When I began my job as Eurasian Energy Envoy 18 months ago, I thought a lot had changed since I last worked on regional energy issues during the Clinton Administration–the respective roles of Russia and Europe; the relative importance of gas vs. oil; the emergence of an LNG spot market; expectations for the global economy, to name a few examples.
But over the last year and a half, the landscape has changed even more dramatically and at a much faster pace. Shale gas was rarely mentioned; energy cooperation between Russia and Ukraine looked improbable; and few would have guessed that suppliers like Russia would be willing to renegotiate take-or-pay terms of existing agreements. Yet all this has happened in the short amount of time I’ve held my position.
The lesson I draw from this is that any serious effort to address the complex, inter-related problems of Eurasian energy must be informed by humility. Trends that look obvious today can reverse, and quickly. With that said, you can’t plan without making some basic assumptions. And those assumptions need to be based on clear-eyed analysis.
Let me share with you today my sense of what we are facing in our work on Eurasian energy during the period ahead.
First, we are moving out of the world of “zero-sum.” Over the past decade or so, there may have been moments when one player or another had the cash or clout to pull others along with it on specific projects. Not anymore. Today, political will, while still a necessary condition, is not alone sufficient for realizing major projects. The orderly, efficient transportation of energy throughout the Eurasian marketplace will ultimately be driven by commercial realities.
Which is another way of saying that big ideas need to be bankable. At the risk of stating the obvious, some of the major projects that have been on the drawing boards for some time now are breathtakingly expensive. Given the uncertainty of energy markets and the aftershocks of the global financial crisis, finding financing for big, new projects will more than ever require a sound business case: one that not only makes sense in terms of the economics, but that factors in political and other risks.
And that implies, in the short to mid-term, that the smart approach to energy security, particularly for specific countries or regions, may be local and incremental: an approach that focuses on getting the most out of existing infrastructure and opportunities. That’s why:
Within Europe as a whole, we also understand that there is much that can be done in terms of connecting existing gas and electric power networks and building gas storage capacity that can pay significant dividends in return for minimal new investment. Indeed, the EU has committed several billion euros for investment in such facilities. The EU has also correctly recognized that improving energy efficiency, investing in renewables, and liberalizing energy markets can make a real difference in the near term. These efforts may be more important than any specific pipeline.
But the reality is there will remain a place in the Eurasian energy security picture for new, major infrastructure projects. Demand for Eurasian energy in Europe will ultimately exceed the ability of existing infrastructure to supply it. There is nothing that comes close to matching the reliability and economies of scale that large-capacity, dedicated pipelines or similar fixed infrastructure can provide.
Pipelines and U.S. Policy
It would appear there are a lot of people out there who would agree with that point. There are more than a dozen projects at various stages of discussion: South Stream, White Stream, Med-Stream, Blue Stream II, an Arab pipeline, pipelines from Qatar, from northern Iraq, from Samsun to Ceyhan and Burgas to Alexandroupolos, from Turkmenistan to India, and of course Nabucco, ITGI, and TAP. It’s a confusing picture. And of course not all of these projects will get off the drawing board, in view of the realities I’ve just been talking about.
Nonetheless, the Obama Administration’s approach to this plethora of projects is grounded in certain core principles:
And as I look forward, it’s clear that we are entering what will be an especially important period for Eurasian energy, particularly as it relates to the diversity of gas supplies for Europe. Indeed, in some respects the period ahead will be decisive.
What do I mean by that? I mean, fundamentally, that a number of things will soon become clear.
First, there will be a Southern Energy Corridor. The June 7 conclusion of a Turkish-Azeri gas purchase/transit agreement removed the last major uncertainty regarding terms for moving substantial volumes of Azeri gas across Anatolia. On that basis the Shah Deniz II consortium, which is developing a large offshore gas field in the Caspian, is moving ahead with project planning.
Negotiations with potential buyers and shippers are underway. Potential shippers of Shah Deniz gas – the Nabucco, ITGI and TAP consortia—are lining up financing and putting in place the organizational structure to transport the gas. Sometime between now and next spring, the Shah Deniz II consortium will decide which of these three groups vying to ship its gas to European markets gets the nod. A Southern Corridor is going to happen.
Second, it will become clear in the months ahead whether Turkmenistan will contribute to the Southern Corridor by shipping gas across the Caspian, or will choose to focus on other routes for diversifying its energy exports, such as the TAPI project. The Nabucco consortium, supported by the EU, has worked hard to elicit a firm commitment from Ashgabat to ship its gas west. The U.S., for our part, has supported the concept of a trans-Caspian gas pipeline since the nineties. Turkmenistan, for its own political reasons, may not be ready to commit to a pipeline. Given, however, that the Shah Deniz consortium is looking to make their decisions in the next six months, other sources of gas must be considered.
This leads to the third point–it is becoming clearer that prospects for bringing gas into the Southern Corridor from points to the south looks more promising.
At some point–hopefully sooner rather than later–a new government will be formed in Iraq. We hope that a priority of the new government will be ending the long-standing stalemate between Baghdad and Irbil on a hydrocarbon law and revenue sharing agreement. This would not only bring important benefits to Iraq in terms of further development of its oil and gas infrastructure, it would also allow for a serious discussion of how to bring Iraqi gas into the Southern Corridor.
Let’s be clear. This won’t be easy. Iraqi domestic priorities must first be sorted out. And in our view, any scheme for exporting resources from the north must be endorsed by Iraq’s central government. But there seems to be a consensus among experts that Iraq has ample gas, in the north and the south. Once these reserves are developed, Iraq should be able to meet domestic demand with significant volumes left over for export. We should not forget that Prime Minister Maliki said last year in Ankara that Iraq could provide 15 BCM of gas to Nabucco.
Additionally, in just the last week, BP and SOCAR have reached an agreement on more projects in Azerbaijan that will mean, if successful, BP and SOCAR will have much more gas going to market, thus making large pipeline projects more attractive. Having said this, commercial issues will still ultimately determine which project gets the go ahead and with which sources of gas. But for our part, we have always said that we support the Southern Corridor.
And any of the three competing projects could, in our view, serve as the basis for that Corridor. In the abstract, Nabucco would be preferable. It has clear advantages in terms of meeting the needs of consumers in the eastern EU countries. A dedicated large pipeline, like Nabucco, operating to international standards, would have important advantages over existing infrastructure, and might be the most profitable solution if operated at full capacity. This is why it is important to line up additional early sources of gas from Iraq and elsewhere.
The conundrum is that beefing up existing infrastructure could be in the short term the most cost-effective way to handle initial Shah Deniz II volumes, although this may prove to be easier said than done. At the same time, no one seriously questions that, in the long term, improvements to current infrastructure will be inadequate to handle expanding European and Turkish demand. And as new gas sources become available for the Southern Corridor, it will need a way to get to market.
The question naturally arises: does this have to be an "either/or" moment?
The short answer is that, although governments will continue to play a role, the markets will decide, or will at least have the strongest voice in making the decisions involved. But I think it would be a mistake to rule out outcomes that incorporate, through means like consolidation or staging, the stronger points of the various consortia.
Flexibility will be the key. The challenge of the months ahead is to get the Southern Corridor up and running in a way that reflects current gas availability, but that also allows room to grow, and that meets in a timely manner the needs of Europe's less well-served consumers. The competing consortia's current business plans all fall short, in one way or another, of meeting that challenge. Maybe this shouldn't be surprising, since all three projects were conceived years ago in a very different environment. Momentous decisions on Shah Deniz II gas are coming up fast. It may be time to take another look at the assumptions underlying the competing projects for transporting that gas. This is a time when commercial creativity is necessary.
As I said at the opening of these remarks, a lot has changed with respect to Eurasian energy since I got into this line of work. But a constant has been that the markets reward those who can best adapt to change when circumstances require it.