TURKEY FRUSTRATED WITH AZERI GAS NEGOTIATIONS

C O N F I D E N T I A L SECTION 01 OF 02 ANKARA 001226 SIPDIS DEPT FOR EUR/SE, EUR/CARC, S/E MORNINGSTAR E.O. 12958: DECL: 08/18/2019 TAGS: ENRG ECON PGOV AJ TU SUBJECT: TURKEY FRUSTRATED WITH AZERI GAS NEGOTIATIONS REF: ANKARA 1150 Classified By: Charge d'Affaires Doug Silliman for reasons 1.4 (b,d). ¶1. (C) Summary. Following the recent round of gas negotiations between Turkey and Azerbaijan, Turkish interlocutors expressed frustration at the lack of progress. Going into the meetings, the Turks had fully expected that they would be finalizing the deal and were surprised by what they see as Azeri intransigence on all agenda items. BOTAS Chairman Saltuk Duzyol speculated that the Shah Deniz consortium is no longer interested in selling gas to Nabucco and prefers instead to use the Interconnector for Turkey-Greece-Italy (ITGI) or to sell directly to the Russians. As neither the GOAJ nor the Shah Deniz consortium want to be blamed for Nabucco's failure, they are trying to shift the blame to Turkey. With both sides digging in - and with negotiations exacerbated by Azerbaijan's recent deal with Russia, Turkey's discussions with other sources of gas, and a deteriorating financial picture at BOTAS - a final deal may take longer than expected. Turkey is likely to stand firm on its current offer and will be reluctant to take steps toward resolving the impasse. End summary. Price Still the Sticking Point -------------- ¶2. (C) In a readout on the recent gas negotiations with Azerbaijan, Saltuk Duzyol, Chairman of BOTAS, was palpably frustrated. He noted that the negotiations had continued to address all three items on the agenda (Shah Deniz Phase-1 price, Shah Deniz Phase-2 volumes and prices, and transit fees) as a package. He said that the Turkish offer for Phase-1 was more than double the previous price and included an automatic staged price increase until 2011, when there would be an additional revision based on market conditions. The main sticking point on this seems to be Azeri insistence on setting the 2011 price in advance. On Phase-2 gas, Duzyol said that the price Turkey offered is very competitive, "very close" to what Turkey pays to Russia, and higher than what most European transporters would be willing to pay to Azerbaijan. He conceded that Russia had just paid USD 330 per thousand cm in a 500 million cm annual contract, but said that price was based on an assumed oil price of USD 93 per barrel. As oil is currently around USD 70 per barrel, Duzyol felt Turkey's price offer was competitive. On transit, Turkey offered a "reasonable" indicator price and is not seeking any additional royalty fees for transiting Azeri gas through Turkey by any means. Shifting Bargaining Positions, Shifting Interests -------------- -------------- ¶3. (C) Duzyol believes that the Nabucco IGA signing convinced Azerbaijan that it is now in the driver's seat in negotiations with Turkey and it is seeking to use its increased leverage to play off potential customers (i.e. Russia, Turkey, Italy) against one another in search of the highest price. He observed that Turkey had made a good-faith, fair offer for Azeri gas, and that Baku should either accept it or offer a realistic counteroffer rather than trying to prolong the negotiations. In recent talks the Azeris reportedly said "let's work on it" rather than offering a specific counter. He nonetheless believed that a decision would be made soon, if only because so many different parties are pressuring the Shah Deniz consortium. ¶4. (C) Stressing that not all of the parties involved in the decision-making process share the same interests, Duzyol speculated that the consortium simply does not want to sell gas to Nabucco and that it is more interested in a deal to sell directly to Russia or to move volumes through the ITGI. He noted with concern proposals to extend ITGI to cover Croatia, Bulgaria, Romania and Moldova, which Russia supports because it erodes the market for Nabucco but does not impact the Central European target countries for South Stream. Duzyol said that he had heard that Statoil in particular was pushing for Azeri gas to go toward the broader ITGI project rather than Nabucco. ¶5. (C) Duzyol was clearly dismayed by the lack of progress, observing that a 120 percent increase in price should be good enough and that the Turkish side had gone to Baku fully ANKARA 00001226 002 OF 002 expecting that they would be finalizing a deal. He argued that if the negotiations were to go to arbitration, then Turkey would likely win based on the objective facts of its proposal. Duzyol says he has become convinced, however, that the Azeris genuinely do not want to sell gas to Nabucco but also do not want to appear responsible for a failure of Nabucco. As such, they are trying to shift blame to Turkey, using transit fees or slightly lower Phase-1 prices as an excuse. ¶6. (C) Echoing his boss, BOTAS Deputy Director General Sakir Arikan said that the Nabucco tariff structure will result in a fee that is simply too high for the consortium's taste, as it is trying to maximize profit at the wellhead. As Nabucco's transport fee will be transparent and incorporated as an integral part of the project, the consortium may see an opportunity to bind BOTAS to a lower tariff in the ITGI negotiations. Edison International, the main partner in ITGI, will soon be making its final offer to SOCAR for gas to Italy. If the Azeris can lock BOTAS into a tariff now, they can use the Italians' offer to calculate their exact profit margin. Note: Although the formula for Nabucco's transport fee system has not been set, it will be based on a number of known determinants (the most important of which is the capital cost of the pipeline),possibly leading to a higher rate than ITGI, whose infrastructure is already partially amortized. End note. Comment -------------- ¶7. (C) While BOTAS's disappointment at not concluding the deal probably colored its interpretation of events, there is a certain logic to the idea that the consortium may prefer ITGI's murkier and more flexible fee structure to that of Nabucco. A recent interview with BBC by Italian Energy Minister Scajola pushing ITGI as a means for delivering Azeri gas to Italy and his explicit statement that "ITGI is further ahead than both South Stream and Nabucco" may put new importance on the October ITGI meetings in Istanbul if there is still no deal to get Azeri gas as a supply source for Nabucco. ¶8. (C) These already-difficult negotiations are being exacerbated by Russia's high price offer for a small quantity of Azeri gas, which sets a price floor in negotiations for Azerbaijan that is probably unrealistic given the disparity in volumes between that deal and the amount needed for Nabucco. Reftel describes energy deals signed during PM Putin's August 6 visit to Turkey. At the same time, the Turks may be starting to believe that the Azeri price is simply too high and that Turkey may be able to find other sources of gas (for example, Iraq or Qatar). Further complicating the deal is the problem of the retroactive payments (back to April 2008) that will be due from BOTAS whenever the new price for Phase-1 is agreed - a problem that will only grow worse with time. If the price increase is really in the ballpark of 120 percent, then this could mean as much as USD 1.5 billion in back payments - money that BOTAS simply does not have. Taking all of this into account, this latest offer may well be Turkey's final offer. Visit Ankara's Classified Web Site at http://www.intelink.sgov.gov/wiki/Portal:Turk ey Silliman