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Recent Dynamics

The Caspian Gas Contest

The outcome of SOCARs tender for choosing the pipeline project that will transport Azerbaijani gas to Europe from the Shah Deniz fields second stage of development may well determine the fate of some of Europes most discussed gas infrastructure projects. Indeed, the competition for Caspian gas resources has become fierce. Of the four submitted bids, which one is more likely to secure the gas supplies: the shortest project (TAP), the strategic albeit expensive one (Nabucco), the earliest to become operational (ITGI) or the newest low-cost proposal (SEEP)? Three frontrunners, one surprising latecomer, politics and suspense surrounding the final decision that will announce the winner by the years end - all these are discussed together with pros and cons for each project, against the background of recent regional and EU policy developments.
by Radu Dudu and Gina Guilov, Romania Energy Center (ROEC) As expected, by October 1, 2011, the familiar contenders for Azerbaijans natural gas to be produced once the Shah Deniz fields full development will have been reached (Shah Deniz II) made their bids: the Nabucco, ITGI (TurkeyGreece-Italy Interconnector) and TAP (Trans-Adriatic Pipeline) consortia are each counting on the initial 10 billion cubic meters per year (bcma) that will be up for sale as of 2017. Each one of them aims at transporting Azerbaijani gas to the European markets. Also, all of them belong to the so-called Southern Gas Corridor, devised by the European Commission (EC) in 2008, in its Second Strategic Review. As noted in the Oil & Gas Journal (Jan. 3, 2011), the strategic objective of the Southern Corridor is to achieve a supply route to the EU of 10-20% of EU gas demand by 2020, equivalent roughly to 45-90 bcma of gas. There has been speculation
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lately about the prospects of each competitor. While Nabucco is a grand-scale, strategic project favored by the Black Sea states and the EC, its size (31 bcma) also makes it the most costly and difficult to fill up with Shah Denizs limited gas volumes Shah Deniz II will bring on-stream an additional 16 bcma on top of the 9 bcma of the current phase, Shah Deniz I. On the other hand, the two interconnectors, ITGI and TAP, have planned capacities of 10 bcma each (expandable to 20 bcma), are more cost effective as they rely on the existent Turkish gas grid, and shorter in their planned routes to southern Italy. Moreover, one of TAPs main stakeholders is Norways Statoil (42.5%), which is also one of Shah Denizs main stakeholders (25.5%). Against this background, as late as this summer, Nabuccos odds did not look too well, in spite of having succeeded a few political and financial

steps ahead. Among them, the September 2010 financing agreement with the European Investment Bank (EIB), the European Bank of Reconstruction and Development (EBRD) and the International Finance Corporation (IFC) for a package of about EUR 4 billion, at that time estimated to be half the total construction costs; and the supportive visit to Baku and Ashgabat in January 2011 by the EC President, Jos Manuel Duro Barroso, together with the Energy Commissioner, Gnther ttinger. On the downside, the bandwagoning behavior caused by Gazproms and ENIs South Stream project, which turned virtually all of the Nabucco governments into apparent partners of this Gazpromled venture, have shadowed Nabuccos prospects. As such, some alternative solutions were put up over the last couple of years, such as AGRI (A z e r ba i ja n - G e o rg ia -R o ma n i a www.petroleumreview.ro

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Infrastructure projects competing for gas from Shah Deniz II Project name Projected capacity Nabucco 31 Bcm/year ITGI 10 Bcm/year 800 new km (representing GreeceItaly section: 600 km onshore 200 km offshore) + 170 new km (spur to Bulgaria) Turkey-Greece-Italy TAP 10 Bcm/year SEEP 10 Bcm/year

Length

3,900 km

520 km

1,300 new km + Infrastructure in place (South Caucasus Pipeline/ Baku-TbilisiErzurum) from Turkey-BulgariaRomania-Hungary-to Eastern Austria

Route

Turkey-Bulgaria-RomaniaHungary-Austria OMV (Austria) Bulgarian Energy Holding (Bulgaria) RWE (Germany) MOL (Hungary) Transgaz (Romania) Botas (Turkey) (with 16.67% each) OMV Initial: EUR 7.9 Bn Revised: EUR 14 Bn 2017

Greece-AlbaniaItaly Statoil (Norway): 42.5% EGL (Switzerland): 42.5% E.ON (Germany): 15% Statoil EUR 1.5 Bn 2017-2018

Shareholders

Edison (Italy) Depa (Greece) Botas (Turkey) Bulgarian Energy Holding (Bulgaria)

BP

Project operator Cost estimate To become operational

Edison EUR 1.5-2 Bn 2015

BP n/a n/a

Interconnector). AGRI is conceived to liquefy a few bcma of Azerbaijani gas (between 2 and 8, pending on a specific configuration) at Kulevi, on the Georgian Black Sea coast, and have them shipped on LNG tankers to Constanta. But in order to become viable, AGRI has to add to Nabuccos plight: first, by competing for the same limited gas volumes of Shah Deniz II, it lines up with ITGI and TAP to grapple for the 10 bcma without which Nabucco cannot take off the ground. And second, just by abiding by the dictum of not having all eggs in one basket, Bucharest and Budapest too, as a formal partner to AGRI inflicts further fissures to Nabuccos show of unity.

Nonetheless, a few events this fall have rendered the dynamics of the pipelines game in the Caspian and Black Sea Basins more complex and volatile. They are reflections of political and economic factors that we discuss in turn. (1) The EC finally seems to have started a bona fide energy diplomacy campaign, emphasized through a couple of distinctive steps. First, on September 6, 2011 the EC released a remarkable Communication called On security of energy supply and international cooperation The EU energy policy: engaging with partners beyond our borders (COM 2011, 537 final). For the first time, the EC presented an integrated and coherent

concept of a collective diplomacy EU-wide, meant to offer a single voice in dealing with Europes main energy providers. To appreciate the importance of this step, recollect the pervasive lament about the apparent disunity in the responses of various member states to the RussoUkrainian gas crises of 2006 and 2009. Talk about the deals with Gazprom that West European major energy companies made with solid support from their governments, thus undermining the European solidarity in energy matters, has been a tenor of policy analysis and political rhetoric, especially in Central and Eastern Europe (CEE). Then, as a practical follow-up, on
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September 12 the EC mandated the facilitation of negotiations between Azerbaijan and Turkmenistan to speed up the construction of a transCaspian gas pipeline, crucial to the viability of the Southern Gas Corridor.

speed up their approval procedures and secure the necessary funding. For the last purpose, the Connecting Europe plan will be backed by the Project Bond Initiative, designed to act as a catalyst to re-open the debt capital

get a morale boost in addition to the financial one. This, in turn, may influence the ongoing decisionmaking process in Baku regarding the sale of the Shah Deniz II production. (2) Recent discoveries of massive

In response, the Russian Minister of Foreign Affairs, claiming a Russian veto on any such project based on the still unsettled juridical status of the Caspian Sea, which Russia and Iran see as a condominium expressed its regret about ECs decision, saying it ignored the international, legal and geopolitical situation of the Caspian Sea. Second, on October 19 the EC announced through the voice of its President a major infrastructure investment plan called Connecting Europe, which envisages the allocation of EUR 50 billion from EUs 2014-2020 budget for transport, energy, and communications infrastructure. Out of that amount, EUR 9.1 billion is to be invested in energy transport infrastructure and climate protection measures. The strategic proposal is to define and approve projects of common interest,
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market (currently largely unexploited for infrastructure investments following the financial crisis) as a significant source of financing in the infrastructure sector (EC press release, Oct. 19, 2011). EU budget funds, combined with European Investment Bank financing, are expected to reduce the risk for third party investors (and thus mobilize additional long-term private sector debt financing). The EUR 9.1 billion amount, although only a small part of the estimated EUR 210 billion needed for Europes energy infrastructure until 2020, is nonetheless several orders of magnitude higher than the amounts previously made available through the Trans-European Networks-Energy (TEN-E) program. Notably, the Southern Gas Corridor is one of the Energy Infrastructure Priorities identified in that strategic plan. Thereby, Nabucco is likely to

gas resources both in Azerbaijan and Turkmenistan may well end speculation about the availability of sufficient Caspian supply for the Southern Gas Corridor. Frances energy major Total announced in September 2011 that Azerbaijans Absheron offshore field holds reserves of around 350 billion cubic meters of gas and 45 million metric tons of gas condensate (Wall Street Journal, Sept. 12, 2011). According to SOCAR representatives, production from Absheron could start as early as 20162018, if a dedicated onshore platform is built. But the really huge news came from over the Caspian, when the British auditors Gaffney, Cline and Associates reported on October 13, 2011 that Turkmenistans South Yolotan and Osman gas fields could together contain anything between 16.4 and 21.2 trillion cubic meters of www.petroleumreview.ro

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gas (Tcm), with a most likely estimate of 16.4 Tcm. This is actually an upwards revision of an earlier, 2008 estimate of 4 to 14 Tcm, which was back then criticized and ridiculed. Todays new data turn south-eastern Turkmenistan into the worlds second largest gas reservoir, after Iran and Qatars South/North Pars field. These figures come as a confirmation of the U.S. Geological Surveys assessment at the end of 2010, according to which the Caspian Area contained mean volumes of technically recoverable, conventional, undiscovered petroleum resources [of] 19.6 billion bbl of crude oil, 243 trillion cubic feet of natural gas, and 9.3 billion bbl of natural gas liquids. (Oil & Gas Journal, Jan. 3, 2011). Naturally, a good deal of the EU authorities recent activism about the Southern Corridor has to do with these data. It is also obvious that a trans-Caspian gas pipeline, linking Turkmenistan (which, by the way, has become increasingly vocal about its desire to accede to the European markets) to Azerbaijans Sangachal terminal. (3) Making the Caspian gas contest all the more confusing, BP has made its own bid for Shah Denizs gas a field which BP also operates and in which it has a 25.5% stake named the South East Europe Pipeline (SEEP). From the little that is known about it, SEEP would use an upgraded Baku-TbilisiErzurum pipeline (from the current 8.8 bcma to the full projected 20 bcma, just enough to accommodate the 10 bcma initially on sale from Shah Deniz II) and then build a line from eastern Anatolia to Baumgarten an der March, near Vienna, more or less following in Nabuccos track in a smaller version. SEEPs distribution scheme would also differ from Nabuccos model; most significantly, the countries along the way are supposed to have the option of buying gas themselves. This move certainly complicates the politics of the Southern Corridor, leaning the odds against Nabucco.

Like ITGI and TAP, SEEP is nonstrategic in nature, i.e. it has a narrowly commercial dimension. These projects cannot make a sizeable contribution to EUs energy security, for the market forces alone are unlikely to overcome the resistance against a trans-Caspian line, particularly in such a (geo) politically loaded region. But again, there may be more to it than meets the eye. Here is a telling quote from Mathew Hulbert (European Energy Review, Oct. 6, 2011): In tabling the SEE Pipeline, BP may have decided to have a bilateral discussion with Moscow. BP knows how important South Stream is to Moscows structural designs over European gas just as much as Moscow knows how crucial an upstream Arctic stake is for BP. So business can be done. This is, of course, only a supposition, albeit one that seems to make sense. The best we can do in terms of evidence is to look for other hints. Another one such hint was dropped in February this year, when BP released a cost assessment for Nabucco, almost doubling its estimate from EUR 7.9 billion (the consortiums own estimate) to EUR 14 billion, partly due to soaring commodity prices especially iron ore. But BP did not pay the same attention to the cost estimates for Nabuccos competitors; those would also be affected by rising commodity prices. True, because they would be shorter, ITGI and TAP would be less affected by the increasing steel price; and also true, since they are both planned to start operating at fuller capacities than Nabuccos mere one third of the full volume, the increase would be less painfully felt. Yet, the cost of upgrading the existing Turkish gas grid, on which the two interconnectors count, is likely to be higher than admitted. Also, while Nabucco already rests on a firm international treaty among the transit states, the juridical regime of the interconnectors use of the Turkish pipelines remains to be sorted out. As to South Stream, there is barely a problem compounding the

three Southern Corridor projects (Nabucco, ITGI and TAP) that would not also affect itself. To begin with, the own cost estimate by the South Stream consortium was EUR 25 billion, already making it one of the most expensive energy projects in the world, even without factoring in the increasing commodities prices. Then, given its gigantic scale (63 bcma) the problem of gas supplies is at least as bad as Nabuccos. Indeed, Gazprom already has a hard time keeping up with its current delivery commitments (World Bank, Outlook for Energy in Eastern Europe and the Former Soviet Union, 2010) and Nord Streams recent opening unequivocally orders priorities while its access to the Caspian Basin gas resources is limited; it currently gets only 10 bcma from Turkmenistan and 8 bcma from Kazakhstan (states that increasingly shift energy exports toward China), and 2 bcma from Azerbaijan. As for the current gas glut on the European markets that is supposed to make Nabucco an unjustified investment at this juncture, it certainly concerns the South Stream project as well, since the latter has the same purported terminus point as Nabucco. On balance, to conclude, the recently added variables to the Caspian pipelines game are on aggregate likely to pull rather in favor of the Southern Corridors flagship project, Nabucco, than against it. It is, at this juncture, more probable than, say, six months ago that the Nabucco pipeline will be constructed, despite its repeated delays. That would definitely be an important achievement for Romanias energy security and for CEEs, more generally. But again, if anything, the politics of the game has got more complicated, and the outcome is still uncertain.

Romania Energy Center

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