MESOP BACKGROUNDER BY MOSCOW CARNEGIE CENTER / Turkish Stream: The Cost of Russia’s Stubbornness & ERDOGAN – Energy Security

Source: Mikhail Mertzel/TASS – &  Mikhail  Krutikhin – 20 Oct 2016

Unlike Russian gas pumped via Ukraine and Germany, that flowing through Turkey will face tough competition from Azerbaijani, Iranian, Iraqi, and possibly even Turkmen and Israeli gas. Gazprom’s rivals won’t need to ship their gas as far, and they will have much lower pipeline construction costs. The gas market in southeastern Europe is not that big and doesn’t have a lot of room for growth.Not so long ago, Turkey was on the Kremlin’s list of adversaries following the NATO member’s shooting down of a Russian fighter jet over the Syria-Turkey border. Now Russia is effectively relinquishing control over its southward gas export to Turkey.

This is the extent to which the Kremlin is prepared to go to punish disobedient Ukraine—but it will come at a cost to Russia.

The Russian and Turkish energy ministers signed an intergovernmental agreement on October 10 in Istanbul—witnessed by presidents Vladimir Putin and Recep Tayyip Erdoğan—promising bilateral state support for the Turkish Stream gas pipeline, which aims to redirect a significant share of Gazprom’s export flows from Ukraine to Turkey.The objective in changing transit countries is to bypass Ukraine, allegedly due to political and technical risks of disruptions in the supply of Russian gas to Europe. This was not always the aim, however. When Russia began setting up the Nord Stream (Baltic Sea) and South Stream (Black Sea) gas transportation systems in 1997, government officials and Gazprom managers alike insisted that new volumes of gas would be shipped along the new pipelines under new contracts, without disrupting the operations of existing routes. Later came cautious admissions that some gas would be cut from old pipelines.

Now, even though the old route was reliable and relatively inexpensive, Moscow has decided to deprive Ukraine of gas transit, punishing its wayward neighbor by stripping it of about $2 billion in annual revenues from the transit of Russian gas to European consumers. State-controlled Gazprom was tasked with finding ways to circumvent Ukraine—and apparently advised to spare no expense.

This approach to satisfying the Kremlin’s political ambitions coincides with the interests of Gazprom’s traditional infrastructure contractors, which—as is often the case—happen to be owned by close friends of the Russian president. The same friends scored contracts to lay pipes and build compressor stations in Russia for Nord Stream and South Stream, and the same friends excelled at padding expenses: the average price per kilometer of constructing the Gryazovets-Vyborg section of Nord Stream was $4.8 million, three times higher than expenses on similar projects in other countries.

Money flowed and pipeline construction continued even when it was obvious that projects were not viable. This was the case with the Sakhalin-Vladivostok pipeline and then with South Stream, on which Gazprom wasted $17 billion before Putin admitted in December 2014 that the route couldn’t be continued on the other side of the Black Sea, and announced that a new project would be launched instead: a project that came to be known as Turkish Stream.

Then, while Russian officials negotiated with their astonished Turkish counterparts, promising a 10.25 percent discount on supplied gas if Ankara agreed to the route, Gazprom began behaving completely at odds with the Kremlin’s plans. The gas monopoly ceased all financing for Turkish Stream, scrapped the department that was responsible for the project, and dismissed two Italian pipe-laying ships that had spent almost a year waiting around for work in the Black Sea (the Italians filed a hefty claim against Gazprom).

In an attempt to save the new incarnation of South Stream and to justify some of the colossal expenses, Russia’s Energy Ministry tried to talk Turkey into laying at least one line of the pipeline with a capacity of about 16 billion cubic meters per year, instead of the planned four lines. Turkish officials insisted that Russia guarantee the price discount. The discussions were halted after the downing of the Russian plane in Syria in November 2015, but resumed once bilateral relations were normalized this summer.

Both sides have made concessions under the new intergovernmental agreement. According to Russia’s Energy Ministry, Moscow has promised a discount on the gas price, while Ankara has agreed to a second line.

Kiev has been dismayed by the plan to bypass Ukraine, as well as somewhat bewildered by other countries’ support for the project: according to participants of the second Ukrainian Gas Forum, which was held on October 12–13, two countries that purport to be good friends of Ukraine—Turkey and Germany—were in favor of the construction of routes bypassing Ukraine. Germany, which expressed readiness for a second line of Nord Stream, sees itself as a hub for the distribution of gas in northwestern and central Europe. European traders hope that Gazprom will offer new deals for gas delivered along the new route. Meanwhile, Turkey is happy to obtain access to Russia’s strategic infrastructure, as well as political and economic leverage over the Kremlin.

Unlike the Russian gas pumped via Ukraine and Germany, the fuel flowing through Turkey will face harsh competition. Construction of the Azerbaijan-led Trans-Anatolian gas pipeline (TANAP) is already underway, and contracts have been signed for delivery of Azerbaijani gas along this pipeline not just to Turkey but also to Italy, Greece, and Bulgaria. Going forward, Turkey expects to become a transit country for gas exported to Europe from Iran and Iraqi Kurdistan. Gas from Turkmenistan and Israel could potentially also feed into this route. Gazprom’s rivals in Turkey won’t have to ship their gas as far as Russia (which transports gas from the Yamal Peninsula in Siberia across the entire country to the Black Sea) or spend as much money on pipeline construction. Furthermore, if gas no longer has to be pumped to Turkey along the existing route via Ukraine, Romania, and Bulgaria, that pipeline capacity can be used in the reverse direction to deliver gas to Bulgaria and Romania from the Caspian region and from the Middle East. Bulgaria already fancies itself as a gas distribution hub.  The gas market in southeastern and southern Europe is not that big and doesn’t have a lot of room for growth. Competition in the region will therefore be particularly aggressive—even without accounting for the global oversupply of liquefied natural gas—and Russia will have to offer significant discounts that won’t justify production and transportation expenses.

The Kremlin’s retaliation against Kiev for its unwillingness to acquiesce to Moscow’s political demands has exacted a heavy toll on Gazprom, on the Russian budget, and therefore ultimately on the Russian people. The only winners are the Kremlin’s crony contractors—and of course, European gas consumers.