European Affairs

Outflanking Russia’s Energy Grip on Europe     Print Email

Matthew BryzaConfronted with new and ongoing challenges to energy supplies – our own and those of our friends in Europe – this administration has decided to reorganize some policies and renew a long-standing U.S.-led effort aimed at expanding oil and gas production in the Caspian, using public-private partnerships as the preferred Western approach.

 

For this, our goal is to get as much oil and gas as possible from the Caspian basin into Europe while avoiding geographic chokepoints and monopolistic pressure. We want to build on the initial set of pipeline projects that have succeeded in the Caspian region over the last decade and add new ones. Despite skepticism and ups-and-downs, U.S. leadership has facilitated major advances of this sort in the last 10 years in expanding the Westward flow of a mix of oil and gas pipelines from the Caspian basin, including two landmark lines – the Baku-Tbilisi-Ceyhan (BTC) oil pipelines and South Caucasus Gas Pipeline (SCGP). Both are now functional. Today, we seek to build on these great successes of engineering prowess, commercial acumen, and diplomatic cooperation to develop a new generation of infrastructure that will help Europe diversify its natural gas supplies through a southern Corridor stretching from the Caspian to southern and central Europe.With the right infrastructure of pipelines in the right place, the Caspian region can provide a major increase in the flow of oil and gas into Europe by 2012-2016 and significantly enhance diversity of supply. Right now Russia’s Gazprom, Europe’s largest single supplier, relies on a pipeline system to move gas from Siberia and Central Asia to Europe.

 

In this context, we want to see Russia continue to succeed as a primary oil and gas supplier to Europe. But we also want to see more competition by expanding the SCGP into a “southern corridor” that will also include a Turkey-Greece-Italy inter-connector and the Nabucco pipeline stretching from Turkey to Austria. Today, there is dysfunctionality in the European gas market: Russia, the largest single provider of gas to Europe, is able to buy gas in Central Asia for $100 per 1,000 cubic meters and sell it in Europe for around $300. In other words, Russia is able to generate an enormous stream of rents. This is problematic because rents, almost by definition, are not distributed in a transparent way. In the case of these massive gas flows into Europe from the Caspian region, we see abuses that weaken the rule of law.

The profits collected by these rents, as we know from economics courses, are disincentives for reform, guiding the beneficiaries, the exporting countries, toward an “energy trap” in which their economies fail to diversify, compete and flourish. The money from these rents makes it possible for a monopoly such as Gazprom – obviously a monopoly de facto and decreed one de jure last year by Russia’s Duma – to continue operating with a business model far different from the one that obliges Shell, Exxon and other Western companies to increase their efficiency and productivity in order to maximize return on their share prices. Like other monopolies, Gazprom has the goal of stifling competition to preserve that monopoly power and keep the revenue stream of its rents coming. It is part and parcel of the monopoly process to absorb, purchase, and acquire as much infrastructure as possible – in order to block out everyone else. (Anyone who grew up playing the game Monopoly knows this in a simplistic but not misleading way.)

For all these reasons, we in the U.S. really don’t like monopolies, particularly in the energy sector.

At times Washington faces charges from abroad that Americans like their own monopolies but dislike Russian ones. It is simply not true. Looking back to the history of U.S. anti-trust cases, one notes that the first landmark case involved Standard Oil: its break-up produced Exxon, Mobil, Chevron, Conoco. Americans have a long history of not liking energy monopolies, including our own.

In the case of the Gazprom monopoly, our opposition is not personal, it is a matter of business (and of good governance). We see deleterious impacts from Gazprom’s role at all the crucial strategic nodes of gas flowing into Europe.

The situation is not set to improve. Right now, much of the Russian gas for Europe comes from Siberia. But Gazprom is becoming dependent on gas that Gazprom buys in Central Asia. That gas, bought at $100 per 1000 cubic meters, can be delivered as fuel in Russia to consumers at a cheap, subsidized price: while that may be good for Russian consumers, it is not so good for the market. Beyond that, Gazprom resells part of that relatively cheap Central Asian gas to its customers in Europe – after a three-fold mark-up in price.

For that, Gazprom has an enormous array of pipelines that is supposed to carry the Central Asian gas in increasing amounts over the next decade or so to meet its European contracts and keep itself going. We certainly do not want to obstruct these Russian gas deliveries to Europe.

What we do want is a little bit more competition. In fact, we’d like a lot more competition to move that Central Asian gas and Azerbaijani gas to Europe via additional, competing routes. Gazprom is not going to be induced to change its monopolistic behavior by dint of our coming to conferences in Moscow and asking them nicely. The only way to elicit more market-based behavior by Gazprom is to change facts on the ground through increased competition. That means finding ways to move as much of that Caspian gas via new routes and pipelines – to Europe and also in other directions toward the east. While we want Gazprom to deliver on its contracts to Europe, we also want to see more Caspian gas moving south – either as actual gas flows through pipelines toward Afghanistan, Pakistan and India or by a kind or relay-effect created by more gas-generated electricity closer to the source in the region. Admittedly, this “pass-along effect” via electricity can seem like a long shot, so our main goal certainly has to be seeing that as much of that gas as possible moves westward using the infrastructure of pipelines that I’ve cited, both newly in place and hopefully to come.

Building on our public-private partnerships involving the governments of Turkey, Georgia and Azerbaijan and the companies developing these countries’ reserves, we want to see a new network of pipelines come into being – to complement what Gazprom already has in place and compete with it.

Azerbaijan has provided the first step thanks to the South Caucuses Gas Pipeline running from Baku in Azerbaijan to Tbilisi in Georgia and into Turkey, carrying gas from Azerbaijan’s Shah Deniz field. We would like to see the companies and the governments work together to expand that project dramatically so that during the course of the next five years or so – or at least by 2015 – Azerbaijan alone could be exporting up to 20 billion cubic meters of gas a year. In theory, that production level would bring on line enough gas to fill the Turkey-Greece-Italy pipeline now under construction and also the first phase of the Nabucco pipeline, which is intended to connect Turkey to Bulgaria, Romania, Hungary and Austria. Gazprom seeks to counter this project by expanding the Bluestream pipeline under the Black Sea to carry gas to Turkey, then back north along a route paralleling the Nabucco project.

Azerbaijan certainly does have enough gas for phase one of the Nabucco pipeline, provided that the right public-private partnerships function. In other words, this can work provided there is enough confidence at both ends: investors in Europe who are going to receive the gas must have confidence that the gas will be available on time in Azerbaijan and investors in Azerbaijan are confident that the market for the gas will be there in Europe.

The U.S. government’s role is, first, to listen to the companies and the countries. We have been doing this and we hear them telling us that they would like our help. Second, our job is to get clear information enabling the players to understand the potential of Azerbaijan’s gas reserves. Third, we can help negotiate agreements when and if the time is ripe. We succeeded in doing this for the Baku-Tbilisi-Ceyhan pipeline and then for the South Caucuses line in the same corridor, and we would like to continue with the new lines. Of course, none of this will work unless the projects are commercially viable. U.S. officials like me can say all we want about this grand vision of pipelines, but it won’t materialize without the investors to put in the money to make it happen. So we listen to the investors, as we did in the case of the BTC pipeline. Initially, some were reluctant, others more enthusiastic: in the end the project happened because investors – private oil companies – decided that it made sense. So they built it. Now we are trying to bring companies and governments together to show that as the next step in the process, Azerbaijan will have gas available by 2014-2016 to fill the Turkey-Greece-Italy pipeline and then to do phase one of Nabucco.

A big new opening may emerge in Turkmenistan with the death of President Saparmurat Niyazov. We may be able to resurrect plans there that were stalled by his fitful approach to negotiations. The country remains uncommitted about the destiny of much of its gas reserves. Another project, still in the very early stages, involves developing gas exports from northern Iraq. (We are talking with Turkey about investigating all the massive number of things that would have to happen to develop, produce and export gas from northern Iraq to Europe.)

Our goal is to be able to fill the Nabucco pipeline with gas from Azerbaijan, Central Asia and Iraq – and not from Iran or, even less, from Russia.

There are reports that these hopes for alternative pipelines are only “pipe dreams” because there is no gas available in Azerbaijan – that Gazprom has bought all there is there and elsewhere in Central Asia. That is absolute disinformation. This spring Secretary of State Condoleezza Rice and Azerbaijani Foreign Minister Elmar Mammadyarov concluded a memorandum of understanding stipulating that the U.S. and Azerbaijan are committed to working with each other – as countries and with our companies – to expand Azerbaijani gas production to fill the Turkey-Greece-Italy pipeline. In other words, nobody has bought Azerbaijan’s gas yet.

There was a hiatus in announcements after Gazprom threatened in mid-2006 to cut off the gas flow into Azerbaijan during the winter if Azerbaijan exported even a molecule of gas west, meaning to Georgia, Turkey or Greece. At that time, Azerbaijan still depended on Gazprom for gas supplies, so under the circumstances, the situation dictated that no fresh moves be undertaken towards our goal. Then last December President Ilham Aliyev of Azerbaijan announced that he was not going to buy any Russian gas. Indeed, Azerbaijan did not. It made it through this winter by relying on Azeri production, including a stop-gap measure of refining crude oil into fuel oil that was burned in Azeri power plants. It was a frightening decision, I think, for the government of Azerbaijan to make. It challenged head-on the country’s major gas supplier, on which Azeris had been dependent until now. Their action changing that sent a signal to all who were listening here and throughout the Caucuses. The message was that Azerbaijan is committed to realizing its vision of free-market investments in pipelines securing access to European markets and is hitching its strategic wagon to Greece, Italy and beyond. The bottom line is that Azerbaijan is not just speaking nice words but has taken a strategic decision. It marks a sea-change in the Caucuses.

This does not mean confrontation with Russia and Gazprom. We do not want confrontation or a new version of the Cold War. But we think that if Gazprom is allowed to continue operating in a way that a monopoly naturally does, the sort of problematic trends we have seen in the European gas market – that dysfunctionality – will only grow deeper. So we think that it is time to step up the competition. Based on my own experience working with Russia, I find that my Russian friends and colleagues actually respect competition as long as we do a good job in not sounding confrontational. So we have to manage our diplomatic relations carefully with Moscow as we search for more competition.

Matthew Bryza is Deputy Assistant Secretary of State for European and Eurasian Affairs. In 2003-2005 he was Director for Europe and Eurasia at the National Security Council after working on the program for Caspian Basin Energy Diplomacy.

 

This article was published in European Affairs: Volume number 8, Issue number 2-3 in the Summer/Fall of 2007.

 
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