NEXT STEPS ON EURASIAN ENERGY STRATEGY

C O N F I D E N T I A L SECTION 01 OF 04 BAKU 000377

SIPDIS

E.O. 12958: DECL: 05/10/2019
TAGS: PGOV PREL AJ ENRG TU KZ TX
SUBJECT: NEXT STEPS ON EURASIAN ENERGY STRATEGY

Classified By: Charge D'Affaires Donald Lu, Reasons 1.4 (b,d0


1. (U) Embassies Ashgabat, Ankara and Astana have provided
input for this cable.


2. (C) SUMMARY. The USG needs to intensify its engagement on
Eurasian energy issues, and do it quickly. In Azerbaijan,
lack of progress on creating a "Southern Corridor" for
Caspian gas, due primarily to Turkey's unwillingness to
provide clear transit terms to European markets, has already
stalled Azerbaijan gas development and makes it less likely
that Turkmenistan will seek to send gas west. Lack of
expertise and experience in creating and operating complex
legal, technical and commercial structures, along with
excessive rent-seeking activity, could weaken the overall
commercial viability of western shipment of the massive
volumes of anticipated Kazakhstani crude oil that will begin
to come to market around 2013. Such an outcome increases the
chance that more of these Kazakhstani volumes will go south
to Iran or north to Russia. In Turkmenistan, lack of a
suitable business climate for foreign direct investment by
international energy companies keeps Turkmen gas production
at relatively low levels, while Russian high-level political
attention to Ashgabat allows Gazprom to continue its control
over Turkmen gas exports.


3. (C) SUMMARY (CONT): For these and other reasons, Embassies
Ankara, Ashgabat, Astana and Baku welcome the appointment of
Ambassador Morningstar as Special Envoy for Eurasian Energy
(SE),whose regular visits to regional capitals will
strengthen our bilateral energy cooperation. We suggest he
focus on working with the GOAJ and the GOT towards Turkey
allowing commercially viable transit for Caspian gas seeking
European markets while also ensuring that Turkey is able to
buy additional upstream gas to meet its growing domestic
energy needs. Such a solution must both allow Azerbaijan to
sell its gas at commercially acceptable terms to customers it
chooses, while also allowing Turkey to derive a benefit from
gas pipelines crossing its territory. In this regard, we are
on the verge of a potentially important breakthrough on gas
transit fees for the East-West energy corridor. The Nabucco
IGA slated to be initialed in Prague in early May and signed
in Istanbul in June contains provisions for a transparent
tariff formula that will be agreed by all Nabucco partner
countries. We suggest SE work with all Nabucco partner
companies with special attention to Turkey and the EU to
ensure such an agreement gets done. The signing of this IGA
could be a milestone in opening the East-West energy corridor
and could serve as a model for other projects. We recommend
SE also continue to follow developments related to other
pipeline projects ( to include TGI) as the USG, previously
seen by many as focused exclusively on promoting Nabucco,
should not be seen as championing specific pipeline projects
to the exclusion of other, equally if not more viable
projects. For many reasons, Nabucco could be too ambitious
a project in its slated timeframe, whereas less complicated
projects like TGI could be more commercially viable at
present or could be seen as a first step in a larger
East-West energy corridor. Additionally, we suggest SE
Morningstar work with the International Energy Companies
(IOCs) in Kazakhstan's Kashagan and Tengiz consortia, to
ensure that their views are sufficiently reflected in the
Trans-Caspian Project (TCP) for shipping Kazakhstani oil
through Azerbaijan. In Turkmenistan, we suggest he focus on
encouraging the GOTX to facilitate foreign direct investment
in the hydrocarbon infrastructure so as to facilitate optimal
production, while also working to facilitate IOC
participation in the development both of the GOTX offshore
and onshore gas sector. END SUMMARY.


4. (C) OVERVIEW: Europe now consumes almost 600 bcm/a
annually, about 50 percent of total gas consumption is
produced in Europe and 50 percent is imported. Russian gas
accounts for about 33 percent of Europe's total gas
consumption or about 66% of its imported volumes. By 2030,
this is expected to grow to 700-730 BCM, given expected
economic growth and Germany's closing down its nuclear
plants. But with the continued exhaustion of North Sea and
Dutch gas reserves, an even larger percentage of that future
supply, about 70 percent will come from imports, and a large
portion of that increase will come from Russia absent
alternatives.


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5. (C) OVERVIEW (CONT): The largest East-West corridor plan,
Nabucco, aims to import at least 30 billion cubic meters
annually (BCM/a) to Turkey and Europe to be commercially and
strategically viable. While that will not dramatically
reduce Russia's monopolistic position, every alternative
source contributes to loosening the European gas market and
alleviating in particular the political leverage of Russia's
position. The problem is that the primary source for
near-term gas for Nabucco, Azerbaijan's Shah Deniz II, can
provide only 12-14 BCM at the Turkish border. Depending upon
Turkey's "takes", of between 4-8 BCM/a, there may not be
enough 'starter' gas to Europe (8-10 BCM/a) to get the
project up and running. Longer term, to be viable additional
gas for Nabucco would have to come from non-Azerbaijani
sources, possibly Turkmenistan, Iraq, or, if politically
feasible, Iran.


6. (C) An optimal USG Eurasian Energy policy should flow from
and be integrated into the overall USG approach to the
Caucasus, Central Asia, Russia, Turkey and Iraq, as well as
European Union members to the West. Such a policy should
seek to ensure the long-term independence and stability of
those Caspian region countries of strategic interest to the
United States, such as Azerbaijan, Kazakhstan, and
Turkmenistan, while acknowledging Russia's enormous
production and exports, Europe's rising demand, and Iran
potential as a supplier should its geopolitical status
change. The Caspian countries have substantial hydrocarbon
resources and face a great risk as a resurgent Russia seeks
to monopolize their oil and gas reserves, Iran makes plans to
develop its huge reserves, and Turkey remains uncooperative
on gas transit.


7. (C) The long term independence and stability of
Azerbaijan, Kazakhstan, and Turkmenistan can best be ensured
by swiftly and efficiently developing their hydrocarbon base,
resulting in needed national income and economic growth, and
strategic links with Europe and the West. This hydrocarbon
development requires cooperation among IOCs and the
respective governments and national oil companies, a process
which is already underway. These countries must also have
hydrocarbon export options, so they are not dependent on any
one customer or transit country for their income. Finally,
these and other Eurasian countries must expand and strengthen
their economic inter-relations that can, inter alia, make the
"Caspian Region" as much an economic reality as a
geographical one.


8. (C) Given large gas reserves in Iraq and Turkey's
willingness to build a pipeline to connect with these
resources with the East-West energy corridor, we should
encourage the government of Iraq to export gas to Europe. We
understand the political situation in Iraq is complex and the
legal and regulatory framework for gas export is not yet in
place. W also acknowledge Iraq's own growing need for gas.
However, we continue to hear about plans for Ira to export
gas to Syria and perhaps south to Egypt. To the extent gas
is available for export, the U.S. should encourage Iraq to
use gas exports to forma strategeic relationship with Europe
which would give Europe an important stake in Iraq's future.


9. (C) Implementing such an energy strategy would take the
following form in the following countries:

AZERBAIJAN: Azerbaijan is important both as a producing and
transit country. Its approximately one million barrels of
oil per day that started flowing from its ACG field in 2006
makes it one of the most significant sources of additional
non-OPEC oil to recently come on-line. As importantly, it
can serve as a transit country for the rapidly increasing
volumes of Kazakhstani oil seeking ways to market that are
not dependent on Russian or Iranian routes. Although
Azerbaijan is a mature oil producer, its natural gas
production is set to increase significantly, allowing it to
become an important gas supplier to European and other
markets. Azerbaijan is keen to be a transit country for both
Kazakhstani oil and Turkmen gas flowing westwards, offering
both these countries a viable option for moving their
hydrocarbons to Western markets via non-Russian, non-Iranian
routes.

USG and Azerbaijan have cooperated closely on energy issues
and share the same strategic vision. Azerbaijan's goal

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remains to deliver gas to Europe through Turkey, thereby
bolstering its strategic ties to Europe. However, for over a
year it has unsuccessfully sought to persuade Turkey to pay a
commercially viable price for the Azerbaijani gas it is
already receiving from the Shah Deniz field, and to allow
transit of future Azerbaijani gas to European markets under
internationally accepted, commercially viable transit
conditions. In the wake of recent tensions with Turkey over
rapprochement with Armenia and given the failure to agree on
transit terms, the GOAJ has recently began to signal that if
transit terms cannot be agreed with Turkey, it may seek new
relationships with Russia to allow Azerbaijani gas to either
be delivered to Europe through Russia, or sold directly to
Russia. In addition, what the GOAJ perceives as USG
reluctance to address more actively and constructively other,
non-energy, concerns in the bilateral relationship could
adversely impact the energy agenda. To achieve our energy,
security and democracy objectives here, we need to elevate
and intensify our overall strategic relationship with
Azerbaijan, and to continue working closely with Azerbaijan
in its efforts to work with Kazakhstan and Turkmenistan in
jointly developing and transporting oil and gas.

TURKEY: Commercially viable westward transit of Caspian oil
and gas to Europe via non-Russian routes requires Turkish
participation. For the last 18 months, however, efforts to
conclude a transit agreement for Caspian gas through Turkey
to European markets, in volumes sufficient to sanction at
least one gas pipeline project (Nabucco, TGI or TAP) have
failed, and relations between Azerbaijan and Turkey, for this
and other reasons, are becoming strained. For months, the
GOT has maintained it cannot grant transit rights to Caspian
gas without some assurance that Turkey will have the right to
buy some of the gas to meet its own growing gas needs. The
U.S. has encouraged Turkey to strike a bilateral gas sales
and purchase agreement with Azerbaijan to meet its domestic
demand. For its part, the EU has proposed the concept of a
Caspian Development Corporation (CDC) which would aggregate
EU demand in hopes of attracting Turkmen gas to Turkey and
Europe. While there are concerns in Washington concerning
competition, CDC is the best example yet of the EU pulling
together on the southern corridor and it will is an important
component of our strategy to move Turkey to yes on transit
issues.

The GOT said it will be ready to sign the Nabucco IGA in
June. If the GOT indeed follows through, it might help break
the impasse on transit terms. According to representatives
from RWE and OMV, an annex to the IGA includes a transparent
tariff formula that is agreed by all Nabucco partner
companies that would be used to calculate the cost of
transporting gas from point A to point B. The IGA will also
include provisions for taxation which is how the national
governments will make money on Nabucco. Turkey will not be
able to impose any additional provisions on transit. It is
not clear whether the tariff and tax formulas will be
acceptable to Azerbaijan, which wants Turkey to grant
commercially viable transit to all upstream gas, as opposed
to being presented with the fait accompli of only a Nabucco
option. Even if Azerbaijan finds the Nabucco IGA as a
necessary but not sufficient condition, such a disagreement
might move the discussion to one between Nabucco partner
companies and potential gas suppliers, rather than between
Turkey and Azerbaijan. The United States should encourage
Turkey to support the Nabucco IGA. If the IGA is signed, we
should encourage Azerbaijan, Turkey and other potential gas
suppliers to view the IGA transit formula as a model for
other projects. As discussion advances on other transit
pipelines, the U.S. must continue to support solutions that
are offered by commercial partners without whose support
these projects will fail.

KAZAKHSTAN: Kazakhstan is poised to become an increasingly
significant source of non-OPEC oil. Its Kashagan field
alone, slated to start production in 2013, is expected to
provide 1.5 million barrels/day to world markets, and
production at Tengiz is expected to grow to 1.1 million
barrels/day. Currently, there is not enough export capacity
for these new expected volumes, and IOCs in Kazakhstan in
conjunction with national oil company KazMunaiGas are looking
for commercially viable export routes, to include one that
flows westward through Azerbaijan to Georgia and Turkey.
U.S. and other international companies continue to press

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Russia and other partners for expansion of the Caspian
Pipeline Consortium, which runs to the Black Sea. The USG,
in promoting multiple routes to market, needs to ensure the
commercial viability of westward export of Kazakhstani oil
through Azerbaijan, while continuing to discourage swaps and
other mechanisms to and through Iran. As such, it needs to
make the commercial viability of Kazakhstani oil transit a
strategic issue in Azerbaijan, to increase IOC participation
in creating the necessary legal, commercial and technical
infrastructures, and to minimize the current rent-seeking
activities that are imperiling the projects' viability.

TURKMENISTAN: Russia's pre-eminence in European gas markets
has been facilitated by its ability to purchase Turkmen gas
for its own markets and Ukraine, while selling its own West
Siberian gas to Europe at premium prices. Turkmen gas
flowing westward ) transparently, to Ukraine and beyond )
via Azerbaijan could greatly increase the commercial
viability of a "Southern Corridor" of Caspian gas to Europe.
Russia knows this well, and places great emphasis on keeping
Turkmen hydrocarbons moving northwards. Realizing that for
largely political and technical reasons it is unlikely that
significant amounts of Turkmen gas will be flowing westward
in the short- to mid-term, any successful USG Eurasian energy
policy must focus in the long-term on creating conditions
within Turkmenistan conducive to IOC investment in and
development of its gas resources, especially offshore. In
this regard, frequent trips by SE Morningstar to Turkmenistan
to meet with President Berdimuhammedov and help "bring him
along" in realizing the importance of a business environment
receptive to FDI, and the importance of IOC participation in
developing Turkmenistan's onshore gas reserves is essential.

China: While Russia's policies with regard to Central
Asian/Caucasus resources are well studied and discussed,
China's arrival on the scene is relatively new and quiet but
arguably just as important. The flow of Kazakh oil eastward
to China and future flow of Turkmen gas, are also "wins" for
a Eurasian energy policy that focuses on diversity of export.
As China becomes more willing to pay market prices for oil
and gas, increasing amounts of Caspian (as well as Russian)
hydrocarbons should flow eastwards. We should not regard
these developments as hydrocarbons "lost" to Europe. Rather,
the U.S. should begin thinking about ways to cooperate with
China in Eurasian energy development.


10. (C) Finally, it bears noting that in conjunction with our
energy policy in Azerbaijan, Kazakhstan and Turkmenistan, we
must work with them to further a long-term, organic process
of economic integration and political development, so as to
better ensure their long-term security and stability. Part
of this effort should be on increased transparency and
furthering the rule of law. In Azerbaijan and Kazakhstan,
the Extractive Industries Transparency Initiative is a good
step along this route.
LU