TURKEY: GAS PRICE HOLDS UP GAS TRANSIT

C O N F I D E N T I A L SECTION 01 OF 02 ANKARA 000490 SIPDIS SIPDIS EEB FOR A/S SULLIVAN EUR FOR DAS BRYZA EEB FOR MANN DOE FOR HEGBURG E.O. 12958: DECL: 03/12/2018 TAGS: AJ ENRG EPET TU SUBJECT: TURKEY: GAS PRICE HOLDS UP GAS TRANSIT NEGOTIATIONS WITH AZERBAIJAN REF: A. 3/8/08 BRYZA-SMITHAM EMAIL ¶B. ANKARA 358 Classified By: Economic Counselor Dale Eppler for reasons 1.4 (B) and ( D) ¶1. (C) Summary. Our focus on getting Turkey to quickly conclude a bilateral agreement with Azerbaijan for gas supply does not address the most important issue for Turkey: price, and how the price is determined. The Turks do not believe they can get a good price from Azerbaijan in bilateral negotiations. Although the Turks have not defined what a good price might be, they have said it would be lower than the price they pay Russia. Turkey is pursuing four different strategies to form alliances to negotiate gas supplies, indicating that the Turks are uncertain about how best to reach their lower price goal. The stakes are high for getting lower gas prices for two reasons. First, Turkey believes a good gas price from Azerbaijan will put downward pressure on other gas contracts, notably high-priced ones with Gazprom. Second, if history is any judge, the Turkish official signing a gas deal in which the price is viewed as unreasonably high at any time in the future will face criminal prosecution. Thus, Turkey wants a lower gas price and some objective outside entity setting the price. End summary. ¶2. (C) Turkey has promoted four schemes in search of a good gas price from Azerbaijan: -- Netback pricing scheme: This would allow Turkey to delegate to downstream customers the hard work of negotiating a good price. Turkey would take the price negotiated by the end consumer and deduct the transit costs; -- Establishment of a commercial gas trading hub: This idea would create a mechanism for transparent gas pricing through a system of open bidding akin to the Nymex trading floor. Turks believe this is a long-term proposition at best, but find open, transparent pricing very appealing; -- Private sector gas purchases: In recent discussions with the EU, Turkey proposed that private Turkish companies negotiate directly with Azerbaijan to import gas into the domestic market (ref A). This would remove the government from any culpability on price and move Turkey,s gas market toward liberalization; and -- Nabucco consortium leads price negotiations: According to BOTAS Nabucco Coordinator Osman Goksel, the EU and OMV agreed on March 7 that the Nabucco Consortium (meaning consumer countries) should act as one entity in gas supply negotiations with Azerbaijan. Again, such an arrangement gives GOT officials room to distance themselves from price negotiations. ¶3. (C) Until February 2008, Turkey had been unyielding in its support for the first scheme ) netback pricing ) but the US and EU have clearly told Turkey this scheme won,t work (ref B). In late February, Turkey floated the second option, a commercial gas hub, with us. (Note: This idea is not new but had not been discussed in official circles since the departure from government of its main proponent, Energy U/S Demirbilek in Sept 2007. End note.) Last week, coming out of discussions with EU Nabucco Coordinator van Aartsen,s staff, we heard about the third and fourth options, the potential role the private sector and the Nabucco Consortium could play in gas price negotiations. ¶4. (C) All of these schemes involve a lower price that is set by outside groups or non-governmental forces. This is because Turkish officials have valid reasons to fear future criminal prosecution if they sign a contract stipulating a gas price that is later determined to be too high. Turkish officials generally are subject to criminal prosecution for making decisions that cause financial loss to the state. In 2003, former BOTAS chairman Mehmet Bilgic, renegotiated Russian gas contracts, rolling three separate contracts into one and agreed to higher price in return for relief from ANKARA 00000490 002 OF 002 take-or-pay conditions. As a result, he was fired and indicted for signing a contract that raised prices. His trial continues. Given this history, no Turkish official is likely to sign an agreement in which they negotiated a price. In fact, BP Istanbul Natural Gas Manager Oktay Sen told us he believes contract negotiations over Shah Deniz Phase I gas will likely go to arbitration because no GOT official wants to sign an agreement with higher prices. ¶5. (C) The stakes are high for getting a lower gas price. If Turkey can get a lower price from Azerbaijan, it can use this contract with other gas suppliers to force down those prices. BOTAS Chairman Duzyol told us he would consider opening arbitration with other suppliers, even Russia, if the Azeri gas prices was markedly lower than the Russian price. ¶6. (C) Turkey's energy bill is a key driver of Turkey's huge current account deficit (CAD). In 2007, 89% of Turkey,s CAD was attributable to its energy bill. This year, estimates put the energy bill at 75-107% of the projected costs. According to investment bank analysts, each USD 1 increase in the price of oil (with pass thru to gas prices) increases Turkey's CAD by USD 400-450 million. Although we don,t know the exact prices, we have heard that Turkey pays Gazprom close to $400/thousand cubic meter (tcm) of gas (roughly 60% of Turkey,s imported gas). From press reports, we have heard the Russian gas price at Baumgarten is roughly $350/tcm. Turkey is highly frustrated by this situation. But because gas contracts are confidential, Turkey cannot prove to Gazprom that they are paying more than Austria. At a minimum, Turkey believes that it should pay less than Austria because transit costs from Russia and Azerbaijan to Turkey are lower. ¶7. (C) Comment: Turkey knows it wants cheaper gas but appears to be uncertain how to go about getting it. Rather than trying to address each of their proposed schemes on the merits, we may do better to understand and deal with the main driver of these schemes: insecurity about Turkey's ability to get a good, objectively set gas price in bilateral negotiations with Azerbaijan. We should help Turkey think creatively about mechanisms that would achieve their goal and we should urge direct talks between Azerbaijan and Turkey, perhaps offering to act as a neutral party to build confidence in the negotiating process. Visit Ankara's Classified Web Site at http://www.intelink.sgov.gov/wiki/Portal:Turk ey WILSON