Geopolitics of Eurasian Energy: Challenges and New Frontiers

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altSelim Kuneralp, Chairman of the Energy Charter Conference

Today the world of energy is experiencing huge change and challenges. It is evident that energy markets are becoming more and more globalised.

Conventional fossil fuels are depleting; and climate change provokes us to de-velop and seek new sources of energy. In the meantime, the Fukushima accident has halted the so-called nuclear renaissance of the early years of this millennium. Moreover, hydrocarbon production has experienced a certain slowdown due to the events surrounding the Arab Spring earlier this year. According to the International Energy Agency; we are about to live through a golden age of gas. More and more players are now involved on the energy markets. International companies, national companies, states, NGOs, all have a stake in the developments  of the global energy scene. This turmoil brings many challenges that must be met. However, I shall sum them up in one question; how shall we create reliable interdependence between the energy actors in order to be prepared for the energy challenges of tomorrow?
To answer that, I will turn in part to the Energy Charter Treaty. The Energy Charter political declaration was signed in December 1991; between what is now the EU and what was then the USSR. However the Charter now involves more than 50 states including Kazakhstan and other CIS countries, the EU, Japan, Turkey, Australia and others. The Energy Charter Treaty was developed on the basis of the 1991 Energy Charter. Whereas the latter document was drawn up as a declaration of political intent to promote energy cooperation, the Energy Charter Treaty is a legally-binding multilateral instrument.
The fundamental aim of the Energy Charter Treaty is to strengthen the rule of law on energy issues, by creating rules for a level playing feld to be observed by all participating governments, thereby mitigating risks associated with energy-related investment and trade.

The Treaty provides for investment protection and security of transit. It also provides dispute resolution mechanisms, including international arbitration. Over the last thirteen year the Energy Charter Secretariat has also been working on energy effciency with the Energy Charter Process, on the legal basis of the Protocol on Energy Eff-ciency and Related Environmental Aspects , signed by 51 states plus the European Union and which entered into force in April 1998. Although I have been asked to address global energy preparedness, I will frst look at the Eurasian continent, where the Russian Federation and the European Union are the important players. The European Union is currently examining opportunities in the Caspian region generally and in Azerbaijan in particular. The Union has other suppliers, such as Norway and Algeria, perhaps Iraq in time, and maybe even Iran in the more long term future, should the political situation change. Russia also has other export markets than the EU, such as China, Turkey and others.

On the Eurasian continent, the key issues relate to gas. The oil market is much more fex-ible, and most transport takes place by ship, generally on international seas, although diffculties sometimes arise from bottlenecks such as the Straits of Hormuz, Istanbul or Gibraltar or the Suez and Panama canals. Thanks to the installation of numerous pipelines in the 1990s and the 2000s, landlocked oil resources have found their way to global markets. Kazakhstan now supplies oil to China, through the Kazakhstan-China pipeline, to Europe, through the Baku-Tbilisi-Ceyhan pipeline, and to Russia, through the Caspian Pipeline Consortium. It is now time for gas to follow a similar path and to reach the global energy market. Gas is of particular signifcance in the context of the Russian-EU relationship. First, Russia is not only a gas exporter. In fact it uses two thirds of its production for its own needs. Similarly, the EU is not only an importer given that half of its needs are covered by its domestic or quasi-domestic (Norwegian) production. There is therefore an important synergy between the EU and Russia which is longstanding, stable and profoundly benefcial on both economic and political levels. However like any market, the gas market is an evolving market. I can say without going into detail that domestic production within the EU is in rapid decline. This therefore boosts the need for imports. On the other hand, on the Russian side, easily accessible gas resources are likewise in decline, which means that large scale and long term investment is becoming vital and urgent.
Pipeline projects, particularly cross-border pipelines, require substantial investments. There are various factors which determine where and how investments are made. Energy investments can only be decided if they make sense economically; that a legitimate return can be anticipated. One of the conditions for this is obviously a reliable stream of energy from production to consumption. Confrmed availability of volumes and con-frmed demand is clearly a determining issue. Project fnancing can only go ahead if there is a clear demand for the pipeline’s proposed capacity.

Over the years, forming pipeline consortia has proved to be a very effective and successful tool to secure off-take markets. Such consortia attract the necessary project fnancing and enable the construction of cross-border facilities. This in turn mitigates the key risks that cross-border pipelines projects are prone to. Each consortium is of course interested in the sound functioning of and economic success of the project. The signif-cance, for example, of the Nord Stream and South Stream projects is the political dem-onstration that it is not just Russia which is involved, but that the European Union or its particular Member States are also fully committed. It is striking to note that in fact the Nord Steam fnancing project was over subscribed by 60 %.

The Southern gas corridor is a major policy initiative which EU politicians and energy companies are attempting to bring to fruition by pushing for concrete projects. Central Asia (and the Caspian region in particular) has considerable gas reserves. The challenge is how to transform these gas resources into actual output, and then fnding a way of delivering them to market. There are today proposals for competing pipelines such as Nabucco, ITGI (Italy Turkey Greece interconnector) and TAP (Trans Adriatic Pipeline). Apart from the resources of Shah Deniz there is the complex political question of whether gas from Turkmenistan and Northern Iraq might join gas from Azerbaijan in supplying the Southern gas corridor pipelines.

There is the other question as to whether Russia’s South Stream might have the potential to become a Nabucco “killer” by making the EU fagship project irrelevant. South Stream has a greater capacity than Nabuc-co, has similar target dates for completion and would largely reach the same Central European clients.

For Europe, building too many pipelines would make little sense. Although they would potentially introduce competition be-tween different suppliers, the high construc-tion costs would also likely infate prices for consumers. On the business side, returns would be too small to justify several projects, meaning some may have to be abandoned. There are also important political dimen-sions to consider. Rather than being cost ef-fective, some of the projects can be viewed as political. Such projects do not necessarily make business sense. Some have the avoid-ance of transit as their rationale. Nabucco is recognised as being of “European interest”. However, other projects which do not enjoy the same status, like South Stream, have received backing from some EU Mem-ber States; Bulgaria, Romania, Hungary and Greece. If both were to be launched it is unclear what the position of those countries would be.
All the planned projects that I have referred to, including those of the Southern Corri-dor and South Stream, incorporate sections of existing pipelines. When all the projects are put on the same map, a clear overlap be-tween several projects becomes visible. The need for massive investment to meet future energy demand is well documented and set to remain for the decades to come. Cancellation or even postponement would endanger the security of supply and in consequence the economy as a whole. Energy investments are among the most complex and capital-intensive in the world. They therefore require a high level of protection against political risk.

But therein lies the diffculty. Companies such as Gazprom, before investing colossal amounts in new production felds, must be certain that gas will be purchased. This is security of demand. This is a very pertinent question in 2011, and a very diffcult one to resolve. Prior to the current economic dif-fculties security of demand was taken for granted particularly from large consumer markets such as the European Union. The economic crisis has had a signifcant impact on energy. The slowdown of industry has reduced energy demand in all sectors: construction, the car industry, services etc. In this context it is noteworthy that for the frst time since the Second World War, electricity consumption (and therefore demand) has fallen. The economic crisis has therefore demonstrated that security of demand is also capable of fuctuation depending on circumstances.
The fnancial crisis, a corollary of the economic crisis, has also had its effects. Investors have become more cautious, credit is tight and major projects are being reconsidered in the light of these new circumstances. To complicate matters even further, we have seen the spectacular price crash, with a sig-nifcant effect on corporate cash fow. The emergence of shale gas on the US market is perhaps an even more signifcant phenomenon. The lack of suitable technology had previously prevented exploitation of this gas whose existence has been known for some time. Now thanks to a technological breakthrough shale gas is being produced in the US, thus making the North American market self suffcient. Remarkably as a consequence, LNG imports, which were developed by large LNG producers, are now excluded from the very market for which they were intended.

Today, large quantities of LNG, previously destined for the US market, are now available on the world market. There is therefore a surplus of gas, at least on the European market, thanks to this shale gas factor and combined with the fall in demand. Therefore at this point in time, there is a new, though perhaps not dramatically different situation. It requires all players to re-view their positions and most likely to consider new policy directions. This is an almost permanent and regular exercise for the EU. EU energy external policy is dominated by bilateralism; the EU does not yet speak with one voice on this issue. However signifcant efforts in this direction are now being undertaken. For its part, Russia is faced with the usual challenges of a supplier; what investments to make, whether and to what extent to de-velop and LNG industry, which new markets it could develop, etc. More generally, the events of the last two to three years prove once again that his-tory constantly changes and that nothing is fxed. This is of course equally true for energy. The strong positions of yesterday are weaker today.

Quite apart from the issues of supply and demand, I must refer to another vital issue, that of transit. Here too, for a long time, Ukraine also enjoyed a quasi-monopolistic position in transiting Russian gas towards the EU. Here too the situation is changing. Nord stream, which was inaugurated last month, will allow the transport, without transit, of 55 bcm, or approximately half the volume currently transited by Ukraine. This particular example illustrates that the various crises which have been experienced, are leading states to seek solutions which avoid transit as far as possible. All of these issues must be viewed in the context of globalisation. Globalisation will continue and become even more pronounced. Globalisation brings risks and dangers. It also has many potential benefts. To reduce the risks and obtain the benefts, globalisation must be contained. Rules of the game must be defned, accepted and known by the players. Very generally this is the aim of the WTO. More specifcally, in the energy context, this is the aim of the Energy Charter which now involves more than 50 states. The Energy Charter Treaty is the only international treaty which sets out the rules of the game.

The ECT aims at developing and implementing frameworks that help the energy actors to be prepared for change on the global energy scene. The Treaty has a special role in bringing together the producer and transit countries and linking them to the main con-sumer markets for their energy products. The multilateral approach envisaged by the Energy Charter Treaty makes a contribution to addressing the energy challenges facing the countries of Central Asia and the Caspian region by providing as it does a forum for states to discuss issues of mutual interest and concern. Experience has shown that dialogue around critical energy issues can do much to promote better understand-ing, transparency, the exchange of information and, in these ways, contribute to building confdence.

In recent years, we have already witnessed tensions rising to worrying levels over energy projects in Caspian region. Unless addressed, these tensions risk contributing to a worsening of relations between states. On the other hand, a constructive engagement in a mechanism for dialogue does much to alleviate such tensions. Above all, the Treaty provides a common set of minimum legally binding rules in the energy sector; and it can serve as a means to promote transparency and confdence. The Energy Charter Treaty aims to establish a positive interdependence between states, laying on strong and reliable relationships. Kazakhstan has been an active member of the ECT since its entry into force in 1998. It notably supported the establishment of a framework for sustainable and secure regional power trade in Central Asia in 2007. The ECT and Kazakhstan have established a long and positive relationship that is ben-efcial to both of them. Kazakhstan makes a successful contribution to the Energy Charter process and the whole Energy Charter constituency and we very much look forward for such a lasting and fruitful relationship. In conclusion I would like to remark that it is also clear that in the fast changing world of energy – and perhaps nowhere more than in Central Asia and the Caspian region – careful refection is required as to whether the existing arrangements for energy governance are suffcient to meet the full range of new challenges. Within the Energy Charter constituency there is already considerable thought on this issue underway as part of a process of modernisation. It is evident that since the Treaty was adopted in 1994 the world and notably the world of Energy in the Eurasian continent have changed in important ways.

This does not mean renegotiating the Energy Charter Treaty, but rather using the considerable opportunities that already exist to strengthen existing provisions and to supplement the Treaty through new protocols and through clarifcation of the existing Treaty text. Today’s challenges point to the need for further creative thinking by all the players. The Energy Charter Process is fex-ible and ready to respond to new challenges. It is hoped that Kazakhstan will continue to fully participate and will contribute sig-nifcantly to the development of the Energy Charter Process.

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