Does Russia's Turkey pipeline make sense?

The EU commissioner responsible for “energy union”, Maros Sefcovic, claims that Turkish Stream is economically absurd.

Let’s take a closer look.

Russia’s export strategy to Europe since the collapse of the Soviet Union was always “from wellhead to burner tip” - to control transport routes from wherever it extracts gas to final consumers in Europe.

From a financial point of view, it maximises Russia’s ability to exercise market power.

From a political perspective, it helps to divide EU member states.

But European market deregulation and liberalisation - a process which began in the late 1990s - has removed the right of gas producers to own gas transport infrastructure, making it increasingly difficult for Russia to sustain its preferred model.

Shift the burden

The Ukrainian crisis put an end to this model in an emphatic way. But the Turkey strategy might fulfill the same objectives.

Firstly, it’s an attempt by Russia to “shift the burden” of Ukrainian transit risks directly onto European consumers.

It requires European Transmission System Operators (TSO) to use their own money to build new infrastructure by 2019 to bring gas from the new hub on the Turkish-Greek border to their home markets.

In the past, as in the 2009 gas crisis, if deliveries stopped, Ukraine suffered losses on its empty transmission network. But under the new model, European TSOs will pay the price.

Secondly, with the advent of spot gas trading and the emergence of new liquid gas trading hubs in Europe, it would make it easier for Russia to manipulate prices.

The hub is to be located on non-EU territory and, therefore, beyond the reach of European regulators.

The onward gas shipments will be subject to EU law. But Russia will be able to limit flows at the new source if spot prices fall, in the same way that the oil cartel, Opec, plays with oil volumes.

Playing with volumes

If anyone doubts that Russia manipulates gas markets for economic and strategic purposes, they should look at recent deliveries from Russia via Ukraine to the EU and from Russia to Turkey.

Gas flow through Ukraine to Slovakia - the main route for Russian gas exports to Europe - eroded over the past year. Deliveries in autumn 2014 were just one third of autumn 2013.

This serves several purposes.

It protects Russia’s monopoly of the Ukrainian market because it limits reverse flows from central Europe to Ukraine: the less gas Russia pumps to Europe the less gas Europe has to pump back to Ukraine.

It could also help Russia in its case against Ukraine at the Stockholm arbitration tribunal.

The case, over the legality of a 2009 Russia-Ukraine contract, has seen Ukraine push for its Russia gas prices to be indexed to gas spot market prices.

But lower Russian flows push up spot prices, making the Ukrainian idea less attractive, while putting more money in the pockets of Russian supplier Gazprom and its trading subisidiaries.

Russia also reduced gas flows to Turkey in October and November of 2014 by at least 30 percent compared to preceding months.

It prompted the Turkish energy minister, Tenar Yildiz, to say: “We don’t want to be in the same situation that EU countries face due to the Ukraine crisis. It indirectly influences Turkey and we don’t want to be part of this problem”.

Immediately after Russia announced the new Turkey project on 1 December, Russian flows to Turkey returned to normal.

If Russia builds Turkish Stream and European TSOs build new pipelines to link to it, we can expect more manipulation.

Paying twice

Whenever Russia restricts volumes, the TSOs will have to recover the cost of keeping their new pipelines empty by increasing energy prices for European consumers.

In other words, European customers will have to pay twice: First for the higher prices due to lower supply and second so that the TSOs can get their money back.

Russia’s new strategy has at least one blind spot, however.

It means Turkey will acquire new leverage over Russia’s strategic aims - Turkey could become another Ukraine, but one that would be much more difficult for Russia to influence.

For Europe, it means gas flows would be controlled by Russia and Turkey - neither of which are friendly towards Europe at this moment, and, one fears, for a long time to come.

The immediate outcome is that Europe must continue to finance Ukraine to secure energy flows until European TSOs build up the new infrastructure to bring gas from Turkey/Greece.

In so doing, it will inevitably put upward pressure on energy prices for European consumers.

But in the long-term, it will change the balance of power in Eurasia.

Turkey will gain political weight in its discussions with Europe and Russia.

At the same time, Ukraine will lose geopolitical importance, making it a less attractive partner for Europe and an easier target for Russian domination.

Chi-Kong Chyong is an analyst at the Energy Policy Research Group, a Cambridge University programme