RUSSIA & TURKEY STREAM

Russian energy company Gazprom has made it clear that it intends to move forward with the construction of the Turkish Stream natural gas pipeline as quickly as possible, whether or not the project can overcome political obstacles in Europe. Earlier in May, Gazprom notified a subsidiary of Italian energy firm Saipem that it could begin laying pipes for the planned 63 billion-cubic-meter pipeline in the Black Sea and also resumed a contract with Germany's Europipe for 150,000 metric tons of pipe for the project. Russia said it plans to start constructing the underwater portion of the pipeline in June.

Gazprom has already told Europe that it plans to cease using its current export route through Ukraine in 2019 and shift those natural gas supplies to the Turkish Stream pipeline. But the Europeans believe Russia will not follow through with its plans if Europe does not build the infrastructure necessary to deliver gas from Turkey to the markets currently serviced by the Ukrainian route. Meanwhile Russia has invested enough and has sufficient supplies available to at least begin construction on the first of Turkish Stream's four parallel pipelines, each with a capacity of about 16 billion cubic meters. Russia is banking on Europe caving in by the time Gazprom is ready to start constructing the other pipelines. Even if Europe does not compromise in the medium term, Gazprom can use a smaller version of Turkish Stream to supply the small but growing Turkish natural gas market.

Analysis

One of Russia's tools for influence in Europe is its status as the dominant producer of natural gas and oil for the Continent. Moscow also uses its pipeline networks to exert influence over transit states such as Belarus and Ukraine as well as European countries further downstream.

For much of the 2000s, Russia's primary export route into Europe was a main line through Ukraine that branched out as it headed west toward Austria, Italy, Germany and other major consumers. This meant that whenever Russia and Ukraine had a dispute that led to a cutoff of natural gas to Ukraine, as occurred in 2006 and 2009, it invariably impacted the supply of energy to the rest of Europe. To avoid repeating this scenario, Moscow mustered enough financial and political support to build the Nord Stream pipeline, which now delivers natural gas across the Baltic Sea directly to Germany, Gazprom's largest European customer.

South Stream was meant to be the southern route that would bypass Ukraine by delivering natural gas across the Black Sea directly to Bulgaria and then to Central and Southeastern Europe. The financial and political support for South Stream came more slowly than support for its northern counterpart, but by the end of 2013, South Stream had enough resources to begin awarding contracts for pipe-laying, pipe fabrication and other construction-related services. However, the crisis in Ukraine halted the project before all the contracts had been awarded, and what little political support it had in Southeastern Europe evaporated under strong political pressure from the European Commission and more dominant European countries. At the same time, Russia spiraled into another major financial crisis, leaving funding for such large projects in question.

South Stream was canceled in December 2014. Almost immediately, it was replaced with the Turkish Stream plan, which is being designed to send the same amount of natural gas to Turkey as its ill-fated predecessor, almost directly across the border with Bulgaria. For Russia, Turkish Stream achieves the same goal as South Stream, but without the political constraints of transporting gas to EU member Bulgaria. And in return for its support of the new project, Turkey is hoping to get a 10.25 percent discount on its energy supply from Russia.

Turkish Stream

Russia is now using the contractors and subcontractors it enlisted for South Stream to accelerate the development of Turkish Stream. The contracts with Europipe and Saipem are just two of many that are likely to be migrated from the canceled project to its replacement. Gazprom is also likely prioritizing work on the first of the four planned parallel pipelines, each of which would carry about one-fourth of Turkish Stream's planned capacity. Gazprom hopes to have the first pipeline finished by December 2016.

Neither the Russian government nor Gazprom have the financing in place for the entire Turkish Stream project. Instead, they have opted to take a piecemeal approach. With oil and natural gas prices low, financing the later portions of Turkish Stream could be a challenge for Gazprom until Russia's economy improves.

Even before Russia envisioned Turkish Stream, it would have been difficult, if not impossible, for Gazprom to concurrently finance both South Stream and another planned energy project, the Power of Siberia pipeline to China — the combined cost of which would exceed $100 billion. This was one of the main reasons Gazprom sought international financial partners for both projects. Russia has secured significant financing from China for the Power of Siberia project, though Gazprom has complained that China has been slow in delivering the money. Russia has also swapped the order in which it initially planned to construct the two pipelines to China, choosing to prioritize the Altai pipeline, which will transport natural gas from western Siberia to the border with China between Kazakhstan and Mongolia. Choosing to construct this shorter pipeline first gives Gazprom more flexibility in financing Turkish Stream given limited Western capital.

Getting foreign participation from Europe is even more difficult for the Turkish Stream project than it was for South Stream. Even if the West relaxes sanctions on Russia, business confidence in long-term contracts with Russia will remain relatively low, meaning that Russia must offer fairly high rates of return. Politically, Turkish Stream is highly unpopular in Europe. The Europeans are making every effort possible to develop alternatives, such as the Trans-Anatolian, Trans-Adriatic and Trans-Caspian pipelines, which could transport natural gas from Turkmenistan to Europe. Companies in Europe are throwing their support and finances behind some of these other projects.

A major worry for Moscow is that Russia will build Turkish Stream but have no means of transporting Europe's natural gas beyond the Turkish border. Right now, almost all of Europe's natural gas transportation infrastructure goes either from Northwestern Europe, bringing natural gas from the North Sea into Central and Southeastern Europe, or from Ukraine westward or southward. None of the infrastructure is designed to bring natural gas from the extreme southeast to other markets. In essence, Turkey and Bulgaria are at the end of Eurasia's natural gas supply chain networks. Moving natural gas to the north and west was a problem with South Stream as well, but Russia eventually found partners to extend the pipeline all the way into Central Europe. Because of the European Union's Third Energy Package, Gazprom cannot build and operate pipelines in Europe, so it must wait for the Europeans to develop the infrastructure. The Trans-Adriatic and Trans-Anatolian pipelines are designed to solve this problem for natural gas from the Caspian region, but the initial capacity for the Trans-Adriatic is exempt from Europe's open access rules, meaning Gazprom cannot use it anytime soon.

Differences Between Nord Stream and Turkish Stream

A similar process existed for the construction of the Nord Stream pipeline. Gazprom began awarding the construction contracts and building the pipeline well before Moscow and Berlin finalized the political agreement for the project and before Gazprom had hammered out the final details concerning the onshore distribution networks. However, there are two major differences between Nord Stream and Turkish Stream.

First, Germany is Europe's wealthiest economy, and its industrial base provided the money needed to finance and build the infrastructure for Nord Stream. There is no equivalent sponsor country for Turkish Stream. The biggest consumer in the immediate region is obviously Turkey, which currently gets half of its Russian natural gas through Ukraine — notably, close to the same amount it could get through one of Turkish Stream's four planned pipelines, about 15 billion cubic meters. Turkey would not need to build a lot of infrastructure, since Turkish Stream would tap into existing pipeline networks north of Istanbul that deliver natural gas southward via the Ukrainian route. Italy could gain from the project, but it is already tied into other networks and is not heavily reliant on Russian natural gas. Economic constraints on many of the countries in Southeastern Europe, including Turkey, limit the financial backing available for projects such as Turkish Stream. Russia's best hope is that Western Europe would provide loans or other means to incentivize the construction of networks to link to the planned Russian pipeline, but doing so would undermine the Europeans' policy of support for Ukraine and is thus politically unpopular in the European Union.

Second, Nord Stream was built in an entirely different geopolitical environment. Germany has become relatively assertive in negotiations with the Kremlin over the future of Ukraine. Nord Stream was planned and built without this tension as a backdrop. Moreover, Brussels has a greater political imperative to protect Ukraine's integrity and prominence. Its role as a transit state is key, because if Russia disrupts natural gas supplies to Ukraine, the Europeans will get involved, making the consequences more daunting for Moscow. Nord Stream was also built during a time of high energy prices, meaning high returns on investments in energy projects. Now that oil and natural gas prices are low, similarly high returns are unlikely.

Building the entire Turkish Stream pipeline project will be a complicated and protracted process, and the project may never reach its full potential. However, Russia's approach reveals a nuanced, low-risk plan for the pipeline. The capacity of the first of four planned pipelines is roughly equivalent to all of the natural gas that Russia delivers to Turkey through Ukraine. Moreover, the pipeline network that carries supplies from Ukraine to Turkey is already filled to capacity. Turkey is one of Russia's most important natural gas markets in the long term, and its natural gas demand has more than doubled over the past 10 years. By the mid 2020s, Turkey's natural gas demand could amount to the entire volume carried by the first two legs of Turkish Stream, and it will almost certainly need the amount of natural gas carried by the first leg even sooner.

This means that moving forward with Turkish Stream serves dual purposes: If the Europeans build the necessary infrastructure for Russia to tap into, then Moscow will have no problem accelerating the rest of the project. If not, then the new pipeline will still allow Russia to expand its export potential to the rapidly growing Turkish energy market.

naturalgaseurope.com