High Stakes in the Caspian Energy Game

Since taking office as president of Azerbaijan in 1993, Heydar Aliyev has struck a balance between establishing ties with the western powers and maintaining economic and political independence from Russia, while trying to avoid antagonizing Moscow. The bilateral relationship between Baku and Moscow has played a significant role in the foreign policy strategy of both countries since 1989, with Russia’s primary interest being to limit alternative supplies of hydrocarbons to Europe.

Tension has arisen on occasion between the two countries since Aliyev’s rise, most recently during the first years of Medvedev’s presidency regarding allegations of espionage and claims of Azerbaijani support to secessionist groups in Chechnya. Bilateral relations are improving, but meaningful cooperation in the joint exploration, production and sale of Caspian-based energy resources remains a joint objectives. In 2009, for the first time, Baku started exporting gas to Russia when Gazprom declared its willingness to purchase all surplus Azerbaijani oil production at the same price paid by European buyers for Russian gas, and much more than the $120 paid by Turkey to Azerbaijan.

Baku and Moscow’s energy relationship is complicated. Although Azerbaijan has been a net energy exporter since the dissolution of the Soviet Union, it has historically been dependent on Russia’s transit routes to export its oil and gas. That changed in 2005, when the Baku/Tbilisi/ Ceyhan pipeline commenced operation. A year later, the South Caucasus Pipeline also began operating. Both of these two projects had the support of the U.S., which entered the Caspian energy game in the mid-1990’s with the aim of creating an east/west energy corridor to bypass both Russia and Iran in an attempt to curb their regional influence. Washington backed the creation of an axis between Azerbaijan, Turkey and Georgia.

The most ambitious project in this regard (and the most opposed by Moscow)—the Nabucco Pipeline project—is caught in a stalemate, in spite of the firm backing of the European Union. Nabucco’s intention is to connect Turkey to Austria through Bulgaria, Hungary and Romania.  Given that Europe currently depends on Russia for approximately 25 percent of its gas supply, the EU has assigned high priority to the development of the project. Nabucco is also consistent with the U.S. desire to free Caspian energy resources from Russia’s grip while making Turkey an alternative energetic hub at the gates of Europe. The Nabucco pipeline stands in direct opposition to the Russian/Italian South Stream pipeline, which aims to connect Europe with Caspian and Middle Eastern natural gas resources (the main suppliers being Azerbaijan, Iraq, and Turkmenistan—the rich Azeri fields of Shah Deniz would play a major role).The pipeline is estimated to be able to provide Europe with 1 trillion cubic meters of gas per year.

South Stream would utilize gas reserves from Turkmenistan, Kazakhstan and potentially Uzbekistan, while Kazakh and Turkmen gas is necessary for the realization of Nabucco. Through a series of bilateral agreements (especially with Turkmenistan and Kazakhstan), and by using gas experts to cast doubt on the viability of Nabucco, Moscow has been far more assertive and effective in drawing key players in this game to its side. In addition, South Stream is supported by the Russian state, meaning it has no issues producing a funding source.

By contrast, Nabucco is a commercial project and must secure its funding. Nabucco also needs access to other gas providers, but political considerations make Iranian gas problematic, and Iraq appears uninterested in the project. Last month the Nabucco project signed a crucial agreement with five transit countries (Austria, Bulgaria, Hungary, Romania and Turkey), defining the legal framework for the project, but this does not address the absence of gas providers. As Russian Prime Minister Putin recently stated: “Nabucco’s major problem is a lack of guaranteed volumes of raw materials and no source to fill the system. Russia will not deliver anything there, Iranian deposits are not explored, and Azerbaijan’s volumes are small. Moreover, Azerbaijan has signed a delivery contract with Russia”. Since the initial gas is supposed to come from Azerbaijan, Putin was in essence saying there is not enough production volume from Azerbaijan to both fill the Russian contract and the pipeline.

It is clear that Nabucco’s destiny will ultimately depend on where the project gets its gas and who is willing to fund it. There is not much either the U.S. or Europe can do about that. Moreover, bilateral relations between Baku and Washington are not at their best at the present time. Baku has invested a lot of political capital to demonstrate that it is a reliable partner to the U.S., but the region is clearly not on top of the Obama administration’s list of foreign policy priorities. Baku also does not approve of America’s pro-Armenian stance on the issue of Nagorno-Karabakh, which undermines Baku’s position. Far from being a matter of secondary importance to Baku policy makers, this issue is deeply rooted in Azeri society and it is a question of national pride for the country. This has proven to be a serious impediment to enhancing relations between the two countries and threatens to impact their larger strategic relationship.

The outcome of the Caspian energy game has the potential to become pivotal in the larger geostrategic contest between Moscow and Washington. For Moscow, what is at stake is its ability to successfully project its power in its own backyard, and by extension, beyond. Should the South Stream project become a reality—at the expense of Nabucco, since there is no need for both— Moscow will gain significant additional leverage over Europe. Given the variety of Washington’s preoccupations, fiscal limitations, and waning influence in the region, Moscow seems likely to prevail. If so, the long-term political and strategic cost to Washington, and the region, will be significant.

Daniel Wagner is CEO of Country Risk Solutions, a political risk consulting firm based in Connecticut, and also senior advisor to the PRS Group.

Luca Costa is a research analyst with CRS, based in Italy.

Reprinted with the kind permission of Daniel Wagner