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September 14, 2010Volume 7, Issue 164

IN THIS ISSUE*Nabucco consortium looks at gas procurement options*Lending institutions move to support the Nabucco project*Dagestan base attack raises questions over Russian military capabilities

**Visit the Jamestown blog on Russia and Eurasia (http://www.jamestown.org/blog):- Utility of the UN Vote on Georgian IDPs

Nabucco Pipeline, Azerbaijans Shah Deniz Field Require Synchronized Development

Russia seems to have lost its lobbying battle for South Stream and against Nabucco in Europe(EDM, July 13, 14, August 3). At present, Moscow seeks as a last resort to negate theavailability of gas supplies to the Nabucco project in the Caspian basin.

Prime Minister, Vladimir Putin, summed up this official line during the recent Valdai Clubmeeting in Russia. He claimed that the Nabucco project lacks guaranteed supplies (and Russiawould not contribute any volumes); that Nabucco cannot fully count on Azerbaijan since thelatter has signed a supply agreement with Gazprom; and a dispute over the delimitation of theCaspian seabed would block the transportation of Turkmen gas to Azerbaijan en route to

Europe. In their acrimonious tone as well as in content, Putins remarks sounded like argumentsof despair (www.premier.gov.ru, September 6; Interfax, September 7).

Azerbaijan is the existential supply source for the Nabucco project. Russia seeks to increase itsimports of Azerbaijani gas to the maximum possible extent, so as to reduce the volumesavailable to Nabucco. During President Dmitry Medvedevs recent visit to that country,Gazprom signed an agreement to purchase 2 billion cubic meters (bcm) of gas fromAzerbaijans State Oil Company (SOCAR) in 2011 (up from the 0.5 bcm first agreed in October2009, then 1 bcm during 2010). The agreement, moreover, does not set any quantitative limit onannual deliveries from Azerbaijan to Russia. Also during Medvedevs visit, Gazprom CEO,Aleksei Miller, signaled his readiness to acquire a stake in Phase Two of development at ShahDeniz, the offshore field in Azerbaijan that constitutes the main supply source for the first phase

of the Nabucco project (Vedomosti, September 6).

However, Gazprom is falling short of those disruptive goals. Its agreements on gas import fromAzerbaijan are valid for one year at a time. Azerbaijan remains free to redirect its gas exportvolumes from Russia in a westward direction, choosing the most advantageous pricing andtransportation terms, as soon as the Nabucco pipeline becomes operational. Russia has no meansat present to induce or coerce the Shah Deniz consortium into accepting Gazprom as a

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stakeholder in Phase Two of development.

That consortium includes BP and Norways Statoil with stakes of 25.5 percent each;Azerbaijans SOCAR, Russian Lukoil, French Total, and the National Iranian Oil Company,with stakes of 10 percent each; and Turkish Petroleum with 9 percent. The distribution of votesprecludes any possibility that the steering committee would willingly allow Gazprom into theconsortium.

Phase Two is envisaged to produce some 16 bcm annually from 2016 onward, at an investmentcost of $20 billion for the duration of the project, assuming an investment decision by 2011.These expectations had formed prior to the three major financial institutions recentannouncement about funding the Nabucco project (Massive Funding In Prospect For NabuccoPipeline Construction, EDM, September 14). That announcement should in turn stimulate thelong-awaited investment decision by the Shah Deniz consortium.

Commercial operator Statoil has recently invited potential customers to hold bilateral talks ongas supplies from Shah Deniz Phase Two. The invitees include consortiums and companies

involved in three projects: Nabucco, the Interconnector Turkey-Greece-Italy (ITGI), and theTrans-Adriatic Pipeline (TAP, in which Statoil itself is one of the stakeholders, and which runsthrough the same three countries as ITGI).

The Nabucco consortium expects 8 to 10 bcm of Azeri gas per year for Nabuccos first stage.Azerbaijan counts on Shah Deniz Phase Two to supply the bulk of that volume, opening the wayfor Turkmen gas in the second stage of the Nabucco project.

These plans, however, could be derailed if the Shah Deniz Phase Two production is broken upamong several pipeline projects. Of those three under consideration, only Nabucco at 31 bcm,and bound for Central Europe, has strategic significance, both in its own right and as the

mainstay of the EU-planned Southern Corridor. The ITGI and TAP, potential components of theCorridor, are far smaller in their projected capacities, and running toward southern Italy. Theyare interesting business propositions for the companies involved, but cannot significantlycontribute to the diversification of supplies to Europe, unless supplementing a Nabucco thatoperates at its full projected capacity.

All these potential components of the Southern Corridor (also including the proposed WhiteStream) are needed to maximize transportation capacity for Central Asian gas to Europe, thusstimulating investments in gas field development. However, these pipeline projects becomesuboptimal or even redundant if they end up competing against each other, over limited volumesof Azeri gas. The financial institutions choice to support Nabucco reflects awareness of thisprojects strategic value.

Putins latest claims notwithstanding, Turkmenistan is quietly moving closer to a transportationsolution for feeding the Nabucco pipeline via Azerbaijan. There is no serious indication thatAshgabat would invoke the disagreement on seabed delimitation to impede a trans-Caspian link.On the contrary, Turkmenistan initiated in early 2010 an East-West pipeline across its territory,from the gas fields in the countrys east to the Caspian shore. Planned to carry 30 bcm annuallyfrom 2015 onward, this project reflects intentions to sell that volume of gas (in addition to

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offshore volumes) at Turkmenistans western border, when a trans-Caspian outlet opens up.

This would not only enable the Nabucco pipeline to operate at maximum capacity, but wouldalso contribute decisively to turning the EU-planned Southern Corridor into a reality. On theother hand, European failure to seize this opportunity would cause Ashgabat to desist from itsEast-West pipeline project; or redirect those volumes, partly or fully, to Russia (via thenorthbound Caspian coastal pipeline that Russia proposes to enlarge) or other non-Europeandestinations.

German RWE, Hungarian MOL, and Austrian OMV are Nabucco stakeholders seeking toprocure gas volumes from Iraqs Kurdistan Region. Last year, MOL and OMV acquired stakesof 10 percent each in the Pearl Petroleum consortium, which develops gas fields in that region ofIraq. The privately owned, Sharjah-based Dana Gas is the operating company in thatconsortium.

Last month, RWE signed an agreement with the Kurdish regional government for developmentof gas deposits and transportation infrastructure. This can open the way for gas supplies from the

Kurdish region to Europe via Turkey and the Nabucco pipeline. RWE aims to conclude anagreement on such supplies. Iraqs central government in Baghdad is raising legal and fiscalobjections. For their part, Kurdish regional authorities declare that they would share the exportrevenue with the central government in accordance with national and regional legislation (RWEpress release, Dow Jones, August 27; Upstreamonline, August 30).

While volumes, timetables, and other conditions for gas supplies from this part of Iraq are yet tobe clarified, it seems that the Kurdish region can contribute significant inputs into the Nabuccoproject. Last month the consortium decided to proceed with construction of two feeder lines onTurkish territory: one from the Georgian border and the other from the Iraqi border, for gassupplies originating in the Caspian basin and in Iraqs Kurdistan region, respectively. Thus, the

Nabucco projects supply outlook is taking a more definite shape, along with the fundingoutlook.

--Vladimir Socor

Massive Funding In Prospect For Nabucco Pipeline Construction

On September 7 in Brussels, three leading international financial institutions launched theprocess of funding the Nabucco gas pipeline project, potentially to a multi-billion Euro level.The European Investment Bank (EIB), the European Bank for Reconstruction and Development

(EBRD), and the World Banks International Finance Corporation (IFC) signed a mandateletter that formalizes the conditions under which the three institutions will conduct theirappraisals of the Nabucco project, and provides an indication of the potential level of financing(joint press release, September 7).

The three institutions are prepared to provide up to 4 billion Euros toward funding the Nabuccopipelines construction, from eastern Turkey to Austria. Of that sum, the EIB would provide upto 2 billion Euros; the EBRD, up to 1.2 billion Euros (including up to 600 million Euros on

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