Russia finds growing competition for Central Asia's oil and gas

By bne IntelliNews May 26, 2009

Nicholas Watson in Prague -

Russia's command of its so-called "near abroad" has been more or less complete over the past few years as the EU has floundered to find a coherent strategy to counter Moscow's dominance there, especially in the energy sphere. But recent oil and gas deals in Central Asia show the Kremlin's grip is loosening.

Russia's hold over Central Asian gas exports appeared to have been reinforced in the spring of 2008 when, after years of buying gas from there on the cheap, the state-controlled Gazprom agreed with the three former Soviet states of Kazakhstan, Turkmenistan and Uzbekistan to pay them European prices for their gas on long-term contracts, rather than see those producing countries sell their gas directly to Europe and thus break its stranglehold on exports to the continent.

Gazprom needs Central Asian gas to help cover demand in Russia and support its 150bn cubic metres a year (cm/y) export business to Europe, which runs via Ukraine. Central Asian imports partly compensate for production falls at Gazprom's large fields in western Siberia and allow the company to delay hugely expensive projects in the Arctic Yamal peninsula, such as the technically challenging Shtokman gasfield development in the Barents Sea. Among Russian projects in Central Asia, Gazprom is drilling some 20 exploration wells in the Ustyurt region of Uzbekistan, where gas reserves are estimated to amount to about 1 trillion cm. Gazprom has agreed to invest $400m exploring in the region before the end of 2011. Lukoil was also planning to produce 2.7bn cm of gas this year from its Kandym-Khauzak-Shady production sharing agreement (PSA) in Uzbekistan, which came on stream in 2007, though the crisis may reduce that amount.

Alongside the supply deals, Gazprom, essentially an arm of the Kremlin, has pursued a tandem policy of controlling the export infrastructure by agreeing to expand its pipeline links with Central Asia. The Soviet-built Central Asia-Center pipeline, the only large export outlet for gas from the region, is to be expanded under a deal signed with the three aforementioned Central Asian states. Separately, Russia, Kazakhstan and Turkmenistan are planning a second pipeline that would skirt the Caspian Sea to carry 20bn cm/y northwards from 2012.

Fast-forward a year from that gas supply deal and things look a little different. Gazprom is smarting from the global economic crisis. On April 29, Gazprom released figures that showed its net profit in the fourth quarter plunged 84% from the previous year to RUB37.5bn ($1.1bn) as the company struggled with sliding demand for its exports and the fall in the ruble against other currencies. Analysts say this demand picture has continued to worsen this year, estimating that gas exports fell by as much as 57% in the first quarter; consumption in Russia is down by about 5%.

Despite rising transit costs and falling consumer demand in Europe and Russia, Gazprom still has to buy the gas contracted from Central Asia at the agreed higher prices, essentially paying a fee for the monopsony it holds over the exports from there. This year, Gazprom will import about 50bn cm of Turkmen gas, 15bn cm from Uzbekistan and less than 10bn cm from Kazakhstan. Jonathan Stern, head of gas research at the Oxford Institute of Energy Studies, reckons Gazprom will have trouble absorbing the 50bn cm of gas it has contracted to import from Turkmenistan.

And Uzbekneftegaz, the state-run oil and gas monopoly in Uzbekistan, said in May there will be no let-up in its plans to increase its gas exports this year despite the lower prices and weaker demand. Shavkat Majidov, the company's first deputy chairman, told participants at an oil and gas exhibition in Tashkent in May that Uzbekneftegaz had increased its gas exports by 7% on year in the first quarter and would "maintain this dynamic" for the remainder of the year. Majidov said that Ukzbekistan plans to increase its export total to 16.2bn cm this year, of which 15.2bn cm will be sent to Russia under an agreement with Gazprom. The remainder of Uzbekistan's gas exports will be sent to Kazakhstan, Tajikistan and Kyrgyzstan.

All this is putting a strain on Gazprom's finances and, although bullish in the long term, the company is having to scale back on some of its plans in the shorter term.

A blast

On May 13, the president of Kazakhstan, Nursultan Nazarbayev, signed a law approving the construction of that additional gas pipeline to Russia, which will carry another 20bn cm/y of Kazakh and Turkmen gas. Russian officials say this pipeline should come on stream by March 2010, a year before construction is scheduled to start on the EU's Nabucco pipeline, which is competing for the same gas to send to Europe only without it having to cross Russian soil. However, the Russian pipeline's cost and precise construction plan remain unclear. And in March, Turkmenistan's president, Gurbanguly Berdymukhamedov, signed several economic agreements during a three-day visit to Moscow, but left without finalising plans to build this pipeline, which was to have formed the centrepiece of the summit.

Neither side disclosed the reasons behind the failure to sign anything on the pipeline, though a more public spat broke out in April when an explosion damaged the pipeline that runs from Turkmenistan's giant Dauletabad gasfield, which delivers gas to Russia via Uzbekistan. Ashgabat blamed the explosion on Gazprom's unilateral decision on April 8 to cut the volume of deliveries, leaving the Turkmen side insufficient time to relieve the extra pressure in the pipeline, thus causing the rupture. Moscow blamed the blast on technical faults on the Turkmen side or simply the worn-out condition of the pipeline, but President Berdymukhamedov has, in an unprecedented move, demanded an international investigation and even compensation from Gazprom.

Then, on April 16, the German utility RWE, one of six shareholders in the Nabucco project, announced that its CEO, Juergen Grossmann, had signed in Ashgabat a memorandum on long-term cooperation in the gas sphere. "Amongst other things, the parties have agreed upon investigating and discussing first direct deliveries of natural gas from Turkmenistan to Germany and Europe. RWE will also engage in the exploration and development of natural gas resources in Turkmenistan's western Caspian Sea," the company said in a statement. According to officials at the signing event, Turkmenistan has assigned its offshore Bloc 23 to RWE as an initial step, with further blocs possibly to be awarded later on. Exploration work is expected to start later this year. RWE will also provide technical training for Turkmen specialists, a group of 20 of which arrived in Germany in April.

Though analysts said this deal could simply be part of Ashgabat's efforts to strengthen its bargaining position with Russia, the Economist Intelligence Unit notes that, "this is the nearest any Western investor has come to a PSA since the president, Berdymukhamedov, came to power in December 2006."

Indeed, Turkmenistan's government has talked a lot since Berdymukhamedov took over from the unlamented dictator Saparmurad Niyazov about opening up the country more to western investment. In May, Reuters quoted a government official as saying that Turkmenistan expects foreign investment in its energy sector to double this year to $4bn. Until now, though, there have only been talks held with western companies such as Chevron and BP over deals to develop the Turkmen sector of the Caspian Sea, while the only PSAs that have been agreed are with the Gulf-owned Dragon Oil and the Malaysian state energy firm Petronas, as well as deals with Russia, China and Iran. "Very few actual development deals have been agreed and finalised since Berdymukhammedov took power, and Turkmenistan disappointed many potential investors last year when the government indicated that it planned to develop the super-giant South Yolotan field – believed to be one of the five largest gas fields in the world – without assistance from foreign companies," says Andrew Neff of Global Insight.

Uzbekistan too is looking beyond Russia to develop its energy resources. On May 11, a summit between South Korean President Lee Myung-bak and Uzbek President Islam Karimov in Tashkent resulted in 16 separate deals designed to strengthen economic ties being signed by the two countries.

One of those deals covers oil exploration, giving state-run Korea National Oil Corporation (KNOC) full exploration rights to the Namangan-Tergachi and Chust-Pap blocks, expanding a previous agreement from 2006 under which KNOC was allowed to serve as the main contractor for the two fields. In addition, the two leaders agreed on the participation of South Korean companies in developing the Surgil gasfield near the Aral Sea, which holds an estimated 4.7 trillion cubic feet of gas. Production from the Surgil field is expected to be used for a $3bn petrochemicals plant, Uz-Kor Gas Chemical, which Uzbekistan and South Korea agreed last year to develop as a 50/50 joint venture. "South Korea's influence in the Central Asian region is growing as the country demonstrates its determination to secure access to oil and gas resources and a willingness to invest in projects, even where South Korea does not stand to benefit from the future output of oil and gas fields and chemical plants," says Neff.

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