Energy Challenges Facing the CIS

The Oil and Gas industries of the Commonwealth of Independent States (CIS) face major challenges in the future. Increasing world energy demands, coupled with increasingly stringent international environmental legislations, have brought about the dramatic growth in natural gas demand. These demands for gas have presented attractive new market opportunities to the CIS but also technical and geopolitical challenges to overcome, both at home and abroad.

Global trends and impact on CIS

To begin with, the increasing world energy demands are significantly being driven by the world’s increasing need for natural gas. Figure 1 shows the current and projected trends in the usage of natural gas as well as other fuel types. Increasingly, such rising demand is driven by the world’s greater need for environmentally friendly fuels, the need for fuel diversity, greater integration of the world’s energy markets due to globalisation, and the advancement of technologies that enables the commercialisation of previously stranded energy fossil fuels such as natural gas. Emerging economies are particularly hungry for gas with China and India projected to rely on imports to meet their aggregate demand totalling more than 40% of natural gas consumption in 2030.

Worldwide demand for natural gas continues to grow at an astonishing pace of 2.4% per annum and by 2030, it is expected to account for 26% of the world’s energy consumption . In 2005, the global consumption of natural gas was estimated at 97 tcf , with projections for 2025 estimating the demand to exceed 156.2 tcf .

Figure 1 World marketed energy use by fuel type

The global trends described above bring to the CIS greater opportunities. The vast amount of energy reserves, particularly natural gas, within the CIS and the continuing government reforms and market liberalisations among CIS members are increasingly bringing to the CIS more challenges to commercialise its vast energy reserves.

CIS international trade and projects

Russia is the largest CIS producer and exporter of both oil and natural gas, and holds some of the world’s largest oil & gas reserves. It accounts for about 80% of the CIS's crude oil production and a similar share of regional net exports. Kazakhstan stands as the second CIS major oil producer and most of its exports go to non-CIS countries. Azerbaijan is also a net oil exporter, with its exports transiting Georgia and Russia to world markets.

The CIS already has several gas pipeline projects that have been completed or are planned. For example, in Armenia, the agreement for the construction of the Iran-Armenia gas pipeline envisions the construction of a 100 km pipeline in Iran and a 40 km pipeline in Armenia.

International gas trade between CIS member states and the rest of the world is also becoming more significant. Table 1 shows the trade movements between CIS member states and the rest of the world. CIS trade with China, in particular, is growing in prominence. For example, oil imports from Kazakhstan to China totalled 3 million metric tons in 2006, or 2.5-fold more than in 2005. Russia has been reported to be in discussions with China to build two 30-40 billion cu m/year gas pipelines from Western Siberia to China that could be commissioned from 2011.

Challenges faced by the CIS

Despite the progress being made and the attractive opportunities, the CIS still faces many challenges to commercialise its vast energy reserves. Much of the natural gas reserves in the CIS is considered “stranded” because it is located far from consuming markets which makes conventional delivery (e.g. via pipelines) uneconomical . With the predicted increase in natural gas demand, access to stranded reserves is critical, highlighting the importance of supply chains that allow the efficient and economic transportation of natural gas to global markets. Technical obstacles appear to limit the chances that the Iran-Armenia pipeline could immediately benefit Georgia. The pipeline's current capacity stands at only about 300-400 million cubic meters of gas (according to the Russian news agency “Regnum”). Its diameter of 770 millimetres - half the original proposed size - is not seen as sufficient for exporting gas to Georgia or other markets. On another note, the Caspian pipeline to be laid from Kazakhstan to Azerbaijan has been reported to be unlikely since the status of the Caspian Sea has not been completely defined.

In addition, Turkmenistan and Uzbekistan are large producers and exporters of natural gas within the CIS but are unable to export to Central and Western Europe because of restrictions on their access to Russian transit pipelines. It has been reported that Turkmenistan has signed a contract with Russia and China to sell all of its gas. Transit routes, going through Belarus, Georgia, Azerbaijan, and Ukraine set discriminatory tariffs on transit access that favour domestic suppliers. The transit of gas through Ukraine has been particularly widely reported, with Gazprom concluding an agreement in 2000 with a Western consortium to study the feasibility of constructing a gas pipeline bypassing the country. Similar difficulties have led Transneft to complete an oil pipeline to bypass a section of the pipeline running through southeastern Ukraine to Rostov-on-Don.

There are also political and economic challenges. Market reforms have been slow and artificially low domestic prices have encouraged the inefficient use of energy by households and industries. By international standards, energy-use intensity levels in the CIS remain extremely high, not only in the region's net energy exporters but also in energy-importing countries, such as Belarus and Ukraine. Investor confidence, though growing, has been hampered by lack of a robust legal environment. The natural gas sector in Russia is virtually a monopoly, with Gazprom controlling 90% of production and 80% of reserves.
In addition to all these challenges, the CIS also needs to meet more stringent emissions requirements in the future that will require capital and influence investment, and the increase in production costs could affect the competitiveness of the CIS oil and gas industries.

Solutions and CIS Response

One of the actions arising in response to the CIS energy challenges is building better regional cooperation. With more open, market-based access to pipelines, many of the CIS’ energy-rich countries could increase their exports outside the region significantly. However, such actions are seen with alarm by non-CIS countries about the possibility of an OPEC-style CIS gas cartel. In particular, the Iran-Armenia gas pipeline has emerged as a source of speculation about regional energy alliances. The 140-kilometre-long pipeline is projected to supply Armenia with up to 1.1 billion cubic meters (bcm) of gas per year until 2019, when that supply target is expected to rise to 2.3 bcm annually.

The internal dynamics of the CIS are also changing. As the CIS seeks to reduce its dependence on assistance from Western countries, many CIS states are simultaneously looking to be less dependent on Russia for their energy supplies. Armenia, for example, has secured fixed gas import prices through to 2009 at one of the lowest rates in the CIS, in exchange for allowing Gazprom to control a new gas pipeline being built between Iran and Armenia. Azerbaijan, on the other hand, has announced that it could join the Nabucco gas pipeline project after 2012, which is supported by the EU as a way of diversifying energy supplies and opposed by Russia. The venture, which brings together Austria’s OMV, Hungary’s MOL, Turkey’s Botas, Bulgaria’s Bulgargaz and Romania’s Transgaz, envisages beginning construction in 2008 of a 3,300km pipeline to supply Caspian gas to Europe, for completion in 2011. Kazakhstan is also reducing its energy dependence on Russia. The Caspian Pipeline Consortium has put Kazakhstan in a better bargaining position against Russia, as evidenced by a recent agreement with Russia securing Kazakhstan's long-term access to the Transneft pipeline and another agreement with Gazprom establishing a joint venture for gas exports.

Conclusion

The CIS is at a crossroads in realising its potential and benefiting from its rising strategic importance in future energy supply. Rising levels of investment in the energy sector are encouraging asset upgrading and replacement. With further market reforms, attention to the legal and regulatory frameworks, and further private sector participation, further development can occur apace. Much depends on the dynamics occurring within the CIS member states, with more cooperation essential to delivering the strategic objectives of the region. As such initiatives occur, the CIS can successfully commercialise its energy industry and play an increasingly important role on the world stage.

About the Authors

Azfar Shaukat is Director of Oil & Gas Consulting at Mott MacDonald, one of the world’s largest multi-disciplinary technical consulting and specialist advisory firms, with over 10,000 staff active in more than 140 countries (see www.mottmac.com). Mott MacDonald serves corporations, governments, regulators, and project developers in the Oil & Gas, Power, Transportation, Water and Environment and Buildings and Infrastructure sectors. Annual revenues exceed $1.2 billion.

Conrad Uy is a Consultant in the Oil & Gas Consulting Group at Mott MacDonald.

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