The Politics and Economics of International Energy (Spring 2009- E657)

1. The Politics and Economics of International Energy (Spring 2009- E657) Lecture 7 Geopolitics of Natural Gas Trade Prof. Giacomo Luciani

2. Summary • Gas as geopolitical commodity • European gas supplies overview • Gas supplies from the South • Gas supplies from the East • Gas supplies from the Southeast

3. Gas vs. Oil Geopolitics • Although oil is more important than gas, gas is more “geopolitical” than oil. • The oil market is effectively global and pretty much impossible to segment • If segmentation is impossible “control” has no political value • Gas logistics are the crucial element in the industry, hence inherently geopolitical • The gas market is/can be segmented – hence “control” of gas – especially the logistics of it – allows for rewarding or punishing, i.e. wielding power

4. Gas regional markets • Of the three main regional markets, Europe and the Far East are intensely influenced by geopolitical considerations, North America much less so • The North American market will be increasingly affected by geopolitical considerations as it “sucks in” gas from the ROW

5. Geopolitics of European Gas Supplies

6. N NE SE S

7. Supplies from the South • 3 operating pipelines from the South: • “Enrico Mattei” (Algeria-Tunisia-Italy) since early 1980s • “Pedro Duran Farrell” (Algeria-Morocco-Spain-Portugal-France) since 1996 • “Green Stream” (Libya-Italy) • LNG from Algeria, Egypt, Libya • 2 pipeline projects: • “MEDGAZ” (Algeria-Spain) • “GALSI” (Algeria-Sardinia-Italy)

17. Contractual + Ownership structure • Ownership of the Enrico Mattei Gasline is divided in three segments: • The section in Algeria is entirely owned by Sonatrach; • The section in Tunisia is owned by SOTUGAT (Tunisian state-owned) but operated by ENI, and the latter has exclusive transport rights. Tunisia receives 5.5% of the transported gas as “forfait fiscal” • Finally the section under the sea is jointly owned by ENI and Sonatrach • Two important implications: • Firstly, Tunisia can take delivery of its share of the gas in kind, but enjoys its own gas production and has a network that is independent of the transit pipeline. • Secondly, the transport rights in Tunisia belong to the final customer, ENI - not to the producer, Sonatrach. Hence the use of the pipeline cannot become embroiled in disputes between Tunisian and Algerian entities.

18. The “Pedro Duran Farrell” • It became operational in 1996 and will eventually reach a capacity of 18-20 bcm/yr. • Improved political relations between Algeria, Spain and Morocco • Increased interest in gas in Spain and Portugal providing for sufficient market

19. Ownership structure • The section in Algeria is entirely owned and operated by Sonatrach. • The section in Morocco, is operated by MetraGas Operation (99% EMPL, 1% Moroccan Gov), and is owned by EMPL. EMPL is 72.6% Enagas (Spain) and 27.4% Transgas (Portugal) • The section under the sea across the Strait of Gibraltar is operated by Gasoducto Al Andalus (Enagas 67%, Transgas 33%), and is owned by EMPL. • The section in Spain is owned jointly by Enagas and Transgas, and operated by Gasoducto Al Andalus.

23. The Green Stream • Originates in renegotiation of upstream oil contract for the Bouri field • Libya insisted on direct route, no transit countries • Additional reserves pledged to reach minimum economic dimension • Limited prospects for expansion

25. The Medgaz • Much shorter to market than previous pipeline • Promoted by CEPSA, BP, Gaz de France, Total, ENI, Endesa • No transit through Morocco • But: Spain is already highly dependent on Algerian gas • Expected in 2008

26. GALSI • Shortest connection from Algeria to Central and Northern Italy and South Central Europe • Promoted by Sonatrach, Edison, Enel, Wintershall and others • No supply and very small potential market in Sardinia • Eni is expanding old pipeline • Gas to gas competition?

27. GALSI and Central Europe

28. Transit issues? • Pipelines from the South never experienced transit issues • No international legal instrument (treaty), but • Good contractual/ownership structure • Alternatives available – very large interests at stake • Nevertheless, preference for avoiding transit

30. Supply from the East

31. Historical background • Supplies from the East originated under the USSR • No concern for transit within USSR; little concern for transit in CMEA countries • Political considerations important from the start: • Separate BDR and GDR supplies – W.Berlin contract • Supplies to West through Czechoslovakia, not Poland • Intense opposition from the USA

32. The day after • The situation changed drastically with the collapse of the USSR • Unresolved transit issues between the FSU successor countries • No agreed contractual and ownership structure in place • Significant potential for conflict

33. Post-Soviet disputes • Disputes have arisen primarily between the new independent republics that originatedout of the breakup of the Soviet Union, notably between the Russian Federation,Turkmenistan, Kazakhstan, Belarus and the Ukraine. • The Russian Federation is a producer, interested in transit across the Ukraine and –more recently –Belarus; and at thesame time itself potentially a transit country, for gas from Turkmenistan andKazakhstan.

34. A politically inadequate network • Soviet pipelines were notdesigned or intended to link independent countries, and no arrangements were in placefor the situation that was created after the collapse of the Soviet Union. • The network was designed as a centralised and integrated whole,with no attention at all being paid to reducing interdependencies and possible conflictbetween the republics. The republics depended on each other also for gas treatment and storage, or for shipping gasfrom one region to another within the same republic. • The system of export pipelines carrying gas from Western Siberiato the West European markets might never have seen the light in a capitalistenvironment.

35. Change of Ownership • When the SU collapsed, ownership of the various pipeline segments passed to the newly independent republics • Gazprom was created as a vertically integrated company controlling all Russian gas pipelines, and adopted a strategy of integrating downstream in its export markets

36. The Gazprom story • From ministry to company • The bid for sovereignty: Yeltsin, Chernomyrdin, Vyakhirev • Back under control: Putin, Miller • The key political asset in Russia • The bid to form a state energy giant

37. Disjointed contractual/ownership • Original contracts prescribe delivery at Austrian/German border – buyers have no say and no interest upstream of delivery • Former CMEA and SU countries asserted ownership on respective pipeline segments • No contract in place to manage interdependence • Gazprom could have opted for delivery at the Russian border – but it hasn’t

38. Differences of Valuation • In the eyes of Gazprom, the export pipeline network was fully amortized and zero marginal cost • In the eyes of the new owners, the pipelines were a potential permanent source of rent • Two irreconcileable points of view

39. Funny prices • Domestic prices in Russia have been a fraction of export prices • Export prices to other FSU have been a fraction of export prices to EU • Huge rent element in access to EU markets • Encourages shady deals, prevents level playing field • Because of low domestic prices in Russia, Gazprom wants to keep the European export market all for itself, excluding Central Asian and independent Russian producers – explains refusal of TPA

40. More Funny Prices • Gazprom has continued to practice low export prices to other FSU republics – Why? • Partly because no alternative: they control export pipelines and did not pay even lower prices • Partly – for as long as pro-Russian leaders in power – to gain back ownership and control of pipelines

41. Rent Seeking • Price differentials create opportunities for rent seeking • Transit rights granted to a succession of shady companies: • Itera • Eural Transgas • RosUkrEnergo • Private/corporate/national conflict of interest?

42. Diversification strategy • To reduce its dependency on the Ukraine, Gazprom has attempted a diversification of export routes: • Yamal-Europe (in operation) • Blue Stream (in operation) • Now the North Stream • And the South Stream • But once the latter are completed, Russia will remain 60-70% dependent on the Ukraine

44. The Ukraine’s Strategic Position • Even after the Baltic pipeline is built, 70% of Russian exports will transit through the Ukraine • Important storage facilities • No separation of transit and domestic networks • Insufficient investment • Conflict on ownership

46. European/Western initiatives • The European Energy Charter • International support for gas sector marketization • The INOGATE • The EU-Russia dialogue • EU-US: differences and convergences

47. Europe’s Approach • The EU was aware of the potential problem early on • Dutch initiative  European Energy Charter (1991)  Energy Charter Treaty (signed in December 1994 and in force since April 1998)

48. THE ENERGY CHARTER PROCESS • The ECT has its roots in a political declaration on East-West co-operation in the energy sector (the “European Energy Charter”); • The ECT is a comprehensive multilateral agreement covering all aspects of energy co-operation (trade, investment, transit, energy efficiency, dispute settlement); • US, Canada insisted on participating in negotiations but finally did not sign • Russia signed but never ratified • An embarrassing agony

49. The ECT and Transit • The ECT obliges CPs to facilitate energy transit on a non-discriminator basis; • The ECT explicitly covers grid-bound energy transport; • The ECT does not oblige CPs to grant third party access; • The ECT provides for a special conciliation mechanism in case of transit disputes; • The ECT’s existing provisions are to be supplemented, extended and modified by a legally binding Transit Protocol that is currently being negotiated; (negotiations interrupted) • Non-legally binding model agreements (both intergovernmental agreements and agreements between host governments and private companies) are being developed as guidelines for individual energy transit projects

50. The INOGATE Programme • INOGATE is an international co-operation program aiming at promoting the regional integration of the pipeline systems and facilitating the transport of oil and gas both within the greater NIS region and towards the export markets of Europe, while at the same time acting as a catalyst for attracting private investors and international financial institutions to these pipeline projects. • Extensive studies of existing pipeline conditions and feasibility of new projects carried out within the program