Azerbaijan’s short window of opportunity to realize its ‘Pipe Dreams’
Lead: “Azerbaijan the producer, Georgia the transit supplier, and Turkey the final exporter”, dixit Robert M. Cutler, an expert in energy in Eurasia, in 2019[1]. While this statement holds true today, Baku should exert maximum effort to become both a producing and transit player itself by pushing through projects to complete the White Stream project across the Black Sea and with Turkmenistan through the Trans Caspian Pipeline. In doing so, it can enrich itself while fulfilling the European Union’s desire to diversify from Russian gas — even if the diversification is marginal at best.
Caucasian energy finally links up with Europe
On the last day of 2020, a symbolic delivery of gas stemming from the Shah Deniz II field in Azerbaijan entered Italy. The event heralded a critical juncture for Baku, where converging interests meet at the nexus of Azeri geo-economic reality. Despite the major global disruptions of 2020 and 2021, the trans-Caspian and Caucasian corridors lie at the center of European-Asian connectivity. Energy is touted to become a core piece in this link. EU officials are seeking to complete their flagship Energy Union[2], whereby interest in energy diversification projects is high. Having completed the final section of the Southern Gas Corridor (SGC) at the tail end of 2020[3], Azerbaijan has been delivering natural gas to continental Europe through Georgia, Turkey and from there on to Greece and Italy. Baku has a short window of opportunity to exploit the juxtaposition of Brussels’ aim to diversify its hydrocarbon-based energy supply while looking to decarbonize by 2050.
Three challenges arise for Azerbaijan. First, the current SGC capacity is insufficient to respond to the EU’s needs. Second, its annual gas production is unable to meet the EU’s declared energy objectives. Third, with the EU aiming to be climate-neutral by 2050[4], i.e. emit net-zero greenhouse gas emissions, carbon-offsetting or mitigation measures will likely be required. All three need to be addressed. It is in Baku’s interest to facilitate the completion of the upstream link with Turkmenistan; to collaborate with Georgia and the EU in completing a SGC offshoot across the Black Sea into Romania; and to future proof its infrastructure to accommodate both higher capacities and potential hydrogen deliveries. Baku’s path forward lies in its momentum gained by the SGC’s Phase One completion, the thaw of relations with Turkmenistan, and a solidified Azeri position in Southern Caucasus infrastructure following its victory over Armenia in the 2020 war.
Diversify, diversify, diversify
For years, the EU ostensibly pursues diversification in its energy supply from Russian gas. The SGC in its current form is a part of the answer. On New Year’s Eve 2020, the final SGC section known as the Trans Anatolian Pipeline (TAP) leading into Italy was completed, with the first gas transported the same day. Its capacity is 10 billion cubic meters per annum (bcm/a)[5], with current deliveries standing at just half that[6]. According to adopted EU documents, at least 10–20% of EU gas demand is to be met by deliveries through the SGC “in the near future”[7]. Over the last five years, EU demand fluctuated between 394 and 494 bcm/a, indicating a desire for the SGC to deliver around 40 to 100 bcm/a — a far cry from the roughly 2.5% it can deliver, and the 1.2% of energy imports it accounted for in the first half of 2021[8].
Ramping up infrastructure investments is therefore critical for Baku to respond to the EU’s objectives and to ensure economic recovery at home. The principal bottleneck to overcome, initiatives are underway to resolve it. Azerbaijan says capacity is expected to double to 20 bcm/a[9] by building two more compression stations[10] in the second phase of the project sometime after 2026[11]. In early 2019, EU Commissioner for Budget and Human Resources Günther Oettinger stressed that there were plans to increase SGC volumes to 20–25 bcm/a within the next decade[12], but failed to deliver on further precisions. Phase two completion is certain to be years away. Azeri officials further claim capacity can even be tripled, but how they intend to do so — let alone the associated timeframe — is unclear.
Either eventuality of 20 or 30 bcm/a falls short from answering the EU’s declared minimum needs. Additional transport capability needs to be built. The White Stream offshoot is another work-in-progress initiative, projected at 15–16 bcm/a. It would cross the Black Sea from Georgia into Romania. Slated for 2016, the project is already years behind schedule. Currently expected to start deliveries to Romania in 2023, its exact status is unclear. It would initially operate at 8 bcm/a, while possibly expanding to 16 and ultimately 32 bcm/a. The Interconnector Turkey–Greece–Italy (ITGI) is another initiative, clocking in at 8 bcm/a. Originally a competitor to the TAP aiming to bring gas from Shah Deniz to the EU, its future is ambiguous due to the TAP’s completion.
Palatability of large-scale international infrastructure initiatives across the Southern Caucasus improved following Baku’s victory over Yerevan and Stepanakert in 2020. A crucial pipeline corridor crossed within missile range of the Nagorno-Karabagh border, making it vulnerable to disruption by Armenian forces. Following territorial gains by Baku, security issues around the Ganja Gap — as it was known due to Azerbaijan’s second city Ganja lying at the center of the chokepoint — have largely been resolved. Pipeline capacity in the Southern Caucasus stands at 25 bcm/a and will need to increase. With a surer security footing and apparent political backing by its counterparts in Brussels, Baku would do well to throw its regulatory, political, and financial heft behind the privately-owned construction companies responsible for boosting SGC’s capacity, in which White Stream could play a critical role.
Entering a transitionary phase
Azerbaijan does not extract sufficient gas reserves to fill its export capacity. This issue will only intensify if and when future SGC pipelines come online. While it can attempt to boost domestic production, it should look to Turkmenistan to fill its pipelines. Azerbaijan produces 26 bcm/a, half of which is for domestic use. Around 12.6 bcm/a is contractually allotted to Turkey, with 11.1 bcm exported in 2020 and 9.5 bcm in 2019[13]. A further 1.5–2.5 bcm/a is sent to Georgia[14][15]. With an additional 10 bcm/a destined for Europe, Azeri’s gas extraction is at its limits without considering domestic consumption. Baku presides over three options. It can attempt to change its energy mix to move entirely away from gas, on which it depends for nearly two thirds of its energy use. This is simply unrealistic. Renegotiating export volumes with Turkey and Georgia is a short-term possibility, but not a durable one. Third, and most favorable, is that it finds alternative sources of gas domestically or internationally. The likeliest outcome is a mixture of renegotiations and locating additional supply. This would equally assist in preparing Azerbaijan for future pipeline developments while mitigating short term gluts.
Before 2020, Azerbaijan exported to two countries: Turkey and Georgia[16]. In satisfying EU demand, Ankara and, potentially, Tbilisi would need to acquiesce in relegating itself to largely a transit role for Azeri gas, rather than a destination one. This is conceivable, but not guaranteed. Ankara seeks to reduce its dependence on imports by pipeline which are indexed to crude oil in long-term contracts, instead preferring to import cheaper spot LNG[17]. Also considering the “one nation, two states” posturing frequently shared by the two countries, Ankara could be inclined to consent to Azeri overtures. Georgia relies on Azerbaijan for 90–100% of its gas requirements[18]. Despite constituting a smaller market, Tbilisi’s demands will need to be heeded to transport gas onwards to Europe. Baku should continue its multi-vector policy and generally fruitful relations with these two countries to nurture closer cooperation within the Greater Caucasus and with Europe.
Azerbaijan needs to significantly beef up extraction infrastructure if it seeks to supply itself, the EU, Georgia, and potentially Turkey. The EU has set decarbonization targets for 2050, thereby imposing a three-decade calendar which would make its economically difficult to profit from such large-scale investments in a short deadline. Azerbaijan faces a glut due to limited domestic production volumes. This will only be exacerbated as regional transit capacity expands. Surplus throughput would need to be filled. Azerbaijan’s enjoys 2.5 trillion cubic meters of proven gas reserves, equivalent to five to six years of total EU gas demand or nearly a century of production at current rates. It would be wise to seek the additional supplies elsewhere, especially with the EU’s decarbonization target looming.
Enter Turkmenistan. Turkmen gas could flow to the West at the same time as Azeri gas, as declared by Vitaly Baylarbayov, deputy vice-president of the national State Oil Company of Azerbaijan Republic (SOCAR) responsible for the SGC. Ashgabat repeatedly expressed its interest in large-scale gas export to the EU. Turkmenistan completed the East-West Pipeline in 2015, allowing 30 bcm/a of Turkmen gas from its eastern reserves to travel to its shores, across the Caspian Sea, and onwards to the West — in theory. Without the remaining link to Azerbaijan, this corridor lies dry. Azeri-Turkmen relations are usually fraught with discord, although relations between Baku and Ashgabat are on an upswing since the Convention on the Legal Status of the Caspian Sea was signed in 2018, followed by an emblematic Memorandum of Understanding signed in 2021 regarding the joint exploration and development of a particularly contentious offshore field. A longstanding sore point in bilateral relations, it was symbolically named Dostluk or “friendship” in both Turkmen and Azeri.
The Trans-Caspian Pipeline (TCP) has an expected capacity of 30 bcm/a and would connect the littoral Caspian states. It remains some years away. White Stream is actually the initiative intended to syphon Turkmen gas on towards Europe once it reaches Georgia; Baku should facilitate completion of the TCP as it should White Stream. Turkmenistan presides over some of the world’s largest proven gas reserves of 13 trillion cubic meters, equivalent to 7% of the world’s reserves. Russia presides over 20%. Azerbaijan 1.3%[19]. With 59 bcm extracted in 2020, Turkmenistan could continue to extract gas at the same rate for 230 years. While it is locked into long-term contracts with China to deliver 30 bcm/a gas, it possesses ample remaining reserves to send to Europe. Assuming a doubling of TAP capacity to 20 bcm/a and the completion of White Stream at 15 bcm/a, this scenario is the only one where Azerbaijan largely succeeds in supplying its domestic and downstream consumers. This said, due to high capital outlays and treating high sulfur content, Turkmen gas might come at an elevated price. It will ultimately depend on Europe’s appetite to pay for a diversified gas supply — and its commitments to reaching net zero emissions.
Europe’s uphill battle to enact Turkmen and Azeri reforms
The West is painfully aware that Turkmenistan is scandalously corrupt, grotesquely authoritarian, and a serial human-right abuser. Azerbaijan is comparatively better, although its authorities are repressive and autocratic at the best of times. The Aliyev dynasty — Azerbaijan’s despotic ruling family since 1993 — initially established and subsequently strengthened their family-based dictatorship using windfalls from oil revenues. Current president Ilham Aliyev and his associates are certain to have their finger in the pie, being intimately linked to SOCAR’s management tasking with constructing the SGC[20]. The Turkmen kleptocracy dwarfs even the Azeri one, with president Berdimuhamedov family imposing a personality cult unrivaled anywhere in the world. Following his predecessor’s death, Berdimuhamedov restructured the oil and gas industry around his family, creating NAPECO, a closed corporation swallowing up the previous state agency responsible for hydrocarbons, other national organizations, and oil refineries. The organization is believed to syphon most of the generated oil wealth[21]. Direct construction and maintenance jobs as well as indirect employment stands to benefit citizens of both countries, but to a significantly lesser degree than their leaders — especially in Turkmenistan. In contrast, the regimes around Aliyev and Berdimuhamedov stand to gain considerable financial wealth with the SGC’s expansion.
The EU should receive no commendation in collaborating with such repressive if not outright oppressive regimes such as that of Turkmenistan. However, there is a limited opportunity for the EU to implement best practices and push for reforms in both states. This can receive modest success, as energy infrastructure in Georgia aided in modernizing the country[22]. However, Azerbaijan and Turkmenistan are not Georgia. In reality, the EU stands to fail in exerting effective pressure on the Caspian littoral neighbors, with the political status quo reigning supreme and delivering further boons to the regimes in power. Baku will likely lose little in pressing forward with upstream and downstream construction.
Feeling blue — opportunity comes knocking for hydrogen?
The EU’s Green Deal jeopardizes investments in long-term hydrocarbon projects. The 2019 strategy intends to form a carbon neutral space in the EU in for the next 30 years. Accordingly, all new gas arriving in the EU will need to be decarbonized. In theory, this all but limits the lifespan of the SGC to three decades. While it remains possible that the EU will renege this date, especially if natural gas takes more of an interim role as a relatively clean petrochemical energy source, it risks rendering multi-billion projects such as the SGC unpalatable to investors. EU members are planning severe reductions in hydrocarbon use to reach the goals of the Paris agreement. Expanding gas import capacity stands at odds with these goals; it could even lock-in emissions beyond 2050[23]. Effects of climate change aside, Baku stands to benefit from such developments. Azerbaijan can capitalize on the interim period, but it should also set itself up for an alternate future.
One alternative is that the SGC — and other existing gas infrastructure — would be used to transport and store hydrogen. One-fifth of the pipeline capacity of TANAP running through Turkey could be used to transport hydrogen to Europe without additional investments. Though cleaner than natural gas, such blue hydrogen (“blue” indicates the hydrogen is produced from hydrocarbons) still produces greenhouse gases. The EU is developing its hydrogen strategy, but the technology itself struggles with widespread adoption even in the most advanced economies. Doubts remain that there will be sufficient demand in the future to render (blue) hydrogen a sustainable, realistic, and affordable alternative to natural gas. Azerbaijan could bank on renewable energy, being in a prime position to take advantage of its natural resources. However, with electricity transportation costs high, it will not be able to export much of it. The low hanging fruit and existing infrastructure around petrochemicals make it an enticing option to simply continue extraction as-is.
A drop in the bucket
By using its diplomatic clout and negotiating competences, elites in Baku can enrich their country — not to mention themselves — by accelerating the extension and expansion of Southern Gas Corridor infrastructure along the upstream Trans Caspian Pipeline and the downstream White Stream projects. It must do so swiftly. With a three-decade ultimatum set by the EU, there is a small window of opportunity to benefit — even if Europe’s net zero emission horizon is prolonged. Revenues from domestic extraction and Turkmen transit fees would be considerable for Azerbaijan. It can grandstand its hydrogen capacity as a way to safeguard a climate-friendly future — neverminded the feeble chances of success.
In contrast, the EU stands to fail in its quest for diversification, although this was never realistic through the SGC alone. Risking being locked-in into non-green hydrocarbon infrastructure due to SGC and other import-boosting initiatives, it could also miss its self-imposed deadlines. Even in a scenario where the SGC would transport 20bcm/a through TAP and 16 bcm/a through White Stream, the combined capacity of 36 bcm/a falls short of matching Nord Stream 2’s dimensions alone at 50 bcm/a. Russia’s gas imports stand at 180 bcm/a, while the EU’s gas consumption hovers between 400 and 500 bcm/a over the past five years. SGC would account for less than 10% of EU’s gas imports and fifth in terms of volume behind Russia, Norway, Algeria, and LNG imports[24].
At its core, the SGC is a drop in the bucket for European diversification, which remains a distant pipe dream. For Baku, the same drop will fill its entire bucket — and state coffers.
Author — Dylan van de Ven is a fellow at the Caucasus-Asia Center.
[Disclaimer- The opinions expressed in this article are those of the author. They do not purport to reflect the opinions or views of the Caucasus-Asia Center or its members.]
References
[1] The Caspian Sea Basin and Europe’s Energy Security | Beyond the Horizon ISSG (behorizon.org)
[2] Southern Gas Corridor — Bankwatch
[3] Just under 1 bcm in the first 4 months of 2021 https://nationalinterest.org/blog/buzz/has-trans-caspian-pipeline%E2%80%99s-time-finally-arrived-187737
[4] 2050 long-term strategy | Climate Action (europa.eu)
[5] TAP transports first 1 bcm of natural gas to Europe › Trans Adriatic Pipeline (TAP) (tap-ag.com)
[6] Azerbaijan and Turkmenistan agreement advances Caspian gas cooperation — Eurasianet
[7] The Project — WS | White Stream (white-stream.com), A lack of critical public debate: Questioning the EU’s support for the Southern Gas Corridor | EUROPP (lse.ac.uk)
[8] quarterly_report_on_european_gas_markets_q1_2021_final.pdf (europa.eu)
[9] The news you possibly missed: TAP pipeline up and running — EURACTIV.com
[10] Southern Gas Corridor: the final TAP — Valve World (valve-world.net)
[11] Southern Gas Corridor: the final TAP — Valve World (valve-world.net)
[12] Commission eager to see the capacity of Southern gas corridor doubled — EURACTIV.com
[13] Azerbaijan boosts natural gas exports to Turkey | Hellenic Shipping News Worldwide
[14] Azerbaijan energy profile — Analysis — IEA
[15] Georgia to Reduce Natural Gas Imports from Azerbaijan by 2.5% in 2020 — Caspian Barrel
[16] Azerbaijan (AZE) Exports, Imports, and Trade Partners | OEC — The Observatory of Economic Complexity
[17] Legacy Azeri gas flows to Turkey halted on contract expiry: source | S&P Global Platts (spglobal.com)
[18] Azerbaijan Becomes Monopoly Supplier of Natural Gas to Georgia — Jamestown
[19] Statistical Review of World Energy | Energy economics | Home (bp.com)
[20] Southern Gas Corridor — Bankwatch
[21] Turkmenistan: A Model Kleptocracy — (crudeaccountability.org)
[22] US foreign policy and Euro-Caspian energy security: The time is now to build the Trans-Caspian Pipeline — Atlantic Council
[23] Europe Gas Tracker Report 2021 (globalenergymonitor.org)
[24] quarterly_report_on_european_gas_markets_q1_2021_final.pdf (europa.eu)
