There is life for the Southern Corridor after Nabucco

Both for reasons of security of supply and for climate policy it is crucially important for Europe to develop the Southern Gas Corridor. But it is not necessary to do this on the basis of a large, politically motivated project like Nabucco. The same purpose can be achieved with smaller, more commercially motivated pipelines that gradually build up capacity.

Four Southern Corridor gas pipeline projects compared (click for larger image). BP's SEEP project is not included in this picture.

At first sight the considerable political controversy over the decision by the Shah Deniz Consortium as to which pipeline system it will choose appears misplaced. Nabucco or no Nabucco? SEEP, ITGI or TAP? One may question why so much controversy and attention when the resources involved are so small. In 2017, all being well, the first gas will come on stream from Shah Deniz 2 field, amounting to 16 billion cubic metres (bcm) of which 6 bcm is destined for Turkey and a further 10 bcm for the European Union. By contrast EU total gas consumption in 2010 was approximately 520 bcm.

But there is at more stake here than meets the eye. First of all, 10 bcm is only a “down payment” for the gas to come. The Shah Deniz 1 and 2 fields are not the only gas fields in the Azeri waters of the Caspian Sea. Other fields such as the Absheron field will be able to provide much more gas for Europe in the future. By 2030 the EU could be receiving as much as 30 bcm from Azerbaijan alone.

In addition, we know through the surveying work of British surveyors Gaffney Cline that Turkmenistan has very substantial gas resources. The South Iolotan field alone has a reserve of between 8 and 21 trillion cubic metres, at that upper level 40 times total annual EU consumption. For the future there is the prospect of Turkmenistan providing substantial gas flows to Europe via a trans-Caspian pipeline through a Baku hub and then via a Southern Corridor route to Austria and Italy.

Secondly, even at 10 bcm gas entering South-Eastern Europe will have a significant regional impact as almost all the states in the region only obtain gas from one external source, Russia. 10 bcm of alternative sourced gas will generate new market dynamics and the prospect of some real gas-to-gas competition.

The case for gas

Some may argue that Europe should not be encouraging additional gas supplies, since these are likely to upset the push to decarbonisation that is part of the EU’s climate change policy. There is considerable force in this argument. However, it overlooks the current European predicament that with growing budget austerity across all Member States the fiscal capacity of states to fund alternative renewable energy sources is limited. It is not unreasonable therefore for governments to consider using gas as an alternative. The argument here is to consider replacing coal with gas fired power as a means of obtaining cheap C02 cuts through the crisis.

The advantages of adopting a coal to gas strategy are underlined by a recent report by McKinsey for the Gas Advocacy Forum, a lobby group of the European gas industry. Notwithstanding the source the analysis is compelling. In the report, “Making the Green Journey Work”, McKinsey pointed to the considerable cost and capital saving advantages of using gas to cut C02 emissions. If for instance the average load factor of Europe’s existing fleet of CCGT (combined-cycle gas turbine) stations were

It is open to question whether European chemical companies such as BASF and AKZO can survive with current high European gas and oil prices
increased from 45% to 65%-70% and an equivalent amount of coal fired power generation were retired, the C02 savings per annum would be in the region of 300 million tonnes. That is one-third of total EU coal and lignite fired power station emissions. In order to deliver that same level of C02 cuts with renewables would require capital expenditures of between €80-120 billion. In other words using gas the EU can cut one-third of its emissions with no capital expenditure, whereas if it deploys renewables it has to spend at least €80 billion to trigger the same level of C02 cuts. Given that gas-fired power is also well-suited as a backup fuel for wind and solar there is a compelling argument that the EU should encourage a gas to coal switch. Once the recession is over, more renewables can then be laid on top of the gas base.

Another factor to consider is competitiveness. The discussion about shale gas in Europe has largely focused on the safety of hydraulic fracturing. It has not concerned itself very much with the economic impact of shale gas in the United States. Yet while the environmental issues have to be properly addressed the economic impact cannot be ignored. Shale gas production is not just very big in the US, where it represented 30% of gas production in 2011, up from 1% in 2001, it also results in much lower prices. A mixture of industrial processing, technological development and a focus on liquids from shale plays has pushed US gas prices down to below $3 per MMBTU. By contrast Europeans are paying $10-14 per MMBTU. Such dramatically lower and sustained low prices are having a major economic multiplier impact across the US economy. Shale gas is reviving US manufacturing industry resulting in the “onshoring” i.e., the return of manufacturing capacity and the enhancement of the competitiveness of US industry. In particular, in respect of the chemical industry where gas is used both as a feedstock and a fuel, sustained low gas prices are giving the US a substantial competitive advantage. It is in fact open to question whether European chemical companies such as BASF and AKZO can survive with current high European gas and oil prices. To make matters worse, the rest of the world outside Europe wherever there are any significant shale gas resources is going to copy the United States, with China heading the list. Europe faces therefore significant loss of competitive advantage and potential de-industrialisation against some of its main trading partners. Competitiveness is therefore a compelling argument for developing a cheap gas strategy.

The EU’s greater gas market

Thus, both for economic and environmental reasons, it makes sense for the EU to push in the direction of a larger gas market. Such a market will be more liberalized and have a greater number of diverse sources of gas. Azeri gas supplies, and eventually Turkmen and Iraqi supplies will add to significantly to this supply diversity. In addition to gas from the Baku hub, Europe should be able to obtain gas from shale sources from the continent over the next decade and greater LNG supplies, including potentially from the Eastern Mediterranean. In addition existing suppliers such as Norway, Algeria and Russia may well be incentivized to increase their supplies as the market grows in size.

Cleary in the context of this development – a liberalized gas market with increasing gas to gas competition with diverse sources of supply – it becomes imperative for the Shah Deniz Consortium to take a very tough commercial view of any of the pipeline projects that are proposed to bring gas to Europe through a Southern Corridor. The Consortium cannot afford to sanction expensive political follies or they will pay for it in the market.

It is in this commercial context that the pipeline options for the Southern Corridor have to be considered.

The most well-known of the pipeline options is the Nabucco pipeline. It is the most ambitious proposal and would significantly improve Europe's energy security. It envisages the building of a 3,800 km-long pipeline capable of carrying 31 bcm per year. It would run from the Turkish/Georgian border across

In all these machinations it is important to not lose sight of the fact that the Consortium decision has to be commercial given the more demanding context of modern European gas markets
Turkey and then across Bulgaria, Romania and Hungary to the main central European gas hub, Baumgarten in Austria. Nabucco, however, has two significant questions hanging over it. Firstly, the costs of building the pipeline appear to be very large indeed. Costs are estimated at €12-€14 billion. It is questionable whether the Nabucco partners, Germany's RWE, Austria's ÖMV and Turkey's Botas, can raise sufficient finance to ensure that the pipeline is built. The second question is whether Nabucco's capacity of 31 bcm, which is far greater than the initial 10 bcm of gas available, is far too great for the gas flowing through it. It is unclear who would pay for the loss of transit fees from Nabucco when it is only one-third full.

These questions hanging over Nabucco no doubt motivated the Azeri and Turkish governments to take matters in their own hands. In November 2011, they announced that they intend to lay a separate pipeline from the Shah Deniz 2 fields across Azerbaijan, Georgia and Turkey to the border with “Europe”. This Trans-Anatolian Gas Pipeline (TAGP) will deliver 16 bcm of gas per year, a figure that could be increased to 24 bcm. It will cost approximately $5 bn. Socar, the state-owned oil company of Azerbaijan, will hold most of the shares (80%).
A late entrant to the pipeline contest is BP’s South-East European Pipeline (SEEP). SEEP is a 10 bcm project which uses a mix of existing and new pipelines connecting from the Turkish/Bulgarian border to Baumgarten. The plan is to be able to upgrade the pipeline network as more gas comes on-stream. This project would be much cheaper to deliver than Nabucco and would be backed by BP which clearly would have the financial muscle to deliver the project.
It could be argued that the deal is now set between TAGP backed by SOCAR and SEEP backed by BP as providing the financial underpinning and political support to deliver a southern corridor to Europe. However, Nabucco is not yet entirely out of the game. Nabucco has the permits and permissions in place for its pipeline ahead of BP. One possibility would be a Nabucco Light running from the Turkish border to Austria. SOCAR having effectively reduced the cost of Nabucco by obligingly building a Turkish pipeline may bring Nabucco back into the game.

Alternative direction

Aside from the pipeline options through Bulgaria and Romania and onward to Hungary and Austria there is an alternative direction through Greece to Italy. Originally there were two projects submitted to the Shah Deniz Consortium, ITGI and TAP.

Shah Deniz in the South Caspian Sea, off the coast of Azerbaijan (photo: BP p.l.c.)
The ITGI project envisages a pipeline across the Adriatic connecting Italy with Greece. On the main Greece-to-Italy pipeline, it can take up to 8bcm, which is scaleable up to 16 bcm, and will cost approximately €1.5 bn-€2 bn. It also includes a valuable link, with ultimate capacity set at 5 bcm, with Bulgaria.
ITGI also provides a reverse flow option from Italy into south-eastern Europe which would make it possible to send gas sourced into the Balkans from the other side of the Adriatic in a crisis. ITGI's major difficulty is the financial problems encountered by the Greek government in the economic crisis. It is difficult for the Consortium to ignore the crisis as one of the two ITGI partners, DEPA , is a Greek state owned company. There is uncertainty stemming from who will own DEPA as it is scheduled to be privatized.

The other proposed Adriatic pipeline, the Trans-Adriatic Pipeline (TAP), has the substantial advantage of having Statoil as one of its major shareholders. Statoil alone could finance and build TAP. The Norwegian company is also one of the principal shareholders of the Shah Deniz Consortium. TAP's proposal is similar to ITGI's, as it envisages a connection across the Adriatic, a spur into Bulgaria, and some reverse-flow capacity from Italy to south-eastern Europe. The cost of the TAP project is relatively low, at €2bn. Its capacity could be upgraded, from 10 bcm to 20 bcm.

Based largely on concerns over the state of the Greek economy and the financial strength of the ITGI partners, the Shah Deniz Consortium announced in late February that they were entering into exclusive negotiations with TAP rather than ITGI.

It looks at first sight now that a decision will be made between either TAP on the one hand or SEEP or Light Nabucco on the other. However, this may not be the end of ITGI. DEPA is going to be privatized. There is a real possibility that a privatized DEPA could pass into Gazprom's hands or a Russian business allied to Gazprom. The danger here is that TAP will need permits and permissions in Greece
As to Nabucco, perhaps the greatest lesson we can learn from the (likely) failure of this project is: do not run before you can walk
itself to build its pipeline. Any Russian entrance into the market could create significant difficulties with that objective. The core problem is that Russian entrance would not only assist the development of the South Stream pipeline. It would also provide Russia with a ringside seat to enter the development of the offshore Eastern Mediterranean gas market. If the Russians enter this market they are not entirely unreasonably going to want to protect their assets and market access which may mean seeking to deny access to other projects. In addition, from a Russian perspective the acquisition of DEPA may be seen as a quid pro quo for acquiescence in gas flowing from Azerbaijan along a Southern Corridor route.

Political concerns

We will not know probably until mid-summer which pipeline will be chosen. What we do know is that we are now really discussing one pipeline from the Turkish/Bulgarian border to Austria, either SEEP or Nabucco Light, or another pipeline direction taking gas through Greece, Albania and into Italy through TAP. The prospect of Russian acquisition of DEPA may trigger a merger of ITGI with TAP and/or a rival Statoil bid.

In all these machinations it is important to not lose sight of the fact that the Consortium decision has to be commercial given the more demanding context of modern European gas markets. Low cost delivery of gas to market with good prospects for gas sales into whichever market the gas is delivered will be of vital importance to the Consortium. Ultimately, as the (probable) fate of the Nabucco project demonstrates, political concerns over energy security in Europe cannot trump core commercial requirements.

It is very likely, then, that Europe will see a Southern Corridor pipeline by 2018. It will start off modestly with a maximum of 10 bcm. However, as more gas comes on stream from both the Azeri offshore and then Iraq it is likely to become a major source of gas for South-Eastern Europe providing significant competition for existing regional gas suppliers. Further down the line we may well see Turkmen gas flowing into an expanded Southern Corridor pipeline system. At that point Europe may well be seeing as much as 60 bcm coming down the Southern Corridor.

As to Nabucco, perhaps the greatest lesson we can learn from the (likely) failure of this project is: do not run before you can walk. Start modestly and then build up capacity.

 

About the author

Alan Riley is Professor, City Law School, City University, London. This article is based on a lecture given at a meeting of the Azerbaijan European Society at the House of Lords, London, February 16th 2012. It has been updated to take account of recent developments.

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