The Nabucco Pipeline: A Sober Assessment November 2008 F. Wallace Hays The Nabucco Pipeline: A Sober Assessment A publication by the Center for European Policy Analysis (CEPA) November 2008 By F. Wallace Hays F. Wallace Hays is a Senior Adjunct Fellow at the Center for European Policy Analysis focusing on energy security policy. Hays concurrently leads FWH and Associates LLC, a non-partisan consulting firm specializing in international energy issues. He has more than sixteen years of experience in foreign policy, international relations and political and economic risk assessments, and has provided intelligence analysis and political risk assessments on American foreign policy issues to a variety of clients, including foreign governments in Europe and the Middle East, as well as several major energy companies. Center for European Policy Analysis 1155 15th Street, NW Suite 550 Washington, DC 20005 Tel: (202) 551-9200 Fax: (202) 296-3880 E-mail: [email protected] www.cepa.org © 2008 by the Center for European Policy Analysis, Washington, D.C. All rights reserved. No part of this publication may be used or reproduced in any manner whatsoever without permission in writing from the Center for European Policy Analysis, except in the case of brief quotations embodied in news articles, critical articles, or reviews. The views expressed in the publication are those of the author(s) and do not necessarily reflect the views of the staff, officers or board members of CEPA. ISBN: 978-0-9797433-6-8 1 Table of Contents Introduction ……………………………………………………………………..……….. 4 1. Lessons of BTC and Odessa-Brody.…………………………………….……........... 6 1.1 BTC and Elements of Success .……………………………..…………..……….7 1.2 Odessa-Brody …………………………………………………...………………. 10 1.3 Lessons…………………………………………………….……………………...12 2. Applying the Lessons of BTC and Odessa-Brody to Nabucco ..…………..............13 3. The Political Environment for Nabucco……………………………………………. 15 3.1 Current Political Conditions …………………………………………………... 15 3.2 Russia’s Energy Dominance ………………………………………………….... 16 4. Challenges Ahead for Nabucco……………………………………………………... 16 4.1 Finding the Gas …………………………………………………………………. 17 4.2 Tariff Structure and Economic Viability…………………………..................... 20 4.3 Competition from Other Pipelines ……………………………………………. 20 4.4 Financing……………………………………………………………...…………...21 5. Impact of Nabucco …………………………………………………………………… 21 5.1 Nabucco’s Impact on Total European Gas Supply…………………………... 22 5.2 Nabucco’s Impact on Incremental European Gas Supply…………………... 23 6. Scenarios for the Future …………………………………………………................... 23 7. Conclusions ……………………………………………………………........................ 26 2 List of Acronyms AIOC Azerbaijan International Operating Company BCM Billion Cubic Meters BCM/A Billion Cubic Meters Annually BTC Baku-Tbilisi-Ceyhan pipeline CPC Caspian Pipeline Consortium ECA Export Credit Agency EBRD European Bank for Reconstruction and Development EIA Energy Information Administration (a unit of the U.S. Department of Energy) ENI Italian state-owned gas company EU European Union FSU Former Soviet Union HGA Host Government Agreement IEA International Energy Agency IFC International Finance Corporation (a branch of the World Bank) IGA Intergovernmental Agreement LNG Liquid Natural Gas NATO North Atlantic Treaty Organization NSC National Security Council (U.S. policy coordination entity in the White House) OMV Austrian state-controlled energy company OPIC Overseas Private Investment Corporation SOCAR State Oil Company of Azerbaijan SCGP/SCP South Caucuses Gas Pipeline TGI Turkey-Greece-Italy natural gas pipeline 3 Executive Summary The Nabucco natural gas pipeline is a multi-national project designed to bring Caspian and Middle East gas to Central Europe. It enjoys broad support among western politicians but faces many external challenges. While Nabucco is not destined to fail, policymakers in the United States and Europe should review whether a commitment to this specific pipeline is a sound policy. They should embrace a broader agenda for energy diversification for Central and Eastern Europe – one that includes support for multiple import options and pipeline routes, alternatives such as Liquefied Natural Gas (LNG), recognition of Russia’s importance as a supplier and market incentives to promote reforms within the Russian energy sector. Introduction In the past few years, a new era in global energy markets has arrived. Global demand has soared, supplies have struggled to keep pace and national governments are positioning themselves to secure additional energy resources to meet future consumption. In Europe, the recent Russian incursion into Georgia, which many claim was at least partially about control over energy routes, has further encouraged debate on energy security policy. Whereas debates about energy security in the United States focus on perceived dependence on foreign oil, dependence on Russian natural gas is the issue du jour in many European capitals. Today, Europe consumes more than 500 billion cubic meters of gas annually (bcm/a). Of that total, about 145 bcm, or about 25 to 28 percent, comes from Russia. But Europe has a two-fold problem looking forward. Its projected demand for gas is expected to increase to 700 to 800 bcm/a by 2020.1 At the same time, Europe’s largest gas fields are facing declining production levels. As a result, Europe will almost certainly have to significantly increase its natural gas imports in a relatively short time-frame. Russia has the natural gas reserves to meet the rising demand to supply Europe. However, Russia’s major gas fields are experiencing a drop in output levels. Russia needs to make substantial investments today in order to meet Europe’s projected demand ten years from now. If Russia makes these investments, the country can substantially increase the amount of gas it supplies to Europe – meeting European increases in demand. For Europe, this means a possible increase in its dependence on Russia as a major supplier of energy. Some Western politicians, including many in the United States, do not want Europe to become overly dependent on Russian gas. Though Europe’s energy security is primarily a policy dilemma for the European Union (EU), Washington has taken an interest in shoring up its allies’ energy security. Specifically, the United States wants to ensure that as Europe develops its near- and long-term energy security policy, Russian influence does not impact issues unrelated to energy. In other words, the United States is fearful that Russia will use its dominant gas supply position in Europe, not to argue for higher prices, but to influence European policies in other areas, like NATO enlargement or U.S. missile defense plans. 1 Sources: “Supply Capacities For Europe 2010-2020 (IEA/OME)” in Eurogas’ Brochure “Natural gas - the energy for a sustainable future” – June 2005, plus CERA’s Special Report “Long-term Outlook for European Gas” (July 2005) plus Michael Townshend, CEO of BTC Corporation, presentation to CSIS on May 8, 2006. 4 Many in the United States view the planned Nabucco pipeline as Europe’s answer to both its gas supply problems and the problem of checking Russia's influence in Europe. The Nabucco project is a planned natural gas conduit that would transport natural gas from Erzurum, Turkey to Baumgarten, Austria, through Bulgaria, Romania and Hungary. The project hopes to deliver as much as 30 bcm/a of gas to Europe from the Caspian, Central Asia and possibly the Middle East.2 Source: The Wall Street Journal3 But the proposed pipeline is plagued by immense commercial weaknesses and political impracticalities. The foremost problems are basic: the project lacks binding commitments on gas supplies and transit agreements as well as immense security concerns. Moreover, it faces competition from the proposed South Stream pipeline – Gazprom’s joint venture with Italy’s Eni. The Russian-backed pipeline will travel on a similar route to that of Nabucco (see above). In effect, both pipelines will compete for many of the same customers. Because of concerns about Russia’s influence in Europe, Western politicians (primarily American and European) increasingly support accelerating the Nabucco project. For example, Senator Richard Lugar, one of the most respected voices in Washington on foreign affairs, recently noted that “European governments must be convinced that their long-term security interests are served by the Nabucco pipeline.”4 2 Nabucco website, <http://www.nabucco-pipeline.com/project/project-description-pipeline-route/project- description.html>. 3 Guy Chazan, “Russia Outflanks EU's Pipeline,” The Wall Street Journal, June 16, 2008. 4 Senator Lugar, Statement to the Senate Foreign Relations Committee, June 12, 2008. 5 On the other hand, the private sector is generally pessimistic about Nabucco’s prospects. Major energy companies generally agree that Nabucco is “a political pipeline for which there is no gas,”5 and are therefore skeptical of its ability to succeed. At the same time, they acknowledge that there is a clear demand for additional routes into Europe. They question whether or not Russia will be able to meet Europe’s rising demand “in a coordinated way and in sufficient scale” because Gazprom’s track record of developing new fields is spotty.6 Industry representatives generally agree that Nabucco will remain in the planning stages for some time even though it has little commercial basis at this stage. To illustrate the divide between the political support for the project and the viability of the project