BACKGROUND: Europe’s natural gas demand is projected to increase substantially in the future. Even under conservative scenarios the demand for importing natural gas to the EU will double from 200 billion cubic meters (bcm) a year in 2002 to 400 bcm per annum by 2030, with total demand raising from 400 bcm to up to 600 bcm in the same period. Russia will try to fill this gap with its own gas, as well as with the gas from Turkmenistan, with the worlds third largest gas reserves, and potentially from Kazakhstan, if those countries do not have alternative delivery options by that time. This alternative may be a natural gas pipeline through the Caspian to Azerbaijan, Georgia, and Turkey and then on to Europe. Among the top policy priorities for EU energy development is “avoidance of strategic dependence”. At the same time, some EU member countries are already strategically dependent on Russian gas, particularly in Central, Eastern, and South-Eastern Europe, where there is an almost 100 percent dependence on Russia’s Gazprom. One step towards an alternative gas corridor to Europe is the South Caucasus Pipeline, connecting Baku to Erzurum in Turkey, via Georgia, which will deliver 6 bcm of gas to Turkey per year under an existing gas purchase agreement. Small volumes will be delivered to Azerbaijan and Georgia, thus contributing to the energy security of those countries. The initial capacity of the gas pipeline will be 8.4 bcm per year with throughput capacity to be increased to up to 30 bcm per annum, with the potential of being connected to Turkmen producers, aiming at European gas markets. The Azerbaijani fields’ proximity to Turkey makes its position very competitive on Turkish and South-Eastern European markets. The natural gas connection between Turkey and Greece is currently under development, and it is to be commissioned in 2006. This connection will provide the first opportunity to ship Caspian natural gas directly to the EU, which can be done in several ways. At this stage of project design, the capacity of a planned Turkey-Greece-Italy pipeline appears to be 10-12 bcm per annum with a possible upgrade to 22 bcm. The second pipeline under consideration is the Turkey-Baumgarten (Austria) system. Five gas companies in Central and South East Europe (BOTAS of Turkey, Bulgargaz, Transgaz of Romania, MOL of Hungary, and OMV of Austria) have agreed to study a possible route from to Baumgarten. In early 2004, the five companies formed a joint company, Nabucco Company Pipeline Study GmbH, to examine possible routes and produce a feasibility study by the end of this year. Each of the companies owns 20% of the company’s capital. A first option envisages the building of a pipeline with a total annual capacity of 30 bcm per annum, of which 20 bcm would be delivered to the gas hub of Baumgarten at the Slovak-Austrian border, where it connects to the Central and Western Europe transit system. The 10 bcm capacity will bring diversification of supplies to transit countries which currently depend exclusively on Russian imports. The sponsors plan to start shipments of natural gas from Turkey in 2009.

IMPLICATIONS: It is in the long-term interest of the Caspian producers to fill these pipelines with natural gas from Azerbaijan, and potentially from Turkmenistan and Kazakhstan. On the other hand, it is obvious that the potential entry of Caspian natural gas will help Europe to diversify energy supply, and to reduce dependence on the state-owned Russian monopoly, Gazprom. This development will perfectly compliment major reforms planned in the European gas sector, aiming at the creation of a competitive market of multiple operators and options of delivery routes. It is also obvious that Russia is trying to prevent new entrants from obtaining a substantial stake in the European and Turkish gas market in order to maintain its dominance there. Currently Gazprom is producing 540 billion cubic meters (bcm) of natural gas. Exports to the EU constitutes 25 percent of its total production, but brings 75 percent of its revenues. Gazprom’s exports account for 20-25 % of Russia’s export revenues. Therefore, Europe is a strategic market for Russia and it is expected that Russia will use its leverage to prevent the opening of a new natural gas corridor connecting the Caspian and Turkey to Europe. The major leverage remaining in Russian hands are the frozen conflicts of the region, and remaining Russian bases in Georgia. The situation in South Ossetia proves that Russia is actively using this leverage for different purposes. But this competition is in the long-term interest of Europe, and Russia as well. Diversification of supply routes and gas sector reforms in Europe will eventually drive Russian monopolistic supplier, as well as Russian gas sector in general, towards much needed reforms. After all, one of the drivers behind the development of the South Caucasus Energy Corridor has been the inflexibility of the Russian state pipeline monopolies. By dominating access to markets and by creating barriers to access for others, they have forced producers to look for alternative means to the market. The result has been the development of alternative routes. Without market liberalization, it will be impossible to attract investments in the Russian gas sector, and without investments it will be impossible to meet the ambitious production goals of Gazprom.

CONCLUSIONS: There is a clear match between the strategic interest of Europe and the South Caucasus. Europe needs diversified energy supplies and supply routes, and to have strategic access to the Central Eurasian inland. The South Caucasus needs to be politically independent and economically viable, and to have strong security guarantees from the major powers of the world. That is why relationships with NATO and the enlarged EU are becoming the top foreign policy priorities for Georgia and Azerbaijan. Responding to this serves Europe’s long-term security interests. Europeans can do at least four things for the South Caucasus: First, to expedite the integration of Georgia and other South Caucasian states in the broader Transatlantic partnership and in NATO. Second, to actively facilitate the internationalization of the conflict resolution processes in the South Caucasus, which is currently monopolized by Russia, who is not interested in the resolution of those conflicts. Third, continuing strong support for the development of pipeline projects of both oil and natural gas. Of particular importance is to reengage Turkmenistan in the development of the TransCaspian natural gas pipeline project, which can substantially balance the energy security of Central and Eastern European countries; Fourth, continuing support for the democratic political process and economic recovery, based on rule of law, private property and free entrepreneurship.

AUTHOR BIO: Mamuka Tsereteli is the Executive Director of the America-Georgia Business Council and Adjunct Professor at the School of International Service at American University in Washington, D.C. His areas of interests include economic security, political and economic risk mitigation strategies, and business development.