CBS Weekly Review: The war’s implications for Caspian gas; plus what’s next for Georgia

The war in Georgia has changed the international political and economic environment for all of the states along Russia’s periphery. In this week’s note I focus on in one particular aspect of the regional economy, the natural gas business, and in particular future transportation routes, while also looking at what might lie ahead for Georgia itself.

First a quick word about Ukraine, which along with Georgia has been seeking membership in NATO, and which (apart from the belligerents themselves) is far and away the country most directly affected by the fallout from the conflict. Indeed the Ukrainian markets have already been hit by a vague perception that Russia may next turn its attentions toward Ukraine. This is a matter which deserves more extensive consideration, and we will address it in the weeks ahead. For now suffice it to say that problems in Russian-Ukrainian relations do indeed represent a threat to Ukrainian stability – but probably later rather than sooner. Whatever goals it has in mind, Russia will be playing a much longer game in Ukraine. In the near term the main risks for portfolio investors in Ukraine are more likely to be generated by the country’s own internal problems, both political and economic.

Azeri and Central Asian gas: Downgrading the Georgian corridor

One of the many casualties of the war in Georgia has been the perception of the Azerbaijan-Georgia-Turkey corridor as an secure and "Western" (in the geopolitical as well as geographic sense) export route for Caspian oil and gas.

This is not to say that the war had any direct impact on existing oil and gas export infrastructure, apart from the destruction of one rail bridge in Georgia that has temporarily disrupted rail exports of oil and oil products. The Baku-Tbilisi-Ceyhan oil pipeline (BTC) – which by coincidence had been shut down just before the war began by an explosion in Turkey – was not affected by the conflict in Georgia (Georgian allegations that Russian bombers had targeted the pipeline remain unverified). The two other pipelines transiting Georgia, including the SCP gas pipeline which brings Azeri gas to Turkey, were similarly unaffected except for a brief precautionary shutdown by their operator BP.

But as far as new pipelines or significant pipeline expansions are concerned, the entire logic of the Georgian transit corridor has evaporated. This logic was based first of all on the fact that this corridor represented a valuable diversification away from Russian transport routes – something which has been seen as critically important for Azerbaijan and the foreign oil companies operating there; and useful even for a country such as Kazakhstan, which has maintained a consistently comfortable relationship with Russia.

This justification is not completely gone, but it is now significantly weakened. Pipeline routes through Georgia will now be seen as the least secure exit option from the region by both shippers and financiers, and whatever happens on the ground it will take many years to overcome that perception. Furthermore, it is now clear to the Caspian hydrocarbon states as well as the foreign oil and gas majors that the security of any hydrocarbon exports from the region depends largely on Russia, and using pipelines that transit Georgia will not change this.

In practical terms the impact of the war in Georgia on regional gas export will be particularly significant.

Nabucco: Not quite dead, but in a coma

This project, intended to bring 30 billion cubic meters [Bcm] of Caspian and/or Middle Eastern gas through Turkey into the heart of Europe, was troubled before August 7; today it is very close to dead. Iran and Iraq have been mooted as possible sources of gas supply for the project, and even if these options do not seem to be very promising at the moment, they are certainly enough to stop the project sponsors from disbanding the project company. But the core idea behind Nabucco was always to fill the pipeline with Azeri gas to be supplemented by Turkmen and perhaps Kazakh gas which would flow through a trans-Caspian gas pipeline. This Caspian portion of the project, which would require transit through Georgia , is effectively dead for the time being, although there will be politically driven efforts to pretend that this is not the case.

There is enough expansion capacity in the existing SCP gas pipeline for substantial additional volumes of Azeri gas (perhaps another 12 Bcm) to be delivered to Turkey, and potentially beyond, as future Azeri gas comes on line; but these volumes would fall far short of what would be needed to fill Nabucco. And it is hard to imagine the Central Asian countries continuing even to pay lip service to the trans-Caspian pipeline concept.

Azeri gas to Russia? Maybe

In early June 2008, Gazprom president Aleksei Miller visited Baku proposing the kickoff of talks on long-term supply of Azeri gas to Gazprom, and this same proposal headlined the visit of President Medvedev to Azerbaijan a month later. The economics of such an arrangement always looked promising from both sides. Russia’s recent negotiations over 2009 gas prices with Turkmenistan and the other Central Asian gas producers have demonstrated that Gazprom’s critical need for supplementary supply from its southern neighbours has made it willing to pay "market-based" prices for their gas. It is not yet exactly clear what this means, but it very least it suggests that Gazprom under present circumstances would be willing and able to outbid potential European consumers for Azeri gas.

The problem with Russia’s gas proposal from the Azeri point of view was not economic as much as strategic. Even if Azerbaijan received higher prices for its gas from Russia in the medium term, turning away from a long-term direct gas link with Europe via the Georgia-Turkey corridor could result in a long-term dependency on Russia that would seem risky to the Azeri government, and even more so to its partners (BP and Statoil largest among them) in developing the massive Shah Deniz gas field. If market circumstances changed, the balance of leverage could shift back to Gazprom’s favour and leave Azerbaijan in a poor bargaining position.

Before August 7, politics was also a significant barrier to Azeri acceptance of the Russian proposal. Although Azerbaijan never went remotely as far as Georgia in terms of its alignment with the United States – and it has almost completely avoided antagonizing Russia in recent years – it has build a strong energy partnership with the US based on its commitment to oil and gas supplies through the Georgia-Turkey corridor. Azerbaijan’s energy relationship with the EU, which has also gained strength in recent years, is also based mainly on the idea of future Azeri gas supply through Nabucco. If Azerbaijan were to "change sides" in the regional gas game, it would damage its relationship with the US and the EU, and perhaps leave it more vulnerable to Russia.

But with its Georgian infrastructure link to Europe now badly compromised, Azerbaijan can now see that it is already highly vulnerable to Russia. This realisation has dealt a serious fright to the Azeri political leadership. Public opinion in Azerbaijan has sided strongly with Georgia, a country which Azeris have tended to see not only as a friend and partner but also as a fellow sufferer at the hands of territorial separatists. One pro-government (but independent) Azeri website was brought down by hackers at the start of the conflict along with many Georgian sites, presumably due to the strongly pro-Georgian tone of its coverage. However, the Azeri government has said almost nothing about the conflict, limiting its public comments to bland statements of support for Georgia’s territorial integrity (which are more about Azerbaijan’s own breakaway region of Nagorno-Karabakh than about Georgia).

It is obviously tricky to predict how the political, economic, and gas strategy aspects of the situation will evolve, and Azerbaijan does not make decisions about gas export on its own: it must find consensus with its partners in the Shah Deniz project. But current indications suggest that Azerbaijan is likely to shift from a policy of resisting energy linkages to Russia to a policy that takes Russian interests and desires more seriously into account. In the case of gas would mean sitting down with Gazprom to discuss long-term gas supply in a serious way.

Georgia: More trouble ahead

Although Russia has begun withdrawing troops from Georgia, it has made plain that this will not be a full withdrawal. Russian troops will not only remain in Abkhazia and South Ossetia but also maintain positions inside Georgia proper. For the time being it appears that Russia will keep control not only of a checkpoint on Georgia’s only main east-west highway near Gori, but also the only main road into the Black Sea port of Poti.

This continued Russian military presence along Georgia’s main roads will keep the country in a state of insecurity for as long as it lasts. But however long this is, this condition will not be permanent: at some point Russia – which has already achieved most of its objectives in Georgia – will see no further purpose in continuing its partial occupation in the face of European and American pressure.

When Russian troops do make their final exit from undisputed Georgian territory, the situation in Georgia will begin to normalise – although this word hardly seems appropriate given the fundamental changes that have already been engendered by the Ossetian disaster. International attention will turn to the status of Abkhazia and South Ossetia; the provision of humanitarian and financial assistance to Georgia; and the tough decisions that will have to be made in Europe and the US about future security cooperation with Georgia.

For the Georgian economy and capital markets, more important than all of this will be developments in Georgian domestic politics as Georgians try to recover from the trauma of military defeat and occupation and refocus on their own internal affairs. The prospects here for stability and constructive dialogue are, to put it mildly, not very promising. The possibility exists for severe instability in Georgia – of the purely domestic variety – in the wake of this short and disastrous war.

Recriminations ahead

At the moment Georgians are still focused on the immediate crisis, and support for President Mikheil Saakashvili remains at a reasonably high level, in part thanks to the stated desire of the Russian leadership to see him removed from office. Russia’s antagonism is at the moment the president’s most important political asset. If Russia continues to attack Saakashvili and call for his removal on a daily basis, his domestic position could remain strong.

The more likely prospect is that Saakashvili will face severe criticism and recriminations at home once the situation in Georgia has sufficiently normalised. Thus far Saakashvili’s political opponents have taken a cautious approach and emphasised national unity, but there have also been criticisms, and open anger against the president is being reported in the foreign press (although not inside Georgia). The concept of a short, quick military campaign to retake South Ossetia seemed attractive to many Georgians before 7 August, but results are what counts – and the end result of Saakashvili’s actions has been a national catastrophe, not least because Abkhazia and South Ossetia now seem to be lost forever.

During last year’s political confrontation, the opposition’s main source of weakness was its lack of a credible leader. Many of the votes that re-elected Saakashvili to the presidency in January 2008 were made by Georgians who were not particularly happy with their president but who could simply not imagine any of his challengers running the country. This situation may now have changed with the apparent decision by former parliamentary speaker Nino Burjanadze to return to active politics. Burjanadze, the last parliamentary speaker under Shevardnadze who had supported the Rose Revolution and served briefly as Georgia’s acting president in its wake, was marginalised (along with the legislative branch more generally) from the start of Saakashvili’s presidency. Upon leaving parliament earlier this year, she announced that she was leaving politics, which fooled no one; in recent days she has spoken of the need for serious questions to be asked about the government’s responsibility for recent events, adding, "I’m afraid it will not be very easy for the government to answer all the questions."

However there are no national elections scheduled until Saakashvili’s present term ends in January 2013. This means that the only route available for political action will be mass public demonstrations along the lines of those that preceded the 2003 Rose Revolution, or the large rallies calling for Saakashvili’s removal in October-November 2007. Until recently Saakashvili’s administration had been making significant progress in restoring its popularity after late year’s troubles, but all of that is now irrelevant. It remains to be seen how strong and how aggressive the next wave of anti-Saakashvili demonstrations will be, but that these demonstrations will take place, sooner or later, is all but guaranteed (assuming Russia does not keep up the pressure on both Georgia and its president).

And this is where the trouble lies. Having come to power himself on the strength of a popular uprising, Saakashvili understands the dynamics of mass action – and he fears it as a result. The most likely reaction to another round of mass protests will be another violent crackdown similar to what took place last November. If Saakashvili can make a case – if only to himself – that the opposition is being financed or coordinated by Moscow, then he will be even more aggressive, and this allegation might even provide a justification to delay lifting the current state of martial law. Anyone hoping that the United States might be able to push Saakashvili to show restraint and take a conciliatory approach toward his opponents need only look at the recent American record in restraining him.

I don’t need to go any further in sketching out scenarios to make the point that Georgia faces a very difficult period ahead, one in which war and Russian occupation are likely to give way to domestic political instability. The presence of Burjanadze in the opposition will provide some reassurance; she is a credible leader who is well regarded in the US and Europe and who would not be anathema for Moscow. But the fact remains that Saakashvili will be in office until January 2013 unless he leaves voluntarily, is impeached by a parliament dominated by members of his own political party or is removed by force. None of these scenarios seems very likely; but neither does an alternative scenario in which Saakashvili maintains his popularity and presides over a stable and calm Georgia.

Best regards,
Laurent Ruseckas
Director, Eurasia Research
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