cursory" in his comments about Ukraine, the BBC observed. Kiselyov didn't discuss Ukraine until more than half way through his show, and this was in a week with deadly clashes outside Ukraine's parliament. Another Russian journalist observed, "Kiselyov knows something about a change in the rules of the game...The rest of us will find out a little later." RT reported that an impetus for better relations is coming from the West.

Talking heads began to speculate that Russian President Vladimir Putin may be looking to ease the Ukraine crisis and restore relations with the West. Carnegie Endowment's Dmitri Trenin writes, "Moscow certainly hopes that cooperation with the United States and the West on Syria would blunt their confrontation over Ukraine." He goes on to say that it's "probably not a mere coincidence" that hostilities in the Donbas have died down when they did. Another possible reason for the timing is Putin's upcoming speech at the United Nations General Assembly on September 28. Reduced hostilities in Ukraine could lead to a blunting of the criticism he can expect from the world community. The strategy is paying off: President Obama has agreed to meet with Putin during his visit.

There are a number of factors for Russia's changing strategy in Ukraine. Despite Putin's bluster about restoring Russian greatness, it is in considerable economic difficulty. The state budget is highly dependent on the sale of oil and gas. Andrey Movchan reports that 60 percent of consolidated budget revenues come from taxes either directly or indirectly related to the oil and gas sector. The Russian government needs oil at $100 a barrel to balance its budget; with oil selling between $40 and $50 per barrel, it is running deep deficits. The Russian economy is projected to decline by three percent in 2015.

The future doesn't look any brighter for Russia's energy sector either. While Rosneft planned to double its oil shipments to China, and Gazprom announced a doubling of the Nord Stream natural gas pipeline, the reality is quite different. Oil shipments to China have fallen below contracted levels (1.48 mt increase for 2015 instead of the contracted 5 million mt increase). Sanctions are preventing western participation in the Sakhalin II project. China is not providing the $25 billion financing to build the Power of Siberia pipeline and has refused to sign a decade-long anticipated contract for the Altai pipeline. In the West, the much ballyhooed Turkish Stream is also being held in abeyance. The Russian mega-energy deals of the last decade appear to be more propaganda than reality.

Economics is not the Russian President's only concern: the Russian people do not support deeper involvement in Ukraine. According to the Levada Center, 70 percent of Russians supported the takeover of Crimea as "Russian" land, and 80 percent say that retaking Crimea proves Russia's great power status. But when it comes to eastern Ukraine, the results are different. As of March 2015, 57 percent of Russians said the country should stay within its present borders, 64 percent said Russia should not try to keep former Soviet republics under control, and 55 percent said the country should focus on domestic issues. As the Russian economy continues to worsen, it's likely these isolationist sentiments will only increase.

Russia's continuing involvement in Ukraine is turning counterproductive for the Kremlin. Before 2014, Ukraine was leaning toward a more Western identity but nothing was solidified. That identity is no longer ambiguous, thanks to the Kremlin's overreach. Now there are US special forces on Ukrainian soil, training Ukrainian troops. The commander of US Army-Europe Lt. Gen. Ben Hodges said that those numbers may be expanded. In 2014, Ukraine signed an Association Agreement with the European Union, eliminating the possibility of it joining the Kremlin-led Eurasia Economic Union. Long divided NATO allies remain united over Russian sanctions, and for the first time in its post-Soviet history, a majority of Ukrainians want their country to join NATO.

Last week US Secretary of Defense Ashton Carter spoke with his Russian counterpart on ways deconflict Syria, but any cooperation between the two countries should not soften our Ukraine policy. The West may have only marginal influence on the worldwide energy market, but increasing pressure on pipeline routes, Russian public opinion, and negative geopolitical developments are taking their toll on the Kremlin's resolve.

James J. Coyle is a Research Fellow at the Atlantic Council and the Director of Global Education at Chapman University in Orange, CA.

James J. Coyle: Energy is the key to making Moscow pay

Published in the Orange County Register on May 17, 2014. To access the original article, click here.

Russian President Vladimir Putin is engaging in a shadow dance – maskirovka – to prove to the world he is not behind the May 11 separatist referendum in eastern Ukraine.

He has called on his allies in Donetsk and Luhansk to cancel the vote, and he endorsed the May 25 presidential election as a “step in the right direction.” He also claims Russian troops have withdrawn from the border. Pro-Moscow separatists ignored the president’s words and the Pentagon has seen no evidence of a withdrawal.

The referendum will, no doubt, show voters supporting independence. This result will be a lie. The majority of people in the East, as shown from the first vote for independence in 1991 to a Pew Research Poll taken in April, have consistently supported remaining in a unified Ukraine.

The U.S. has threatened additional sanctions if the referendum is held. Canada and Japan have already joined the United States and the European Union in leveraging sanctions against Russia for its actions in Ukraine. These measures, targeting individuals and companies instead of the Russian population as a whole, appear to be a tepid response to recent events.

However, the threat of additional sanctions is having an effect on the international financial community.

The rating company Standard and Poor’s has downgraded Russian sovereign debt from BBB to BBB-, one step above junk status. As a result, Western banks are refusing to refinance Russian debt. Moscow has had to cancel some bond auctions for lack of buyers. The Russian 10-year bond yield stands at 9.7 percent, higher than Eurobond yields from such troubled countries as Greece and Portugal.

Citigroup has reduced its exposure by 9 percent, JP Morgan has reduced its exposure by 13 percent, and Bank of America has reduced its exposure by 22 percent. Capital flight from Russia in the first quarter of 2014 was over $63 billion, approximately the same amount as left the country in all of 2013.

The actions of the financial community by itself may not be enough. In his keynote address to the Baltic American Freedom League’s annual dinner on Saturday, U.S. Congressman Ed Royce, R-Fullerton, noted the way to make Moscow pay for its behavior is through energy policy. Royce noted that 52 percent of the government of Russia’s annual budget comes from hydrocarbon revenues. “If you want to hurt Moscow,” he said, “drive down the price of energy.”

Royce proposed exporting liquefied natural gas, also known as LNG, from the United States to Europe.

This would reduce Europe’s dependency on Russia for its gas and oil, increase the depressed prices in the United States, and decrease the price for gas in Europe. In addition to the congressman’s suggestions, there are a number of other steps the world community could take.

The European Union can stand fast in opposing the construction of the Gazprom-owned and operated South Stream pipeline. This energy conduit is designed to send 63 billion cubic meters per year of natural gas to Europe. The pipeline will not increase the total amount of Russian gas delivered, however, as its sole purpose is to bypass the pipeline through Ukraine. This will allow Russia to squeeze Ukraine whenever Moscow desires, while keeping Europe “hooked” on Russian energy.

At the same time, the EU can support the Southern Energy Corridor, designed to bring non-Russian natural gas to Europe. Kazakhstan could increase its flow of oil to Europe through the underutilized Baku-Tblisi-Ceyhan pipeline.

Poland, Hungary and Slovakia can reverse the flow of natural gas in the pipelines transiting those countries, to provide Ukraine with non-Russian gas at prices at least $100 per thousand cubic meters less than what Russia is charging that country.

Middle Eastern energy production should be maximized. This requires a number of political advances. If peace were restored in the Libyan Civil War, harmony brought to the warring factions of Iraq, approvals granted to the Kurdish regional government to export its product, Iranian production brought back into the international mix and the gas deposits of the Eastern Mediterranean exploited, the quantity of oil and gas would increase markedly and Moscow’s revenues would decline precipitously.

James J. Coyle, Ph.D., is the Director of Global Education at Chapman University, and the Executive Director of the Caspian Research Institute, an online think tank.

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EU Reliance on Russian Gas Increasing

The European Union's dependency on Russian energy continues to increase.  Demand for natural gas has grown from 325 bcm (billion cubic meters) per year in 1990 to an estimated 550 bcm in 2015, according to the International Energy Agency.  Consumption is projected to increase to 669 bcm by 2035.    Some European countries, such as Belarus, Latvia, Lithuania and Slovakia depend on Russia for 100% of their natural gas, according to the US Senate's Committee on Foreign Relations.  Several others, such as Austria, Bulgaria, the Czech Republic, Estonia, Finland, Moldova and Turkey rely on Russia for over 60% of their gas needs.

European consumption of Russian gas had been expected to decrease in face of competition from coal, LNG, and shale fuels.  Alternative fuel sources, combined with the slowdown in European economies, was supposed to reduce the demand for Russian gas, which is priced at a premium to the market.

Faced with these forces, Gazprom has initiated a series of price cuts for its European customers.  In 2012 they reduced prices 7-10% on average, even returning money via "retroactive payments" to customers with long-term supply contracts.  These rebates totaled $3.22 billion.  In June 2013, Gazprom export chief Alexander Medvedev announced that prices would be further reduced, but "The price correction will be even less than in the previous round of talks."  Medvedev estimated the new reductions would total less than $800-$900 million.  Medvedev also said that the company would cut prices in new contracts in which the price of gas is tied to the price of oil.  As a result, the average gas price for Europe would decline to approximately $375 per 1,000 cubic meters, from the 2012 price of $402.  (Of course, not all European countries benefit from this action:  Ukraine is stuck with a long term contract with a price of $440 per tcm.)

As a result of these actions, in the first eight months of 2013 Gazprom shipments to Europe and Turkey increased 14%, to the highest level since 2010, according to Gazprom Export.  The reasons are price (the premium over the spot price dropped 66% over the previous 12 months) and the failure of LNG supplies to materialize.  "The European gas market is shifting again, to a certain extent, from a buyer's market to a seller's market because of a sharp decline in LNG supply," said Sberbank analyst Valery Nesterov.

The increase in demand is providing Gazprom a rationale to limit further price concessions.  Gazprom, and its owners (the Russian government) rely heavily on the European market for its revenues--and the Russian budget relies on the income.  50% of the Russian government's budget comes from energy export revenues; with the decline in price for Gazprom's product, the funds are coming more from Rosneft's sale of oil.  80% of energy export revenues today are due to oil, not natural gas. according to the Atlantic Council's senior fellow Dr. Frank Umbach.  This has led to a shakeup in the Kremlin's hierarchy, with Rosneft's Igor Sechin increasing in influence at the cost of Gazprom's Alexey Miller.

  

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.

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."

Ukraine's Days Numbered as Natural Gas Conduit

Ukraine continues to argue that repair of its aging pipeline structure is an economical alternative to construction of the more costly South Stream pipeline.  According to Uralsib's Chris Weafer, however, such an alternative is a non-starter from Russia's point of view.  Weafer argues that repairs would continue to deprive Russia of control over the delivery of Russian oil, would remove Russia's ability to extend its economic interests into countries to be serviced by South Stream, and it would provide Central Asian gas a viable alternative transit route to Europe--thereby depriving Gazprom of its Eurasian monopoly. 

Russia could overcome one of these objections if it owned or controlled the pipeline network.  An unidentified Ukrainian  Presidential aide reported that Gazprom had offered $4 billion for the system.  The Ukrainians refused to transfer ownership of the pipelines, however, and various proposals for joint operations remained unconfirmed.  In December, 2011, Kommersant-Ukraine quoted an unnamed official in the Ukrainian Energy and Coal ministry as saying Ukraine and Russia had agreed to form a group to handle the pipelines.  The only real disagreement was that Russia wanted the new unit to be formed bilaterally, while Ukraine was hoping for European participation.  According to Ukrainian Ambassador Viacheslav Kniazhnytsky, however, "I have no information about this kind of consortium.  Besides, Ukrainian legislation doesn't provide for a consortium within which Gazprom can run Ukraine's pipeline."

To force the ownership issue, Russia is trying to use transit pricing as a weapon.  In December 2011, Prime Ministers Putin of Russia and Azarov of Ukraine failed to agree on a Ukrainian-demanded reduction in the price of gas, because Ukraine would not give Gazprom a stake in the pipeline network.  Gazprom CEO said Kyiv was demanding a $9 billion annual reduction in price, while citing the cost of modernization of the network between $3-8 billion.  Kyiv estimated the value of the system as roughly $20 billion, but Miller speculated the value could drop significantly once South Stream had been constructed. 

In reply, Ukraine announced it would reduce the volume of gas it would purchase from Russia from 40 billion cubic meters (bcm) in 2011 to 27 bcm in 2012 unless the price came down.  An angry Miller replied that gas sales to Ukraine were on a "take or pay" basis, and the price would be the same (based on 33 bcm per year) regardless of the quantity Ukraine imported.  "We are working strictly in line with the contract, strictly in line with this volume, " Miller told reporters.  Gazprom spokesman Sergei Kupriyanov added, "The time for discussion on contract volumes in the new year has passed.  And, unfortunately, we must remind our Ukrainian friends again that the terms of gas delivery are determined only by contract, and cannot be changed unilaterally by this or that letter."  Kuriyanov believed that time was on the side of the Russians:  "South Stream to full capacity, Nord Stream with additional lines and our existing capacity through Belarus and the Black Sea will reduce Ukraine's importance for transit to zero," he wrote in an email.

Ukraine may have felt pressured to procure a lower gas price because of pressure on its balance of payments position.  Deputy prime minister Serhiy Tigipko said that if the Russians did not agree to a lower price, the country would be forced to raise household gas fees by 30 percent.  Renaissance Capital's Anastasia Golavach explained:  "It is becoming crucially important for Ukraine either to reduce the volumes of the gas it buys or renegotiate the price, otherwise there will be huge pressure on its balance of payments, which are especially strained in the current global environment."  Golavach predicted it was only a matter of time before Ukraine gave in to Russian demands and sold the pipelines.  "The government realizes it's high time to sell the network because Russia has already launched one alternative pipeline and is planning construction of another.  But they won't do it before the elections because the move would be too unpopular domestically."  In the end, the government did not raise the rates.

Ukraine decided to up the ante by exploring alternative sources for its energy needs.  In January 2012, Minister of Energy and Coal Industry Yuriy Boiko told journalists he had entered into negotiations with Turkey for gas shipments via a new route.   There were also reports of plans to purchase LNG from Azerbaijan.  Prime Minister Azarov discussed plans to buy the gas from Germany.  No one addressed how any of these purchases would take place, since there was no direct pipeline connection with any of these countries, and Ukraine lacked a gasification plant if it tried to buy LNG.

In the midst of the controversy, Russia reduced the flow of natural gas to Western Europe because of a spike in domestic demand caused by an abnormally cold winter.  The Kremlin blamed the shortage on the Ukraine, arguing that the transit country was stealing the gas destined for Europe.  Ukraine denied the charges.  (See my blog entries "Kyiv Pulling Away from Moscow" and "Russia-Ukraine Price Dispute" for additional details.)

As Moscow threatened to cease using Ukraine for any gas transport, the European Union weighed in on the side of Ukraine.  EC spokeswoman Marlene Holzner demanded Ukrainian officials develop a plan to maintain their crucial role."The unique geographical location of Ukraine and its gas storage capacities mean that Ukraine can offer increased flexibility of gas supply.  The European Commission is convinced that Ukraine needs to elaborate a long-term strategy to ensure its position as the leading gas transporting country."  To help, the European Bank for Reconstruction and Development agreed to a $308 million dollar loan for emergency repairs, but only if the state energy firm Naftogaz agreed to a restructuring.

The Ukrainian parliament agreed to the breakup to the company in March 2012, lifting a previous ban on any reorganization of the company.  The law required, however, that the successor gas companies to be fully state owned--which would prevent Kyiv from selling shares to Gazprom, according to Reuters.

Ukrainian President Viktor Yanukovych held out hope for a new gas deal with Russia, but IHS Global Insight analyst Andrew Neff said such a deal "would probably be part of an agreement that would give Gazprom a stake in or control over Ukraine's gas transmission system."  Russia cranked up the pressure, with Gazprom confirming they were redirecting gas to the newly-opened Nord Stream and through Belarus. Gazprom spokesman Kupriyanov e-mailed, "We are at the start of a big move to redistribute gas transit volumes from Ukraine to our Beltransgas unit and new undersea pipelines."  Naftogaz's deputy CEO Vadym Chuprun admitted at the end of March that gas-transit flows to Europe had been halved. 

In April, the Ukrainian National Commission of Energy Regulation announced the gas distribution and storage system would be open to any gas producer, Ukrainian or foreign.  In theory, this removed the monopoly held by Gazprom; in practice, however, without alternative sources of gas, nothing changed. 

Gazprom then agreed to make an advance payment of $2 billion to Naftogaz so the company could purchase sufficient gas to fill its storage facilties.  "If Ukraine needs more money to fill up underground storage facilities in order to live through the next winter without any issues, we will consider providing these additional funds,"  said Gazprom's Miller.  Such actions would indicate that, while the Russians continue to pressure Ukraine by reducing gas flows, they are not abandoning the transit route entirely.  It is unclear that this money was ever received, however; as President Putin in December 2012 said Russian would have filled the system with fueld if Ukraine had agreed to its offer to lease the pipeline network--implying that it had not occured.

In a July meeting with Russin President Putin, Ukrainian President Yanukovich held out a possible compromise:  instead of giving Gazprom ownership rights in the transit network, Ukraine would consider a different Russian request--Ukraine might join a Customs Union with Moscow.  "We are not saying 'No', we are thoroughly and seriously studying these integration processes," he said. 

Such words were not backed up by action, however.  Instead of pulling closer economically to Russia, in August Ukraine passed over the Russian oil company Lukoil in favor of ExxonMobil and Shell for an $8.1 billion project to develop the Skifska hydrocarbon field in the Black Sea.  Prime Minister Azarov expressed confidence that Ukraine could become energy independent.  He predicted domestic gas production would increase 25% over the next three years, and opined that hydrolic fracturing technology could cover all of Ukraine's needs.  (There is an estimated 5.5 trillion cubic meters (tcm) of shale gas in Ukraine, of which 1.18 would be recoverable using current technology).

Boyko announced the country had begun importing gas from Germany, at a price 20 percent cheaper than Gazprom.  He also said there were plans to build an LNG terminal on the Black Sea, to be completed by 2015.  Buying gas from Germany is a reversal of gas flows, which traditionally have been East to West.

Azarov again brought up the possibility of a trilateral consortium (Ukraine, Russia, Europe) as a way to modernize the pipelines, He proposed transferring control of the network to the group, which would then involve all members in the projected 4.5 billion Euro modernization project. The EC's Holzner's response was coy, stating no specific proposals had been presented.  She then offered qualified support to the idea:  "The EU has consistently emphasised that it is up to Ukraine to decide how to manage its gas transmission system and should Ukraine and other parties be willing to move in the direction of a consortium, including the EU gas industry, the European Commission is ready to play a facilitiating role, provided that the application of EU and international law, including as enshrined in the Energy Community Treaty, is guaranteed."

Putin claimed that Russia supported the consortium, and that Ukraine had ultimately rejected t.  "It was a strategic error on the part of Ukraine to turn down an offer by Russia and its European partners to lease its gas pipeline network without breaching the Ukrainian legislation and providing for it to remain Ukrainian property," he said.

In the end, the two countries appear to be in a lose-lose situation.  Ukraine wants to remain the main transit route for Russian gas, but only if Russia will sell gas to that country at rates significantly below those stipulated in the 2009 project.  Russia refused, and Ukraine unilaterally announced a reduction in the amount of Russian gas it would take.  In retribution, Russia reduced the amount of gas it was selling--to the levels Ukraine had previously unilaterally set.  Russia, on the other hand, wants to buy or lease the Ukrainian network, a demand Ukraine has refused.  In the meantime, the valuable transit route continues to age, without sufficient money to effect necessary repairs.

European Commission Challenges Gazprom

With the industry's eyes turned toward the BP-Rosneft deal, little attention is being paid to the  Russian state-controlled natural gas company, Gazprom.  This institution has held a monopoly on the control of gas to Eastern Europe, and a controlling interest in the gas to the rest of the continent.  Now, however, Gazprom's position is being challenged by the European Commission.

On September 4, 2012 the EU's antitrust authories opened a formal investigation into whether the company had blocked fair competition in the natural gas markets of Central and Eastern Europe.  The European Commission said Gazprom may have divided markets by hindering the free flow of gas across European Union member states, and imposed unfair prices on its customers.  "Such behavior, if established, may constitute a restriction of competition and lead to higher prices and deterioration of security of supply," they said.  If found guilty on such charges, the EC could fine Gazprom as much as ten percent of its worldwide income. 

The EC investigation is currently focusing on the Eastern European countries of Poland, the Czech Republic, Slovakia, Hungary, Bulgaria, Estonia, Latvia and Lithuania--although it could be expanded.  It follows last year's raids on the office of Gazprom's European partners, probably in search of evidence to support the charges.

Russian President Vladimir Putin responded quickly, issuing a decree that strategicially important companies--including Gazprom--could not provide information to regulators from "unions of foreign states" without prior approval of the Kremlin.  Further, no approval would be granted if the changes "damage the economic interests of the Russian Federation."  Gazprom spokesman Sergei Kupriyanov characterized the investigation as commercial pressure, and threatened to direct Russian gas away from Europe.  The investigation "can be viewed as pressure from the European Union on Gazprom, with the goal of influencing prices and the results of commercial contracts, which clearly contradict the principles of market," he said.  Kupriyanov added the investigation is encouraging Gazprom to look to Asia for new markets.

The EC's actions are generally popular in Eastern Europe among a population that has been paying high gas prices under "take or pay" contracts.  "It is important what Brussels is doing," said Szymon Kardas, a Russian energy expert at the Center for Eastern Studies in Warsaw.  "This is the Competition Commission that took on Microsoft for its dominant position in Europe."  Lithuanian deputy ambassador to the European Union, Arunas Vinciunas, said, "For a small country it means a lot.  It shows that we can defend our interests through solidarity inside the E.U."  Not everyone agrees that the investigation is a good idea, however.  The Suddeutsche Zeitung called it an unprecedented action and a direct attack on Russia's President Putin.

Anders Aslund, a senior fellow at the Peterson Institute for International Economics, predicted Gazprom will be found guilty on all charges.  "The proceedings can take years," he wrote in the Moscow Times, "but the outcome appears obvious.  The oil-linked prices are likely to be deemed anti-competitive, as the very long-term contracts with fixed prices and volumes.  The Gazprom take-or-pay clauses that force a customer to take the whole volume or pay for it in any case will be prohibited, and prohibitions against reselling are evidently anti-competitive.  Finally, Gazprom will in all likelihood be fined billions of euros for its long-lasting malpractices."

Separate from the investigation, Gazprom is also under pressure because of weak demand in Europe and Asia.  In September, Gazprom announced it was restricting access to their pipelines by independent producers.  "Today the gas market in Russia has an excess of resources over demand," said Gazprom's deputy head of marketing and liquids processing, Alexander Mikheyev.  "In this situation we are looking at cuts to gas intake from independent producers."

The Europeans had long demanded that independents have unrestricted access to the pipeline network, as a way to insure a diversified supply for the European market.  But Merrill Lynch oil analyst Karen Kosanian points out that Russian domestic demand for natural gas is down 3.6 percent so far this year.  "In this environment Gazprom would have to shut in its own production to sustain the independents," she said.

The falling revenues, EC investigations, and competition from shale gas and LNG, have led Gazprom to lose its favored position in the Kremlin constellation of stars.  Gazprom has been the principle source of Kremlin revenue for decades.  The Russian government owns over 50% of the $119 billion company, and Gazprom accounts for 12% of all Russian exports, according to the Washington Post.  Profits were $44 billion in 2011, but have declined more than 23% in 2012.  Russian deputy minister of Economic Development, Andrei Klepach, said the company could face serious problems because of shale gas competition.  Further, the company has not made sufficient investment to modernize their operations.   "It's the nationalization of costs and the privatization of profit," wrote Rusenergy analyst Mikhail Krutikhin.

BP May Open Britain to Russian Gas

Additional ramifications of the BP-Rosneft deal are now coming to light.  With the purchase of TNK-BP by Rosneft, BP's Russian partners have agreed to end their legal battles with British Petroleum.  Sources claim that the two sides agreed to settle all their disputes after BP  made a $325 million payment to the Russian consortium AAR.  Supposedly, this move has been taken to give BP the freedom to pursue the development of Arctic oil.  "BP is not taking an equity position in Rosneft as a portfolio investor," said chief strategist at Sberbank CIB Chris Weafer.  "they are looking at a future relationship through which they can grow production and reserves in Russia."

It appears, however, that this deal has also cleared the boards for BP to work with Gazprom to bring Russian natural gas to Great Britain.  AAR had previously taken the position that their partnership with BP mandated all BP business opportunities in Russia be run through TNK-BP.  With all claims settled, sources report that the consortium has relinquished all claims on BP's future Russian activities.  That could include moving into the natural gas market.  Gazprom's  Chief Executive Alexi Miller reported in June that BP was interested in participating in an expanded Nord Stream pipeline, one that would carry product to Britain.

Such a move is a  questionable investment decision by the British company, given the plummeting price natural gas is commanding, and the large quantities of liquified natural gas (LNG) coming on the market to compete with pipeline gas.

Transcaspian Back on the Board

Recent armed spats between Azerbaijan and Turkmenistan in the Caspian Sea placed the future of the Trans Caspian Pipeline in doubt, but European Union-backed talks in Ashkabat appear to have put things back on track.  According to EU spokeswoman Marlene Holzner, the Turkmenistan Energy Minister Myrat Artykow and Azerbaijan Minister for Industry and Energy agreed with EU Energy Commissioner Gunther Oettinger that the project could be an important part of efforts to reduce Europe's dependence on Russian gas supplies. 
Holzner said both Azerbaijan and Turkmenistan had expressed a desire to supply Turkmen gas to Europe, but neither country was willing to make any firm commitments.  "Turkmenistan said it continues to be interested in delivering gas to Europe.  Azerbaijan also confirmed its interest in being an 'enabler', meaning it would also be a transit country for gas."

Despite the expressions of good intentions, who moves first to make the pipeline a reality remains in doubt.  Holzner said that the EU was waiting for a gurantee from Turkmenistan on supply (despite the fact that Turkmenistan President Gurbangulu Berdimuhammedov is on record as promising 40 bcm per year for the project).  At the same time, she said that the EU would neither own the pipeline nor pay for it.  For his part, Berdimuhammedov has previously said that while he would sell the gas to Europe, it would be up to the Europeans to figure how to get it from Turkmenistan.  So, all good wishes aside, no progress appears to have been made other than to get the parties talking again.

Turkmenistan appears to have turned its attention east, with most of its gas sales going by pipeline to China.  For Azerbaijan's part, the pipeline could be seen as either competition for its own future gas production, or for Gazprom's South Stream.  In either case, the benefits of a Trans Caspian Pipeline do not appear to be overwhelming.  The one country that would benefit is Turkey, who would like to see Turkmen gas made available to expand the proposed TANAP pipeline.

"With the TANAP project we have created a structure that will allow gas to transit across Azerbaijan and facilitate trade.  This structure is also targeting Turkmen gas.  We are seeking Turkmen gas," said Turkish Energy Minister Taner Yilmaz.

According to Gulmira Rzayeva of the Center for Strategic Studies of Azerbaijan, an expanded TANAP could increase Turkey's chances of joining the European Union.  "Turkey can achieve political gains with this pipeline; it can be an ace in terms of its European Union membership negotiations.  With the finalization of this project, Turkey will have a whole new position within the region."  Whether Turkey wants to join Europe is, of course, an open question.  Turkey's annual growth continues at around 7%, while Europe continues to stagnate and -- possibly--sink back into recession.

Gazprom May Punish Hungary for Supporting Nabucco

Faced with Hungary's approval of an environmental permit for the construction of the Nabucco pipeline, Gazprom may be considering moving west the route for the rival South Stream pipeline. 

Reinhard Mitschek, managing director of Nabucco, announced on August 14 that Hungary was the first country to issue the project all its permits.  "The granting of this permit is a substantial step forward in Hungary and signifies the advanced stage of development of Nabucco West," he said. 

Within a week, Gazprom announced they were in talks with Croatia over the South Stream pipeline route.  "An intergovernmental agreement between Russia and Croatia on joint participation in the South Stream project was signed in 2010," a spokesman commented.  "Currently, based on the results of a pre-investment stage, Gazprom and Plinacro Ltd. are discussing the terms of a shareholder agreement for a joint compnay project with a view to its subsequent establishment."

The Croatian side is optimistic.  "At the moment the chances are 50:50 that we get the transit route of South Stream," said a source involved in the Gazprom negotiations.  The reasons for changing the route are uncertain.    According to the Voice of Russia, a Croatian list serve, Jutarnji, listed a number of possible concerns:  lower costs, differences between Gazprom and the Hungarian leadership, uncertainty over ownership shares of various Hungarian companies, and slow work on the Hungarian economic feasibility stateement.  Gazprom's board chairman Alexei Miller minimized these reasons, however, calling them "not significant."  An unnamed Plinacro source added that there could be no official confirmation on the status of the talks, as both sides are bound by a mutual confidentiality pledge.

Timing would indicate the talks are retribution for Hungary's cooperation with South Stream's rival, Nabucco.  Whether the talks will result in the route change, or are merely a pressure tactic on Hungary by Gazprom officials, is yet to be seen.

Higher Priced Gas Not Detering South Stream

Faced with competition from TANAP, Nabucco-West, LNG and alternative fuels, Gazprom is coming to grips with lower anticipated revenues from their proposed South Stream pipeline.  Sergei Komlev, head of price formation for Gazprom Export, believes Europe will buy the gas anyway.  In June, he told the World National Oil Companies Congress in London, "Our estimate is that the difference (between hub-priced gas and South Stream supplies) is $2 per million British thermal units," according to Reuters.  Komlev said the price would be attractive because Gazprom would provide South Stream gas via long-term contracts, which would provide more security of supply than spot-priced hub gas.

Revenues will suffer, however, because of price breaks to various countries.  As an example, to keep Bulgaria in the South Stream consortium, Gazprom has agreed to an 11% price discount for the upcoming year, a loss of USD 115 million.  Bulgarian Economy and Energy Minister Delyan Dobrev gave the results of these negotiations to reporters in June.  "Currently, there is no danger of Bulgaria not participating in South Stream," he said.  "We support the South Stream project.  We believe it is profitable for Bulgaria, but we have to specify all the details."

While Dobrev is pleased with the negotiations, there is a question as to whether Bulgaria can finance its share of the pipeline.  According to an unconfirmed source, Gazprom might pay for the Bulgarian section of the pipeline and then repay itself by deducting the gas transit fees the company would otherwise owe the country.  Regardless of the financing, South Stream has begun the Environmental Impact Statement for the 250 kilometer section that will run off the Bulgarian Coast, according to the Sofia News Agency.

South Stream has also recruited a new member of the consortium, Macedonia.  According to Macedonian Vice Premier and Minister of Finance Zoran Stavreski, membership will secure gas supplies for future generations of Macedonians, although the country was not originally considered for membership.  "This was in fact done (through a myriad of contacts and high-ranging talks) from a position where there were no plans to be included in the project," he said.  "There is no more dilemma--Macedonia is joining the international gas pipeline corridor 'South Stream' as it has been agreed between PM Nikola Gruevski and President Vladimir Putin.  We've received the text of the draft-agreement."

Russian President Putin continues to remain optimistic toward the project, and in June said the pipeline could begin natural-gas flows as early as 2014.  This would inaugerate the pipeline years before the Nabucco-West rival, which is scheduled for completion in 2017-2018.

European Responses to Gazprom Delivery Cuts

In February 2012 Gazprom reduced its deliveries of natural gas to Southern Europe to meet domestic demand in Russia.  This was the third time in six years that Gazprom cut deliveries to Europe:  2006, 2009 and 2012.  Unlike the first two interruptions which appear to have been politically motivated (aimed at influencing Ukrainian politics), this cutoff was precipitated by high demand--and Gazprom's inability to meet that demand.

Following the first two cutoffs, Europe united in demanding the creation of an alternative natural gas source.  Just as the gas outage was different than the first two, reactions have also differed.  In fact, European countries have diverged wildly as to their reactions.

The first to react was Russia itself.  On February 1, Gazprom acknowledged there had been increased demand, caused by the coldest weather to hit Europe in decades.  They pointed out that even though not everyone was getting all the gas they wanted, that Gazprom was honoring all its contractual obligations--a point acknowledged by the Europeans themselves.  Citigroup analysts in Moscow Ronald Smith and Alexander Bespalov released a note that read, "Gazprom will almost certainly meet its minimum contract requirements."  Gazprom Deputy Chairman Andrei Kruglov informed then-Prime Minister Putin that Gazprom could not increase gas deliveries to Europe.  Putin gave orders for Gazprom to do whatever was needed--but not at the expense of Russia's inhabitants.  "I am asking you to make a real effort to supply the demands of our foreign partners given that the top priority of our energy companies, including Gazprom, is to supply Russian customers," he said.

Gazprom's admission that they had cut back on deliveries was given hesitantly, however.  At first, they blamed Ukraine for the shortage--stating that Ukraine was stealing excess gas from the pipeline that passes through that country (See my blog entry "South Stream Advancing", June 12, 2012.)  When it became apparent that domestic demand was taking all the gas, Gazprom's other deputy chair, Alexander Medvedyev, admitted gas demand exceeded expectations by 50%.  Deputy Kruglov then stated the cuts had lasted several days, and had reached up to ten percent.  Officials in Austria and France reported shortages of 30%, and Italy reported shortages of 24%.  Ukraine itself claimed it was receiving 15% less gas.

IHS regional energy analyst Andrew Neff stated the obvious:  "The cold weather spike in demand raises questions about...Europe's apparent expectation that Gazprom can quickly ramp up export volumes as a "swing supplier,"  reported AFP.  East European Gas Analysis chief Mikhail Korchemkin explained why:  "Turkmenistan and storage gas could have contributed some 240 million cubic meters per day--enough to provide a stable gas flow to Europe," noted the same report.  But that gas was not available, because Gazprom has been building its network instead of storage facilities.  Deputy Chief Medvedyev conceded the problem and said, "We cannot promise that this will not happen again next winter or over the next five years..That is why we have given the green light to a program aimed at doubling the volume of our European storage facilities."

Jonas Gratz of the Center for Security Studies in Zurich, notes the paradox that while Russia can no longer play supplier of last resort, many European countries are rewarding Russia instead of seeking alternatives.  "The premise of stable supplies from Russia is crumbling fast," he wrote.  "Gazprom is not the "reliable supplier" that the Soviets may once have been (in the eyes of Western Europe).  Gazprom's market share in the EU turns out to be already too high for the sort of power play Moscow wants to pull off with the EU.  By exploiting irregularities and crises to display and test the EU's vulnerabilities, Russia strives to derail the EU's market liberalization agenda...Many EU member states and institutions have so far rather rewarded Russia's unreliable behavior...Instead of rewarding Russia, the EU and its gas industry have to focus on diversifying suppliers."

Europe's dependency of Russian energy will continue to grow in the future.  A doctoral student at Old Dominion University, Katerina Oskarsson, compiled an interesting report.  She wrote that the EU's gas imports are projected to accelerate due to a depletion of indigenous gas resources.  The European Commission estimates that the proportion of EU gas consumption met from imports is set to rise from 60% to 73-79% by 2020 and 81-89% by 2030.    These statistics, while alarming, need to be kept in perspective.  Russian gas only accounts for 6.5% of the EU's primary gas consumption.  The issue, however, is regional.  In Central and Eastern Europe, all states reply on Russia for at least 50% of their natural gas, and six countries get over 80% of their supply from Gazprom.

The Cold Snap has brought home the European need for non-Russian sources of natural gas.  As Nabucco is replaced by TANAP, however, the only non-Russian sourced pipeline is reduced to delivering less than 2% of Europe's energy needs.  Europe's dependence on Russia appears destined to continue, unless a combination of LNG, shale gas, and unconventional fuels can break it.

Nabucco Reduced to Rump Project

With the announcement of the proposed Trans Anatolian Natural Gas Pipeline (TANAP) in December 2011, Nabucco has recreated itself as a pipeline proposal that begins at Turkey's western border.  Instead of being the European Union's premier pipeline project in the Southern Energy Corridor, it is now a regional competitor to the Trans Adriatic Pipeline (TAP) and the Interconnector Turkey Greece Italy (ITGI).

The weakness of the original Nabucco proposal could never be overcome:  there was no source for the natural gas that the pipeline was supposed to carry.  In January Sergey Pravosudov, Director of the Russian Institute of National Resources, said, "Europe has long been discussing supply alternatives.  However, nothing is being done in their main project Nabucco.  Europeans themselves admit that the more time passes the fewer chances remain to breathe life into Nabucco."

Because of this inaction, Turkey decided it could not wait for the European actors to get their act together, and Azerbaijan did not want their market to be limited to Russia.  According to a report in Hurriyet Daily News, a Turkish Foreign Ministry official stated, "With the economic slowdown that will reflect in the use of natural gas, Europe put the breaks on."  A Turkish Energy Ministry official added, "Azerbaijan wanted to sell the gas that it will produce from Shah Deniz 2 gas fields.  It did not want to sell it to Russia and did not have the time to wait for the EU to decide."  Azerbaijani parliamentarian Valeh Alasgarov characterized Europe's approach as indifference.  "No one takes care of this project," he said.  The result was TANAP, an abridged Nabucco to carry 16 bcm of natural gas from the fields.  Turkey would consume 6 bcm themselves, and pass 10 bcm to its Western border for onward movement to Europe.

Mark Adomanis, a contributor to Forbes magazine, declared Nabucco a failure.  As a project to demonstrate European unity against Russian energy policy, the pipeline showed the European Union as "almost comically incompetent and incapable."  Adomanis noted that in 2012 Gazprom was arguably more deeply entrenched in Europe than it ever had been.  Jamestown Foundation's Vladmir Socor noted that while the Nabucco shareholders would never leave the consortium, there were chinks in the armor.  German shareholder RWE was making overtures to TANAP, and the Turkish government (owner of the shareholder Botas) was prioritizing TANAP which was "easier to implement" than Nabucco. Hungary's MOL went on record that as long as there was no definite source of natural gas supply, no final investment decision could be reached on the project.   Julian Lee, an analyst at the Center for Global Energy Studies, declared the project dead.  "I think that Nabucco in the way that it was originally envisaged as a pipeline running from Turkey's eastern border all the way to Europe...is probably over.  I don't think that is going to happen.

In April, Hungary's Prime Minister Viktor Orban met with Gazprom CEO Alexey Miller.  Less than a week later, he announced that MOL would leave Nabucco in favor of South Stream.  In an email, they held out hope that they could rejoin a Nabucco in a different format.  MOL cited "uncertain costs and gas sources and, with the current structure and project management, the implementation of the Nabucco project is not secured.  We believe in the South Corridor concept, that could eventually also include a re-considered Nabucco."  

Austrian shareholder OMV began to consider a Bulgaria to Austria version of Nabucco.  It would use the intergovernmental agreements and regulations that had been negotiated for the original Nabucco, and would cost considerably less since the distance would be shorter.  The consortium submitted the modified proposal for a 1,300 km pipeline to the Shah Deniz consortium.  Nabucco's Managing Director Reinhard Mitschek put the best face he could on it:  "We are convinced that we have submitted a competitive and comprehensive proposal...and that this proposal represents a win-win situation for our shareholders and for suppliers alike."  In changing its size, Nabucco West may have lost the support of the EU.  European Commission spokeswoman Marlene Holzner told the press it did not matter whether Nabucco or a rival won, as long as the EU got direct access to the Caspian gas, and that the initial 10 bcm capacity could be increased in the future.

Nabucco's construction costs for a 10 bcm pipeline are now approaching the per kilometer price of the 63 bcm South Stream pipeline, according to Investcafe's Grigory Birt.  Given the convergence in price, he predicted the new Nabucco had little chance for success.  "The lower the capacity of the project, the less profitable that project will be," he said.

While the final decision rests with the Shah Deniz consortium, the question remains if the European Commission will bring enough political pressure to bear to keep Nabucco-West in the game.  The original Nabucco was designed to carry only 5% of the projected natural gas needs of Europe, and Nabucco-West has less than one-third of the original capacity.  The new proposal does little to meet Europe's desire for a modicum of energy independence from Russia.

After over a year of wrangling over price, India and Pakistan have signed a gas purchase contract with Turkmenistan.  This is the first step in the creation of the TAPI (Turkmenistan Afghanistan Pakistan India) pipeline.  Interestingly, transit country Afghanistan did not sign a contract although they did initial a memorandum of understanding.

The Asia Development Bank (ADB) celebrated the development.  "After more than 20 years of diplomacy, the 1,800 kilometer (818 miles) natural gas pipeline that connects one of Central Asia's largest energy suppliers with South Asia's critically underserved market has moved a step forward," it said in a press release.  Klaus Gerhaeusser, Director of the ADB's Central and West Asia Department, was enthused.  "The pipeline represents a win-win scenario for each member country, as it will give Turkmenistan more diverse markets and help fuel the energy hungry economies to the South."

In theory, Gerhaeusser is correct.  The pipeline is designed to take 33 bcm per year for 30 years of natural gas from Turkmenistan to feed the energy hungry subcontinent.  The pipeline is also supposed to help Afghanistan develop economically, thereby helping the peace process.  Not only would Afghanistan purchase 5 bcm of gas from the consortium (India and Pakistan would get 14 bcm each) but they would also earn transit fees.  Turkmen President Gurbanguli Berdymukhamedov has said Afghanistan could earn more than $1 billion annually in transit fees, and Afghan President Hamid Karzai predicts pipeline maintenance could provide employment for 50,000 Afghans, according to the Associated Press.

The cost of the project is estimated to be between $10 billion and $12 billion to construct, and it has attracted US interest.  Daniel Stein, senior adviser to the US State Department's special envoy for Eurasian energy, said that two major US oil companies were interested in participating in the project.  The US government also supports the project, both because of the positive contributions to Afghanistan and because it would detract from a competing project to service South Asia with Iranian gas.

Despite American support, TAPI does not appear to have fallen prey to the US-Russian rivalry for Central Asian energy resources.  Russia is also interested in investing.  Gazprom has gone on record as saying they wanted to be involved in any way the project envisions.  In reply, leaders of the governments involved issued a statement that, "The parties welcome Russia's interest in participating in implementation of the Turkmenistan-Afghanistan-Pakistan-India gas pipeline project."

One would think that with American and Russian support, that TAPI would be a done deal.  Unfortunately, its transit of the worst parts of Afghanistan and Pakistan makes the project problematic.  Andrew Neff, the Moscow-based senior energy analysts, said the instability in Afghanistan meant the project was unlikely to attract financing from Western banks.  "The main hurdle is the security concerns in Afghanistan," he said.  Neff's colleague at IHS Global, Lilit Gevorgyan, concurs.  "With the Western troops' pullout by 2014 from the still volatile Afghanistan, building an expensive pipeline in country with very weak central government seems almost unattainable."

Trans Anatolian Gas Pipeline Strongest Game in Town

The Trans Anatolian Natural Gas Pipeline (TANAP) is the latest proposal to bring Shah Deniz II gas to Europe.  It currently holds the inside track, since the owners of the project are the state owned oil and gas companies of Turkey and Azerbaijan.  The pipeline will originate at the Caspian, and will take natural gas to Turkey's western border.  Ever since it was proposed in December 2011, it has frightened competing pipeline projects.

According to Olgu Kumus, an analyst at CERI Sciences Politiques in France, TANAP is the main competitor for Nabucco, and not the Gazprom-supported South Stream.  "The Trans-Anatolian pipeline aims to transfer the same gas source to Europe as Nabucco," he told SE Times.  "The most important partner in the Trans-Anatolian pipeline is SOCAR (the State Oil Company of Azerbaijan), which manages the Shah Deniz II gas field with BP.  In other words, the Trans Anatolian pipeline will not have a supply problem because the region's dominant supplier is a stakeholder."  Faced with such competition, Nabucco has now proposed a scaled-down version of its pipeline that starts at the western Turkish border, aptly named Nabucco West.

Not only is TANAP a threat to Nabucco, however, but as more Shah Deniz II gas comes on line the pipeline could expand its capacity.  This puts it in competition with South Stream.  SOCAR president Rovnag Abdullaev said that Azerbaijani gas production would reach 30 bcm by 2015, and 50 bcm by 2025.  He claimed that TANAP, originally planned to carry 16 bcm per year, would have the capacity to carry 60 bcm annually with a possibility of an increase.   Such expanded capacity would leave room for Turkmen gas if the Trans Caucasian Pipeline were to be built.

As plans proceed, SOCAR has invited other companies to join in the TANAP project.  "We would like other large international companies to be part of the project as well," said Abdullayev.   Ukraine's Ambassador to Turkey, Sergiy Korsunsky, told reporters that Ukraine would like to take a stake of up to 10% of TANAP and could pay for it with cash, or by supplying the project with pipes.  In addition, competing pipeline consortiums TAP (Trans Adriatic Pipeline) and ITGI (Interconnector Turkey Greece Italy) said that their projects were compatible with TANAP.  "TAP will be happy to work with the developers of TANAP for any required coordination between the two pipelines, thus providing a fully integrated solution for the delivery of Caspian gas to Europe," External Affairs Director Michael Hoffman told Reuters.  Similarly, the CEO of IGI Poseidon, ITGI's operator, said "The ITGI project starting at the Turkish-Greek border is fully compliant with any option to transit Azeri gas through Turkey, including TANAP."

South Stream Advancing

While Western companies still compete over which route will be the Southern energy corridor, Gazprom's South Stream continues to plan for its construction.

In December, the company made a slight modification to its originally-planned route.  Following the EU's blocking of Gazprom's purchase of 50% of the Central European Gas Hub in Austria, a Gazprom spokesman told Reuters the project was no longer considering that country as a transit route.  "Only a spur will run to them," he said, adding that the route would now end in Italy instead of Western Europe.  Whether this decision will hold is uncertain, however, since in April 2012 the head of ENI (Italian energy company and South Stream partner) announced that the northern leg of South Stream to Austria will be built before starting work on the southern leg to Italy.  This report was contradicted by Gazprom in May, when they published a story that they might abandon the offshore section of the pipeline to Austria entirely.  The report added that the line would end in the northeastern Italian city of Tarvisio.

Gazprom CEO Alexei Miller confirmed in February that final investment decisions on the pipeline would be made in November, with construction scheduled to begin in December.  "We have entered into the stage of actual construction of South Stream," he said in a statement.  "I can say without exaggeration that Gazprom is working on the project 24 hours a day."

There had been a discussion within Gazprom whether it should be built for its maximum capacity of 63 bcm per year, or if the project should be started with a smaller pipeline that could be expanded at a later time.  In Winter 2012, however, Italy shivered without natural gas during some of the coldest weather in recent years.  Many analysts believed Russia had cut back deliveries to foreign customers while servicing their domestic customers.  In their review of the situation, however, Gazprom blamed the shortages on Ukraine's siphoning fuel from the transit line.  Gazprom CEO Alexei Miller told Russian president Demitri Medvedev, "On certain days, as much as 40 million cubic meters of gas remained on Ukraine's territory...  Our Ukrainian partners took as much gas from the export pipeline as they felt necessary."  In reply, Medvedev told Miller to build the pipeline at full capacity.  This decision will eliminate the need to use the Ukrainian pipeline to export Russian gas to Europe.  (Ukraine denied any diversion had taken place).

Julian Lee, senior energy analyst at the Center for Global Energy Studies in London, theorized as to why South Stream's tempo has increased.  In an interview with New Europe, he said "We are seeing a general sort of shift at the moment in the region of countries that are favoring South Stream.  There is a realization that Nabucco is not going to happen, at least in its original form...I think supporting or at least voicing support for South Stream is no longer perhaps seen as undermining Nabucco because I think the idea of Nabucco has largely evaporated now."

The European Commission continues to oppose South Stream because it is only a diversification of supply routes, instead of a diversification of suppliers.  Others, such as Russian energy consultant Mikhail Krutihin, oppose the project because of the price.  Citing a potential cost of construction of $40 billion, he told Nezavisimaya Gazeta, "This is madness.  It would be cheaper to strike a deal with the Ukranians."