Turkmenistan's Dilemma

By Akram Esanov, RWI Senior Economist

	The Presidential Palace, Ashgabat, Turkmenistan Photo: Carpetblogger/Flickr

When the Soviet Union collapsed in 1991, the Central Asian country of Turkmenistan was left with substantial natural gas endowments, estimated at between 4 and 14 trillion cubic meters, and a poorly diversified export market for its natural gas. The only pipeline connecting Turkmenistan with its ultimate consumers in Europe runs through Russia and is almost entirely controlled by the monopolistic, state-controlled Russian gas company, Gazprom. 

Taking advantage of its dominant position, for the past two decades Gazprom has bought Turkmenistan's gas cheaply and sold it for a profit to Ukraine—one of the major importers of Turkmen gas. In 2005, Turkmenistan signed a contract to sell gas directly to Ukraine, but the deal never came to fruition due to objections from Moscow.  Other Turkmen efforts to find new markets have been stymied by the difficulties of transporting Turkmen gas independent of Russia.

However, when energy prices soared between 2003 and 2008, European Union countries began to consider using various gas suppliers to reduce their dependence on Russia. Additionally, China has intensified its search for new gas suppliers in Central Asia to satisfy its growing demand for natural resources. These developments have significantly improved Turkmenistan's chances to diversify its export markets and have weakened Russia's position as the sole buyer of Turkmen gas. Under these new market conditions, Russia had no choice but to begin paying Turkmenistan full market prices for its gas imports under a new 2008 energy-supply contract. Despite this victory, Turkmenistan continued its efforts to find new export markets, such as the EU and China, both of which have expressed interest in building pipelines that could bypass Russia and deliver Turkmen gas directly to customers. Neither alternative comes without problems, though, and in the midst of an economic crisis, Turkmenistan faces a policymaking dilemma: whether to compromise with autocracy-leaning Russia, or strengthen its relations with China and cultivate new ties with the European Union.

Negotiating energy deals between Turkmenistan and Russia has always been a complicated and uncertain process, due to non-transparent political and commercial arrangements meant to benefit various interest groups. The relations between the two countries deteriorated further after an explosion along the Turkmen section of a Gazprom pipeline this April disrupted Turkmen gas exports to Russia. Turkmen authorities blamed the Russian company for the incident. According to Turkmen officials, Gazprom sharply reduced its natural gas intake from the Turkmen-Russia pipeline without giving advanced warning to its Turkmen counterparts, creating a pressure build-up that caused the explosion.

On April 10, the Turkmen Foreign Ministry issued a statement accusing Russia of engineering the explosion and violating the terms of the gas supply contract between the countries. The explosion led to enormous financial losses for Turkmenistan, and forced its national gas company, Turkmengas, to halt extraction activities at several sites. Wherever a shut-off wasn't possible, the authorities had to sacrifice some amount of gas by flaring to avoid further damage to the transit system.

In response, Gazprom denied responsibility and argued that aging pipeline infrastructure caused the industrial accident. What isn't disputed is how the accident spotlighted Turkmenistan's highly concentrated natural gas market, and its problematic reliance on Russia to market its gas.

Understanding its monopolistic power over Turkmen exports, in June Gazprom started high-level talks with Turkmenistan to renegotiate its contract. Under the existing contract, signed before energy prices plummeted, Russia must pay a fixed price for Turkmen gas regardless of falling global oil prices. But Russia is seeking to impose a new contract, under which Turkmen gas prices will be linked to world oil prices, and Turkmenistan will probably not receive European prices for its exports. In talks with Turkmen officials, Gazprom demanded that the country either reduce the volume of gas it supplies to Russia, cut its export prices, or reduce both its volume and price. In any case, the economy of Turkmenistan would be hit hard.

Turkmen authorities have hinted that they might take Russia to the International Court of Arbitration if Moscow continues pressuring Turkmenistan to sign a new energy contract, undoing the provisions of the 2008 agreement. At present, Russia seems to assume that it has the upper hand in its energy negotiations with Turkmenistan, since it can meet its gas supply obligations to the EU without Turkmen gas—at least as long as current market conditions remain unchanged. In the meantime, Russia's aggressive negotiation style has prompted  Turkmenistan to intensify its discussions with China, the EU, European companies and the United States.
 
One potential new supply route is the Central Asia-China pipeline. Since late 2007, Turkmenistan and China have been building a pipeline, expected to be operational in 2010, to run between the two countries, by way of Uzbekistan and Kazakhstan. Once the pipeline is built, Turkmenistan will transport 30 billion cubic meters of natural gas to China per year. Turkmen authorities in Ashgabat are now negotiating to increase the pipeline's transit capacity to 40 billion cubic meters annually. Additionally, this June China's State Development Bank opened a new credit line of $4 billion on soft terms to Turkmengas to finance exploration and development projects in Turkmenistan’s vast South Yolotan gas field.  The Turkmen government understands that enhancements to the transit capacity of the new pipeline will increase the country's dependency on China for exports and will have repercussions for Russia-Turkmen relations. If China replaces Russia as a dominant market for Turkmen gas exports, chances are that it will eventually attempt to purchase gas at below-market rates, hurting the Turkmen economy.

A second alternative gas export route for Turkmenistan is the proposed Nabucco pipeline running from Central Asia to the EU. This pipeline is a new initiative of the EU intended to import natural gas directly from Central Asia, Azerbaijan and the Middle East, and lower EU dependency on Russian gas supplies. Although Azerbaijan is fully committed to this project, its financial viability is seriously weakened without Turkmen gas.

While the Nabucco pipeline could be an attractive opportunity for Turkmen gas diversification, trade negotiations stalled in late June due to the EU's demand that all Turkmen energy payments be made public. Furthermore, most international human rights and advocacy groups criticize the Turkmen government for its poor human rights record, lack of transparency and rampant corrupt practices. Some NGOs have pressured the EU to exercise its political leverage and demand that Turkmenistan improve its position on human rights and compliance with other key international standards before signing any agreement with its government. At this point, the Turkmen government is not enthusiastic to accept transparency standards and the EU has little, if any, immediate leverage to influence their position.  With China standing ready to further expand its financial presence in Turkmenistan with energy sector investments, Turkmenistan feels little economic pressure even if the EU halts cooperation. However, in the long run Turkmenistan would do well to improve its cooperation with the West.

After the failed talks to renew the trade agreement between Turkmenistan and the EU, Turkmen Foreign Minister Rashid Meredov visited the United States to meet with US Secretary of State Hillary Clinton and seek Western investment to develop Turkmenistan's massive energy resources. The ambitious plan to diversify Turkmenistan's export market and boost natural gas production needs huge investment and modern technology. On one hand, Turkmenistan appears eager to attract Western energy companies to invest in the local economy. On the other hand, the government avoids discussions of human rights and transparency issues in the extractive sector in its negotiations with the EU countries and the United States.  At least for now, the EU seems to be signaling that improved transparency is a condition for further negotiations with Turkmenistan. The U.S. position remains unclear.

Throughout the last two decades, Russia has played a key role in shaping Turkmenistan's energy policy, but Russia's increasingly monopolistic demands have forced the Turkmen government into diversifying its natural gas export routes. If Turkmenistan begins transporting gas to China in 2010 as scheduled, the pipeline linking Turkmenistan and Russia may quickly become obsolete, since Turkmenistan's current production capacity cannot fill both pipelines. It seems clear that finally, with the help of China, and additional prospects in the West, Turkmenistan is poised to break the Russian monopoly on its most marketable resource.

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