Reflections - King's College London [PDF]

European Centre for Energy and Resource Security ‘Reflections’ Working Paper Series Volume 3, Spring 2017

EUCERS ADVISORY BOARD Chaired by Professor Michael Rainsborough, Head of the Department of War Studies, King's College London Marco Arcelli, Executive Vice President, Upstream Gas, Enel, Rom Professor Dr Hüseyin Bağci, Department Chair of International Relations, Middle East Technical University Inonu Bulvari, Ankara Andrew Bartlett, Managing Director, Bartlett Energy Advisers Volker Beckers, Chairman and non-Executive Director of Reactive Technologies Ltd, Vice Chairman (since October 2016) and Member of the Board of Directors (non-Executive Director) of Danske Commodities A/S, Denmark and Chairman, Chair Audit Committee of Albion Community Power Plc Professor Dr Marc Oliver Bettzüge, Chair of Energy Economics, Department of Economics, University of Cologne; Director of the Institute of Energy Economics at the University of Cologne (EWI) and President of the Supervisory Board, ewi Energy Research & Scenarios Professor Jason Bordoff, Professor of Professional Practice in International and Public Affairs, Founding Director, Center on Global Energy Policy, Columbia University, New York Professor Brahma Chellaney, Professor of Strategic Studies, Centre for Policy Research, New Delhi, India Dr John Chipman, Director of the International Institute for Strategic Studies (IISS), London Iain Conn, Group Chief Executive, Centrica plc Professor Dieter Helm, University of Oxford Professor Dr Karl Kaiser, Director of the Program on Transatlantic Relations of the Weatherhead Center for International Affairs, Harvard Kennedy School, Cambridge, USA Frederick Kempe, President and CEO, Atlantic Council, Washington, D.C., USA Thierry de Montbrial, Founder and President of the Institute Français des Relations Internationales (IFRI), Paris Chris Mottershead, Vice-Principal (Research & Development), King's College London Hildegard Müller, Chief Operating Officer (COO) Grid & Infrastructure of Innogy SE Janusz Reiter, Center for International Relations, Warsaw Professor Dr Karl Rose, Senior Fellow Scenarios, World Energy Council, Vienna/London Jonathan Stern, Chairman, Natural Gas Research Programme and Senior Research Fellow, the Oxford Institute for Energy Studies (OIES), University of Oxford

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PUBLISHED BY European Centre for Energy and Resource Security (EUCERS), Department of War Studies, King's College London The European Centre for Energy and Resource Security (EUCERS) was established in the Department of War Studies at King’s College London in October 2010. The research of EUCERS is focused on promoting an understanding of how our use of energy and resources affects International Relations, since energy security is not just a matter of economics, supply and technological change. In an era of globalization energy security is more than ever dependent on political conditions and strategies. Economic competition over energy resources, raw materials and water intensifies and an increasing number of questions and problems have to be solved using holistic approaches and wider national and international political frameworks. www.eucers.eu IMPRESSUM © 2017 EUCERS. All rights reserved. Brief excerpts may be reproduced or translated provided the source is stated. Please direct all enquiries to the publishers. The opinions expressed in this publication are the responsibility of the author(s) and do not necessarily reflect the views of EUCERS. EDITORIAL Dr Slawomir Raszewski, Editor ‘Reflections’ Working Paper Series, EUCERS Ms Rose Armitage, Editorial Assistant, ‘Reflections’ Working Paper Series, EUCERS European Centre for Energy and Resource Security (EUCERS) Department of War Studies, King's College London, Strand, London WC2R 2LS, UK ONLINE VERSION About EUCERS Professor Michael Rainsborough (Head Department of War Studies, King’s College London) Professor Dr Friedbert Pflüger Dr Frank Umbach Dr Adnan Vatansever Carola Gegenbauer

Chair, EUCERS Advisory Board Executive Director, EUCERS Research Director, EUCERS Associate Director, EUCERS Operations Coordinator

Senior Research Associates Professor Nick Butler (King’s College London) Dr Petra Dolata (University of Calgary)

Dr Tomas Maltby (King’s College London) Androulla Kaminara (European Commission)

Research Associates Jan-Justus Andreas Alexandra-Maria Bocse Jose A. Bolanos Kalina Damianova Arash Duero Moses Ekpolomo Thomas Froehlich Maria Kottari Dr Maximilian Kuhn

Flavio Philipp Nießen Philipp Offenberg Marina Petroleka Dr Slawomir Raszewski Aura Sabadus Dr Chunping Sue Xie Dr Kaho Yu Shwan Zulal

Lira

About the Working Papers Series EUCERS ‘Reflections’ Working Papers Series (WPS) focuses on promoting an understanding of how use of energy and natural resources affects international relations. The Series seeks to contribute to questions including but not limited to economic competition over energy resources, raw materials and water through multidisciplinary approaches which are academically-rigorous and policy-oriented. The WPS intends to stimulate debate and exchange of research ideas including those in an early stage of development. The WPS intend to provide a space for scholars and practitioners to present their work to a broad readership and connect with established expert community working on issues related to energy and resource security.

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Foreword The third volume of the EUCERS Working Paper Series ‘Reflections’ takes on board a selection of key developments in the energy and resource security domain that are closely linked to Europe. Ole Gunnar Austvik, a professor at Lillehammer University College and Gülmira Rzayeva, a senior research fellow at the Center for Strategic Studies under the President of the Republic of Azerbaijan, outline the role of Turkey in the geopolitics of natural gas. Austvik and Rzayeva point out to a number of factors, including commercial, infrastructural and, political factors, which increasingly elevate Ankara’s regional energy role as both key transit country for current and future projects and, at the same time a major natural gas demand centre in its own right. Recent oil and gas discoveries in Eastern Mediterranean have placed the region in the spotlight of international energy diplomacy. Lebanon-based Mona Sukkarieh, a political risk consultant at Middle East Strategic Perspectives, critically evaluates these developments pointing out the positive role of outside actors in setting the ground for regional cooperation. Sukkarieh urges a well-defined and result-oriented policy by the regional actors that would allow for establishing a set of shared interests and creating new dynamics in the ‘EastMed’ region. Drawing on mining in developing countries, Dr Edvard Glücksman explores emerging trends within lending institutions and risk management frameworks explaining how these affect the work of international practitioners. With the emphasis on business ethics, Glücksman explains the potential these trends have in promoting international cooperation in the quest for natural resources. Developments in the Black Sea Region are discussed by Gökçe Mete, a researcher at Dundee University, who provides a detailed legal analysis of the Turkish Stream (TurkStream) natural gas pipeline project. Set to connect Russia with Turkey with a potential of changing geopolitics of natural gas in Europe, Mete emphasizes the demand projections and political concerns are ultimately the key determinants of the future of this pipeline project. I would like to thank Ms Rose Armitage for her excellent editorial assistance on this volume. The responsibility of views and opinions expressed in the papers remains with their authors.

Dr Slawomir Raszewski Editor of EUCERS ‘Reflections’ Working Paper Series

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Contents

Turkey and the Geopolitics of Natural Gas By Ole Gunnar Austvik and Gülmira Rzayeva………………………………….…………………6

The Fragile Dynamics of Establishing a New State of Affairs in the Eastern Mediterranean By Mona Sukkarieh ……………………………………………………………..………………..…….…18

For Responsible Investment and Successful Corporate Social Responsibility, Interdisciplinary Approaches Will Prevail By Edvard Glücksman ……………………………………….………………………………..………….25

TurkStream Pipeline Project: An Analysis of Legal, Financial and Technical Aspects By Gökçe Mete …………………………………………….………………………………………………….35

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Turkey and the Geopolitics of Natural Gas Ole Gunnar Austvik and Gülmira Rzayeva

Abstract This paper outlines Turkey as an increasingly more important natural gas consuming country, while being strategically located as a transit country between major consuming areas in the EU and suppliers in the Middle East, Central Asia and Russia. Turkey’s ability to import additional volumes of gas to meet growing demand and renew contracts after they expire 2020s is fraught with daily send out capacity constraints of the state-owned Boru Hatları İle Petrol Taşıma A. Ş. (BOTAŞ), BOTAŞ system entry points and legal limitations in its Natural Gas Market Law. The longterm contracts with all its current pipeline gas suppliers – Russia, Azerbaijan and Iran – expire in the 2020s. Contract renewals could be beneficial for all parties, but price uncertainty and concerns about the ongoing Turkish market liberalisation, new gas suppliers, liquefied natural gas and political developments make the import picture more viable. As a transit country Turkey may transport additional volumes of natural gas from Iran and other Middle East countries (especially Iraq) from the next wave of production in Azerbaijan, or from new gas production in the Eastern Mediterranean (Israel/Cyprus) to Europe via the Trans-Anatolian gas pipeline operational from 2018. Commercial, financial, infrastructural and politics constrain this potential. Turkey is most likely to have an increased role as an east-west transit country if its domestic market continues to develop and grow, and when legal and infrastructural constraints are solved.

Introduction With a rapidly growing economy and a population of 80 million people, Turkey has been one of the fastest growing energy consumers in the world. It must import some three quarters of its total energy needs and almost all of its oil and gas. Turkey has some domestic coal and hydro resources for electricity production. Around two-thirds of these resources are located in the Eastern part, while most demand is in the more populated Western part of the country.1 For the future, there may be significant shale oil and gas reserves under the Aegean Sea, the Black Sea and in the Dadas shale in the southeast of Turkey in Diyarbakir Province.2 Located strategically between two continents, Turkey is also an important oil and gas transit destination, decisive to its own import dependence and for regional energy security. Currently, Azerbaijani and Kurdish oil is transported from the east Turkey to Ceyhan by the Mediterranean Sea. In 2018, natural gas will be transmitted from Azerbaijan to the Greek border through the 3,500 km East-West natural gas pipeline project, of which 2,000 km is on Turkish territory, referred to as the Southern Gas Corridor (SGC). The SGC could make Turkey a significant international and regional gas transit country and Turkish Ministry of Foreign Affairs, Turkey’s Energy Profile and Strategy, Ankara: Ministry of Foreign Affairs, 2016 2 Energy Information Agency, Turkey. Country Analysis. Washington DC: US Department of Energy, 2015 1

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physical hub between producers in the Middle East, Central Asia and Mediterranean on the one side, and the European Union (EU) on the other. Turkey’s priority to secure energy for its own market coincides with the aim of becoming an international physical hub and transit corridor for natural gas, and determines its geopolitical role in the natural gas market. Investments in SGC capacity are dependent on domestic Turkish demand. The difficult domestic political situation creates uncertainty about how decisions will be made for energy demand and energy transit. The great political risks it faces in its neighbourhood may also prevent it from launching new pipeline projects and exploiting supply options. This paper will identify the drivers of Turkish demand growth from a longterm perspective. Second, the expiration of the long-term contracts (LTCs) with Azerbaijan, Iran and Russia that expire in the 2020s and their possible renewal is reviewed. Third, domestic market liberalisation efforts and impacts on future gas demand and transit growth are outlined. Fourth, the possibilities for Turkey to purchase gas from new sources such as Iraq, Israel/Cyprus and Turkmenistan liquefied natural gas (LNG), or through pipelines such as the TurkStream from Russia, are discussed. Last, we assess Turkey’s potential as a future consumer and transit hub for natural gas. Turkey’s Natural Gas Demand The most important fuel in Turkey’s energy mix is natural gas. Its share of

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total energy demand is around 35 per cent. Natural gas is also one of the most important strategic industrial segments due to its impact on economic development, growth and imports. The energy sector and the energy intensive industries remain under government control and/or regulation. According to estimates from state-owned BOTAŞ demand for natural gas is projected to increase on average by 2.3 per cent/year from 2014 till 2030, implying that demand will grow from some 48 billion cubic meters (bcm) in 2015 to 70 bcm by 2030, down from the 80 bcm BOTAŞ estimated in 2012.3 This is driven mainly by industrial consumption, but also by domestic and commercial sectors, and gas-fired electricity generation. In 2012, BOTAŞ itself predicted that the share of gas in the electricity sector would reach 45 bcm/year by 2030. Currently, Turkey imports gas from Azerbaijan, Russia and Iran by pipeline, and LNG from the world market (Figure 1). The Baku-TbilisiErzurum Natural Gas Pipeline (690 km) became operational in 2007 following an intergovernmental agreement between Turkey and Azerbaijan, and between BOTAŞ and the State Oil Company of Azerbaijan (SOCAR) to transport 6.6 bcm of Shah Deniz Phase-I (SD1) gas to Turkey. The Shah Deniz consortium pays Georgia transit fees for transportation of gas

Gülmira Rzayeva, Natural Gas in the Turkish Domestic Market, Oxford Institute for Energy Studies Paper NG 82, February 2014, https://www.oxfordenergy.org/wpcms/wpcontent/uploads/2014/02/NG-82.pdf 3

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through Georgian territory to Turkey, in the form of delivered gas. Apart from the contracted volume of 0.3 bcm/year, the gas delivered to Georgia depends on the gas volume transported through the SCP for Turkey.4 Figure 1: Turkey’s gas import outlook, 20155

The Turkish Government intends to reduce the share of gas in the electricity generation sector, replacing it with domestically produced lignite coal, renewable energy and nuclear energy. This policy has been driven by high oil prices and expensive contracts for gas imported from Russia and Iran persisting from 2008 to mid-2014.6 A

Gülmira Rzayeva, The Outlook for Azerbaijani Gas Supplies to Europe, Oxford Institute for Energy Studies Paper NG 97, June 2015, https://www.oxfordenergy.org/wpcms/wpcontent/uploads/2015/06/NG-97.pdf 5 Source: Okan Yardımcı, Energy Expert, Energy Market Regulatory Authority of Turkey 6 All Turkish long-term contracts are linked to end-user oil product prices with a lag of 6 to 9 months. For an overview of how natural gas prices have been set in European LTC see: Ole Gunnar Austvik, Gas pricing in a liberalized 4

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decline in consumption of gas in the electricity sector is encouraged by the expiration of BOTAŞ contracts to supply gas-fired power stations between 2018 and 2020, which are most likely to be replaced by private companies generating electricity from coal and renewable sources. The share of natural gas in power generation declined from 48 per cent in 2014 to 39.8 per cent in 2015. However, the current gas price in Turkey is averaging around US$150160/thousand cubic meter7 which is around $5.1/MMBtu, making natural gas preferable to petroleum products and low quality locally mined coal (low calorific value) in all non8 transportation energy uses . The low prices give less incentive to reduce the share of gas in the electricity sector. Although gas for electricity is declining, residential gas demand is growing. The number of households connected to natural gas grids is close to 13 million, which means that approximately 40 million people have such access. Based on expansion and growth in the residential and service sectors, each year 1 million new users hook up to natural gas in Turkish cities. A similar growth rate was European market: Will the rent be taxed away? Energy Policy Vol 25, No. 12, pp. 997-1012, 1997, in particular pages 1001-1003. 7 This is the average price of piped gas only, which includes Russian, Azerbaijani and Iranian gas (and excluding LNG). 8 To give a frame of reference, the current (as of November 2016) gas price in JKM (Japan Korea Market) hub is around $6.2/MMBtu, in HH (Henry Hub) of the U.S. is around $2.4/MMBtu and NBP (National Balancing Point (UK)) forward price is around $4.7 MMBtu (Source: www.platts.com)

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observed in the industrial sector, with consumption reaching 13.4 bcm in 2015. Taken together, gas demand in Turkey to will continue to grow over the next two decades modestly but steadily. Demand projections have led to concerns in the Turkish Government on how to find 20 bcm/year of additional gas volumes over the next two decades, from current or new suppliers. Ankara’s main strategy is to import gas from multiple sources to reduce dependency on any one supplier. Turkey’s long-term sales and purchase contracts with the three existing land based gas suppliers, like Azerbaijan through the Baku-TbilisiErzurum line, Russia through the Blue Stream and Trans-Balkan lines and Iran through the Tabriz-Dogubayazit route, will expire in the 2020s. This affects some 40 bcm/year, or 80 per cent of current gas demand.9 Extension of these contracts depends both on commercial and political issues, as Turkey has either political or pricing controversies with both Russia and Iran. Relations with Russia have been strained following the downing of a Russian jet in the spring of 2016, but seem to be recovering after the meeting of Presidents Putin and Erdoğan in St. Petersburg on August 9, 2016. Domestic infrastructure is not sufficiently developed to handle the average 1.5 bcm/year demand growth

The rest comes to the Marmara Ereğlisi and Aliaga LNG terminals in the Western part of the country, which receives gas from the international LNG market, mostly from Nigeria and Algeria as well as direct imports by private companies from Gazprom

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anticipated over the next few years. Import of LNG could mitigate the problem for a while, but the limited capacity of regasification terminals, and the BOTAŞ storage and transmission system, especially during peak winter seasons, are significant constraints. The Turkish Government is keen to increase the LNG regasification capacity of the Egegas and Marmara Ereğlisi terminals (current total regasification capacity of both terminals is 12.2 bcm/year) and is negotiating with Qatar for LNG terminal expansion investments. It is also considering using floating storage and regasification units, which would be the fastest capacity increase option. Floating terminals could create mobility and deliver LNG in a flexible manner. However, increasing Turkey’s LNG regasification capacity is not a practical solution to the diversification of supply sources and increase of import volumes. The transfer capacity of BOTAŞ is the main impediment to increasing gas volume imports to the country. Theoretically, each LNG terminal can feed around 20 million cubic meter (mcm)/day into the system. The LNG terminals have been shown to be working at near 100 per cent capacity between 1 November 2015 and February. Another problem with LNG is BOTAŞ and government pricing policy. Only BOTAŞ and Egegas are importing LNG due to the pricing strategy of BOTAŞ, which sells gas to the domestic market at heavily subsidised prices. BOTAŞ has to subsidise domestic gas prices, especially from Iran (whose prices are the highest), and the Government

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reimburses subsidies.10

BOTAŞ

through

The Extension of Long Term Contracts Turkish contracts that expire in the 2020s are: 1) 6 bcm/year of gas imported from Azerbaijan's SD1 expiring in April 2021 (concluded in March 2001, became operational in 2007); 2) private contracts with Gazprom to import 4 bcm/year through the Western pipeline, expiring in 2021; 3) a LTC with Algeria to import 4.4 bcm/year of LNG ending in 2021; 4) a contract between BOTAŞ and Gazprom to import 16 bcm/year through the Blue Stream pipeline that expires in 2025; and; 5) a LTC between BOTAŞ and Iran to import 9.6 bcm/year that expires in 2026. In total, these contracts represent almost 40 bcm/year of gas supply that will expire by 2026 (Table 1, Figure 1).11 Gülmira Rzayeva, Natural Gas in the Turkish Domestic Market, 2014 11 Capacity in the BOTAŞ gas transmission system is around 197 mcm/day (including all pipelines, LNG terminals and storage), yet the peak daily demand on the grid was around 240 mcm/day in 2015, and in winter 2016/2017 is likely to be around 250 mcm/day. The major problem for BOTAŞ is the limited capacity of all its import entry points. Turkey imports around 90 mcm/day from the north-west via the Blue Stream and Western lines. If gas northwest flows stops, partly or entirely, this amount cannot be replaced with another option on the south or east entry point. This is anticipated to be solved with the completion of TANAP in 2018. This scalable pipeline will potentially, transport 31 bcm/year to the 10

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Table 1: Natural Gas Purchase Contracts

Source: BOTAŞ12

There is no doubt that Turkey and its gas suppliers are all interested in the extension of the sales and purchase agreements after their expiry dates. Turkey wants to provide a secure supply of natural gas given a possible supply squeeze that could occur in five years when 15 bcm/year of gas contracts will expire. Turkey’s supply sources of contracted natural gas are not sufficient and the country has to meet any, even small, demand growth and seasonal fluctuations with the help of spot LNG. In light of these realities, Turkey cannot afford to lose any imported volumes of Russian gas, whatever the political situation seems to dictate. Since 2011, private companies in Turkey have directly imported 10 BCM/year from Gazprom through the Western Line pipeline. Piped gas otherwise comes across the Black Sea through Blue Stream from Novorossiysk to Samsun. After the

Turkish market, with two exit points at Eskisehir and on the Turkey-Greece border 12 BOTAŞ, Gas Supply Contracts, BOTAŞ Official Website, 2016, http://www.BOTAŞ.gov.tr/

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cancellation of South Stream, some ideas have been put forward to build a Turkish Stream directly to the Istanbul area (see Map 1). Russian gas imports by private companies via the Western Line constitutes 22 per cent of the total market, which partly resulted from the liberalisation of the natural gas market. However, the extension of 4 bcm/year of private Turkish companies with Gazprom is fraught with pricing difficulties. Private companies must buy this gas from Gazprom for a lower price than BOTAŞ, which benefits from subsidisation of gas prices to households, industrial and electricity generation. Private companies do not get this subsidy and must therefore sell in the domestic market at a loss, if the imported gas price is not lower than the BOTAŞ imported price. Gazprom is the only company that sells gas to others than BOTAŞ at a lower price. Gas export companies may want to sell these volumes to BOTAŞ for a better price. As a response, Gazprom could decline to renew the existing contract and demand the price difference between BOTAŞ and private companies. However, given that Gazprom has a direct or indirect interest in the shares of the private companies, it may be in the Russian monopoly's interest to continue this practice. For Russia and Gazprom, Turkey is the second biggest market after Germany, with a yearly export of 27 bcm, which represents a 55 per cent share of the Turkish market. In the current low price environment, Gazprom faces enormous financial losses. Moreover, it has lost one of its biggest markets,

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Ukraine, to which it exported only 4 bcm in 2016, in comparison with around 15 bcm in 2014.13 Gazprom’s sales in the Russian market have reduced by 83 bcm/year between 2011 and 2015. This is because independent suppliers in Russia have started to supply base demand leaving Gazprom to meet the seasonal peak demand in the cold months, which is fraught with additional expenses for Gazprom.14 Turkey, meanwhile, has no binding agreements for alternative short- and mid-term sources of supply to replace Russian gas, with the exception of a 15year contract to import 6 bcm/year of gas from SD2 through Trans-Anatolian gas pipeline (TANAP). It is, however, most likely that this volume will only replace the 6.6 bcm/year of gas from Phase 1 of the Shah Deniz field. In light of these realities, both Russia and Turkey will be keen to renew contracts. Azerbaijan is Turkey’s only gas supplier that has not been subject to a serious price conflict with BOTAŞ or other political or geopolitical tensions. Given the cultural, ethnic and historic ties between the two nations, they are cooperating to realise the US$40 billion SGC project. The most important segment of the value chain, the US$9.5 billion TANAP passing through Turkish territory, will deliver

Gazprom, Ежеквартальный Отчет [Quarterly Report], May 2016, http://www.gazprom.ru/f/posts/36/607118/g azprom-emitent-report-1q-2016.pdf 14 James Henderson and Tatiana Mitrova, The Political and Commercial Dynamics of Russia’s Gas Export Strategy, Oxford Institute for Energy Studies Paper NG102, 2015, https://www.oxfordenergy.org/wpcms/wpcontent/uploads/2015/09/NG-102.pdf 13

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6 bcm/year to the Turkish domestic market beginning in 2018. Given that the SD1 field started producing in late 2006 and reached a plateau in 2010, the field’s geological tail-off period should begin in 2025-2027. During the tail-off period, production levels may decrease to around 2 bcm/year or more, depending well productivity. There may not be enough gas to renew the SD1 contract for a longer term. The 15-year sales and purchase contract signed between the SD consortium and BOTAŞ to import 6 bcm/year of SD Phase 2 gas could simply replace the SD1 6.6 bcm/year, rather than being an additional volume. Another scenario is that the remaining volume from SD1 could be added on top of the contracted 6 BCM/year of Shah Deniz Phase II (SD2) gas. Realization of this scenario will strongly depend on whether both seller and buyer would be interested financially and legally in the exchange of SD1 volumes under the SD2 contract. The Iranian contract expires in 2026. Iran is the owner of the world’s largest proven gas reserves, holding 37 tcm of gas, but historically the country has not been able to fully benefit from its huge potential and become a major player in the global gas trade, primarily because of U.S. and other international sanctions and an unfavorable legal and contractual investment regime within Iran. In addition, its rapidly growing domestic demand, which has surged because of, among other factors, government subsidies, is important. Turkey is currently the only Iranian export destination, with a contract for 9.8 bcm/year. The price for Iranian gas to

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Turkey is the highest that BOTAŞ pays for pipeline gas, much higher than average European gas price. Iran would not easily be able to develop an alternative outlet for its gas, and has already invested heavily in pipelines. It currently has four operating contracts with neighbouring countries, four concluded but not yet operational, and four under negotiation. Turkey does not have any choice other than to renew its sales and purchase contract with Iran upon expiry. Gas and other relations between the two countries have always been complicated and encountered many problems. Delivery shortfalls during the peak seasonal demand in Iran has been one issue, but also BOTAŞ's inability to take all contracted volumes due to transmission system capacity constraints in the eastern part of the country and temporary reductions in demand during the low demand seasons is important. Turkey has sought a 30 per cent price reduction, a removal of the ‘take or pay’ clause in contracts signed in 1996, and operational in 2001. It has taken the case to arbitration twice. In both cases, Turkey won, receiving US$800 million15 and US$1 billion16 in compensation respectively, because of recovering 13-15.8 price reductions.

‘Turkey wins gas price row against Iran in court’, Hürriyet Daily News, 2 February 2016, http://www.hurriyetdailynews.com/turkey-winsgas-price-row-against-iran-incourt.aspx?pageID=238&nID=94643&NewsCatID= 348 16 Begüm Gürsoy, ‘Turkey prevails in Iran arbitration’, Hürriyet, 27 February 2009, http://www.hurriyet.com.tr/turkey-prevails-iniran-arbitration-11094366

Potential Turkey

gas

suppliers

to

TANAP will play a crucial role for Turkey both in covering its own demand and in becoming a transit hub.17 The capacity of TANAP will be 31 bcm/year, which can be extended in three stages. Azerbaijan may have unallocated gas above SD1 and SD2 volumes by the 2020s and 2030s, and may potentially produce an additional 15 bcm/year from just three fields – Absheron, Umid/Babek, and AzeriChirag-Guneshli deep layer gas18, plus a possible extra 15 bcm/year if Shah Deniz Phase III (SD3) is implemented. In total, the Absheron field operator plans to start production in 2019 and reach a plateau level of 5 bcm/year. There are three potential markets for this gas: the domestic Azerbaijani, the Turkish and the European market. A main issue will be whether the SCP will increase its capacity, as currently all is booked for SD1 and SD2, and whether there will be a favorable pricing environment and marketing arrangement. Future potential supplies to the SGC also include some countries in the Middle East, Central Asia and the Eastern Mediterranean. First, Iran with the biggest gas reserves in the world could become a substantial global gas exporter now

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Bulgargaz has already signed a gas purchase contract with the Shah Deniz consortium of 1 bcm/year from 2020. Preparations for a Greece–Bulgaria Interconnector (IGB) are made, supported by the EU under the Connecting Europe Facility (CEF) fund. 18 Gülmira Rzayeva, The Outlook for Azerbaijani Gas Supplies to Europe, 2015 17

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that sanctions have been lifted. The main priority of the Rouhani Government has been to develop the remaining 14 phases of the giant South Pars offshore field in the Persian Gulf, which is expected to add approximately 172 bcm/year of natural gas to the current 210 bcm/year. The timeframe of the 12 phases and other onshore fields will strongly depend on Iran's ability to attract multibillion dollars of foreign investment in the upstream and midstream industry, as well as to create a favourable legal and contractual framework. Despite the low-cost environment in Iran, it may take several years before the country is able to deliver. Most produced gas will be consumed domestically due to rampant demand growth, leaving little excess for export. Iran will have to choose whether to increase injection into aging oilfields to produce more oil and petrochemical products and thus restore its market share, mainly in Europe and elsewhere; or export either power generated from gas or more gas. However, the maximum capacity in the Iran Gas Trunk line I that exports gas to Turkey is 11-16 bcm/year depending on compressor stations, of which currently 11 bcm/year is used, which leaves little space for additional volumes.19 Iran has signed Memoranda of Understanding and sales and purchase agreements on gas exports with different neighbouring countries. For Iranian gas exports in general, the country will more likely copy Qatar

and become an LNG exporter, rather than investing in very costly pipelines to Turkey, or elsewhere in the near future. Iraq’s Kurdistan region (KRG) appears to be a stronger option for new supply to Turkey. Development of the Miran and Bina Bawi fields with 350-400 bcm of gas reserves by Turkish-British company Genel Energy is ongoing with an estimated cost of US$2.9 billion.20 The financing of a US$2.5 billion, 250 km pipeline remains unresolved, although the tender process for construction of the stretch on Turkish territory has already begun, and the construction can be accomplished within a relatively short timeframe. Turkish officials have repeatedly referred to the fact that if the transport solution materialises, Iraqi gas would be the cheapest option for imports to Turkey. However, the main obstacle lies in the security issues in Iraq. Companies need increased financing to fund security in Northern Iraq, and the influx of refugees to KRG combined with terrorist attacks in the country has led companies to holding back from investment in the upstream and mid-stream business. Israel and Cyprus may soon be new gas producers in the Eastern Mediterranean region. The reconciliation of Turkey with Israel and ongoing negotiations on the reunification of Cyprus create opportunities for Turkey to import gas

Genel Energy plc, Audited results for the year ended 31 December 2015, Genel Energy, 3 March 2016. http://www.genelenergy.com/media/1909/ge nel-energy-fy-2015-results-03-03-16-final.pdf

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Gülmira Rzayeva, Post-sanction Iranian natural gas production and export potential: challenges and opportunities, Cedigaz (available for subscribers), 2016 19

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from the Eastern Mediterranean region. Potentially, 10-20 bcm/year of gas can be exported from Israel and Cyprus to Turkey through subsea pipelines once reunification is resolved. Having access to a large and growing market with appropriate prices can make the development of the Israeli Leviathan field commercially viable and justify the building of a subsea pipeline to Turkey through the exclusive economic zone of Cyprus. Israel can benefit not only economically, but can also gain politically from enhanced trade agreements with Turkey. Rapprochement between Israel and Turkey could restrain Iranian influence in the region in which both sides are interested. Such development would put Turkey at the centre of the Easter Mediterranean regional geopolitical and energy network. Russia, acknowledging Turkey as its second largest market, would prefer that Israeli gas not only penetrate the Turkish market, but also, through Turkey, the European market. It seems that this fact plays no minor role in the repeated attempts of Gazprom to enter Israel’s gas market and upstream projects although Gazprom’s attempts to bid for a 30 per cent share in the Leviathan field and to sign a deal to export LNG from Tamar have failed to materialise.21

Charles Ellinas et al. Hydrocarbon Developments in the Eastern Mediterranean: The Case for Pragmatism, Washington DC: Atlantic Council Global Energy Center and Dinu Patriciu Eurasia Center, 2016. http://www.atlanticcouncil.org/images/public ations/Hydrocarbon_Developments_in_the_ Eastern_Mediterranean_web_0801.pdf 21

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Conclusions Turkey is an increasingly important natural gas and energy consuming country, and is strategically located as a transit country for oil and natural gas for major consuming areas in the EU and suppliers in the Middle East, Central Asia and Russia. Around Turkey, there are large tapped and untapped gas reserves that can ensure the country’s future energy needs and supply security. Infrastructural problems and capacity constraints in the BOTAŞ system, and legal limitations in its natural gas market law, may create regional gas shortages, especially at times of peak demand. Turkey’s ability to import additional volumes of gas is fraught with technical and legal constraints. For Turkey to meet the forecasted natural gas demand growth over the next two decades of almost 3 per cent, or 1.5 bcm/year on average, two primary goals need to be achieved. First, to solve the internal political, legal and technical impediments; and second to make the necessary cooperation with potential partners in neighbouring countries. The latter includes actively promoting a solution of the Cyprus problem; rapprochement with Israel; contributing to security efforts in Iraqi KRG; and solving its gas price disagreements with Iran. Turkey’s role in the geopolitics of natural gas is determined by its domestic situation, the political surroundings develop and how Turkey relates to these, and the development of transit routes for gas. The Turkish Government has set a number of

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strategic objectives, including liberalising and creating a competitive domestic market and ensuring security of gas supply. It also wants to minimise and gradually nullify the state budget deficit and BOTAŞ’s losses, and shift risk and investment responsibilities from the state to private companies. Finally, it wants to transform Turkey into an international natural gas trading hub, playing the role of a bridge for hydrocarbon flows from the East to the West. Turkey’s long-term contracts with all its current pipeline gas suppliers Russia, Azerbaijan and Iran - expire in the 2020s. Contract renewals are beneficial for all parties, but price uncertainty and concerns with the ongoing market liberalisation, new gas suppliers, LNG and political developments make the import picture more open. The natural gas market law restricts this process, since BOTAŞ cannot sign new contracts or renew expired agreements. Furthermore, private companies cannot buy gas from countries from which BOTAŞ is currently importing. To speed up processes, this legal impediment needs to be lifted, or exemptions should be made. Another obstacle for private companies is subsidised gas prices in Turkey, as they have to sell gas to households below the state-subsidised price. In addition, the capacity of BOTAŞ’s gas transmission system is limited on all its six entry points. If, for instance, any supply interruption occurs from the northwest route from Russia, it will not be possible to substitute this gas from other import directions, for instance, from the east (Azerbaijan or Iran). Russian

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TurkStream can mitigate this problem in the Western part of the country, as will also TANAP when it becomes operational in 2018. If TurkStream becomes the solution, both Turkey and the EU will suffer from stronger dependency on Russian gas. Thus, Turkey’s foreign relations to and balance between the EU and the U.S. on the one side, and Russia on the other, in addition to its relations to countries in the Middle East, Central Asia, and Mediterranean, can become important for the scale and scope of its roles as natural gas consumer and transit country.

About the authors Ole Gunnar Austvik is a senior researcher focusing on international political economy and European integration. He is professor at Lillehammer University College (HiL). Previous employment includes BI Norwegian Business School and Statistics Norway. Austvik holds a doctorate in political science from University of Oslo, a Master in Public Adminstration (MPA) from John F. Kennedy School of Government, Harvard University, and a master in economics (cand.oecon) from University of Oslo. Gülmira Rzayeva is a senior research fellow at the Center for Strategic Studies under the President of Azerbaijan, research associate at the Oxford Institute for Energy Studies and Advisor at World Energy Council Global Gas Center.

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The Fragile Dynamics of Establishing a New State of Affairs in the Eastern Mediterranean Mona Sukkarieh

Abstract The discovery of substantial gas reserves in the Eastern Mediterranean is infusing new dynamics in a region that has for a long time been defined by conflicts, uneven socio-economic development and limited intra-regional cooperation. The hype that surrounds these discoveries in the countries of the region contrasts with the more measured response beyond the Eastern Mediterranean. The difference in perspective is noteworthy because it explains how various actors view the added value behind these resources, and how this, in turn, defines their policies. For many, the newly discovered reserves propel the region into the league of large oil and gas producers. This perception has triggered a flurry of diplomatic activity and grandiose ambitions. Beyond the Eastern Mediterranean, the added value of these resources is perceived as having the ability to foster unprecedented political cooperation and economic integration.

Introduction The discovery of substantial gas reserves in the Eastern Mediterranean is infusing new dynamics into a region that has long been defined by conflicts, uneven socio-economic development and limited intra-regional cooperation. Located north of the prolific Nile Delta Cone, the Levant Basin – a mostly offshore area covering approximately 83,000 km2 in the Eastern Mediterranean – is estimated to hold a mean of 1.7 billion barrels of recoverable oil and a mean of 122 trillion cubic feet (tcf) of recoverable gas1. This is significant for the small and resource-poor countries of the region, but is not a global gamechanger. This is compounded by the fact that these resources are spread over various countries and jurisdictions, their extraction is costly and their exploitation rendered even more difficult by the lack of relevant infrastructure. The hype that surrounds the discovery of hydrocarbon resources in the region is how one would expect resource-poor countries to welcome the discovery of hydrocarbon wealth, and contrasts

Christopher J. Schenk et al., ‘Assessment of Undiscovered Oil and Gas Resources of the Levant Basin Province, Eastern Mediterranean’, in: U.S. Geological Survey Fact Sheets, No. 2010-3014, March 2010, http://pubs.usgs.gov/fs/2010/3014 1

with more measured responses beyond the Eastern Mediterranean. The difference in perspective is noteworthy because it explains how various actors view the added-value behind these resources, and how this, in turn, defines their policies: for many in the region, the newly discovered reserves propel the region into the league of large oil and gas producers. For those outside, because of their modest size the added-value of these resources lies elsewhere: for the United States (US) in particular, the successful exploitation of these natural gas resources “will require exactly the political cooperation and economic integration that the United States has long supported in the region. This remains a top foreign policy priority for the United States”.2 How do these differences in perception translate on the ground? At the regional level: Grandiose ambitions and an unprecedented

Amos J. Hochstein, Special Envoy for International Energy Affairs, Bureau of Energy Resources, U.S. Department of State, Joint Subcommittee hearing by the Committee on Foreign Affairs’ Subcommittee On the Middle East and North Africa and the Committee on Science, Space and Technology’s Subcommittee on Energy, Washington, 8 September 2016, http://docs.house.gov/meetings/FA/FA13/20 160908/105275/HHRG-114-FA13-WstateHochsteinA-20160908.pdf

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surge in diplomatic activity… both lacking a strategic vision The discovery of gas resources in the Eastern Mediterranean has initiated a surge in diplomatic activity in the region. Trilateral tracks have been launched, at the core of each we find the same duo: Cyprus and Greece pursuing different – but not entirely separate – tracks with Israel, Egypt, and to a lesser degree Jordan and Lebanon. The flurry of diplomatic activity is unprecedented. Cypriot President Nicos Anastasiades, Greek Prime Minister Alexis Tsipras and Egyptian President Abdelfattah al-Sisi held a total of four summits since November 2014. The Cypriot and Greek leaders also met with Israeli Prime Minister Benjamin Netanyahu in Nicosia in January 2016 after which the three heads of State announced a second tripartite summit would be organised in Israel in the second half of 20163. That is not counting the numerous bilateral summits or ministerial – and director general-level meetings over the past few years. On the energy front, several projects have been put forward, although their viability has not always been confirmed. Following the discovery of Aphrodite, the Cypriots made the construction of an onshore LNG plant in Vasilikos that would process Cypriot and Israeli gas a priority. It took some time for Cypriot officials to admit the

Cyprus – Israel - Greece Trilateral Summit Declaration, Nicosia, 28 January 2016, http://www.mfa.gov.cy/mfa/mfa2016.nsf/All/ 225D5758514728BBC2257FA000459B4B 3

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project was not commercially viable4 due to a lack of enough gas in Aphrodite and Israel not committing to send gas, which forced a refocus of the Island’s energy policy. Attention then turned to the East Mediterranean pipeline, a mostly subsea pipeline intended to carry Israeli and Cypriot gas to Greece, and from there to European markets. While technically feasible, the pipeline carries an exorbitant price tag that strips it of any commercial viability at this point5. Gas exports to and via Egypt appeared for a while to be the most viable option. But the global LNG glut and falling prices would make Israeli or Cypriot gas liquefied in Egypt’s LNG plants uncompetitive in Europe, at least until the market rebalances and prices adjust. As for supplying the Egyptian market with gas, the discovery of Zohr in 2015, and the development of several other projects by 2020, will reduce and probably eliminate the need for imports by the early 2020s, according to Egyptian officials6. The short timeframe makes

Government Spokesman Nicos Christodoulides in Spokesman: Natural gas terminal a primary goal, CAN, 11 November 2014, http://www.cna.org.cy/webnewsen.aspx?a=86b03395a30847e094728faf50692 ea4 5 Charles Ellinas et al. Hydrocarbon Developments in the Eastern Mediterranean: The Case for Pragmatism, Washington DC: Atlantic Council Global Energy Center and Dinu Patriciu Eurasia Center, 2016. http://www.atlanticcouncil.org/images/public ations/Hydrocarbon_Developments_in_the_ Eastern_Mediterranean_web_0801.pdf 6 Ehab Farouk, ‘Egypt chases own energy sources as government struggle to meet 4

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this option challenging, particularly that two of the three gas fields in question, Aphrodite and Leviathan, are not expected to be developed before 2020. In the rush to supply the local Egyptian market before the need for imports dissipates, Israel’s Tamar gas field, already in production, appears to have an advantage, although challenges remain. While energy is one important driver behind this flurry of diplomatic activity, the troubled relationship each of these countries has had with Turkey at one point or another over the past few years, has been a decisive factor. For Israel in particular, the prospect of improved relations with Turkey has limited the extent of its involvement with Greece and Cyprus. Israel, which views its gas resources as a strategic commodity, is hoping the resources give Israel a geopolitical advantage that would strengthen its position in the region7. The idea is to weaken animosity towards it by creating shared interests with its neighbours, specifically those countries and societies that have a tendency to question the legitimacy of the State of Israel. For years, Turkey was the only Muslim-majority country maintaining ties with Israel, breaking a near perfect Arab and Muslim boycott of Israel.

This is the strategic edge that Ankara can still provide. Israel has made efforts to nurture relations with Athens and Nicosia, but stopped short of a full-commitment that would jeopardise its relationship with Turkey8. No Israeli gas was committed to the proposed LNG plant in Vasilikos, rendering the project unfeasible at the time, and making the development of Aphrodite a challenging endeavour. Similarly, no unitisation agreement has been signed between Cyprus and Israel9, further complicating the development of Aphrodite, a small part of which extends into the Israeli Exclusive Economic Zone. Israel’s commitment is not the only reason why Aphrodite has not been developed, but it is a significant contributor. In terms of resource development in the region, the results of increased diplomatic activity have so far been underwhelming. The countries involved have yet to translate their political wishes into actual projects. Political convergence alone is not enough. Solid partnerships require more robust foundations, which do not solely rely on circumstantial factors,

‘Keeping an eye on Turkey, Israel pursues rapprochement with Cyprus’, Middle East Strategic Perspectives, 12 November 2015, http://www.mesp.me/2015/11/12/keeping-aneye-on-turkey-israel-pursues-rapprochementwith-cyprus/ 9 Hedy Cohen, ‘Cypriot President to visit Israel for gas talks’, Globes, 10 November 2015, http://www.globes.co.il/en/article-cypriotpresident-to-visit-israel-for-gas-talks1001080015 8

demand’, Reuters, 23 October 2016, http://www.reuters.com/article/us-egypt-oilidUSKCN12N0M2 7 Stuart Winer, Marissa Newman, ‘Grilled by lawmakers, PM says gas deal vital for Israel’s future’, Times of Israel, 8 December 2015, http://www.timesofisrael.com/knessetcommittee-to-grill-netanyahu-over-gas-deal/

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but on a strategic vision. Effective energy cooperation requires a longterm stabilisation of political relations, not just a partnership based on provisional circumstances and positions vis-à-vis a third state at a certain point in time.

Beyond the region: Fostering political cooperation and economic integration Perhaps because of their nature and modest size, the added-value of these resources is perceived from a different angle outside of the Eastern Mediterranean. The U.S. is a case in point. While intra-regional cooperation, and in particular the gradual integration of Israel in the region, has been a priority for Washington’s Middle Eastern foreign policy, the U.S. administration sees recent discoveries as an additional instrument that can be used to achieve this objective. Encouraging cooperation

political

The maritime border dispute between Lebanon and Israel, which emerged in 2010, triggered a U.S. mediation activity between both sides, first led by special coordinator for regional affairs in the Department of State’s Office of the Special Envoy for Middle East Peace, Frederic Hof, and then by Amos Hochstein, currently serving as Special Envoy for International Energy Affairs in the Department of State. In parallel,

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the U.S. put its weight behind amending the ties between two of its key allies in the region, Turkey and Israel; and it also played an important role in restarting negotiations between Greek and Turkish Cypriots to settle the decades-old dispute that has divided the island in two. Up until this point, the size of gas discoveries in the Levant Basin, and the size of the local markets, did not grant the countries in question the autonomy they would have wished for to exploit and export these resources. Although not an instrument for peace, by their very nature these resources will impose cooperation. This is convenient if the objective of developing the resources is to create “physical interdependency”10. Promoting economic integration There is considerable attention to support Israel’s economic integration into the region - especially with its Arab and Muslim neighbours – which has encountered resistance despite a number of Arab countries signing peace agreements with the Jewish State. The U.S.-brokered Israeli apology to Turkey in March 2013 has revived chances of energy cooperation between the two countries. A pipeline linking the two countries is being considered, with the active backing of the U.S., although significant

Barbara Plett Usher, ‘US election 2016: America’s Great Game as energy superpower’, BBC News, 26 October 2016, http://www.bbc.com/news/election-us-201637722140

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challenges persist, including the Cyprus Problem. Due to their functional nature, countries do not enjoy full sovereignty over their Exclusive Economic Zone (EEZ). Third states enjoy the “freedoms of navigation and overflight and of the laying of submarine cables and pipelines and other internationally lawful uses of the sea related to these freedoms”, as long as they “comply with the laws and regulations adopted by the coastal State”.11 Theoretically, passing the pipeline through the Cypriot EEZ may be possible, but it is unlikely to go ahead against an outright Cypriot refusal. A breakthrough in the negotiations between Greek and Turkish Cypriots would be helpful. Absent that, the Cypriots may be encouraged to move forward with a comprehensive settlement, at a faster pace than they would have wished. Israel’s reluctance to commit gas to the Vasilikos field and to sign a unitisation agreement with Cyprus has contributed to the Aphrodite gas field not being exploited, and can be seen as indirect pressure on Nicosia. Indeed, Aphrodite will be harder to exploit if the island remains divided12. The same logic of economic integration applies to Jordan. The U.S. was

instrumental in facilitating two contracts to supply Jordan with Israeli gas. In February 2014, the Tamar partners signed a deal to provide two Jordanian companies, Arab Potash and Jordan Bromine, up to 2.2 billion cubic meters (bcm) of natural gas over a period of 15 years, for a total of US$500 million. The deal required Amos Hochstein to hold 14 meetings with the parties involved over a period of 18 months13. It was a prelude to a much larger agreement, once again facilitated by the Americans and requiring several rounds of secret negotiations. It was signed in September 2016 between the Leviathan partners and Jordan’s National Electric Power Company. Under the terms of the agreement, the consortium will provide the Jordanian company with 45 bcm of natural gas over a period of 15 years, thus turning Israel into Jordan’s main gas supplier.14 Negotiations with Egypt are ongoing on whether to supply the local market – knowing that the need for imports is expected to dissipate in the early 2020s – or to liquefy the gas in one of the country’s two LNG plants for reexports. Once again we find the U.S.

Amiram Barkat and Koby Yeshayahou, ‘Tamar partners sign Jordan gas deal’, Globes, 19 February 2014, http://www.globes.co.il/en/article-tamarpartners-to-sign-jordan-gas-deal-today1000918429 14 Irina Slav, ‘Major Deal Turns Israel Into Jordan’s Leading Gas Supplier’, Oil Price, 26 September 2016, http://oilprice.com/LatestEnergy-News/World-News/Major-DealTurns-Israel-Into-Jordans-Leading-GasSupplier.html 13

UN General Assembly, Convention on the Law of the Sea, 10 December 1982, article 58. 12 ‘The chances of a Cyprus settlement look better than ever’, The Economist, 2 November 2016, http://www.economist.com/news/europe/217 09503-turkeys-mercurial-president-nothingever-certain-chances-cyprussettlement?fsrc=scn%2Ftw%2Fte%2Fbl%2Fed %2F 11

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facilitating diplomatic talks.15 Market conditions and Egypt’s decision to freeze gas import talks following a ruling by the International Chamber of Commerce requiring Egyptian companies to pay US$1.7 billion to the Israeli Electric Corporation stand in the way of a final decision16. While it might be difficult to overcome the first, the second appears to be within reach.17 The above showcases the differences between regional actors and outside actors in their approach to newly discovered resources in the Eastern Mediterranean: regional actors have lacked a strategic vision but have shown willingness to cooperate; whilst the U.S. has established a defined policy and attainable goals. The region has more to gain if energy issues are addressed in a sober, pragmatic and result-oriented way. That said, diplomatic activity and the determination to establish regional obliging mechanisms is in itself an

accomplishment. It has taken intraregional cooperation, which was previously insignificant until the discovery of offshore resources, to a new level. Shared interests, including but not limited to hydrocarbon wealth, is creating new dynamics. This natural wealth could provide the economic incentive needed and might indeed play a role in cementing a new state of affairs in the Eastern Mediterranean. About the author Mona Sukkarieh is a political risk consultant working on the oil and gas sector in the Eastern Mediterranean. She is co-founder of Middle East Strategic Perspectives (MESP), a Beirut-based political risk consultancy focusing on strategic sectors in the MENA region where she heads the Energy unit.

Amiram Barkat, ‘US special envoy: Gas fields must be developed quickly’, Globes, 5 January 2015, http://www.globes.co.il/en/article-usenergy-envoy-gas-fields-must-be-developedquickly-1000998337 16 Ari Rabinovitch, Steven Scheer, Ehab Farouk and Lin Noueihed, ‘Egypt to appeal $1.76 billion award to Israel in gas dispute, freeze gas import talks’, Reuters, 6 December 2015, http://www.reuters.com/article/us-iec-egyptnatgas-appeal-idUSKBN0TP0HL20151206 17 David Wainer, Yaacov Benmeleh, Jonathan Ferziger, ‘Israel, Egypt Said Nearing Compromise on Natural Gas Dispute’, Bloomberg, 18 May 2016, http://www.bloomberg.com/news/articles/20 16-05-18/israel-egypt-said-close-to-accord-onnatural-gas-dispute 15

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For Responsible Investment and Successful Corporate Social Responsibility, Interdisciplinary Approaches Will Prevail Edvard Glücksman

Abstract The demand for social accountability in industry has never been greater. In the financial sector, Corporate Social Responsibility propels corporate entities to behave responsibly and improve society. Leading financial institutions now recognise that the development projects they fund carry environmental and social risks, and can incur financial losses and reputational damage if improperly managed. This holds particularly true for large industrial projects in developing countries where domestic laws, regulations, permits and oversight may be lacking. This growing concern with reputation management - and the need to obtain a ‘social license to operate’ – has pushed project financiers to require that sponsors and operators comply with a range of internationally recognised standards of environmental and social best practice.

Introduction The demand for social accountability in industry has never been greater. In the financial sector, Corporate Social Responsibility (CSR) propels corporate entities to behave responsibly and improve society. Leading financial institutions now recognise that the development projects they fund carry environmental and social risks, and can incur financial losses and reputational damage if improperly managed. This holds particularly true for large industrial projects in developing countries where domestic laws, regulations, permits and oversight may be lacking. This growing concern with reputation management - and the need to obtain a ‘social license to operate’ - has pushed project financiers to require that sponsors and operators comply with a range of internationally recognised standards of environmental and social best practice. These include the Equator Principles, International Finance Corporation’s Environmental and Social Sustainability Framework and the European Bank for Reconstruction and Development’s Environmental and Social Policy. These ‘soft laws’ represent a form of applied cross-border CSR. They are widely used by practitioners to guide Environmental and Social Impact Assessments and stakeholder engagement programmes that are required by project financiers as benchmarks within risk management frameworks. Focusing on mining in

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developing countries, this paper explores emerging trends within lending institutions’ risk management frameworks and how these affect the work of international practitioners. These frameworks are evolving in content, from conventional discourse around singular environmental and social aspects to the integration of comprehensive and interdisciplinary areas such as ecosystem services, climate change, gender and human rights. These broader, cross-cutting issues are affected by a series of interlinked factors and cannot be addressed in isolation. Their deployment within CSR programmes and adaptation to the unique challenges of developing countries can improve society. They can promote international relations and facilitate cooperation between nations that host lending institutions and those representing our common frontier in the global quest for natural resources. Social Responsibilities of Business What responsibilities to society may businessmen [sic] reasonably be expected to assume?1 Howard Bowen’s book Social Responsibilities of the Businessman (1953) is widely seen as having stimulated the modern era of CSR.

Howard R. Bowen, Social Responsibilities of the Businessman, University of Iowa Press, 1953

1

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Then known as social responsibilities (SR), early CSR theory was based on the idea that the private sector had obligations to pursue policies, decisions, and actions that were seen as desirable by society. Environmental sustainability and the wider impact of industry on society was thus assumed but not explicitly stated. As Volkswagen, Abercrombie & Fitch or Samarco (a subsidiary of mining giant BHP Billiton) have recently experienced, CSR has never been more vital for companies worldwide. Their reputation hinges on the spread of positive news and information. With the penetration of the Internet and social media across the globe, misconduct can quickly become apparent.2 A few broad categories of CSR that many of today’s businesses are practicing include environmental efforts, philanthropy, ethical labour practices and volunteering.3 As they emerged during the 1990s, CSR initiatives became a cornerstone of social accountability within the financial sector. In particular, lending and investment frameworks developed towards increased transparency, integrating and reporting environmental, social and governance (ESG) criteria within

these processes.4 As CSR initiatives became more mainstream and civil society groups began calling on banks to account for the environmental and social impacts of some of the more controversial projects they financed – the construction of dams, forestry, oil and gas pipelines and mining – financial institutions began to recognise that the projects they fund carry environmental and social risks.5 Realising that a failure to mitigate against negative environmental and social risks could incur financial losses and reputational damage, leading commercial and investment banks developed initiatives to help address their environmental and social responsibilities. Some of the most widely used of these initiatives are sustainability frameworks created by the private sector. These include the Equator Principles (EPs) for banks, the International Finance Corporation’s (IFC) Environmental and Social Sustainability Framework and the European Bank for Reconstruction and Development’s (EBRD) Environmental and Social Policy. These ‘best practice’ benchmarks aim to help companies actively address

Niamh O’Sullivan, ‘The Global Reporting Initiative Guidelines and External Assurance of Investment Bank Sustainability Reports: Effective Tools for Financial Sector Social Accountability?’ in Karen Wendt (ed.), Responsible Investment Banking, 2015 5 O’Sullivan and O’Dwyer, ‘Stakeholder perspectives on a financial sector legitimation process: The case of NGOs and the Equator Principles, Accounting, Auditing and Accountability Journal Vol 22, No. 4, 2009, pp. 553-587 4

Karen Wendt, ‘Editor’s Contribution’, in: Karen Wendt (ed.) Responsible Investment Banking, CSR, Sustainability, Ethics & Governance, Heidelberg: Springer, 2015 3 Sammi Caramela, ‘What is Corporate Social Responsibility?’, Business News Daily, 27 June 2017, http://www.businessnewsdaily.com/4679corporate-social-responsibility.html 2

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their environmental and social responsibilities in an era of growing public scrutiny on where and how money is invested. They are voluntary and intended for application in emerging economies where domestic laws, regulations, permits and oversight may be lacking. This article focuses on the ‘soft laws’ – recommendations and best practice methodology – that guide sustainability initiatives for the private sector in developing countries and emerging economies. In particular, it presents an overview of current trends, guiding the application of these frameworks as they develop in their scope from an emphasis on singular environmental and social aspects to a more holistic and integrative approach. This work argues that, with each iteration, initiatives such as the IFC Performance Standards or the EBRD’s Environmental and Social Policy increasingly represent an example of truly interdisciplinary applied science with global reach and large-scale financial impact. Sustainability and the finance sector From the mid-1990s, some pioneering banks started producing environmental and later sustainability reports about their direct, in-house ecological impacts. The United Nations Environment Programme Finance Initiative (UNEP FI) and the Global Reporting Initiative (GRI)6

Global Reporting Initiative, Financial services sector supplement, 2008, 6

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subsequently brought together multistakeholder working groups to develop a set of indicators for financial sector sustainability reporting. These initiatives carried out between 2003-05 comprised representatives of the financial sector, civil society, ratings agencies and academics that produced a draft set of environmental indicators to assist reporting on the indirect impacts of banking, asset management and insurance activities. The result of these actions and the initiatives they inspired led to the GRI Financial Services Sector Supplement (FSSS), which consisted of indicators aimed at improving the reporting of environmental and social performance of retail products and services, corporate and commercial bankers, insurers and asset 7 managers. Its use became obligatory on 1 January 2010. At the same time the EPs, which were developed in 20038, aim to help banks address their environmental and social responsibilities. EPs use the IFC’s Safeguard Policies, which were redrafted in 2006, to become the IFC PSs and incorporated into the EPs as the basis for project assessment. The EPs also incorporate

www.globalreporting.org/resourcelibrary/FSS S-Complete.pdf 7 Niamh O’Sullivan, ‘The Global Reporting Initiative Guidelines and External Assurance of Investment Bank Sustainability Reports: Effective Tools for Financial Sector Social Accountability?’ 8 The ten founding signees were ABN AMRO, Barclays, Citigroup, Crédit Lyonnais, Crédit Suisse, HypoVereinsbank, Rabobank, the Royal Bank of Scotland, WestLb and Westpac

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the World Bank Group’s Environmental, Health and Safety (EHS) Guidelines, which provide industry-specific good practice levels in the protection of the environment, worker and community health and safety. EPs have drastically improved the environmental credentials of projects being financed, particularly the standard of impact studies and action plans as well as the quality of stakeholder engagement with affected populations. Today, the EPs form the basis of many CSR systems of international financial institutions. Now in their third iteration since January 2014 and adopted by 80 private sector lenders in 35 countries, covering over 70% of international project finance debt in emerging markets, they provide a minimum due diligence framework for determining, assessing and managing environmental and social risk for participating private sector banking institutions.9 They also provide a pathway for clientsborrowers to analyse and manage the impact of their projects in accordance with the World Bank’s environmental and social standards10 IFC and EBRD sustainability frameworks

Nigel Clayton, ‘The equator principles and social rights: Incomplete protection in a selfregulatory world, Environmental Law Review, Vol 11, No. 3, 2009, pp. 173-195 10 IFC Performance Standards: http://www.ifc.org/wps/wcm/connect/Topics _Ext_Content/IFC_External_Corporate_Site/ IFC+Sustainability/Our+Approach/Risk+Man agement/Performance+Standards 9

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The EPs are the foundation on which many instruments for the management of non-technical risks for international lending. In practice, they provide methods requiring the identification of environmental and social risks and impacts and a complementary assessment process, and are applied within environmental and social impact assessments (ESIA) and stakeholder engagement programmes. They guide operators in the development of a comprehensive management framework through presenting the risks and opportunities within each aspect of a project throughout its lifetime, including beyond closure. Environmental aspects incorporate air and water quality, noise, soils and land use, whereas the social elements of a venture include archaeology and cultural heritage, economics, demography, health, education and infrastructure. Though broadly similar in content, each framework differs slightly in terms of application and context. The IFC PSs, which were one of the earliest frameworks to be deployed across different industries and sectors worldwide, can be applied even when there is no intention to apply for project finance.11 The PSs cover human resources aspects, resource efficiency and pollution prevention, community aspects such as health and safety, land rights and protection of

Victor Galaz et al. ‘Why Ecologists Should Care About Financial Markets’, Trends in Ecology & Evolution, Vol 30, Issue 10, 2015, pp. 571-580

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indigenous peoples, biodiversity and cultural heritage. The EBRD’s Environmental and Social Policy comprises ten specific Performance Requirements (PRs) and works in conjunction with other bank policies, particularly the Public Information Policy and the Project Complaint Mechanism, to provide a high level of assurance, transparency, and accountability. Projects are usually assessed 1-2 years after the final disbursement of finance, with assessments made against project objectives, the requirements of the bank’s Environmental and Social Policy and relevant country and sector strategies.12 As with the IFC, the EBRD also places a strong emphasis on stakeholder engagement. It seeks outcomes that protect and benefit society and the environment as well as addressing the business case for sustainability as a contributor to business growth. Emergence themes

of

cross-cutting

Environmental and social issues were conventionally addressed as standalone topics within the sustainability frameworks that guided ESIAs and stakeholder engagement programmes. However, in response to stakeholder’s heightened awareness and a shift in the formulation of international and domestic policy priorities, a series of crosscutting

Dariusz Prasek, ‘EBRD Environmental and Social Governance Standards and their Impact on the Market’, in: Karen Wendt (ed.) Responsible Investment Banking, 2015 12

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themes have progressively emerged to the fore of sustainability frameworks. Issue areas within these interdisciplinary areas, which include climate change, biodiversity and ecosystems services, gender and human rights, increasingly shape the interpretation of standards and requirements as well as the deliverables they provide guidance for. They cannot be addressed in isolation and require an integrated approach and actions, and multidisciplinary expertise. Ecosystem services refer to the benefits that people derive from nature and are a prime example of a theme that bridges the environmental and social components of a project’s impact management framework.13 Ecosystem services, exemplified by the provision of potable water, are well-researched by scientists and are widely featured in policy agendas14 but have only recently been introduced to financial institutions and developers. Their complex nature makes it difficult for non-specialists to understand how impacts to ecosystem services can affect the bottom line of their business. By adopting what is called an ecosystem services (or the broader ‘catchmentbased’) approach, each component

Elena Amirkhanova and Raimund Vogelsberger, ‘Challenges and advantages of IFC Performance Standards: ERM Experience’ in Karen Wendt (ed.) Responsible Investment Banking, 2015 14 Houses of Parliament, Biodiversity Offsetting, Parliamentary Office of Science & Technology POSTnote, 2011, http://www.parliament.uk/documents/post/p ostpn_369-biodiversity-offsetting.pdf 13

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and every stage within the development of an ESIA is assessed in light of interlinked ecological components of ecosystems, human well-being and a consideration for all other industrial activities in the area.15 The intrinsic value of these aspects is now well established and sustainability frameworks of financial institutions require that negative impacts to ecological components are minimised whenever possible. In practice, this means that developers and lenders should consider a broad variety of alternatives within their project design to ensure sure that natural resource use or destruction is avoided or minimised throughout project life.16 Gender is another aspect that cuts across environmental and social dimensions of sustainability frameworks. Working with gender issues is complex because they are characterised by their context-specific nature based on local legislation, beliefs and values. Apart from the different risks and impacts of a project on gender relations, good practice frameworks also examine the differential opportunities that a project may offer to men and women.

Sonal Pandya Dalal, Curan Bonham and Augustin Silvani, ‘An Investigation on Ecosystem Services, the Role of Investment Banks, and Investment Products to Foster Conservation’ in Karen Wendt (ed.) Responsible Investment Banking, 2015 16 A detailed report on the relationship between biodiversity and ecosystem services and industry, with the mining sector as a case study, was produced in 2013 by the ICMM: https://www.cbd.int/development/doc/Minin ing-and-Biodiversity.pdf 15

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Gender is also a key factor in stakeholder engagement strategies, for example in areas where men and women do not traditionally attend public events together. In the mining industry, gender was one of the first interdisciplinary issues to be integrated within sustainability frameworks and has also been further formalised by some of the major mining operators.17 With total greenhouse gas (GHG) emissions from industry having almost doubled over the past 40 years and most scenarios predicting that global demand for industrial products will continue to rise, climate change is increasingly prominent within sustainability and risk management strategies.18 They address climate change both directly and indirectly through environmental and social assessments, commitments and reporting. Within the 2012 iteration of the IFC PSs, apart from directly assessing GHG emissions of a project, an emphasis is placed on maximising resource efficiency and understanding community health and safety in light of climate change. Likewise, in the EPs (iteration III), an annex was included to provide guidance on climate change and reporting on GHG

Rio Tinto: ‘Why Gender Matters’, 2010, http://www.riotinto.com/documents/Reports Publications/Rio_Tinto_gender_guide.pdf 18 CISL, Climate Change: Implications for Extractive and Primary Industries, Key Findings from the Intergovernmental Panel on Climate Change Fifth Assessment Report, 2014, http://www.cisl.cam.ac.uk/businessaction/low-carbon-transformation/ipccclimate-science-businessbriefings/pdfs/briefings/IPCC_AR5__Implica tions_for_Extractive_and_Primary_Industrie s__Briefing_WEB__EN.pdf 17

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emissions.19 In emerging economies, where domestic GHG emissions regulations are not as stringent , companies seeking international finance have to adopt more carbonefficient project models than is the local norm. Finally, human rights remain one of the most difficult concepts to quantify in terms of its impact, yet they are a vital component of the sustainability frameworks that guide lender actions. Human rights are closely related to, and interlinked with, ecosystem services, gender and climate change, and are based on a starting point of maintaining close relations with the communities that live near a project development.20 Taking human rights into account is particularly important for work with indigenous peoples but also within broader stakeholder engagement initiatives comprising NGOs, civil society organisations and development operators. In this context, the EPs explicitly acknowledge a number of international conventions on human and worker rights, and the IFC PSs and EBRD PRs broadly cover human rights within stakeholder engagement guidance. Practical consideration for human rights involves disclosing information about a project development to all members of local communities clearly and in local

The Equator Principles, Annex A, June 2013, http://www.equatorprinciples.com/resources/equator_principles_ III.pdf 20 Manuel Wörsdörfer. ‘10 Years’ Equator Principles: A Critical Appraisal’, in: Karen Wendt (ed.) Responsible Investment Banking, 2015

languages, consulting with communities as early as possible in the assessment process and including them in decision-making processes. For indigenous peoples, whose culture and traditions may be particularly sensitive, the guidance recommends acquiring their free, prior and informed consent (FPIC) to ensure their rights are adequately represented. Responsible oxymoron?

mining

–

an

Mining is a prime example of an industry that is increasingly engaging in CSR programmes to ensure that projects obtain a Social License to Operate (SLO). Although mined materials support roughly 45% of the world’s economic activities, the industry’s historical reputation amongst the broader public is largely negative, in particular regarding its environmental legacy. The nature of mining activities – characterised by industrial energy and water use, land take, changes in access to natural resources and sometimes the need for resettlement of local populations – has a direct bearing on each of the cross-cutting aspects mentioned here. 21

In 2001, the International Council on Mining & Metals (ICMM) was created to improve the social and

19

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Ucilia Wang, ‘Sustainable mining: an inherent contradiction in terms?’, The Guardian, 5 January 2015, https://www.theguardian.com/sustainablebusiness/2015/jan/05/sustainable-miningbusiness-poverty-environment-newframework

21

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environmental performance of the mining and metals industry based on the idea that the industry can play a significant role in catalysing social and economic development. This global industry-specific CSR initiative brings together 23 of the largest mining and metals companies, which are represented on the ICMM’s Council of CEOs, and 34 national and regional associations, represented by nominated representatives.22 In addition to the ICMM, a host of initiatives now exist for improving the design and delivery of CSR within the mining industry. These include the Initiative for Responsible Mining Assurance (IRMA23); Alliance for Responsible Mining24; International Cyanide Management Code25; the Partnering Against Corruption 26 Initiative ; Voluntary Principles on Security and Human Rights27; Towards Sustainable Mining28; and the Extractive Industries Transparency Initiative29. This growing number of voluntary responsible mining initiatives has been reviewed at length by the World Economic Forum, which views them

ICMM: https://www.icmm.com/engb/about-us/our-organisation 23 IRMA: http://www.responsiblemining.net/ 24 ARM: http://www.isealalliance.org/onlinecommunity/organisations/alliance-forresponsible-mining 25 ICMC: https://www.cyanidecode.org/ 26 PACI: https://www.weforum.org/communities/part nering-against-corruption-initiative 27 Voluntary Principles on Security & Human Rights: http://www.voluntaryprinciples.org/ 28 TSM: http://mining.ca/towardssustainable-mining 29 EITI: https://eiti.org/ 22

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as a collective way of linking clear national development indicators with mining.30 By raising CSR standards, these initiatives are transforming the reputation of mining, an industry that is increasingly reliant on developing operations in emerging economies where host country environmental and social awareness is still under development. In December 2016, the EBRD announced record investment in Kazakhstan for a third consecutive year, having spent between USD$898-951 million on more than 30 projects across the country, including agricultural business, public utilities, infrastructure, energy, financial institutions and small and medium-sized enterprises.31 The future of sustainable industry in countries like Kazakhstan and, specifically, that of responsible mining, relies on nesting best practice approaches within profitable business models to ensure that the benefits of business are maximised and negative impacts reduced as much as possible. Future iterations of both IFC PSs and EBRD PRs will certainly address cross-cutting, interdisciplinary themes such as those mentioned here in greater detail than ever before,

‘Voluntary Responsible Mining Initiatives: A review’, World Economic Forum White Paper, August 2015, http://www3.weforum.org/docs/Voluntary_R esponsible_Mining_Initiatives_2016.pdf 31 Yerbolat Uatkhanov, ‘2016 EBRD Investment in Kazakhstan Breaks Record for Third Year’, Astana Times, 13 December 2016, http://astanatimes.com/2016/12/2016-ebrdinvestment-in-kazakhstan-breaks-record-forthird-year/ 30

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providing a platform for practicing interdisciplinary applied science with a level of potential impact that is unprecedented. Interdisciplinary expertise will be vital within this context. Further, when applied to facilitate the funding of development with an eye on sustainability, the international guidelines, such as those provided by the IFC or EBRD, will strengthen relations and facilitate cooperation between nations that host lending institutions and those representing our common frontier in the global quest for natural resources. Sustainable investment frameworks can forge new and stronger diplomatic ties based on truly interdisciplinary, applied science. About the author Edvard Glücksman is a Senior Environmental & Social Specialist at Wardell Armstrong and Stakeholder Affiliate at the Environment & Sustainability Institute, University of Exeter. He is a Chartered Scientist and a member of the Atlantic Council and Ecologic Institute's Emerging Leaders in Energy and Environmental Policy Network and the Friends of Europe 2016 class of European Young Leaders. Edvard holds a DPhil and MSc in Biology from the University of Oxford, a BSc in Environmental Biology from the University of St Andrews and a BA in Sociology from McGill University.

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TurkStream Pipeline Project: An Analysis of Legal, Financial and Technical Aspects Gökçe Mete

Abstract In October 2016, Turkey and Russia signed an intergovernmental agreement for the construction and development of the TurkStream natural gas pipeline connecting Russia to Turkey via the Black Sea. There is no international law governing the offshore section of the pipeline other than the intergovernmental agreement, as Turkey is not party to the United Nations Convection of Law of the Sea, and Russia is not party to the Energy Charter Treaty. This paper will endeavour to provide a synopsis of different aspects of the TurkStream pipeline project, addressing legal, policy, fiscal and technical challenges, and concludes with some reflections on the event that the project is realised.

Introduction In October 2016, Turkey and Russia signed an intergovernmental agreement (IGA) for the construction and development of the TurkStream natural gas pipeline. The project, which was first announced in 2014, will have a 31.5 billion cubic meters (bcm) total per annum capacity, divided into two separate lines to be constructed from Anapa in Russia to Turkey via the Black Sea. The first line of the pipeline is designed to supply the Turkish market and the second line, construction of which is dependent on a firm commitment from the European Union (EU), is planned to supply Southern Europe. Turkey already has the Blue Stream natural gas pipeline from Russia, and a transit pipeline, the Western Line, through Ukraine, Moldova, Romania and Bulgaria. The TurkStream pipeline project will substitute 14 bcm of Russian gas that currently flows through the Western Line. The Blue Stream transit-avoidance pipeline which was based on a 1997 IGA between Russia and Turkey and was commissioned in 20031 - has an annual capacity of 16 bcm.

The lack of significant increase in demand that would necessitate new pipeline infrastructure investment, coupled with the public perceiving it as increasing Turkey’s dependence on Russia, challenges the need to build more pipelines. Yet, as the following sections will reveal, there are financial, political and strategic motivations for both sides to come to an agreement regarding a new direct pipeline between Russia and Turkey. The rationale is so important that it even overcame the political dispute that followed the shoot down of a Russian jet by the Turkish air force in November 2015. The project requires an estimated €11.4 billion investment and, as it is an offshore project, these costs could increase in the implementation stage. There is no international law governing the offshore section of the pipeline other than the IGA, as Turkey is not party to the United Nations Convection of Law of the Sea (UNCLOS)2, and Russia is not party to the Energy Charter Treaty (ECT)3. This paper will endeavour to provide a synopsis of different aspects of the

United Nations Convention on the Law of the Sea, 10 December 1982, 1833 UNTS 3 (UNCLOS). 3 Energy Charter Treaty, 17 December 1994, reprinted in: ILM 34 (1995), 360. 2

Factual information on Blue Stream pipeline is available at: http://www.gazprom.com/about/production/ projects/pipelines/active/blue-stream/ 1

TurkStream pipeline project, addressing legal, policy, fiscal and technical challenges, and concludes with some reflections on the event that the project is realised.

Background The TurkStream pipeline project revives the previous South Stream pipeline project, which was planned to bypass Ukraine en route to European markets from Russia to Central Europe via the Black Sea and the Balkans. The onshore section of the pipeline was to cross Bulgaria, Serbia, Hungary, Slovenia and Italy, with gas branches going to Croatia and Serbia. A set of bilateral IGAs between Russia and the respective countries were signed between 2008 and 2010. It was originally designed to compete against the EU-backed Nabucco project4. After the cancellation of the South Stream project in 2014 due to regulatory

The Nabucco project aimed connect the European Union with Caspian Sea and Middle East States. The Nabucco-West pipeline was a proposed natural gas pipeline from the Turkish-Bulgarian border to Austria. It is a modification of the original Nabucco Pipeline project, which was to run from Erzurum in Turkey to Baumgarten an der March in Austria. A number of important factors led to the demise of Nabucco including geopolitics, waning interest of external actors in the Caspian region, as well as commitment of business partners, low prospects for production and, finally, the Shah Deniz Consortium’s decision to favour the TAP/TANAP route instead regarded as more viable and acceptable vis-a-vis Moscow.

conflict between Gazprom and the EU Commission, Russian President Putin announced Russia and Turkey’s joint intention to construct a new pipeline that would bypass Ukrainian gas transportation infrastructure and realise Turkey’s long-standing ambition of becoming an energy hub. The new pipeline, which could theoretically provide Gazprom and the Kremlin a blockage to diversified gas flows from Azerbaijan, Turkmenistan, the Eastern Mediterranean and Iraq, will compete with Nabucco’s successor, the Trans-Anatolian Natural Gas Pipeline (TANAP) project. On 25 October 2011, Azerbaijan and Turkey signed an IGA on the “Sale of Natural Gas to Turkey and the Transit Passage of Natural Gas through Turkey and the Development of a Standalone Pipeline for the Transportation of Natural Gas across the Territory of Turkey”. The two states then signed another IGA, on 26 June 2012, specifically for the TANAP Pipeline, which will transport natural gas from the Eastern border of Turkey to the Western border, stretching to a length of almost 2,000 km.

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When the TurkStream pipeline was first proposed the capacity of the pipeline was 63 bcm, the same as South Stream, and it was planned to consist of four parallel lines, two of which were to supply Europe at the Turkey-Greece border through a physical gas hub on the Turkish side. A natural gas hub is a distribution tool between upstream and downstream segments of the natural gas value chain for short, medium and long-term supplies. It can be physical by

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connecting to multiple pipelines, or a virtual balancing point for financial transaction of gas. As a rule, gas hubs promote and facilitate the trading of gas and creates a competitive market based on transparent prices. To enable a functioning platform, ideally the national regulator should ensure nondiscriminatory access to the gas hub by all sellers and buyers. For this, the hub operator should be an unbundled, independent legal entity and separate from the hub participants. Finally, by establishing a competitive market, clear regulations and nondiscriminatory access, it can incentivise further investment in natural gas infrastructure and upstream activities. First the project was suspended due to the jet incident in 2015, and when it was resumed in October 2016 at the World Energy Congress in Istanbul, the capacity of the pipeline was halved to 31.5 bcm and now may only supply gas to Turkey. This is due to several factors, some political, some technical and some due to competing pipelines, as Russia’s Gazprom is currently in the initial phases of constructing the Nord Stream 2 pipeline, which will double the existing 55 bcm capacity of Nord Stream 1. Commissioned in 2011, Nord Stream is a direct pipeline connecting Russia and Germany through the Baltic Sea5. Rationale

Factual information about Nord Stream is available at the project home page at: http://www.nord-stream.com/ 5

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The TurkStream pipeline will not bring new and additional gas to Turkey, but will instead replace the transit volumes it is receiving through the Western Line. However, if the two lines of the pipeline are commissioned, then the pipeline would increase transit capacity in Turkey, hence serving Turkey's long-standing ambition to be a hub for natural gas supplies to Southern European consumers. The direct link from Russia to Turkey increases Turkey’s energy security and increases its political leverage. For Russia the project is a part of its systematic efforts to avoid certain transit routes. For the same reasons leading to the planned Nord Stream 2 pipeline, Russia aims to increase Gazprom’s non-transit pipeline capacity and redirect volumes that would otherwise flow through Ukraine. This is a result of a series of transit interruptions and transit fee disputes between Ukraine and Russia that took place between 2006 and 2014. Russia’s transit contracts with Ukraine will expire in 2019, and Russia announced that these contracts will not be renewed, thus transit of Russian gas via Ukraine to Europe will be discontinued. In addition to pursuing its transit avoidance objectives, Russia also increases its market power in Turkey, its second largest consumer after Germany. Turkey’s national gas demand is over 45 bcm per annum, and is expected to grow rapidly towards 2030. The TurkStream pipeline gives Russia leverage against an already contracted 6 bcm of gas from Azerbaijan, future flows of gas

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from Kurdish Regional Government in Iraq, and current supplies from Iran which Turkey pays the highest price for. The IGA of the project indicates that the second gas line will be commissioned only if there is a demand and commitment from European buyers. In this, TurkStream will be in competition with the TANAP project. The Trans-Adriatic Pipeline (TAP)6 will then connect to TANAP at Kipoi in Greece, on the border of Turkey. From there, TAP will cross Greece and Albania towards the Adriatic coast. First gas deliveries from TANAP to Turkey are expected in 2019, and approximately a year later to Europe. The TANAP project implements the Southern Corridor initiative, a USbacked plan to enable Europe to diversify away from Russia, which dates back to the construction of the Baku-Tbilisi-Ceyhan7 oil pipeline in the early 2000s that brought Azeri oil to international markets without the need for transit through Russia. The TANAP project however is becoming increasingly expensive, with total costs currently estimated around $45 billion. And unlike the initial expectations, the State Oil Fund of the Factual information on TAP can be found at the project’s home page available at: https://www.tap-ag.com/. 7 The BTC pipeline transports oil from the Azeri-Chirag-Gunashli field from Shah Deniz across Azerbaijan, Georgia and Turkey. It links the Sangachal terminal on the shores of the Caspian Sea, to the Ceyhan marine terminal on the Turkish Mediterranean coast. In total length, the BTC pipeline is 1,768 km long. 6

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Republic of Azerbaijan (SOFAZ) and BOTAŞ, the Transmission System Operator of Turkey, will not be able to jointly fund the project from their budget, as SOFAZ’s funds are running low due to the 2014 oil price slump. Therefore, BOTAŞ is to receive a loan of $400 million from the World Bank. Initially the Southern Corridor was to accommodate large volumes of natural resources from the Caucasus, Central Asia, the Middle East and North Africa, however over time the US has lost interest – due to various factors, but predominantly a lack of availability and access to oil and gas exports to Europe — to fill the corridor. The TANAP project is currently contracted to carry only 16 bcm of gas annually, 10 bcm for Europe and 6 bcm for Turkey. The pipeline’s capacity is expected to exceed 31 bcm in 2026. TurkStream, while in principle in competition with TANAP, could be connected to TANAP if TurkStream’s second line is constructed. Gas could then flow through the TAP pipeline, which can be expanded by 10 bcm, and offered to shippers under an open season procedure as per EU legislation, and accommodate Russian gas alongside natural gas from Azerbaijan. BOTAŞ could then increase its transit fees and alleviate investment costs. There are not many alternative export routes for these supplies, as Turkey is surrounded by resource rich gas exporting countries in Central Asia, the Southern Caucasus, the Middle East and North Africa. However, European indigenous gas production is rapidly

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falling, and 2016 supplies from Russia to Europe are expected to be a record high 175 bcm for 2016. As the main reason for South Stream’s failure was the EU’s Third Energy Package requirements, particularly third party access, unbundling and competition law concerns, a route to Europe through a non-EU country such as Turkey would allow Russia to access the EU market without these restraints. EU energy law would be applicable from the Greek border onwards, however. While there are motivations for both sides to complete the pipeline, there are also risks, in particular for Turkey. It may damage its political relationships with Azerbaijan as a rival pipeline supplier, and the EU as the pipelines access to Southern Europe would further complicate these states’ conflict of interests with core member states. The risk for Russia is not being able to supply gas to Europe via TurkStream, and also future competition from potential suppliers such as Israel in the Eastern Mediterranean and Iraqi Kurdistan in the Middle East. Despite this, a recent meeting held in December 2016 between the CEOs of Russia’s Gazprom, Italy’s Edison and Greece’s DEPA to discuss possible routes for Russian gas exports to Greece and Italy shows that the prospect of Russian gas deliveries to Europe from the Southern Corridor is rather substantial.

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Technical aspects The offshore section of TurkStream will traverse 900 km across the Black Sea, between the Russkaya CS near Anapa and the Turkish seaboard. The onshore line will run up to Turkey’s border with Greece. Figure 1: Route of the TurkStream pipeline, source: Gazprom

The first line was going to be constructed by an Italian company, Saipem, under the same contract concluded for the construction of the South Stream project. However, as they failed to reach an agreement for a deal worth €2.4 billion, the Swissbased Allseas has been contracted to lay the first line of the TurkStream offshore gas pipeline with its single-lift installation and decommissioning vessel, Pioneering Spirit. It will start work from the first half of 2017. Construction of the first line of TurkStream should end by December 2019. This line will substitute the volumes transported via the Western Line (through Ukraine, Moldova, Romania and Bulgaria), which is currently

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contracted for private shippers. This line represents the only liberalised import capacity of Turkey under its Natural Gas Market Law (NGML)8. The NGML presently does not allow private companies to import pipeline gas from suppliers that already have a supply contract with BOTAŞ. After expiration of these contracts private importers may sign natural gas contracts for the same quantities as BOTAŞ’s imports. Imports from those countries where no contracts with BOTAŞ exist are subject to evaluation and permission of the Energy Market Regulatory Authority of Turkey. The NGML initially aimed at limiting BOTAŞ’s gas imports to 20 per cent of the total consumption of Turkey via contract and volume transfers to private companies. However, this ambitious target could not be met to date. Hence, the draft amendments to the NGML propose to reduce the share of BOTAŞ’s imports to 50 per cent. The existing supply contracts between Gazprom and private shippers will be amended to change their delivery points to Kıyıköy in Turkey, instead of their current delivery point the Malkoçlar gas-measuring station on the Bulgarian-Turkish border on the Western Line. Today, these contracts amount to 14 bcm annual capacity, and the first line of TurkStream will have 15.75 bcm annual capacity. Therefore, the contracted volumes will more or less coincide with the original

No. 4646, Published in the Turkish Official Gazette No. 24390 on 2 May 2001, available in English at: www.emra.org.tr/TR/Dokuman/6667. 8

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contracts. Should the second line be built, the capacity will be reserved to Gazprom and it is not clear whether private shippers will have access. After the existing volumes from the Western Line is replaced with TurkStream, the spare capacity in the pipeline can be used for reverse flow to Bulgaria and Romania, and natural gas may also be transported to Greece by the Bulgaria-Greece Interconnector with limited capacity. This would allow Gazprom to meet its supply commitments under its capacity contracts with Bulgaria and Romania that expire in 2030. However, this is only true to the extent that usage of pipeline capacity in ‘reverse’ mode does not need changes in existing capacity contracts to be considered a termination or extension under the Third Energy Package. This would automatically require them to be brought into line with the capacity allocation network code.9 Around 700 km of the offshore part will lie within Turkish waters and the Turkish Exclusive Economic Zone (EEZ) in the Black Sea. It will be divided into two parts. For the section of the pipeline that runs from the Turkish and Bulgarian EEZ to the Turkish coastline, with a length

Jonathan Stern, Simon Pirani and Katja Yafimava, Does the cancellation of South Stream signal a fundamental reorientation of Russian gas export policy? Oxford Institute for Energy Studies, Oxford Energy Comment, January 2015, https://www.oxfordenergy.org/wpcms/wpcontent/uploads/2015/01/Does-cancellationof-South-Stream-signal-a-fundamentalreorientation-of-Russian-gas-export-policyGPC-5.pdf

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of approximately 275 km, the pipeline company South Stream Transport will conduct an Environmental Impact Assessment (EIA). This will be developed according to Turkish legislation and will cover local environmental conditions, communities and overall pipeline safety. For the rest of the route, an EIA was approved by Turkey in 2014 as part of the scrapped South Stream project. The Russian part of the offshore line is developed according to an approved EIA under Russian permitting procedures and it uses data available from the Environmental and Social Impact Assessment (ESIA) of the South Stream, which was developed by engaging communities in the Anapa region near the landfall, along with NGOs and other interest groups. Financial aspect The TurkStream project is expected to cost €11.4 billion and the first line will cost approximately €4.3 billion. The offshore segment could cost around €7 billion. Gazprom will provide €310 million to South Stream Transport,,a subsidiary of Gazprom, to develop the project. The Russian state budget is estimated to gain around $750 million from export taxes. For Turkey, the economic advantage is discounted gas prices, and if the second line is built it will receive any profits from transit fees should it be able to resell the gas.

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The offshore section of both the first and second lines of the pipeline will be fully owned and financed by Gazprom. BOTAŞ, on the other hand, will create a company for the construction of the first onshore line that will supply gas to the Turkish market. This line will be nearly 180 km long. For the second onshore line, a 50-50 joint venture company undertaken by Gazprom and BOTAŞ’s subsidiaries will be established. The participants of the joint venture, proportionate to their respective shares, will pay the costs of the second onshore line. If both sides agree, third party funding could be sought for the second onshore line and a third participant could be added to the joint venture. For the second line, Italy and Greece are likely destinations for Russian gas via the Southern Corridor, if Russian supplies transit through Ukraine is at least partly ceased after 2019, and these volumes will be redirected to North Stream II via Germany. If TAP’s current capacity of 10 bcm is expanded to 20 bcm by adding two compressors in Greece and Albania, Russia can use this capacity via third party access. Transporting larger volumes of both Russian and Azeri gas further to Europe will diminish overall network costs for TAP operators.

Negotiations and the IGA The IGA between Turkey and Russia was approved and ratified by Turkey in December 2016 and by Russia in January 2017. The agreement will stay

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in force for 30 years subject to further extension. The negotiations of the project took two years as Turkey insisted on a price reduction from Gazprom for Turkey’s supply, which the Russian giant was unwilling to provide. The shooting of a Russian jet by Turkey has also prolonged the negotiations period as President Putin suspended the project. Eventually, the financial and political motivations to construct the TurkStream pipeline outweighed previous discord.

technical specifications on both offshore and onshore parts of the pipeline. Disputes will be resolved in Switzerland judicial courts. Implications for International and EU Energy Law

There will be significant tax exemptions, particularly for offshore operations, construction will be corporate and profit tax-free and gas supply services will also be tax-free. In addition, there will be no stamp and customs duties for the technical equipment coming from both countries.

The EU’s Third Energy Package includes a Gas Directive concerning common rules for the internal natural gas market and a Gas Regulation on conditions for access to natural gas transmission networks. This legislative package requires capacity of pipelines located in the EU to be open to third party access in a non-discriminatory way, under market-based principles and published tariffs. Transmission system operators are obliged to unbundle their upstream, midstream and downstream assets so that no gas company can own the gas, operate and own the pipeline and market it at the same time. These rules caused the cancellation of the South Stream pipeline. The EU Commission came to the conclusion that the IGAs signed by Russia, with each Bulgaria, Serbia, Hungary, Greece, Slovenia, Croatia and Austria, are all in breach of EU law and need to be renegotiated from scratch or be terminated. The project was eventually suspended not as a result of a legal case but due to political pressure exerted by the EU Commission.

After the construction of the first line is commissioned, the gas supply from the Western Line will be directed to the first line. The gas supply agreements will be revised to reflect the new dispatch point and for the

In the case of TurkStream, it seems that the Third Energy Package will work for the benefit of Gazprom should the second line be build, because it will give Gazprom access to the TAP pipeline, which is operated by

The TurkStream pipeline will use the gas compressor station in Russkaya on the shores of the Black Sea in Anapa as an entry point. For the second line, there will be a long-term supply agreement with a take or pay contract with Gazprom, and the full capacity of the second line will be reserved for Gazprom. Third parties can participate in the joint venture. The construction of the second line however, can be cancelled with notification from the Turkish side.

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BP, Statoil, SOCAR, Fluxys, Enagás and the Axpo. Currently, the TAP pipeline has an exemption from the provisions of the Third Energy Package. An exemption is only provided if a pipeline project brings new sources of gas, it does not damage competition and the exception is indispensable for its development. Regardless of the fact that the TAP pipeline complies with the criteria, the Commission awarded an exemption but only for 50% of its capacity. The total capacity of the pipeline is 20 bcm - 10 of which are now dedicated to the gas from Azerbaijan via TANAP – but the remaining 10 bcm could be awarded to Gazprom. Gazprom may still face competition for that capacity from other sources of gas such as through a prospective pipeline between Israel and Turkey, or if Iraqi gas comes online. Yet, in all likelihoods, the TurkStream’s second line will be completed faster as it is easier and more efficient to construct the second line, as it will be parallel to the first line. Some provisions of international law may be relevant to the TurkStream pipeline project. Russia needs to seek permission from other Black Sea countries for the construction of an underwater pipeline, which would evoke old disputes over whether the Caspian sea is a lake or a sea and accordingly which international convention or treaty should apply. As for the TurkStream pipeline, Turkey is not party to UNCLOS, an international treaty that regulates offshore pipelines. Yet Turkey declared at least a partial

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EEZ that covers some of its waters, and thus given UNCLOS’s EEZ stipulations legitimacy as customary law. Another instrument of international law, the ECT, also provides rules and principles for offshore pipelines and transit passage of natural gas, and includes provisions on the resolution of transit disputes. Turkey ratified it in the early 1990s, but Russia is no longer a party to the ECT after it withdrew in 2009 following a transit dispute between Ukraine and Russia. Russia blamed the ECT for its failure to capture transit interruptions when a major cut of Russian supplies destined for Europe in the middle of winter occurred. This means there is no international law other than the IGAs that is applicable to the TurkStream project, but it provides at least a route for dispute resolutions under international arbitration, and includes substantial undertakings and commitments from both countries. Conclusions The likelihood of Turkey becoming a natural gas hub depends on Europe’s appetite for more Russian gas - or redirected Russian gas as the case will be. However, there are other factors that need to be considered, for instance the funds required to build the second line and whether that would be feasible without firm commitments from European buyers. Furthermore, for Turkey to become a gas hub it will need to be able to resell the gas at the Turkey-Greece border and prove technical feasibility. For instance, a competitive and liberalised,

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and hence accessible market needs to be established where multiple consumers could meet multiple customers and enter into transactions in competitive prices. A reference price for the spot gas needs to be determined.

is also an existing Turkey-Greece pipeline with a 6 bcm capacity: this line could also be utilised to ship Russian gas to South East European markets, in addition to possible reverse flows from the Western Line to Bulgaria.

Perhaps instead of a physical hub, as planned, Turkey could establish a virtual hub at the Turkey-Greece border and restructure the market from oil-price indexation to spots market. In addition to Russian gas, natural gas from Azerbaijan, Iraq and, in the future even from Israel, could be traded at the virtual hub linked to the financial markets in Turkey as well.

In conclusion, there are little infrastructure and funding related concerns that can in principle be resolved. The future direction of the pipeline project is likely to be impacted by demand projections and political concerns coming from the EU – such as reliance on Russia and Turkey for supplies. About the author

For Russia, the true success of the project will be achieved if gas can be moved into Europe. While gas could be shipped to Greece and Italy (and Albania), who are already contracted to receive 10 bcm of gas from Azerbaijan from the TAP, there is no infrastructure to carry this gas on to Bulgaria at the moment. There is a planned Greece-Bulgaria interconnector, but even when this is commissioned further infrastructure will need to be built to transport this gas to other EU member states. There

EUCERS ‘Reflections’ Working Paper Series, Vol 3, Spring 2017

A qualified lawyer, Gökçe Mete is a Research Fellow at the Extractives Hub at the Centre for Energy, Petroleum, Mining Law and Policy. This is a UK funded digital project to support natural resources-rich developing nations to make informed decisions regarding extractives sector development. She is concurrently finalising her PhD on EU energy acquis and its impact on investment in energy infrastructure in University of Dundee.

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European Centre for Energy and Resource Security (EUCERS) Department of War Studies King’s College London Strand London WC2R 2LS [email protected] www.eucers.eu Tel 020 7848 1912 EUCERS ‘Reflections’ Working Paper Series, Vol 3, Spring 2017

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