Russia and Turkey Holding South Stream Hostage

Turkey and Russia are engaged in a game of chicken over the South Stream Pipeline. Both sides are threatening the construction of the Russian-inspired natural gas pipeline, in an effort to see who blinks first.

Turkey has signed a number of natural gas agreements over the years, and it is committed to purchase more gas than it can use. Unfortunately for the Republic, Turkey's contract with Russia is a "take or pay" contract which means it has to pay for the gas whether it is shipped or not. In addition, the long-term contract price for the gas is much higher than current spot prices. At the same time, Gazprom has been waiting for Turkey to issue the permit allowing construction of South Stream in Turkish waters of the Black Sea. "So far, we don't understand the reasons why we didn't receive the permit," said Deputy Prime Minister Igor Sechin, as reported in the Moscow Times.

According to the online newspaper Gazeta.ru, the reason is obvious: Ankara is looking to use the pipeline issue to lower the gas prices. The strategy may work, as the Moscow Times quotes President Demitri Medvedev that discounts were possible in exchange for unspecified Turkish concessions.

Russia also has hard-ball tactics at its disposal; namely, a proposal to replace South Stream with LNG shipments. According to the Sofia News Agency, Russian Prime Minister Vladimir Putin asked Russian Energy Minister Sergey Shmatko to examine building a liquified natural gas terminal in place of constructing a Black Sea pipeline. Under this scheme, Bulgaria would also have to build an LNG terminal to receive the gas shipments. According to ITAR-TASS, Shmatko said that according to preliminary assessments the most attractive option was the delivery of natural gas from the Yamal Peninsula, because much of the transportation costs would be within Russia.

Shmatko claimed that the European Commission has proposed the LNG terminal as one of many alternatives to the South Stream project. According to the Moscow Times, however, EC spokeswoman Marlene Holzner denied that the Europeans had anything to do with the idea. "This was not discussed during the meeting between the Russian government and the European Commission in Brussels at the end of February," she said.

It would appear that the threatened LNG plan is a ploy designed to pressure the Turks into granting the construction permits without reducing the price of gas deliveries. The key to this assessment is Shmatko's assertion the best option was gas from the Yamal Peninsula. Delivery costs from this area, which is snowed in for much of the year, would be excessive. AFP quotes RusEnergy expert Mikhail Krutikhin: "Has he seen the globe?...Producing on Yamal for the South Stream is nonsense...Once transported it would have the price of diamonds." Krutikhin concurred that it is a bluff: "an attempt to scare the Turks."

There is other evidence that the talk of an LNG option is bogus. According to Steve Levine in his Foreign Policy blog, South Stream pipeline director Marcel Kramer has received no new instructions, and is proceeding with his existing orders to make the $21 billion pipeline work. Further, in their March 17 summit meeting, Medvedev and Turkish Prime Minister Recep Tayyip Erdogan did not discuss the project. (Bloomberg reported that Russian Deputy Prime Minister Igor Sechin tried to dismiss the lack of discussion by claiming it was unnecessary. "Why discuss something we can do on our own?...This was resolved a hundred years ago," he said.) Finally, Shmatko himself denied Russia having any plans to abandon the pipeline. According to the RIA/Novosti, Shmatko said, "We are not wording the issue in such a fundamental way...We'll have several ready alternative routes of supplying gas directly to European countries."

Whether South Stream is ever built is a question yet to be resolved, but it is clear the LNG proposal--for the moment--is a red herring.

Ukrainian Tightrope

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

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

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

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

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

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

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

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

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

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

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

AGRI Jeopardizes Nabucco

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

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

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

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

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

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

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

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

Thinking Shortage in a Time of Plenty

It is hard to remember that oil has only been used for energy production for about 150 years, and for half of that time the industry was plagued with fear that the oil would run out. Daniel Yergin, in his Pulitzer-prize winning book The Prize, documents how the Royal Navy recognized the advantages of oil-burning ships, but on the verge of World War I hesitated to convert from coal for fear of having no fuel for the new fleet. the shortages were soon replaced with an overabundance of energy, for a number of reasons:
1. New technologies allowed new oil fields to be discovered. From examining rocks and ponds for oil seepage, to the use of satellite imagery, the ability to discover oil continues to improve.
2. The invention of the cracking process allowed raw petroleum to be broken into various petroleum distillates, making each barrel of oil more exploitable.
3. Blind luck: many fields have been discovered by wildcatters in areas the "experts" claimed had little or no oil or natural gas.
4. New technologies have allowed old fields to be better exploited. The introduction of gas and water infusion techniques have resurrected many played out fields.
5. Energy experts recognized that natural gas was more than just a waste byproduct of the oil industry, but an energy source in itself.
6. The investment in oil and gas pipelines, international and national, allowed the efficient distribution of these products.
7. Improvements in LNG technologies is allowing the use of natural gas to spread from pipelines to a worldwide market.
Fears of shortages remain, however. As World War II approached, the Royal Navy recognized that there was plenty of oil world-wide, but that much would be in the hands of the Nazis. There could be a man-made shortage created not by nature, but by politics.
When the Soviet Union invaded Afghanistan in 1979, U.S. President Carter was alarmed that bombers from Afghanistan could reach the Straits of Hormuz. The Russians had the theoretical ability to close off the free world from its access to Persian Gulf oil. This was such a concern that the President issued the Carter doctrine, a statement that access to Persian Gulf oil was a VITAL interest of the United States.
In another publication, Yergin argues that the main protection of a country's energy supply is diversification (Yergin, "Energy Security and Markets" in Kalicki and Goldwyn, eds. Energy and Security, 2005).
In search of such diversification in the 1990s, oil companies from the United States signed the "Deal of the Century" with Azerbaijan, opening Caspian energy to the West for the first time since the 1920s. The Caspian energy fields, however, are landlocked. Getting the oil and gas from the Caspian to international markets was quite a feat in itself. Azerbaijan shipped "early oil" out via the old Soviet pipeline system and continues to use this system for some of its production. Most of the oil, however, is shipped via the Main Energy Pipeline that was built at the dawn of the 21st Century.
This Caspian energy was important because it became another, diversified source for energy. Where, then, could the Main Energy Pipeline run? The easiest routing would have been to send all the oil through the Soviet pipeline system, but that would have placed control over this source in the hands of America's Cold War former nemesis. In addition, the oil would have to be transported by boat through the Black Sea and the Turkish Straits in order to reach world markets. It would have meant a massive increase in tanker traffic through the heart of Istanbul, a metropolitan area of 10-20 million people (depending on who'se counting).
The shortest route to the open sea would be through the Islamic Republic of Iran. This would put control of the energy in the hands of the mullahs who have elevated anti-Americanism into an art form.
To make sure that Caspian energy could be delivered to the world market independently of the influences of Russia or Iran, the decision was to route the Main Energy Pipeline from Baku, through Georgia, and into Turkey, ending at the port of Ceyhan. The Main Energy Pipeline is better known as the BTC, or Baku to Ceyhan pipeline.

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