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The U.S. Perspective on Eurasian Energy
Remarks by Ambassador Richard L. Morningstar
Special Envoy for Eurasian Energy

2010 Black Sea Energy and Economic Forum
Istanbul, Turkey
September 30, 2010

When I started this job 18 months ago, I was frequently asked what had changed since my work on regional energy issues during the Clinton Administration.  I had what I thought then were some good answers:  the respective roles of Russia and Europe; the relative importance of gas vs. oil; the emergence of an LNG spot market; expectations for the global economy.  Recently, though, I’ve come to the conclusion that there is a simpler answer:  “just about everything."

And what’s becoming clearer to me is that the pace at which basic assumptions about Eurasian energy security are changing is, if anything, increasing.  When I started my current job, to say nothing of when I was Caspian Energy Coordinator a decade ago, shale gas was not even discussed.  Prospects for future Russian-Ukrainian energy cooperation looked slim to none.  Few would have predicted that suppliers like Russia would be willing to renegotiate take-or-pay terms of existing agreements.  Nobody was predicting the U.S. would become a net exporter of gas.

The lesson I draw from this is that any serious effort to address the complex, inter-related problems of Eurasian energy needs to be informed by humility.  Assumptions that look rock solid today can change — and change quickly.  If we build in that realization up front, we are most likely to come out at the other end with solutions that work.

That said, you obviously can’t plan without making assumptions.  And those assumptions need to be based on the best, most realistic analysis available of the context in which decisions will be made.

The Realities

Based on my work of the past 18 months, let me share with you today my sense of the context, of the realities, we face in our work on Eurasian energy during the period ahead.

First, we are moving inexorably out of the world of “zero-sum.”  There may have been moments over the past decade when one or another player had the cash or clout to pull others along with it on a specific project or projects.  Not anymore.  Political will is a necessary but not sufficient condition for realizing major projects.  Lasting solutions to the problem of securing the orderly, efficient transportation of energy throughout the Eurasian marketplace will require a high degree of compromise and common benefit, or they may well not happen.

Which is another way of saying that big ideas need to be bankable.  At the risk of stating the obvious, some of the major projects that have been on the drawing boards for a while are breathtakingly expensive.  Too expensive, in most cases, for any single actor to pay for out of petty cash.  Given the uncertainty of energy markets and the aftershocks of the global financial crisis, finding financing for big, new projects will more than ever require a sound business case:  one that not only makes sense in terms of the economics, but that factors in the risks in a region where predictability can be an issue.

One big challenge in making a convincing business case is the reality that energy demand and supply both loom today as big question marks.  While there is every likelihood that energy demand in Europe, including Turkey, will return to and eventually exceed pre-slump levels, it is not at all clear how fast this will occur.  And on the supply side, shale gas and other developments could emerge as real game changers.  Some argue, for example, that the U.S. could become a substantial exporter of gas to Europe and global markets in just a few years.

This means that some very big investment decisions may have to be made on the basis of “best guesses” that may or may not hold up.  And that implies, in the short to mid-term, that the smart approach to energy security, particularly for specific countries or regions, may be local and incremental:  an approach that focuses on getting the most out of or adding marginally to existing infrastructure.

Within Europe, for example, there is much that can be done in terms of connecting existing gas and electric power networks and building gas storage, that can pay significant dividends in return for minimal new investment.  Indeed the EU has committed several billion euros for investment in such facilities.  The EU has also correctly recognized that improving energy efficiency, investment in renewables and liberalization of energy markets are smart moves that can make a real difference in the near term.

But my final point in this quick reality check is that — much of what I have just said notwithstanding — there will remain a place in the Eurasian energy security picture for new, major infrastructure projects.  At the end of the day, demand for Eurasian energy will exceed the ability of existing infrastructure to supply it.  There is nothing that comes close to matching the reliability and economies of scale that large-capacity, dedicated pipelines or similar fixed infrastructure can provide.

Pipelines and U.S. Policy

Based on the torrent of press releases that come through my office on a regular basis, it would appear there are a lot of people out there who would agree with at least my final point.  South Stream, White Stream, Med-Stream, Blue Stream II, an Arab pipeline, pipelines from Qatar, from northern Iraq, from Samsun to Ceyhan and Burgas to Alexandroupolos, from Turkmenistan to India, and of course Nabucco, ITGI, and TAP.  It’s a confusing picture.  And of course not all of these projects will get off the drawing board, in view of the realities I’ve just been talking about.

What is the Obama Administration’s approach to this plethora of projects?

Our approach is grounded in certain core principles:
•    Europe’s energy security is in America’s national interest.  Our economies are interdependent.  An energy-secure Europe is in the U.S. national interest and vice-versa.
•    Diversity is good.  Just as in investing, having alternatives in terms of sources of energy, suppliers, and transit options will ultimately benefit all players.
•    The best solutions are those that the market produces.  Indeed, given the need for bankability I described a moment ago, they are likely to be the only solutions.

Based on those principles, some of the projects and ideas that have surfaced have made more sense to us than others.  And we’ve said so.  We have, for example, strongly supported the concept of a Southern Corridor to complement existing networks for moving gas from Eurasia to Europe.  We are working with the EU and Ukraine to make the Ukrainian gas transit system more reliable.  We are engaged with Russia on a range of energy issues. We’ve worked with international oil companies, along with Azerbaijan and Kazakhstan, to develop means to move the anticipated increase in Kazakh oil production to world markets.  We’ve facilitated exchanges of information and expertise on emerging technologies like shale gas, where the U.S. has unique experience.  We’ve worked across the region on realizing the potential of clean energy technologies, including energy efficiency and renewable energy.

As we look ahead after 18 months of work, the principles I’ve enumerated will continue to guide U.S. policy on Eurasian energy.  At the same time, we should recognize that we are entering what will be an especially important period for Eurasian energy, particularly as it relates to the diversity of gas supplies for Europe.  Indeed, in some respects the period ahead will be decisive.

What do I mean by that?  I mean, fundamentally, that a number of things will soon become clear.

First, it will become clear — indeed it is already clear — that there will be a Southern Energy Corridor.  The June 7 conclusion of a Turkish-Azeri gas purchase/transit agreement removed the last major uncertainty regarding terms for moving substantial volumes of Azeri gas across Anatolia.  On that basis the Shah Deniz II consortium, which is developing a large offshore gas field in the Caspian, is moving ahead with project planning.  Negotiations with potential buyers and shippers are underway.  Potential shippers of Shah Deniz gas – the Nabucco, ITGI and TAP consortia—are lining up financing and putting in place the organizational structure to transport the gas.  A Southern Corridor is going to happen.  And I’d like to congratulate our Turkish hosts and their Azeri and commercial interlocutors for getting to “yes” after years of negotiation, although we understand there are still details to be worked through.

Second, it will become clear in the months ahead whether Turkmenistan will contribute to the Southern Corridor by shipping gas across the Caspian, or will choose to focus on other routes for diversifying its energy exports, such as the TAPI project.  The Nabucco consortium, supported by the EU, has worked hard to elicit a firm commitment from Ashgabat to ship its gas west.  The U.S., for its part, has supported the concept of a trans-Caspian gas pipeline since the nineties. 
This is obviously a sovereign decision for the government of Turkmenistan, and it may well be that Turkmenistan will not agree to gas crossing the Caspian by pipeline in the foreseeable future.  In that case the window for its involvement as an early contributor to the Southern Corridor would inevitably close.  Given that the Shah Deniz consortium is looking to make their decisions in the next six months, other sources of gas must be considered.  Even Azerbaijan might ultimately be a source of additional gas.

This leads to the third point — it is becoming clearer that prospects for bringing gas into the Southern Corridor from points further east and south are looking more promising.

At some point – hopefully sooner rather than later, but at some point – a new government will be formed in Iraq.  We hope that a priority of the new government will be to break the long-standing stalemate between Baghdad and Kurdish regional authorities on a hydrocarbon law and revenue sharing agreement.  This would bring important benefits to Iraq in terms of further development of its oil and gas infrastructure, of jobs and of revenue creation for both national and regional authorities.  It would also create the framework for a serious discussion of how to bring Iraqi gas into the Southern Corridor. 

Let’s be clear.  This won’t be an easy discussion.  There are some Iraqi domestic priorities to be sorted out.  And in our view any viable scheme for exporting resources from the north must be endorsed by Iraq’s central government.  But there seems to be a consensus among experts that Iraq has ample gas – in both the northern and southern parts of the country.  Once these reserves are developed, Iraq should be able to both meet domestic demand and export significant volumes without difficulty.  We should not forget that Prime Minister Maliki said last year in Ankara that Iraq could provide 15 BCM of gas to Nabucco.

It’s also worth noting that Qatar is becoming an increasingly important exporter of gas to European markets and may now be more interested in exporting piped gas as well as LNG.  Proposals for bringing "Arab gas" across the Syrian border to Turkey have also re-emerged.  And reports of the size of the Tamar and Leviathan fields off the Israeli-Lebanese coast simply underscore the fact that, to Turkey’s east and south, there is abundant gas to meet Europe’s long term energy needs, even if other options remain blocked for now.

One more thing will become clear in the months ahead.  Sometime between now and next spring, the Shah Deniz II consortium will decide which of the three groups vying to ship its gas to European markets gets the nod.  That decision will have profound implications for the three consortia — Nabucco, ITGI and TAP — whose business models rely on locking in early, substantial volumes of Shah Deniz gas.  Indeed, the consensus among industry experts is that, given their competitive approach and the impediments to accessing non-Azeri sources of gas in the near term, only one of the three can remain viable after that decision.

Commercial issues will principally determine the decision of the SDII consortium, whose members have a duty to their stockholders to cut the best deal they can.  For our part, we have always said that we support the Southern Corridor.  Any of the three competing projects could, in our view, serve as the basis for that Corridor.

In fact, each of the pipeline consortia brings to the table elements that could provide added value to a Southern Corridor.  In the abstract, Nabucco would be preferable.  Nabucco has clear advantages in terms of meeting the needs of consumers in the eastern EU countries.  A dedicated large pipeline, like Nabucco, operating to international standards, would have important advantages over existing infrastructure, and might be the most profitable solution if operated at full capacity.  This is why it is important to do everything possible to line up additional early sources of gas from Iraq and elsewhere. 

The conundrum is that beefing up existing infrastructure could be in the short term the most cost-effective way to handle initial Shah Deniz II volumes, although this may prove to be easier said than done.  At the same time, no one seriously questions that, in the long term, improvements to current infrastructure will be inadequate to handle expanding European and Turkish demand.  And as new gas sources become available for the Southern Corridor, it will need a way to get to market.

The question naturally arises:  does this have to be an "either/or" moment? 

The short answer is that, although governments will continue to play a role, the markets will decide, or will at least have the strongest voice in making the decisions involved.   But I think it would be a mistake to rule out outcomes that incorporate, through means like consolidation or staging, the stronger points of the various consortia. 

The challenge of the months ahead is to get the Southern Corridor up and running in a way that reflects current gas availability, but that also allows room to grow, and that meets in a timely manner the needs of Europe’s less well-served consumers.  The competing consortia’s current business plans all fall short, in one way or another, of meeting that challenge.  Maybe this shouldn’t be surprising, since all three projects were conceived years ago in a very different environment.  Momentous decisions on Shah Deniz II gas are coming up fast.  It may be time to take another look at the assumptions underlying the competing projects for transporting that gas.    This is a time when commercial creativity is necessary.

As I said at the opening of these remarks, a lot has changed with respect to Eurasian energy since I got into this line of work.  But a constant has been that the markets reward those who can best adapt to change when circumstances require it. 

That may be a good place to end.

Thank you.