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May 14, 2010 | 12:10 GMT

11 mins read

Russia, Turkey: A Grand Energy Bargain?

VLADIMIR RODIONOV/AFP/Getty Images
Summary
After months of intense negotiation, it appears a grand energy bargain has been made among Russia, Turkey and Azerbaijan. The deal will allow Russia a stronger foothold in Turkey's energy sector, give Turkey the opportunity to mend relations with Baku and secure a crucial source for natural gas to supply the European market, and provide Azerbaijan with political and security guarantees in its territorial dispute with Armenia. Several parts of this deal are not only completely unprecedented in terms of scale, but also could unravel down the road when political priorities shift and other opportunities or threats arise. For now, though, Moscow and Ankara appear to have found a way to use energy to enhance the strategic entente between the two Eurasian powers.
Russian President Dmitri Medvedev paid a visit to Turkey on May 11-12, during which he signed agreements for $25 billion in projects — mostly in the energy sector — including a massive commitment to build a $20 billion, 4.8-gigawatt (GW) nuclear power plant. Medvedev's visit is the culmination of months of negotiations between Ankara and Moscow over where the countries could agree to disagree on the future of Eurasian energy flows. Turkey, straddling Europe, Asia and the Middle East, is looking to bolster its geopolitical standing by signing deals that would allow Turkey to transit energy from the East to the European markets. Russia, as the dominant natural gas supplier for Europe, wants to ensure Turkey does not give Europe too many options in circumventing Russian energy networks. Since Russia and Turkey are both resurgent powers in the region, the energy issue can turn quite thorny at times, particularly as the West is leaning on Turkey to keep its distance from Moscow. But Russia and Turkey are not looking for an energy brawl at the moment. Tensions exist between these historic rivals, but the current geopolitical environment is pushing the two sides to work with — instead of against — each other.

Competing Over Azerbaijan

Azerbaijan has long been a pawn in Turkey's negotiations with Russia. The country shares deep cultural and linguistic linkages to Turkey, and already transports roughly 9 billion cubic meters (bcm) of natural gas per year for the Baku-Tbilisi-Erzerum pipeline, which circumvents Russia and carries natural gas from Azerbaijan's offshore Shah Deniz fields through Georgia to Turkey for the European market. Phase II of Azerbaijan's Shah Deniz project is expected to come online in 2018 and produce 15 bcm per year, 12 bcm of which would be available for export. Turkey wants to secure as much of that remainder for export as possible so it can transit substantial amounts of natural gas through its territory for projects like the much-touted Nabucco pipeline, designed to provide Europe with a non-Russian-influenced natural gas alternative. Russia, which has a strategic interest in maintaining an energy stranglehold on Europe, naturally wants to ensure pipeline projects such as Nabucco remain pipe dreams. (click here to enlarge image) Such an opportunity arose for Russia roughly two years ago when Turkey began pursuing a diplomatic rapprochement with Azerbaijan's biggest foe, Armenia. Azerbaijan was deeply offended that Turkey would try to make nice with Armenia without first ensuring Azerbaijani demands were met on Nagorno-Karabakh, a disputed territory that Armenia seized from Azerbaijan in a war in the early 1990s. As Turkish-Azerbaijani relations deteriorated, Russia made sure it was there for Baku in its time of need, giving Moscow the leverage it was seeking over issues such as Shah Deniz II pricing agreements. So, whenever Turkey approached Baku for a pricing deal on Shah Deniz II, Russia would outbid the Turks and the Azerbaijanis would continue to hold out on a deal. At the same time, Russia used its clout over Armenia to ensure that Turkish-Armenian negotiations remained deadlocked. In the days leading up to Medvedev's visit to Turkey, however, signs of progress between Turkey and Azerbaijan over Shah Deniz II started coming to light. Azerbaijani Energy Minister Natik Aliyev announced May 5 that Turkey and Azerbaijan were coming close to a final pricing agreement to supply Turkey with a minimum of 7 bcm of natural gas from Shah Deniz II. According to a STRATFOR source, Turkish Prime Minister Recep Tayyip Erdogan has thus far made a verbal agreement with an advisor to Azerbaijani President Ilham Aliyev for Turkey to pay around $220-270 per thousand cubic meters. This starting price is considerably lower than the Russians' earlier offer of $300 per thousand cubic meters. It is unlikely to be a coincidence that these negotiations picked up just prior to Medvedev's visit. If Baku was moving forward with Ankara on a Shah Deniz II deal, the Russians likely facilitated these negotiations.

Nabucco On The Back Burner

However, this assistance came at a price. Russia does not want Azerbaijan's natural gas to go toward a pipeline project like Nabucco that directly violates Russian energy imperatives. That said, there are signs that Russia may be willing to let a bit of its energy stranglehold over Europe slip if, in return, it can more firmly entrench itself in Turkey, the crucial link to Europe's energy diversification efforts. According to a STRATFOR source, Russia has given its consent for now to the Turkey-Azerbaijan natural gas deal on the condition that the massive Nabucco project be shelved. The source claims Russia and Turkey have agreed for the time being that Turkey will focus its attention on another, smaller pipeline to carry the extra Azerbaijani natural gas: the Interconnection Turkey-Greece-Italy (ITGI) and Poseidon pipeline project. This pipeline would take Azerbaijani natural gas across Georgia and Turkey (through an existing Baku-Tbilisi-Erzerum pipeline) into Greece, and from there into Italy through an underwater pipeline across the Ionian Sea. The ITGI-Poseidon project would have a capacity of 11.8 bcm per year compared to Nabucco's capacity goal of 31 bcm per year. This difference in market share makes ITGI-Poseidon a more acceptable compromise for the Russians. Moreover, there is potential down the road for Russia to link into this pipeline project through its ambitious South Stream project led by Russian natural gas giant Gazprom, which aims to deliver Russian energy supplies to Europe across the Black Sea. The ITGI project — priced at roughly $507 million — would be far more cost effective than Nabucco, the total estimated cost of which is as high as $11 billion. The ITGI project is also already under way, with the Greece-Turkey connection having come online in early 2007. Under the European Economic Recovery Plan (EERP), the European Union has also pledged a grant of $126.9 million for the final section of the project, the Poseidon pipeline. It remains to be seen whether Turkey will be able to convince its European partners, now struggling with the Greek financial maelstrom, to put down more money to see through this project, as well as others such as Nabucco in the future. However, Turkey will be able to make a much more convincing argument for more funding if it can secure Azerbaijani natural gas to source these projects.

Azerbaijan's Demands

Azerbaijan's demands in this whole affair are quite simple. Baku wants a favorable price on its natural gas, but is also looking for guarantees from Ankara that the Turkish government will not pursue meaningful peace talks with Armenia without first addressing Azerbaijani concerns over Nagorno-Karabakh. Given that the Turkey-Armenia talks have been deadlocked since early spring, Turkey likely has the diplomatic bandwidth to offer such guarantees in the interest of securing this natural gas deal and mending its relationship with Azerbaijan.

Unprecedented Deal-Making?

Russia had to have a strategic purpose for it to start easing its grip on the Shah Deniz II negotiations between Turkey and Azerbaijan. That strategic purpose may have manifested itself during Medvedev's May 12 visit to Turkey. During that visit, two significant energy deals were signed that signaled Russian-Turkish energy integration on an unprecedented scale. The first deal was for the construction of Turkey's first nuclear power plant by a Russian-led consortium led by Atomstroyexport and Inter RAO. The power plant will have four reactors with a total capacity of 4.8 GW and cost roughly $20 billion. The scale of this project cannot be emphasized enough. If this nuclear power plant is built, Turkey will be home to one of the largest nuclear energy installations in the world. Russia has not even built a nuclear power plant on this scale for itself, and does not have a reputation for providing the necessary funding to bring such projects into realization. STRATFOR sources, however, claim many of the details of the deal have been worked out. Russia will have a controlling stake in the plant and sell the rest (up to 49 percent) to other investors, most likely Turkish firms such as AKSA, which has strong political and family ties to Erdogan and the ruling Justice and Development Party (AKP). The plant will likely be built in two stages; two reactors built, followed by the second two. The construction for the power plant near Turkey's southern Mediterranean coastal town of Akkuyu is expected to take seven years, and can only begin after both parliaments ratify the agreement. Instead of having Turkey pay a large amount of money up front, Turkish electricity firm TEDAS has signed an agreement to buy electricity from the plant for a minimum of 15 years, allowing Turkey to pay for the construction in installments once the plant becomes operational. Russia is expected to use this 15-year guarantee to secure loans for the project. Turkey will also have to rely on Russia for maintenance and the technological components for the plant, giving Moscow the long-term leverage it has been seeking in the Turkish energy sector. Still, $20 billion is an enormous sum, and STRATFOR remains deeply skeptical as to whether Russia will indeed follow through with its financial commitment to get this project off the ground. If it does, this project would signify a sea change in Russian investment behavior. It would also raise questions as to where else Russia could put its money in pursuit of its strategic energy goals. Another agreement was signed for Russia to supply a pipeline that would pump Russian oil from the Black Sea port of Samsun in northern Turkey to the Ceyhan oil terminal in southern Turkey on the Mediterranean coast. Turkish firm Calik Energy (which has close ties to the AKP government) and Italian firm ENI (which has close ties to Russian energy giant Gazprom) are building the pipeline, which will have a capacity of between 1.2 million and 1.4 million barrels per day. Russian Deputy Prime Minister Igor Sechin said the Samsun-Ceyhan deal would cost $3 billion, and STRATFOR sources claim Calik Energy will be responsible for financing most of the deal. The purpose of this north-south pipeline is to alleviate the heavy congestion of oil tankers traveling through the Bosporus and Dardanelles straits to travel between the Black and Mediterranean seas, an issue Turkey and international energy firms have been grappling with for some time. The main purpose of the pipeline will be to decrease traffic of the larger 350,000-400,000-ton tankers and free up the straits for the 150,000-ton tankers. The economic viability of this pipeline has long been in question, however, given that transit through the Bosporus and Dardanelles is free by law. It thus remains to be seen what economic incentives will be given for tankers to bring oil to Samsun port to be transported through the Samsun-Ceyhan pipeline. Turkey already imports more than 60 percent of its energy supplies from Russia, and that energy dependence will deepen if this pipeline becomes operational.

Nothing Firm Yet

STRATFOR will thus be closely watching the Turkish-Russian nuclear power and Samsun-Ceyhan agreements, as well as whether Turkey and Azerbaijan will strike a deal over Shah Deniz II in the coming days, as officials on both sides have been claiming. Any of these deals would only be sealed under a broader understanding between Moscow and Ankara. Yet each of these deals also comes with substantial caveats. In addition to the economic feasibility issues attached to the nuclear power plant and Samsun-Ceyhan pipeline deals, a potential Shah Deniz II deal would likely contain a number of loopholes. For example, Turkey can assure Russia right now that the extra natural gas it receives from Azerbaijan will not go toward Nabucco, and then divert the natural gas toward whatever project it chooses down the line. By the same token, Russia can facilitate negotiations between Turkey and Azerbaijan over Shah Deniz II right now to secure the energy deals it wants with Turkey on nuclear power and natural gas supplies, but can also use its influence with Azerbaijan to scuttle the Shah Deniz II deal between Ankara and Baku at a later point in time. Nothing is set in stone in this flurry of pipeline politics, but for now, Russia and Turkey appear to be working toward a mutual energy understanding.

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