The cost of Russia’s victory

Jun 29, 2007 02:00 AM

by Kirill Martynov

Russian President Vladimir Putin’s visit to Kazakhstan and Turkmenistan in May 2007 was very successful. The agreements signed during the visit frustrated the plans of presidents of Azerbaijan, Poland, Ukraine, Lithuania, and Georgia, whose summit was going on at that time. The summit’s main purpose was to obtain guarantees from Central Asian leaders that they would supply oil and natural gas bypassing Russia.
Yet, Moscow managed to sign the agreements which actually put the kibosh on building the pipelines that detour Russia in the next 5-10 years.

Taking steps timely
Presidents of Russia, Kazakhstan, and Turkmenistan signed on May 12, 2007, a declaration on building the Caspian shore gas pipeline. This document commissions the governments of the three states to prepare and sign a corresponding agreement before September 1. It will stipulate “the feasibility study, main characteristics and terms of implementing the project, joint obligations for creating favourable conditions for making the implementation cost-effective” and will determine the organizations in charge.
The governments will also have to “secure the implementation of the pipeline project with the organizations in charge beginning from the second semester of 2008, in accordance with the agreement.”

Besides, the parties have agreed to begin the modernization of the Central Asia-Centre (CAC) pipeline network, so as to increase its carrying capacity (from the current 50 bn to about 60 bn cm annually). The CAC has needed reconstruction since long ago: the network’s construction began back in 1967.
Moreover, Russia’s Gazprom and Kazakhstan’s KazMunaiGaz are creating a joint venture for annually buying 16 bn cm of natural gas of Karachaganak deposit in Kazakhstan for reprocessing it at the Orenburg Gas Refinery. The presently functioning JV Kazrosgaz buys around 7.5 bn cm per year. So, the amount of Kazakh gas purchases is to double.

Gazprom head Alexei Miller said the Caspian shore gas pipeline will be laid in the corridor of the existing Central Asia-Centre-3 pipeline. According to preliminary information, 360 km of the pipe will go through Turkmenistan’s territory, and 150 km -- through Kazakhstan. In Alexandrov-Gai town, the pipeline will become part of the unified gas-supply system of Russia. The new pipeline’s capacity might reach 30 bn cm annually.
The Caspian shore gas pipeline is Russia’s response to the attempts of the United States, the European Union, and Turkey to supply Central Asian gas to Europe bypassing Russia’s territory. They discuss building the Trans-Caspian gas pipeline, which will go along the Caspian seabed, and which will later be connected to the Baku-Tbilisi-Erzurum gas pipeline (Azerbaijan-Georgia-Turkey) and/or to the planned Nabucco gas pipeline (Turkey-Austria).

However, even after the three-sided declaration had been signed, the issue of the Trans-Caspian pipeline is still on the agenda. Turkmen President Gurbanguly Berdymuhammed assures there is enough gas for implementing both pipeline projects. Kazakh President Nursultan Nazarbayev also said that diversifying the oil and gas supplies is a condition favourable for his country.
“There is no politics in it. The growing amounts of oil and gas extraction by Kazakhstan require such diversification,” Nazarbayev said.

Experts believe that Russia is so far ahead of its Western competitors in the struggle for Central Asian resources because the US-European negotiators have been making uncertain offers.
Ilham Shaban, director of the Oil Studies Centre in Azerbaijan, was quoted as saying: “The question is who will pay for creating the entire necessary infrastructure. Analysts resistant to political influences state: if conditions are favourable for investors, then creating the Trans-Caspian pipeline is possible. If there is someone ready to invest $ 5 bn into laying a seabed pipeline, and ready to buy Turkmen gas at a price $ 10 more than the price for Russia, then I believe Ashgabat will approve this project, and will even find enough gas for it, because there are more undeveloped gas deposits in Turkmenistan than developed ones. It’s just that the West has not really tried so far to boost the implementation of the Trans-Caspian pipeline project. Meanwhile, Moscow seized the initiative. Yet, it does not mean the West will not try to compete with Russia.”

However, the West has small chances to outdo Russia in the short-term perspective. Otherwise, Central Asian states need to quickly find extra amounts of natural gas, which is hardly possible. Whatever will be extracted in the upcoming years will go into Russia’s gas-transporting network through the Caspian shore pipeline.
“The possibility that Turkmen and Kazakh gas might be supplied to Europe by detouring Russia’s territory is a problem for Russia. Certainly, Turkmenistan can supply up to 50 bn extra cm of gas annually to European markets. Yet, if the gas goes there past Russia, and competes with Russian gas, both we and Turkmenistan will suffer losses. Therefore, we found a solution for expanding and reconstructing the CAC pipeline network and for building the Caspian shore pipeline,” said Valery Yazev, chairman of the Energy, Transport, and Communications Committee at the State Duma of Russia, and head of the Russian Natural Gas Association.

“The total capacity of our pipelines is to grow by nearly 30 bn cm of gas, reaching 90 bn. That gas will come to Russia, and we will re-export it thru Russian pipelines together with Turkmenistan and Kazakhstan.”
“The gas sales issues are just being discussed now. Yet, the main thing is that we do not create alternative transporting corridors, unlike the US and Europe, who support all projects of pipelines bypassing Russia,” said Yazev.

Overflowing pipes
Meanwhile, hardly anyone noticed the warning of Russia’s Industry and Energy Minister Viktor Khristenko.
The minister said: “From my point of view, the pipelines that already exist in Central Asia are more than enough to cover the demands of both the domestic and the foreign markets. So, the gas will go north, into Russia’s network, which will require expanding the Russian gas-transporting system.”

If we sum up the amounts of natural gas which Russia intends to additionally receive into its gas-transporting system (GTS), we will get 40-50 bn cm. Yet, it is unknown whether the GTS will have enough capacity by the time when the new gas starts arriving (in 2010-2015).
Gazprom spends billions of dollars annually on reconstructing and expanding the GTS. According to the company’s data, the capacity of the entire system already needs to be increased by 35 bn cm. However, most pipelines were built 20-30 years ago, and now Gazprom spends a considerable part of funds and efforts on keeping the aging pipelines in working condition, and on preventing breakdown situations. So far, it has been hard to significantly expand the GTS capacity. Meanwhile, both Gazprom and independent gas producers plan to gradually increase the amounts of gasextraction.

Gazprom’s main efforts are now focused on building the SRTO-Torzhok gas pipeline, expanding the Urengoi gas-transporting junction point, expanding the GTS in Russia’s north-west (also for securing gas supply thru the Nord Stream gas pipeline), building branch pipelines and the GTS, and reconstructing the transport networks. So, neither the CAC, nor the southern direction, are priorities for Gazprom.
The Ministry of Economic Development writes in its Prognosis for Russia’s social and economic development that “the main factors limiting the development of gas extraction are: the fall in extraction from the developed major deposits; the fact that Russia’s unified gas-supply system lacks capacity, in comparison with the extraction capacity of gas producers independent from Gazprom”. The prognosis adds: “The development of gas-main pipelines’ network is still falling behind. Moreover, it is difficult to connect independent gas producers to the network. All this will not allow to raise the gas extraction by more than 1.5-1.7 % a year.”

Yet, the problem of transporting Central Asian gas is not confined to the difficulties with Russia’s GTS only. It is planned that Turkmen and Kazakh gas will mainly go for export. Gazprom now has only two export channels: Ukraine and Belarus.
Meanwhile, both countries have the same problem: old pipes in need of repair. Everyone remembers the recent breakdown at the Ukrainian section of the Urengoi-Pomary-Uzhgorod gas-main pipeline, which happened chiefly because the facilities are old. It is absolutely unclear how it is possible to increase gas export thru these countries (Gazprom left the question without comments). Are Ukraine’s and Belarus’ pipelines capable of piping extra 30 bn cm of gas?

Gazprom will now deal with Belarusian pipelines directly, because the company has recently acquired 50 % of Beltransgaz, becoming a co-owner of the country’s GTS. However, it is much more complicated with Ukraine. Gazprom head Alexei Miller has recently had a working meeting with Ukraine’s Fuel and Energy Minister Yuri Boiko.
They discussed the reliability of Ukraine’s transit GTS. Both parties underlined the country’s important role in transporting Russia’s natural gas to Europe. Nevertheless, Gazprom’s influence on Ukraine is not strong. The idea to create an international consortium for managing Ukraine’s GTS has never been implemented.

Back in autumn 2006, Ukrtransgaz company presented a program of modernizing Ukraine’s GTS before 2010. It stipulates the reconstruction of just 2 out of the 4 major gas-main pipelines. The cost of reconstruction is around hryvnyas 23 bn ($ 4.5 bn). Yuri Boiko estimated that it is necessary to spend about $ 500 mm annually on modernizing the country’s GTS.
It is unknown whether Ukraine will find the necessary sums of money. Gazprom refrains from comments on the issues of Ukraine’s transit and of creating a consortium.

So, all gas-transporting systems – of Russia (except Gazprom’s new Yamal-Europe gas pipeline), Ukraine, Belarus, Central Asian countries -- need to be reconstructed and expanded, in order to transport extra amounts of Turkmen and Kazakh gas. How much money will this global reconstruction require?
The total length of gas-main pipelines is tens of thousands of kilometres, while the minimal cost of 1 km of a new pipe is around $ 2 mm. Even if reconstruction works are somewhat cheaper, the sum of necessary investments still equals to billions of dollars.

Meanwhile, Gazprom plans to spend less on reconstruction in 2007 than it had planned before, although the total amount of investments will grow up to roubles 762.3 bn. It is by roubles 232.92 bn more than it had been planned in the investment program ratified in January 2007.
Long-term financial investments will increase either, making up roubles 442.52 bn (which is by roubles 273.7 bn more than planned). On the contrary, the capital investments are to make up roubles 319.78 bn (roubles 40.78 bn less than before). This relocation of funds is due to Gazprom’s acquisition of shares of Sakhalin Energy, Beltransgaz, and Mosenergo. Here are the company’s priorities.

However, Gazprom will partially solve the problem of transporting capacity deficit. The company will not increase its own gas extraction; on the contrary, it might lower it.
The missing amounts will be replaced by Central Asian gas, which will almost entirely go for export (Russia’s natural gas will stay at the Russian market). Yet, it will cost Gazprom a pretty penny.

Turkmen way
Gazprom works with Turkmenistan on the basis of the intergovernmental agreement on cooperation in the natural gas sphere for 25 years, signed on April 10, 2003. That day, Gazprom Export (Gazprom’s subsidiary) and Turkmenneftegaz concluded a long-term agreement (also for 25 years) on purchase and sale of Turkmen natural gas.
In September 2006, Gazprom’s delegation went to Turkmenistan on a working visit, where the amounts and prices for gas supplies in 2007-2009 were determined. The planned amounts of Turkmen gas to be supplied in 2007-2009 are 50 bn cm annually. The price is fixed for that period: it is $ 100 for 1,000 cm. These agreements were preceded by President Saparmurat Niyazov’s demarche: he refused to sell gas for a price fixed earlier, $ 65 for 1,000 cm.

At that time, Russia and Turkmenistan also agreed on the principles for correcting the terms of gas supplies for the next 3-year period. The price is to remain unchanged till the end of 2009. Before July 1, 2009, the countries will hold negotiations on correcting it according to the change of prices on supplies under long-term contracts at Europe’s gas markets.
According to the intergovernmental agreement of 2003, the amounts of purchased Turkmen gas might grow up to 70-80 bn of cm annually by 2010. What would be the cost of Turkmen gas? If no drastic changes at the world markets happen, then Turkmenistan will almost definitely insist on raising the purchase price. The nearest mark is $ 160: it is the price at which Russia buysKazakh gas. So, 80 bn cm of Turkmen gas will cost Gazprom a lot, $ 12 bn annually.

By selling that gas to Europe, Gazprom will certainly cover its expenditures. Yet, it will not receive such super-profits as it does now. If a joint venture of Gazprom and a local company (for instance, Turkmenneftegaz) markets and sells Central Asian gas, Gazprom will not have super-profits either. There already exist such JVs (for instance, RosUkrEnergo).
The growth of expenditures and the loss of profits are inevitable, even if Gazprom begins developing Turkmen deposits on its own, which was declared during Vladimir Putin’s tour of Central Asia. In this case, the company will have to invest into geologic exploration and gas extraction, and to share extracted gas or profits with Turkmenistan.

All that means that the time of easy money and frantic buying is coming to an end for Gazprom. The company’s expenses will grow more and more, and Gazprom will need more and more efforts and funds to retain its positions.
At first sight, these conditions are unfavourable. Yet, they have a positive side either: perhaps, Gazprom will eventually begin acting in its own interests only, disregarding the state’s political goals. Tougher financial obligations might make Gazprom less aggressive and scandalous, and more pragmatic. At least, we would like to hope so.

The progress of natural gas extraction and export (bn cm)
2006, report -- 2007, estimation -- 2010, prognosis -- 2010/2006 (%)
1st variant -- 2nd variant -- 1st variant -- 2nd variant
Gas extraction, total 656,3 -- 665 -- 702 -- 717 -- 107,0 -- 109,2
Export 202,8 – 198 – 218 – 223 -- 107,5 -- 110,0
Source: the Ministry of Economic Development of Russia

The cost of several built and planned pipelines
Length (thousand km) -- Cost ($ bn) -- Cost of 1 km ($ mm)
The Yamal-Europe pipeline 4,1 – 14 -- 3,41
The Yamal-Europe pipeline (outside Russia) 1,7 – 6 -- 3,53
The SRTO-Torzhok pipeline (Russia) 2,4 – 8 -- 3,3
Nord Stream seabed pipeline 1,2 -- 5,7 -- 4,75
Nord Stream pipeline’s onshore section (including the compressor station) 1 -- 5,7 -- 5,7
Altai pipeline to China 3 – 5 -- 1,67
Blue Stream (Russian section) 0,769 -- 2,8 -- 3,64
Nabucco pipeline 3,4 – 5 -- 1,47
The Iran-India-Pakistan pipeline 2,67 -- 2,62 -- 2,62
The Turkmenistan-Afghanistan-Pakistan pipeline 1,27 -- 2,9 -- 2,28
Modernization of the Baltic Pipeline System 0,945 -- 2,5 -- 2,65
The Burgas-Alexandroupolis pipeline 0,367 – 6 -- 2,25
The Baku-Tbilisi-Ceyhan pipeline 1,77 – 4 -- 2,26
The Atasu-Alashankou pipeline (Kazakhstan-China) 0,962 -- 0,806 0,84

Source: FitchRaitings, according to the data of Gazprom, Transneft, Argus, FSU Oil & Gas Monitor.

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