A Framework for Mitigating the Curse of “Next Prize” for Azerbaijan and Turkmenistan

Barış Sanlı

Abstract

This article starts with the motivation behind study as referring to natural gas as “Next Prize”, provided that LNG will be an important part of world natural gas trade. In the second part, technical details of LNG, reserves, new political reality in Turkmenistan and Turkey’s need for natural gas is explained. Third part is the discussion of rentier situation with ideas of Amartya Sen, Karl Polanyi, Joseph Schumpeter. The discussion is knitted to a conclusion in the final part.

Introduction

Is the natural gas “Next Prize”? The question makes an attribute to what oil industry has achieved during the 21st century. Natural gas is another form of hydrocarbon which can be defined as a gas phase oil. Generally oil and gas are found together, as well as there are gas only wells. Whether the geology or the science, will the paradox of plenty or the curse of oil affect the owners of “Next Prize”?

Azerbaijan and Turkmenistan are two emerging entrants to global gas market those are not having the chance to connect to major trade routes without collaborating with neighboring countries. After years of Soviet legacy, both countries have the scars and experiences of the past. Yet, their economic situation has started to change not long ago. The holders of the “Next Prize” are blossoming with rapid economic growth and being at the center of attention of gas hungry competitors. Winds are blowing by their side.

Figure 1 Hydrocarbon Price Hike

Between 2000 and 2008 the oil and natural gas prices have nearly tripled. In the first quarter of 2008, the prices alone has nearly seen a 30% increase. This has nearly tripled the revenues of the hydrocarbon exporting states. But none of the producers have escaped from the inflationary effect of this huge cash stream. Saudi Arabia is in trouble with high inflation, where as Russia is experiencing high levels of inflation. According to IMF, the developing countries will see double digit inflation numbers. The rise of oil and gas prices are increasing the revenue but biting the economic health in the producing countries.


Figure 2 Russia's export revenues from energy

Yet, there is no guarantee for them not to fall in to the same trap of Venezuela as mentioned in the Terry Lynn Karl’s Paradox of Plenty. The rentier situation of their economies and the tight balance of global oil reserves both push the prices and revenues of the corresponding states. With global warming and clean energy technologies becoming more important, their natural gas reserves become more important. The economies are cherishing the rise of revenues, but the developmental fates of these states are not differing from the other rentier troubles of the past, whether it is the traditional prize –oil, or next prize –natural gas.

This article(and the writer) favors the idea of coupling a rentier situation with a developing country’s experience. The lack of solid institutions and tax revenues of the state in both countries is a major characteristic of the resembling pattern of rentier states. Also, the power house is dominated by clans and the cronies of the leader. The efficiency of totalitarian states in the short term can be demonstrated in such countries, but the long term stability of these states is arguable.

Turkey on the other hand is an energy poor country in terms of natural resources. According to 2007 statistics, Turkey is nearly 73% dependent on imports in primary energy demand. Also, 64% of one of the major sources of primary energy demand, natural gas is exported from a single source, Russia. Most of the energy is used in power generation (electricity) sector and households. The high price of energy import bill (which is 28 billion $ in 2007) is expanding rapidly with sky rocketing oil prices. To compensate for this Turkey has to find more capital and built a more innovative economy to create more value added from the energy and labor.

Country / Amount (Billion m3) / %
Russia / 23 / 64
Iran / 6 / 17
Algeria / 4 / 12
Nigeria / 1 / 4
Azerbaijan / 1 / 4

Table 1 Turkey's import countries for natural gas

Turkey, Azerbaijan and Turkmenistan can gain a better strategic position by both collaborating with each other and acting together. The gains of each party differ. While Turkey purchases or trades a certain amount of gas from Azerbaijan and Turkmenistan, these countries may provide a certain amount of their revenues in Turkish financial system to isolate the inflationary effects of cash flows. Turkey also open the doors of Mediterranean and Europe to these countries directly and in collaboration with Turkey. An LNG liquefaction terminal at Ceyhan and a vertically bundled energy firm with a substantial amount of investments in renewable and nuclear power plants in Turkey is both an opportunity and a chance for all.

Azerbaijan and Turkmenistan will have the chance to sell some of their natural gas through Ceyhan in LNG form, which is a value added product. Also, with their investment in Turkey, they will own an energy corporation in a European candidate state. The structure of the energy corporation will share experience of Turkey’s renewable projects and upcoming nuclear technology with these states. Both countries will benefit from trade as well as shared investments and research and development.

Natural Gas Demand, LNG and Reserves

Gas Demand

After the Ukrainian gas crises, Europe has started giving a special importance to Central Asian countries. During the German presidency of EU, a new Central Asian policy has been crafted. The first gas disruption occurred on December 21, 2005 when Turkmen gas flows were abruptly halted, until a rapid negotiation between Ukraine and Turkmenistan resulted with a price of $58/mcm (50:50 cash/barter) on 3 January 2005. In January 2005, the new joint venture RosUkrEnergo was became the shipper of Turkmen gas. (Stern 2006)

During 2006 crises, Russia increased the natural gas prices for Armenia, Georgia and Azerbaijan to $110/mcm. According to Cohen, “During the 2006 crisis it would have been very useful for the EU to have known the contractual obligations which existed for supply and transit of gas between: Turkmenistan and Russia , Turkmenistan and Ukraine and Russia and Ukraine” (Cohen 2006).

These gas disruptions increased the importance of both Central Asia and LNG especially after 2007. Central Asia provided an alternative source for Europe’s surging demand, while LNG provides spot purchases of natural gas without a need for pipeline infrastructure.

LNG

For natural gas to be “next prize” one of the very important requirements is the liquidity of trade, both globally and regionally. Natural gas is currently mainly transported through pipelines and long term agreements. In oil business however, you can buy and sell oil overnight and let it delivered to the port you requested.

This is one of the major advantages of oil markets. Natural gas does not have this kind of flexibility. Liquefied natural gas or LNG is natural gas that has been converted to liquid form by cooling down the gas and providing a 1/600 shrinkage in volume. This lets the gas to be stored or transported easily. LNG is odorless, colorless, non-corrosive, and non-toxic. When vaporized, it burns only in concentrations of 5% to 15% when mixed with air. (Wikipedia, Wikipedia 2008)

Up to a certain distance, it is economic to carry the gas through pipeline. But if the distance has increased to more than 3000 km and volumes more than 5 bcm/year, LNG becomes a good alternative.

Figure 3- Transportation of Natural Gas (Afgan, et al. 2007)

The flexibility of LNG is attracting many consumers’ attention. The deficits in supply and demands are generally compensated by spot LNG cargos. The price of the LNG can be up to 3-4 times that of an off-peak hub price, depending on demand and available cargos.

There are limiting factors as well. Such as , oil is a unique resource for transportation sector. The technology to substitute oil in transportation sector is years away. In addition the lack of widespread availability limits the prospects. LNG trade is less than 8%, where as oil trade is more than 50% between different regions.

Natural gas supply-demand chain for LNG starts from the liquefaction plant. The liquefied product is then carried in the world market through bunkers. These bunkers called as LNG cargos can be sold in the spot market up to 30 times after their departure from the ports, until the cargo is destined to final buyer. Then the buyer re

There are two types of LNG ports in the world.

  • Liquefaction
  • Regassification

World Liquefaction Capacity

Liquefaction is the process where dry natural gas is cooled down to liquid form. It is an energy consuming process and requires substantial investments to achieve this. Liquefaction is the process that defines the supply of LNG.

Figure 4 World LNG Liquefaction Inventory

Regassification is a process to turn the liquid natural gas in to gas form again. Currently most of the countries including Turkey has regassification plants. The forecast for regassification capacity is set to increase close to 40% in the next two years. This is a sign of LNG’s increasing popularity.

Figure 5 World LNG Regassification Inventory

According to CERA, “ The growing role of LNG in Europe’s supply portfolio has led many industry observers to believe that this new supply will bring about the break in oil-indexed pricing.”. Generally natural gas prices are indexed to oil prices, especially heating fuels. Historically this has been the norm due to economic substitution effect. Before becoming popular in power sector due to high efficiency (over 50% compared to a 35% coal plant), natural gas was a substitute for heating fuel. Therefore the indexation was done accordingly.

Therefore world LNG market is expected grow rapidly in the following years. If Turkey is to be an energy corridor an LNG liquefaction plant is a must to diversify markets. The likely forecasts for the world LNG market is as follows :

  • Global gas trade will increase from 22% today to forecasted 40% of world wide consumption in 2030.
  • Cost reductions in LNG train investments will lead to a more global market as the break even distances decline.
  • 50% of the 2030 gas trade will be in LNG
  • LNG trade will be done up to 30% on spot basis
  • Gas contracts start to be shorter term
  • The US, starting from nearly zero will be the second largest LNG importer in 2010 and the biggest in 2015
  • Prices in global gas markets are set on conversion

(Weisser 2007)

These forecasts are also shared by European gas importers and they assume LNG as a commodity to diversify their sources of supply. In 2004, only 11% of Europe’s gas imports were in LNG form. But new terminals are built and this capacity is set to at least double in the next 10 years. Europe’s biggest LNG provider is Algeria followed by Nigeria. The other countries are Gulf countries(Oman, Qatar, UAE), Libya and Trinidad & Tobago. (Harris ve Jackson 2005) North African LNG is important for Europe, that is why in Gas OPEC discussions Algeria and Russia are named as the key countries rather than Iran and Russia. If two countries come together, they will have a monopoly over European gas imports.

From the political economy side, LNG resembles oil, in the sense that the price is historically linked to oil prices. Therefore, the economic and politic effects of oil can be observed in the LNG market, if LNG succeeds to get truly global.

On the other hand, chances for both producer and consumer countries to trade this asset without long term commitments can be seen as a blessing as well as insecurity. The supply side requires security of demand, where demand side looks for security of supply. The pipelines provide the security for both sides. However, as Ukraine Gas Crises in 2006 have demonstrated, the transit countries can be a threat to security of supply.

Therefore, LNG increases the flexibility of trading natural gas. For both Turkmenistan and Azerbaijan, being part of global LNG market is not possible due to geographic constraints. The closest they can get is either Georgia for Azerbaijan or Iran for Turkmenistan.

In Caspian Sea Region, less than half of the total reserves are owned by Turkmenistan, followed by Kazakhstan and Uzbekistan. Azerbaijan has only 1/9th of Caspian reserves. The total can be comparable with Saudi Arabia’s reserves.

Central Asian Reserves

Figure 6 Natural Gas Reserves in the Caspian Sea Region(Cohen 2006)

Azerbaijan

Azerbaijan is one of the most important and historical countries in oil business. Oil was well known in Azerbaijan for centuries. Now oil is not as much as it was during the early 20th century, but natural gas has substituted the place left by depleted oil.

Azerbaijan’s gas reserves are close to 1.28 trillion cubic meter. Azerbaijan started exporting part of this natural gas by 2007 to Georgia and Turkey through Baku-Tblisi-Erzurum pipeline. Also, part of this gas has been exported to Greece through Turkey. This was the first time, Central Asian gas has been reached to Europe without Russian infrastructure.

Figure 7 Azerbaijan's Natural Gas Production (2005-2007)

With the completion of BTC oil pipeline and BTE natural gas pipeline Azerbaijan’s prospects in the region and the world has changed. Although not a big exporter of gas, Azerbaijan has became a stability factor for ailing Georgian economy and an minute alternative to Russian gas. In November 2007, Azeri gas has been carried to the Greece via Turkey-Greece interconnector. This has been a historic moment. Caspian gas was carried to Europe without Russian infrastructure.

Figure 8 Azerbaijan's Natural Gas Balance (BP Statistical Review 2008)

Turkmenistan

Saparmurad Niyazov, Turkmenbasi, was an inward looking eccentric man who was trying to erect his legacy over the country. His death has raised suspicion over the stability and continuation of the Turkmenistan’s existing policies. Will the country turn to a country like Nigeria and domestic unrests occur? Berdimuhammedov with his speeches had drawn a different picture than his predecessor.

After Niyazov’s death on December 21,2006 at the age of 66, the State Security Council and cabinet ministers have chosen deputy prime minister and health minister Gurbanguli Berdimuhammedov as the acting president. At the same time the constitutional acting president, speaker of Meclis has been detained on vague charges. The first message of Berdimuhammedov to the people was to remain calm and do not expect any change in Turkmen domestic and foreign policy. Air flights and train traffics into the country were halted and internet connections disconnected. The isolated country became more inward looking. Berdimuhammedov promised “undeviating … democratization of society, broadening of openness and the enlistment of people’s efforts in the administration of the State” before the upcoming elections. He also said that secondary education will be restored to ten years and higher education to five years with an increase in educational and medical exchange program. Most excitingly, he vowed to provide access to internet “to all Turkmen” (Nichol 2007)

Amazingly enough, Berdimuhammedow made his first official visit abroad, after becoming president, to Saudi Arabia in mid-April 2007. There he performed the pilgrimage umrah, and met with King Abdullah. He then visited Russia and its president Vladimir Putin at the end of the same month.(Wikipedia 2008)

This more openness policy has risen hopes for alternative routes. In the solution of this problem, Berdimuhammedov has portrayed a constructive behaviour. His arrival has started a new era between Azerbaijan and Turkmenistan. The high mood is reflected in solving crises of the past such as the debts from the 1991-92 natural gas usage. Slowly by positively, both countries are expected to overcome the diplomatic problems from the Niyazov era. (Oğan, 13 Mart 2008)

For the year 2004, Turkmenistan’s 44 bcm of 55 bcm of natural gas production has been exported. The biggest share has been Russia and Ukraine’s with 39 bcm of natural gas carried through Central-Asia-Center (CAC) pipeline. Only 9% of the whole production has been exported to Iran. The largest gas field in Turkmenistan is the Dauletabad-Domez field in the Southern part with reserves of 1300 bcm.(Uwe Remme 2008)

Turkmenistan’s gas reserves are also essential for Russia, too. Gazprom can be the largest gas company in the world but to fulfill the agreements Gazprom have to purchase gas from Caspian region. Gazprom and Turkmenistan agreed on a trade of 70 to 80 bcm annually from 2009 to 2028. In 2006, Turkmenistan agreed on the price of 65$/mcm to deliver as much as 30 bcm. (Stern 2006) This also provided the Russian gas sector to postpone the greater risk of failing to increase production in line with her agreements. (Kjarstad ve Johnsson 2007)

Turkmenistan’s gas reserves are around 2.67 trillion cubic meter cube. The natural gas balance sheet is as follows: