The Other Energy Superpower: Central Asia? (Part II of II)

October 18, 2011 § 1 Comment

Although Kazakhstan, Turkmenistan, and Uzbekistan have the capacity to significantly influence the energy sector, their current development of oil, natural gas, and coal are too varied and many obstacles still stand in the way before they can be coined an “Energy Superpower.”

So, what are these obstacles?

Geopolitical

Central Asia’s geographical location is landlocked: Russia to its north, China to its east, the Middle East to its south, and Eastern/Western Europe to its east. Of the three major resource-rich countries in Central Asia, only Kazakhstan and Turkmenistan have access to the Caspian Sea which has the  potential to link them to the world energy market via the Black Sea.

This geographical position potentially allows them market access to many countries in the area. But the lack of direct access to the sea and to locations further in Eastern/Western Europe, the Middle East, and Asia makes the proliferation of their energy products politically sensitive and challenging.

Markets

At the moment, the markets available for Kazakhstan, Turkmenistan, and Uzbekistan are limited depending on the energy source they are exporting. Kazakhstan, a major producer of sweet crude (lower sulfur= less processing) but not yet gas, has access to Russia, Turkey, Georgia, and China. Uzbekistan, an exporter of natural gas and to a lesser degree of petroleum products, sends its products to Kazakhstan, Kyrgyzstan, Tajikistan, and Ukraine. Uzbekistan will also add China to its profile, as the country has already begun the third stage of pipeline production earlier this year. Lastly, Turkmenistan has traditionally exported the majority of its oil and gas to Russia, but has now diversified into China, Afghanistan, Pakistan, India, and Iran. Turkmenistan is also in talks with Western Europe as a possible gas supplier for the Nabucco pipeline project.

These overlapping markets make competition fierce as Russia, Azerbaijan, and Iran also wish to have increasing influence on the energy supplies of these countries. However, due to Russia’s long monopoly over energy supply and the political sensitivity surrounding Iran, Central Asia has become a welcomed entry into the market.

Transit Countries

Despite being preferred as an alternative energy supplier, Central Asia still faces barriers in expanding its oil and gas to overseas markets. The most efficient way to transport oil and gas is through pipelines, however, in Kazakhstan, Uzbekistan, and Turkmenistan’s case,  their geographical location hinders their ability to directly connect to consumers. Therefore, these three countries are intrinsically dependent on transit countries to help supply their products. This will require a great deal of regional stability, as well as bilateral or even multi-lateral negotiations to secure the safety and completion of cross-border pipelines in the future.

However, despite these efforts, problems can still occur. In a World Bank study of cross-border oil and gas pipelines, the organization highlighted historical conflicts arising from “profit”, “rent-sharing”, competition of market share, differing political interests, and the lack of enforced contracts as the main reasons pipelines fail to be completed or managed. Central Asia is not immune to this, and will potentially have difficulty coming to an agreement with countries such as Russia, Iran, and Azerbaijan who are currently competing for increased market share in the region. For this reason, a regional body (formed by contracted countries) which regulates and enforces the contracts of transit countries, while monitoring the supply and demand of oil and gas producing states would be needed in order to give consumers confidence and ensure that disruptions to supply will not happen.

Infrastructure

Another large barrier in the development of oil and gas for the global market is the infrastructure required. Infrastructure, in this case, refers to oil and gas pipelines, exploration and production technology, transportation links, oil refineries, and where needed, gas processing centers. At the moment, many of the exploration, mining, and transportation networks built in Kazakhstan, Uzbekistan, and Turkmenistan were done during or immediately after the Soviet Era. This illustrates Central Asia’s heavy reliance on Russia as their primary market and transit point, as well as the possibility that the technology being used could be out of date. At the same time, new infrastructure is very costly and requires a tremendous amount of investment, as these countries are still developing and do not have the resources to explore or produce domestically.

For this section, I will take the construction of pipelines as an example to explain the difficulties of increasing energy infrastructure in this region.

One of the issues facing pipeline construction is the large initial investment it takes to complete a project. Pipelines are often constructed through complicated terrain that require additional funding to bring in supplies, laborers, and managers to properly handle the pipeline construction. As a result, a single project can cost billions of dollars as seen in Turkmenistan and India’s recent negotiations to build a 2,000km pipeline through Pakistan and Afghanistan where the proposed pipeline would take $7.6 Billion to complete. This amount of money is possible to raise when cross-border pipelines are constructed. However, is rather difficult for developing countries such as Uzbekistan, who had to borrow 1.8 Billion from foreign institutions to build their vast network of domestic gas pipelines.

Secondly, pipelines can handle only one type of crude or gas pressure. This makes pipelines inflexible and much analysis and care should be taken in order to maximize the use of pipelines once they have been built. This issue is especially pertinent to exporting countries that have different varieties of gas, such as Uzbekistan and Turkmenistan, which require the construction of gas processing facilities to accommodate the nature of the pipelines.

The last issue plaguing the creation of pipelines is the actual security of the structures once they have been constructed. Often dubbed as pipeline security, many countries are concerned about the physical security of the pipelines from militia groups, protesters, or even everyday citizens disrupting the supply of energy products. At the moment, not much as been done to secure these pipelines but the implementation of regular checks along the length of a pipeline would ensure timely discoveries of leaks or breaks in the structure.

Implications for future investors or markets

Although there are still a number of obstacles standing in the way of Kazakhstan, Uzbekistan, and Turkmenistan’s control of the global energy trade, they cannot be ignored and should be engaged in international discussions on oil and gas. The amount of resources that these countries hold, in combination with their location and growing diplomatic ties will create fierce competition with other energy producers. This will either help reduce the cost of energy in the future or bring catastrophe as countries fight to monopolize energy markets.

Future investors and potential markets, however, should pay close attention to the domestic energy policies of these countries. As most of these oil and gas fields are owned by national governments, their main priority will be to fuel their economy and provide for their citizens. This has already been seen through the long-standing oil and gas subsidies these countries give to their to their industries and citizens, increasingly not only their energy intensity but also energy inefficiency. As a result, their current and future practices will affect the amount of reserves available for export (i.e. Uzbekistan’s former oil reserve to production ratio was to last 13 years, in 2002 it was revised to only 11 years. The same goes for their gas reserve to production ratio, which was 42 years but is now only 33 years.).

Author’s Forecast

In my opinion, the most important issue to note will be their relationship with Russia as this will dictate how far and wide their exports will go. At the moment Russia controls a large proportion of European markets and is steadily increasing in the Asian market. In order for countries such as Kazakhstan, Turkmenistan, and Uzbekistan to have an impact, Russia needs to be willing to cede control and influence. In the coming months, if not years, close monitoring of the Nabucco Project (bringing Caspian Sea resources to Western Europe, while weaning off Russian resources) is of extreme value as it will illustrate Russia’s position on Central Asian resource expansion.

Monitoring of the Chinese and Indian pipelines is also of extreme value as it will dictate the importance of Central Asian energy as these countries will be the largest consumers of energy in the coming years. However, since India’s pipeline has to pass through the troubled countries of Afghanistan and Pakistan, China will have an advantage due to their direct pipelines. In this regard, I foresee Kazakh oil primarily relying on the Chinese market, while Uzbek gas will run into trouble as the country balances its own energy needs with its export dreams. Additionally, if the Nabucco pipeline does not halt again, Turkmen gas will be primarily directed to Western Europe.

The first part of this series can be seen here.

For a closer look at the region’s major oil pipeline projects: http://maps.grida.no/go/graphic/major-oil-pipeline-projects

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