Europe Faces Key 2011 Test for Natural Gas Diversification

BRUSSELS (Dow Jones Newswires), Dec. 23, 2010

Europe's efforts to diversify its sources of gas supply face a critical test early next year amid expectations that Azerbaijan and some of the world's largest energy companies will pick a buyer for the biggest share of gas from a giant field they are developing in the Caspian Sea.

Gas from Azerbaijan, and potentially from other countries in its neighborhood, is critical to the European Union's strategy of breaking the near-monopoly Russia has over Central European gas supplies. But with Moscow pushing ahead with two pipelines of its own to Europe--one of which is already under construction-- there are lingering questions about which, and how many, of these pipelines will make economic sense.

All eyes will be watching the massive $20 billion development of the Shah Deniz II natural gas field offshore Azerbaijan, which is expected to begin producing gas in 2017. Although there is no official time-table to announce buyers, several people involved in the discussions expect the Shah Deniz II consortium to select buyers in the first half of 2011.

Azerbaijan's gas is prized by the architects of the EU's long-discussed 3,300 kilometer-long Nabucco pipeline which would carry the gas across Turkey all the way to Austria. But the Azeri gas is also being sought after by two much smaller pipeline projects led by other European companies.

These projects have until recently been seen as competing options, generating concern among observers that European infighting for Azeri gas could damage Europe's energy security efforts and ultimately lead the country to sell the gas to the Russians.

But in recent weeks, EU policy makers and some company officials have begun speaking more seriously about the prospects for cooperation between Nabucco and the other European lines.

"Nabucco doesn't exclude being combined with other projects," Guenther Oettinger, the head of energy at the commission, said at a recent dinner debate. "We will do our best to make the projects work together," he said at the dinner, where he met top representatives of a competing project.

The prospects for such cooperation were also highlighted in a recent report by the International Energy Agency, an international organization that represents leading energy consumer nations. The IEA's recent World Energy Outlook pointed to signs of a breakthrough on long-delayed Caspian exports to Europe and said a "hybrid option" among pipelines might "emerge as the favorite choice."

Cooperation isn't going to be easy, with the smaller projects each seeking to ultimately show off as the winners of the battle for the Azeri gas. At the same time, stakes are high for Nabucco, on which many policy makers, including the EU Commission President Jose Manuel Barroso, have spent much political capital. The challenge is then to make sure that cooperation can be presented as a success by the political sponsors and financial backers of each project.

How a combined project might play out on the ground is also still unclear, but one outcome might be the eventual construction of a smaller pipeline than Nabucco, with outlets both to Southern Italy and to Central Europe.

European energy heavyweights behind competing options

The commission has long backed the EUR7.9 billion Nabucco pipeline as the best way to open a "Southern corridor" for Central Asian and Middle Eastern gas to supply Europe's most Moscow-dependent central European countries. The EU has targeted the southern corridor for roughly 10-20% of EU gas demand by 2020, equivalent roughly to 45-90 billion cubic meters of gas per year, according to a recent European Commission strategy document.

The Nabucco consortium includes some of Europe's biggest energy companies, including Germany's RWE and Austria's OMV.

The immensity of Nabucco means it could transport greater volumes. But to make economic sense, and to convince the Shah Deniz consortium to sell the gas to them, the sponsors have to get another source of gas, because the Azeri's would only fill about one third of the 31 billion cubic meters planned pipeline capacity. EU officials have also targeted Turkmenistan and Iraq as potential sources of Nabucco gas.

The Shah Deniz II project is part of the same geologic structure as the Shah Deniz field, which is currently operated by BP and is expected to produce 7.6 bcm in 2010. The second phase would include two new production platforms linked with a bridge and as many as 30 wells under the sea.

Besides the Nabucco consortium, Shah Deniz II is holding talks with the backers of at least two other pipeline groups.

The Interconnector Greece-Italy, led by Edison and Greek monopoly gas company DEPA, would carry gas to Southern Italy, which could then be sold in Europe. At 10 bcm a year, the capacity is much lower than Nabucco.

Statoil, Swiss energy-trading company Elektrizitats-Gesellschaft Laufenburg and Germany's E.ON are also working on a pipeline project, TAP, or Trans Adriatic Pipeline. Very similar to IGI, it would carry gas the same way, but crossing Albania, and its initial size of 10 bcm could be easily doubled.

At the same dinner where Oettinger raised the possibility of cooperation between Nabucco and other lines, mainly IGI, Edison chief Executive Umberto Quadrino described IGI and Nabucco as "totally complementary." A TAP spokesman said it too is open to cooperation.

Under the current plan, Shah Deniz II is expected to add roughly 16 billion cubic meters of annual production as early as 2017, ten of which would be ready for export to the EU. BP and Norway's Statoil both own 25.5% stakes of Shah Deniz. The State Oil Co. of Azerbaijan, or Socar, Lukoil of Russia, France's Total and National Iranian Oil Company all own 10% each, while Turkey's TPAO owns 9%.

A Baku-based BP spokeswoman said the group has no time-frame for taking a final investment decision on Shah Deniz II, or for announcing buyers. But the group was "positively surprised" by the "high level of demand" for Azerbaijani gas in Europe.

"Discussions are currently underway with all interested parties to agree all necessary steps," the spokeswoman said. "We are closely working with the Government of Azerbaijan, the European Commission and the US Government to move the project forward as quickly as possible."

Socar officials could not be reached for comment.

Some observers are dubious of the chance of a deal very soon. The risk consultancy Eurasia Group said an announcement about Shah Deniz II was "unlikely" to be reached in 2011, because "too many issues remain unresolved." But the IEA, while noting that Azerbaijani gas production has been constrained by uncertainties over marketing and transit agreements, said progress in 2010 "opens up the prospect of a significant expansion in production and export, starting the second-half of the 2010s."

Russia Also Taking More Azerbaijani Gas

The Russians are also standing by and are in direct contact with Azerbaijan's Socar regarding Shah Deniz II.

"An official request has been filed to (...) Socar as a member-company of the Consortium to specify certain particulars of the possible deal, including volumes on offer," an official with Gazprom Export told Dow Jones Newswires. "Gazprom expects a detailed reply to map out further moves," the person added.

Earlier this year, Gazprom agreed to double imports from Azerbaijan to two billion cubic meters a year in 2011. Imports will further increase in 2012, but the company hasn't specified a quantity.

Russia is interested in the Shah Deniz gas because "they would like to use it as a supply source in the North Caucasus as well as providing an alternative to having it flow to Europe and competing with their own gas," said Matthew Sagers, Senior Director for Eurasia's Energy Economics at U.S. IHS CERA, an energy consultancy.

Gazprom is the main Russian gas exporter to Europe --over half of its gas sales came from Europe exports-and is already building Nord Stream, a pipeline running offshore in the Baltic Sea that will supply gas to Germany. It is also proposing to build South Stream, a EUR15.5 billion pipeline that would bring Russian gas to Central Europe under the Black Sea, directly competing with Nabucco.

But Azerbaijan would prefer to sell westward and open up a new market for its commodity, Sagers said. "They would naturally prefer to sell the gas to Europe to demonstrate that they are an independent country," he said.


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