Iran, sanctions and the ‘great game’ of Eurasian energy politics

Conflicts Forum's Weekly Comment, 10-17 April 2015

The Lausanne ‘joint’ statement on the outlines of a nuclear agreement has already – with any final settlement yet several months away – brought big changes to the region: Saudi Arabia’s very young ‘regent’ is intent on a demonstration of Saudi-led Sunni independence and power in Yemen and Syria.  The possibility of an Iran deal is also lending new momentum to the ‘great game’ of Eurasian energy supply and market politics.  On the one hand, there is the question of Europe’s energy connections with Russia (which America ideally would like to see wither); and, on the other, is the question of an Iran removed from sanctions. Again, the US has a definite interest here: It would wish to see Iranian energy flowing to Europe, in place of Russian gas (thus binding Iran closer to the West, and driving a wedge into the present good relations between Russia and Iran).  The outcome to these various (and conflicting) manoeuvres will shift the tectonic plates one way or another.

This week Russia mounted a campaign in Europe to convince Europeans that energy supply – particularly in respect to security of supply – is an issue that should be de-politicised, and disengaged from the current political differences existing between Russia and the EU.  The politicisation of energy policy (in the wake of the Ukraine crisis), they argue, works directly at odds with the EU’s ostensible desire to achieve long term energy security.  The Russians are surely right that short-run politicisation requirements and long term investment needs, make for uncomfortable bedfellows.  But their second-strand argument, which merits much deeper attention, is that in pursuing its present course, the EU within a very few years, may face a severe crisis in respect to gas supplies, which European leaders will not readily be able to remedy.

To make their case, the Russians brought together in Europe the head of Gazprom, Alexey Miller, the Russian Minister of Energy, Alexander Novak, plus a number of representatives of European international energy companies who explained that their companies were still working in Russia (including in the Arctic), and that they had every intention to remain there (sanctions not withstanding). 

What was striking firstly, was that this presentation (essentially being made to the EU) was not held in Brussels, but in Berlin. This says mountains about today’s EU. Secondly, the vice-president of Total described the financing of the artic joint venture with Novatek as being partly Russia’s sovereign wealth fund, part Euro-finance and part Chinese finance: no dollars obviously.  Plainly, the non-dollar financing of what is one of the world’s biggest LNG projects has wide ramifications for the future. It suggests that finding non-dollar finance for big energy projects may not prove as problematic as some have argued.

The Russian argument essentially is that EU policy is pursuing conflicting aims: It wants diversification of supply (read: less dependency on Russia), it wants competition at all levels (read: no integration of the supply chain from upstream to consumer, which has been the Russian practice), a uniform price (read: no Russian playing of country favourites), but it also wants to pursue environmental protection (which effectively means more gas in the energy mix).  

Russia well understands that much of this EU ‘competition strategy’ is about diluting Russian influence in Europe (and depriving it of a prime source of revenue). But it also understands that the EU is deeply divided.  Some see Europe as having erred in deliberately pushing Russia out of the ‘European’ political, economic and security space, while other Member States remain embittered toward Russia.  Russia patently is appealing to the pragmatic side of Europe, which is visible in several European states at the moment.

Alexey Miller of Gazprom said quite simply that these EU policies amounted to a fundamental skewing of the risk curve: the huge investment lay with production and transit to market.  The EU wanted a risk-free consumer market (multiple suppliers, a single market price, short contracts (enabling quick switching between suppliers) - but with security of supply, too).  ‘But would the massive upstream investment be forthcoming on this basis’, he questioned?  All the risk was being pushed along the risk curve – to fall on producers.  But the latter also needed energy security: they needed the security of a long-term consumer market – otherwise upstream investment would not be forthcoming.

Miller offered the EU a proposal: he suggested reviving the EU-Russia energy dialogue (which is currently suspended), and expressed Russia’s willingness to work with the EU’s Third Energy Package. But he warned that some elements needed further thinking through to be workable: Aiming for a common EU gas price would not result in the EU obtaining the lowest uniform price for its gas, but rather a higher price (to account for market and infrastructure differentials).  Though it was true that gas prices in Europe were likely to fall, this too did not imply a uniform Euro-wide (low) price: some prices would in the future be determined by hub prices (at differential rates), but long term contracts were not things of the past – rather on the contrary, parties were still keen to enter such contracts (because both suppliers and consumers needed long term assurances).

Finally, he pointed out that in the West Siberia field, the infrastructure investment has been made; the production capacity (to supply Europe) is there, and spare capacity was significant.  It was not explicitly said, but it was implied, that the EU was in danger of ‘cutting off its nose’ (ignoring the prime asset which already is in place) ‘to spite its face’ – that is to say, just to ‘spite’ Russia over Ukraine.

In short, the deliberate politicisation is taking the EU toward a crisis: Yes, the EU will continue to be supplied with Russian gas and oil, but by 2019, the pipeline transit agreement with Ukraine for supplying the EU ends.  Russia will supply the EU from thence through the Turkish Stream, and a ‘hub’ at Turkey’s border (with perhaps a pipeline extending through Greece into the non-EU Baltic states – portending another geo-strategic shift).  But, as Miller noted, if the EU wishes to take gas from this projected hub (due in 2017), the EU should already have begun planning its own pipeline structure. But, in fact, there is no sign of any preparation being done at all.

Here the bigger picture enters in to all of this: if the EU remains determined to whittle down Russian dependency, where does it imagine its alternative source of gas supply will come from? North Africa is slipping into the political mire with chaos and ISIS on the ascendancy; the East Mediterranean basin is beset by deep political divisions; North America’s LNG is likely to be significantly more expensive than existing gas costs, and thus undermine European competiveness; Caspian, or at least Turkmen gas, seems destined for China, which leaves Iran and Iraq as the effective possible options for European diversification of supply -- if there is a lifting of sanctions on Iran.

And here, Alexey Miller’s comments about the EU wanting complete consumer security at the expense of producer security is relevant. If Iran, like Russia, has no prospect of securing a long term, contractual end-purchaser agreement in the EU, as a result of the EU’s Third Energy Package, then Iran may well look to other options to find such security elsewhere (a security which will be necessary to underpin the major financing it too will require).

Last week, the Wall Street Journal reported that a deal is expected to be signed during the Chinese President Xi Jinping’s forthcoming visit to Pakistan (possibly later this month) under which “China will build a pipeline to bring natural gas from Iran to Pakistan to help address Pakistan’s acute energy shortage”.

As former Indian diplomat turned analyst, M K Bhadrakumar has noted:

“Beijing cannot but be eyeing the prospects of extending the pipeline eventually to China. Ideally, China would like this happening in the form of an extended pipeline transiting through northern India leading to China’s southeastern Yunnan province. (Xinjiang is already directly linked to the Central Asian energy producing countries.) Which means that China would be hoping that at some point India too would join the IP project.

“Originally, this was to have been an Iran-Pakistan-India [IPI] gas pipeline project – that is, until the middle of last decade when Delhi, under U.S. arm twisting, developed cold feet on the project…But the Chinese assessment seems to be that the Indian stance is pragmatic [toward such] initiatives such as the IP gas pipeline project … Most certainly, Iran too will be keen on such a project involving China and India as that would guarantee access to three of the biggest Asian markets for its gas exports through a single mega pipeline system.” (CF emphasis added).

“There are sub-plots too. China and Iran would have a degree of interest in smothering the US-backed Turkmenistan-Afghanistan-Pakistan-India [TAPI] gas pipeline. China has invested heavily in the Central Asia gas pipeline network evacuating Turkmen gas to Xinjiang and would prefer that the Turkmen reserves do not get diverted to the South Asian markets. Iran too wouldn’t want the TAPI project rivaling the IPI pipeline. From the Iranian viewpoint, locking in three big energy guzzlers next door is a highly desirable thing as it guarantees long-term market tie-up. Pakistan will certainly prefer a Chinese partner to an American sponsor”.

Here precisely lies the risk to Europe’s energy supplies: If it bends to US wishes to disdain the offer of West Siberian plentiful supply, it may find that the Iraqi–Iranian huge reserves have been scooped up by Pakistan, India and China. 

Of course America will do its utmost to prevent this happening. And the usual argument advanced is that Iran simply cannot manage without western technology (although Iranians tell us that this is no longer true – that China and Russia do have the technology).

Liberal competition policies may be fine in theory, Alexey Miller seems to be saying, but they do not always work out as intended – if they skew risk too far in the direction of suppliers. The large producers will prefer whomsoever will give them longer term assurances of access to a large market.  Did then Germany and the EU take note of Russian arguments in Berlin?  A German minister and a senior EU representative had been invited to the Russian-facilitated conference, had accepted to attend, but both, at the eleventh hour, pulled out.  The EU note-taker dispatched to the presentation, as these things somehow happen, was Polish – and fulminated throughout at Russia’s nefarious politicisation of energy supply.

Plainly the differing internal dynamics within the EU, together with US pressures on Europeans, are incapacitating any EU decision-making at this time in respect to its longer term relationship with Russia, but as a colleague remarked to us, out east, events are changing at an ever accelerating pace.  The grinding sounds of tectonic plates on the move are quite discernible.