Nabucco: Europe’s Geopolitical Battle

 In the energy business it normally pays to be, at best, cautiously optimistic, at worst, cynical. Failure to take either of these qualities onboard can leave you looking wet behind the ears. Despite its recent transit agreement, Nabucco remains a strong candidate for those still needing a towel as the task of finding sufficient gas, political cohesion and financing to access Central Asian and Middle Eastern gas in order to diversify European supplies beyond the Kremlin proves to be a formidable challenge. This will not be quick or easy, and will assuredly be politically ugly.

If you build it, they will come...

The fact that Austria, Bulgaria, Romania, Hungary, RWE of Germany and most critically Turkey managed to agree on terms across the pipeline’s 3,300-kilometer route does of course provide evidence that Nabucco has some serious political capital behind it. But it will need even more if it is ever going to be successful - not least because Nabucco turns the ‘classical economics’ of pipelines on its head. Gas is normally found, then the pipeline built; in this instance, the idea of constructing the pipeline has always come first; the reality of sourcing sufficient gas to fill it has always remained a distant second.

This is still the case. Europe assumes if it builds the pipeline the gas will fall into place from plentiful proven reserves in Central Asia and the Middle East. Turning infrastructure into supply is a strategy that could still work for Europe in the longer term, but it is one that private sector investors are only likely to consider once a significant down payment of the £7 billion ($11.4 billion) funding for the pipeline has been made from state coffers. Extremely favorable terms on unregulated prices and third-party access will also be presented to the EU as a fait accompli to recoup outlay (competition lawyers should probably look away now if they don’t want to see the results). But putting financial and legal ‘niceties’ aside for a moment, the real issue for Brussels is how to turn upstream reserves into European supplies.

The grand plan (at this stage at least) is to try and sign up Azerbaijan, Iraq and Egypt for the first phase of the pipeline to fill supply gaps, before looking to gain Turkmenistan as an additional supplier for the second phase to bring around 31bcm/y online by 2020. Iran, although not mentioned in official political channels, will also be on the long-term radar for those in Brussels willing to put gas over proliferation as a core European interest. Other Central Asian and Middle Eastern suppliers will also be seriously considered in the European in-trays, but at this stage are not marked as ‘high priority’.

Strategic snags

The slight snag with such supply options is that they are all heavily contested, and indeed, fraught with risk. Supplies from Azerbaijan would have to transit Georgia (mirroring the BTC oil pipeline) and would only have capacity to fill initial throughput without serious development of the Shaz Deniz 2 field. Even then, such gas is still sorted by Russia to help feed its competing South Stream pipeline, alongside Turkey and two other planned pipelines running from Greece to Italy as part of the Turkey Greece Italy pipeline (ITGI) now linking in Bulgaria and the Trans-Adriatic Pipeline (TAP). Not only would ‘Nabucco gas’ become increasingly scarce, but Baku would look to leverage its position to maximum effect amid competing international interest for its supply. This also includes approaches from the National Iranian Gas Company to secure “large amounts” of gas for domestic purposes.

Further West, Turkmenistan remains similarly challenging – as do the other ‘Stans.' The prize is bigger in terms of reserves, but the stakes are even higher. Despite President Gurbanguly Berdymukhammedov’s party trick of promising supplies to pretty much anyone who asks, the gas sector has serious capacity constraints, and currently remains the sole preserve of Russian tutelage buying all of Ashgabat’s reserves. Turkmenistan will of course play Russian, Chinese and European interests off against each other for all they are worth, but even if such supplies were to directly reach European markets, it would require a new pipeline under the legally contested Caspian Sea. Iran and Russia wield a heavy veto.

Supply options from Iraq are looking more credible than they did six months ago after Hungary’s MOL and Austria’s OMV (alongside help from the UAE) to sign an $8 billion plan to extract gas from the Kurdish region came to fruition in May 2009. Iraqi Prime Minister Nouri al-Maliki duly confirmed that he would be happy to fill half of Nabucco’s capacity (15bcm/y) by 2015, but unfortunately failed to put any timeline on field development, or indeed confirm that he would be happy to allow Iraqi Kurdistan gas to form part of the mix rather than the more prominent Akkas field that Baghdad clearly has in mind for Nabucco.

Any additional supplies from the likes of Egypt and Syria to Europe via Iraq and Turkey would not only rail against domestic demand, but more lucrative LNG options and the political vagaries associated with an Arab gas pipeline. Iraq falling back into a state of anarchy is clearly the most explosive risk once foreign troops leave, but ongoing contractual revisions across six transit states would be a more credible regular occurrence. Iran is of course the bigger wild card as far as supplies are concerned. Clearly the US had been trying to slowly open the door toward some form of reconciliation, but with the nuclear question as prominent as ever and hardliners increasingly willing to use whatever means necessary to stay in power, Iranian supplies are not to be had at an affordable political price in the foreseeable future.

Indeed, even if such supplies (either from the Middle East or Central Asia) made it as far as Turkey, how closely Ankara, as a key arbitrage state, would stick to the transit terms agreed? Erdogan has dropped demands allowing for 15 percent of the take for Turkish consumption, but has negotiated generous cash transit fees alongside a raft of guarantees granting access to European stockpiles at times of his choosing. Should the political outlook in Ankara become sticky, Turkey is likely to leverage its position as a regional energy hub for political and commercial effect, rather than simply signing standard transit deals. This will inevitably act as gravitational weight on Nabucco’s progress, and indeed could raise serious complications for the EU in relation to Turkish accession given Ankara would have a serious stake in the European energy security game.

Either/or not an option for the EU

None of this is to say that the EU should not continue to explore as many supply options as possible, but that it must remain politically robust when doing so. As the latest dispute between Russia and Ukraine showed in January 2009 (affecting most of the EU to some degree or another), Europe desperately needs to reduce its 150-160bcm/y dependence on Russian gas supplies, but this is no arena for half measures or the politically limp-wristed. Whether the European Commission can rise to the challenge is thus the main question of the day.

The Russian-inspired extension of Blue Stream and the proposed construction of the South Stream pipeline are still very much on Moscow’s agenda, but with Gazprom’s finances in a state of ruin (leveraged to around $40 billion debt) the EU has a major window of opportunity to reduce its overall dependence on Russian supplies. South Stream will need to find around €20 billion to be realized, while Nord Stream (linking Russia to Germany via the Baltics) will cost up to €13 billion to execute.

Alas, the bluster over Nabucco has actually disguised a bigger problem in play for the EU: Individual member states continue to put their own perceived security of supply over the ‘European good.’ Germany has been piling increasing pressure on Sweden to acquiesce over Nord Stream to ensure security of supply from the North, while the ‘Nabucco states’ are still keeping open South Stream as a possible option while toying with greater Russian influence downstream in return for lucrative swap agreements upstream.

But what might work well for the likes of Berlin or Vienna’s ‘energy security’ are of course disastrous for others, such as Ukraine and other Eastern European states. If Russia can cut them off without affecting broader European supplies as new pipelines materialize, they will do so for commercial and political gain.

This is where Nabucco supporters point to its greatest resonance of course. Even if supplies are slow to come online, many in Brussels hope that it will remain a useful deterrent to keep Russia and indeed transit states on the straight and narrow to ensure consistent (if probably not cost-reflective) supplies. This certainly has more than a grain of truth, but the best way of protecting those in the Russian ‘line of fire’ is not only through supply side diversification, but by properly integrating infrastructure and establishing a single competitive energy market to reduce the Kremlin’s bilateral effect. Greater storage, more LNG options and a more flexible energy mix would also help, but these should not be seen as either/or options for the EU, but an overall package of where its real energy battles will be fought or lost.