Nicholas Watson in Prague -

In April, Azerbaijan's government is due to take a crucial decision regarding which of several planned pipelines to Europe will be picked to transport natural gas produced at its huge Shah Deniz gasfield. No one outside of the highest circles knows if it's leaning toward the heavily EU-backed Nabucco pipeline or one of the two smaller-scale private sector projects, and the race is too tight to call.

Pipelines rarely make the headlines, but this one should be different: at stake is whether the EU can truly diversify its pipeline gas supplies away from Russian imports in the medium term, and whether the EU executive body, the European Commission, is capable of successfully pushing through projects that are deemed strategic to the bloc's interests.

The decision before the State Oil Company of Azerbaijan Republic, or Socar, is to choose between the not-yet-built pipelines of Nabucco, the Interconnector Turkey-Greece-Italy (ITGI) and the Trans-Adriatic Pipeline (TAP). All three are part of the Commission's attempt to open up what it calls the "Southern Gas Corridor," a network of pipelines that it hopes will transport eventually 60bn-120bn cubic metres per year (cm/y) of Caspian, Central Asian and Middle Eastern gas directly into Europe, without crossing Russian territory.

The opening up of this corridor became a strategic goal after Moscow cut off gas supplies to Ukraine in the winter of 2006 over a dispute about prices, which left large swathes of Europe shivering in the cold, as Russia provides about a quarter of the gas consumed in the EU and about 80% of this transits through pipelines across Ukrainian soil. This objective got a shot in the arm when Russia cut off the gas again in 2009. While the proportion of gas imported from Russia constitutes 18% of EU15 consumption, in the new EU member states this figure rises to about 60%, with Slovakia and some Western Balkan countries wholly dependent on Russian gas.

Of course, Russia has its own solution to this problem: avoid sending its gas across troublesome Ukraine. Thus, it is in the process of building the Nord Stream gas pipeline, which will transport eventually 55bn cm/y of gas under the Baltic Sea direct into Germany from 2011, and South Stream, a giant €24bn scheme that will bring up to 63bn cm/y of new supplies through Southeast Europe from 2015.

But for Europeans like Joschka Fischer, former German foreign minister and now an advisor for Nabucco, South Stream is no answer to Europe's energy security. "South Stream is by definition is not a European project, it's a Russian project," he said in January. "South Steam won't help Europe because it's not part of diversification."

Supporters of South Stream counter this by pointing out that half of the project belongs to the European transit countries such as Bulgaria and Serbia, and Italy's Eni is building the pipeline in a joint venture with Gazprom. "It's very much a joint Russian-EU project, but from a political view some might like to say something else," sighs Marcel Kramer, former CEO of the Dutch gas transportation company Gasunie and now head of South Stream.

Europe certainly needs more gas over the next few decades, but is unlikely to need the amounts from both South Stream and the 31bn cm/y from. Eurogas says EU gas demand rose 6-8% from the 410bn cm in 2009, though the continent is currently oversupplied, with IHS Global Insight, a consultancy, estimating the overhang in 2010 at around 110bn cm. Eurogas says that while demand will recover in the coming years, growth could be 20% lower than expected before, and with the possibility that large amounts of unconventional gas reserves – hard-to-get-at deposits of tight and shale gas, as well as coal-bed methane – will be discovered in places like Poland and Ukraine, analysts say Nabucco and South Stream are mutually exclusive projects.

The southern route

To open up this Southern Corridor, Azerbaijan committed on January 13 to making "substantial" volumes of gas available from the second phase of the 1.2 trillion cm Shah Deniz field, where a BP-led consortium plans to begin producing 16bn cm/y in 2017. Comments from Azeri officials indicate that the amount will be 10bn cm/y and this will be sold through a common policy agreed by all the Shah Deniz producers - BP (25.5% stake), Statoil (25.5%), Socar (10%), Lukoil (10%), National Iranian Oil Company (10%), Total (10% and Turkiye Petrolleri Anonim Ortakligi (9%) - rather than unilaterally, thus preventing the subdivision of the production among competing consortiums of buyers and shippers. To ensure impartiality in the bidding process, Socar has been mandated to handle all the negotiations.

Though the European Commission is ostensibly neutral on which project should open up this Southern Corridor, behind the scenes it's heavily lobbying for Nabucco, the most ambitious of the three ventures bidding for the Shah Deniz gas. Nabucco involves the construction of more than 4,000 kilometres (km) of new infrastructure costing an estimated €7.9bn that will eventually bring 31bn cm/y of first Azeri and then Central Asian and even Middle Eastern gas through Turkey, up through southeast Europe and into a gas hub in Austria.

The problem for Nabucco is the very feature that its supporters tout as its main advantage: size. With the Azeris limiting the amount of gas they will make available to Nabucco, at least initially, the consortium needs to find other suppliers to fill the capacity.

There is talk that Iraq's Kurdistan region could start exporting gas, but as Jen Coolidge, executive director of CMX Caspian and Gulf Consultants, notes, the central government of Iraq is prioritising its domestic need for gas that will be used for electricity production. "I understand from Iraqi officials that electrification has to be guaranteed before any exports of gas will be made," she says. "That doesn't discount the potential for small-scale, near-term volumes of perhaps 5bn cm/y... but rhetoric from the Commission about 15bn cm/y for Nabucco has to be taken with a careful look at Iraq's electrification needs."

That leaves Turkmenistan as Nabucco's potential saviour. Fortunately for the Europeans, the Turkmens fell out spectacularly with the traditional buyer of their gas, Russia, in April 2009 when Gazprom, faced with falling demand from Europe and at home, allegedly tried to reduce its imports of gas at short notice on the Central Asia Centre (CAC) pipeline, which caused a dangerous build-up of pressure in the pipeline and a subsequent explosion. Russia's decision to cut imports is an implicit admission that it's policy to tie up Turkmen supplies and prevent other countries, notably the EU, from getting their hands on them is unsustainable; Gazprom plans to buy just 11bn cm from Turkmenistan in 2010, compared with forecasted supplies of 70bn cm/y under a 25-year cooperation agreement signed in 2003.

For cash-strapped Turkmenistan, this precipitous drop in gas exports has been disastrous for their economy. Coolidge calculates that the country earned just $4bn last year from gas exports, which will probably force it to go cap in hand again to its energy-hungry patron, China. In 2009, China gave Turkmenistan a $3bn loan to develop the South Yolotan gasfield and last year approved an additional $4bn to complete the first stage of this project.

While Valery Yazev, president of the Russian Gas Society and deputy chairman of the State Duma, harrumphs that "the gas in Turkmenistan will be China's gas, there's no doubt about that," analysts counter it's looking increasingly as though Turkmenistan's leadership is minded to supply Europe with the gas it needs. In January, Barroso and EU Energy Commissioner Guenther Oettinger met with President Gurbanguly Berdymukhammedov in Ashgabat, who made positive remarks about building the pipeline across the Caspian Sea into Azerbaijan that is essential if his country is to supply Nabucco with gas. "We are ready to provide gas to the countries of Europe," Berdymukhamedov said on a report carried on state television. "As for the ways of delivering natural gas from Turkmenistan to European markets, there are several options here. The most attractive one from a commercial, financial and infrastructure point of view is construction of a pipeline under the Caspian Sea."

This newfound willingness to build a trans-Caspian pipeline is further fallout from the deterioration in relations with Russia. In November, Turkmenistan and Azerbaijan agreed that they had the right to build any offshore pipelines that crossed their territory in the Caspian Sea, ignoring pressure from Russia which claims that nothing can be built until there is an internationally accepted status of the Caspian Sea (since the break-up of the Soviet Union, the five littoral states of the Caspian now all have competing claims over parts of it) and in any case it objects to a pipeline on environmental grounds. Russia's position is seen by most as a naked attempt to prevent Nabucco from being built. "Russia objects on environmental grounds, but there are already kilometres of pipelines on the seabed... [and] if Russia can actually economically provide gas to Europe under the increasingly competitive conditions of the European gas market, then logically Russia should have no trouble with a trans-Caspian pipeline," says Coolidge.

Coolidge estimates that Russia's decision to reduce imports means there is up to 30bn cm/y of gas being shut in at the Dauletabad gasfield that could be made available to Nabucco, plus Petronas could supply another 5bn-10bn from the fields it's developing in the country, meaning that it should be possible to fill Nabucco after all. As Joschka Fischer stated: "There was always this question of whether there was enough gas for Nabucco to be built, now we know that with commitments from Azerbaijan, Turkmenistan and Northern Iraq, there is enough gas."

This puts Nabucco supporters like Fischer in confident mood, so much so that the former German foreign minister at a January energy conference held out the possibility of rolling the three projects into one, with the two projects opening up the Southern Corridor and then Nabucco later providing the strategic element. However, representatives of the ITGI and TAP didn't even bother to acknowledge Fischer's offer, but instead spent their allotted time extolling the undoubted virtues of their projects over Nabucco - they are cheaper, more cost-efficient, more flexible and more practicable.

Think small

For ITGI, approximately 1,700 km of the overall 2,500 km of pipeline already exists. Missing is a 207-km offshore section - the Poseidon Pipeline - linking the Italian and Greek gas networks across the Ionian Sea, which is under development by Italy's Edison and Greece's Depa through the consortium IGI Poseidon. This will have a capacity of 8bn cm/y and cost around $1.5bn, while the existing section of the pipeline between Turkey and Greece has a capacity of approximately 12bn cm/y. "We are ready today to buy Caspian gas," says Elio Ruggeri, CEO of IGI Poseidon. "How can Europe rely on a project [Nabucco] without any political clearance, since one, maybe two countries don't want to see a trans-Caspian pipeline built?"

Aleksandra Jarosiewicz of the Centre for Eastern Studies says from Azerbaijan's standpoint, the attractiveness of ITGI is that it could sell gas not only on the Greek and Italian markets, but also to Bulgaria and the Western Balkans, including the Macedonian, Albanian and Serbian markets.

The TAP project too would give Azerbaijan access to similar markets, but like ITGI shares the drawback of having to rely on the transportation infrastructure on Turkey's territory, which desperately needs to be modernised, the cost of which is estimated to run into the billions of US dollars.

TAP, being built by a consortium of Statoil, E.On and EGL, will actually require the shortest pipeline to be built, just a 520-km long section with a 10bn cm/y capacity that will transport gas via Greece and Albania and across the Adriatic Sea to Italy's southern Puglia region. The cost of the project is approximately $2bn.

TAP is the only project that has one of the members of the Shah Deniz producing consortium in its shareholder structure, Statoil with a 42.5% stake. The extent of how much this gives TAP an edge in the bidding for the Azeri gas is debatable, though analysts say that if Nabucco had decided from the beginning to include Socar among its shareholders, then it's likely that neither TAP nor ITGI would have come into existence. "The buyers decided to exclude Azerbaijan from the beginning. Had they included Socar among their members from the start, we wouldn't be having this discussion, it would've been a done deal, you never would've seen the emergence of competing projects," reckons Andrew Neff of IHS Global Insight.

Kjetil Tungland, the Norwegian managing director of TAP, cuts a snazzy figure, brimming with confidence. "TAP is in a strong position at this critically important stage and we remain optimistic of the outcome," he says. "Distance is money and so we need to use the shortest route and need to use as much existing infrastructure as possible - TAP is the most cost efficient project for this corridor."

He says that TAP is tailor-made as a conduit for Shah Deniz gas - the producers have offered 10bn cm/y, and TAP has a capacity of 10bn cm/y. Here he also counters what Nabucco supporters argue detracts from TAP's suitability - it's limited capacity. "Tap is flexible, it can easily be increased to 20bn cm/y by simply adding compression."

If that's the case - and some analysts take it with a pinch of salt - then it could ultimately swing the decision in TAP's favour. It is a project that is feasible at the initial volumes of gas, and can be scaled up if the Azeris and Shah Deniz consortium agree to provide more volumes. And it's not reliant on the hitherto mercurial and not very credible Turkmens.

The danger for Azerbaijan is that its gas is left in the ground after opting for a pipeline that eventually founders on its complexity and its vulnerability to the shifting sands of the global gas market, which in just several years has seen the emergence of shale gas, a global gas glut and prices drop to record lows. "Even going back three years ago, some of the facts on the ground have changed dramatically, with Europe's need for gas much less than it has been and this has pushed the [Nabucco] project back for several years," says Neff, whose gut feeling is that the Azeris will back Nabucco.

So for Azerbaijan too, just as much as the project consortia, the decision is a crucial one. As Tungland says: "The plot is set. The players are lined up. Let the games begin!"