WINTER CRISIS

"Winter is coming."This motto of the House Starkfrom the popular TV series Game of Thrones accurately encapsulates Europe's fears regarding the import of Russian gas in light of the deepening crisis between the Ukraine and the Russian Federation.

Ukraine itself turned down Russian natural gas several months ago due to the high price - 485 dollars for a thousand cu m - and set up the import of natural gas from a number of European countries: Poland, Slovakia, Hungary. At the same time Kiev filed a suit at the Stockholm Court of Arbitration because of what Kiev calls discriminatory pricing. Kiev is in no hurry to accept Russia's offer of a 100-dollar discount in the form of elimination of customs duties; the Ukrainians insist on changing theten-year contract from 2009 that established such a high price. Kiev's position on this issue is understandable - the Russian Federation already gave a hundred-dollar discount in exchange for a rent agreement on the Sevastopol base for the Black Sea Fleet, and in late 2013 even lowered the price to 260 dollars, though with the caveat that this reduced pricewould be reexamined once every quarter. However, when the Crimea later joined Russia, Sevastopol automatically became part of Russia, and Moscow cancelled all discounts to Kiev, returning prices to their initial level - 485 dollars per cu m. With such a turn in events Kiev wants a long-term gas price in writing that does not depend on separate decisions by the Russian government.  

Meanwhile, as the Ukraine lives without Russian natural gas by cutting back on consumption and increasing coal usage as well, a possible winter crisis looms. As R+ has been told by Azerbaijani students studying in the Ukraine, this academic year the winter break may be expanded from the current one or two weeks to the months of January and February in their entirety. The reason - possible disruptions to the country's natural gas supply. 

What's more, this winter Europe won't be able to deal with Ukraine's problems in this area - it will be focused on satisfying its own needs. It's no secret that up to fifty percent of Russia's gas exports to Europe go through Ukraine's gas transit network. If the Kiev-Moscow conflict worsens, Moscow may completely cut off the flow of gas - a scenario which has already taken place in the recent past. Not only is Brussels unable to solve the problem of guaranteeing gas supplies - it is also unable to get Kiev and Moscow to sit down at the negotiating table. 

No matter how hard Europe tries to get rid of Gazprom's monopoly, in the next few years it will not be able to. According to a report from the ratings agency Fitch Ratings, Europe is very unlikely to be able to reduce its dependence on Russian natural gas for at least another decade, and possibly for much longer. 

Attempts to increase energy security by decreasing Europe's dependence on Russia will require either a significant decrease in the overall demand for gas or a significant increase in supply from alternative sources. Both possibilities are considered unlikely by analysts at Fitch. With all this going on, Europe's improving economy also entails increasing demand forsources of energy, which will cancel out the effect of energy efficiency measures. 

Fitch expects a faint increase in the European demand for natural gas until the mid- 2020s. The growth may then accelerate as electric power plants that use gas will replace old coal-driven and atomic power plants. However, experts say that even if coal and atomic power are given preference over gas-driven power, the effect on Europe's energy security will be limited, since Russia also supplies 26 percent of the EU's coal and is the only supplier of nuclear fuel rods for atomic power plants in a number of countries. 

Fitch also points out the underdevelopment of the extraction of shale gasand believes that at least a decade is needed before production of this fuel can reach significant volumes. By then shale gas will, in all probability, only compensate for a decrease in extraction at traditional gas fields in the region. 

"Piped gas imports from markets other than Russia are also likely to remain limited. We believe the Trans-Anatolian Gas Pipeline is the only viable non-Russian pipeline under consideration. This could provide 31bn cu m of gas a year by 2026, but that is not enough to cover the incremental increase in gas demand we expect over the period, let alone replace any supplies from Russia," notes Fitch Ratings.

A third alternative source is liquefied natural gas (LNG). Fitch predicts that world LNG production capacity will increase by about 70bn cu m by the end of 2017. However, a significant portion of this new output will be tied to long-term supply contracts, and availableLNG output in the world will, in all likelihood, be low, at only a few dozen billion cu m. 

It's hard to disagree with Fitch Ratings. Among potential suppliers of gas to Europe one can name Iran, Iraq, Turkmenistan, and the United States. Virtually all possible gas supply projects from these regions run into either political or price problems. 

At last week's Caspian Shelf conference in Baku Liana Zhervalidze, advisor to the head of the Georgian Oil and Gas Company, stated that Iran and Turkmenistan possess some of the world's greatest gas supplies - 33 trillion and 17 trillion cu m respectively.  However, for several years now Iran is under strict Western sanctions, part of which will stay on the agenda because of Teheran's nuclear program. Even the lifting of sanctions will not enable quick access to Iranian gas by European markets, since it would require large-scale investment in extraction and transport. In the latter case support may come from the Southern Gas Corridor's system (the Trans-Anatolian and Trans-Caspian pipelines), created as part of a project to deliver Azerbaijani gas to Europe. 

Zhervalidze believes that Turkmenistan, on the other hand, is willing to deliver up to 30bn cu m of gas to the European market right now. Turkmenistan is building a gas pipeline from the eastern part of the country, where the primary oil fields are located west of the Caspian coast. In the future, however, there stands the question of the construction of the Trans-Caspian Gas Pipelineand the willingness of Ashgabat to sell gas at its border. Due to these factors it is unclear who will have to buy this gas on the eastern shore of the Caspian - Azerbaijan, Turkey, or European countries interested in diversifying their energy sources. 

Supply of Iraqi gas to the European Union comes up against the country's political instability and lack of coordination between autonomous Kurdistan and the central government in Baghdad regarding authority and the distribution of income from the export of fossil fuels. 

During delivery of shale gas from the United States, according to Zhervalidze, liquefied gas, no matter how cheap it is at the source, will be quite expensive on the consumer market due to the large investment into the creation of liquefaction and regasification terminals and gas tankers. Therefore shale gas from America will have trouble competing with natural gas delivered through pipelines in this regard. 

In light of these factors at the moment the most realistic means of diversifying Europe's energy deliveries remains Azerbaijan, which has already launched a second-stage development project for theShah Deniz [Sah Daniz] gas field together with the construction of gas-transit infrastructure into Italy. 

At the same time the European market is also the most attractive for Azerbaijan due to Europe's stable pricing and growth of consumption. According to Gulmira Rzayeva, an expert at the President of Azerbaijan's Center of Strategic Research, the European market will open a multitude of outlets to various pipelinenetworks, enabling the delivery of gas to many markets - a priority for suppliers. 

"In this regard Italy has good intersections with other countries. Transit pipelines to Switzerland and Germany are already in place, with additional ones being built. These pipelines also allow delivery to Austria and France. The only issue in supplying Azerbaijani gas to other European countries is ensuring reverse flow from southern to northern Italy. The European Commission is willing to earmark 150 million euros for this. With this in mind, Italy is developing a strategy in which it is a southern gas hub, and Azerbaijani gas will play a part in this strategy," she said. 

Gulmira Rzayevaholds that fears that Russian gas supplies to Europe will be interrupted will open a big opportunity for Azerbaijan. For instance, the countries of the Balkans do not want to rely on only one source and are ready to begin buying Azerbaijani gas in 2015. Although the amount of gas from the Shah Deniz gas field is not that significant for the European market, it will be the first new source of supplies in ten years. With this in mind Azerbaijani gas is headed for the markets of the Balkans and southern Europe, where consumption is rather low, and until now satisfied by only one source. In particular, the vice premier of Macedonia Zoran Stavreski has recently expressed his interest in joining the TAP project.

In Gulmira Rzayeva's opinion, the construction of the TAPpipeline in Greece and Italy will have a significant influence on the economies of these countries, and will also contribute to the creation of new jobs in these crisis-hit regions. "In the future the Southern Gas Corridor will open a path into Europe for gas from Iraq and the Middle East in light of leading development on the Israeli shelf, and in further prospective for Iranian gas as well," the expert stated. At the same time one can already say that Azerbaijan's gas resources are not limited to the Shah Deniz gas field. As First Vice-President of the State Oil Company of the Azerbaijan Republic (SOCAR) Xosbaxt Yusifzada announced at the Caspian Shelf conference, thanks to the opening of the Shah Deniz, Absheron [Abseron], and Umidfieldsand a number of other gas reserves the country has reached a level of 2.5 to 3 trillion cu m in recent years. 

"Future structures will give us the opportunity to forecast larger reserves of gas. In the last few years deep well-drilling has found mainly gas reserves. Practical experience from all over the world and the geological conditions under which hydrocarbons are formed support the law that at great depths gas is more often found than oil. With future structures in mind I can say that Azerbaijan's gas reserves may grow to 6 trillion cu m in the next few years," said Yusifzada. 

He noted that September 20 will mark the twentieth anniversary of the signing of the development contract for the Azeri-Chirag-Guneshli[Azari-Ciraq-Gunasli] fields, which went on to become the country's main driver of development. It is no accident that thefoundation-laying ceremony for the Southern Gas Corridor is set for that day. The ceremony will take place at the Sangachal[Sangacal] Terminal, which marks the beginning of the route. 

"This agreement, named the nation-wide leader for 'Contract of the 20th Century', was a new stage in the development of the oil industry. First, it sent a message that Azerbaijan is a stable state where one can work. That is the political meaning of the contract. The economic meaning is this: whereas in 1997 we extracted only 9 million tonnes of oil, in 2010 we extracted 51m tonnes. After this contract a further 32 contracts were signed to develop Azerbaijan's oil and gas reserves, which attracted over 50 billion dollars of investments into the oil sector alone,"saidYusifzada.

According to Yusifzada, perspectives for growth in oil extraction in Azerbaijan are most closely tied to land-based structures. "Now the technology has developed significantly, and together with Statoil, Total, and Conoco we will carry out mining of Mesozoic deposits. Earlier we had surveyed there, drilling 350 wells in the process, all to no avail. Now we think that we can get positive results.On top of that SOCAR is now carrying out joint surveys with Noble Oil and ExxonMobil for shale deposits of oil and gas," he said. 

Development of the Azeri-Chirag-Guneshli oil fields opened up great opportunities for Azerbaijan's economic growth. 

Proceeds from the extraction of oil from the Azeri-Chirag-Guneshli fields exceeded 100 billion dollars. These funds contributed not only to the execution of essential socio-economic projects for the current state and development of Azerbaijan, but also enabled investment for future generations. In particular, the State Oil Fund of Azerbaijan bought high-end real estate in London, Paris, Moscow, and Seoul and is considering expanding this investment strategy. 

Thanks to the "Contract of the 20th Century" that revealed Azerbaijan's possibilities to foreign investors, the country is turning into an essential player in the European gas market. It is no accident that Azerbaijani President Ilham Aliyev named realization of the Shah Deniz-2 project and the construction of the Southern Gas Corridor pipelines the contract of the 21st century.