President Recep Tayyip Erdogan greeting Azeri President Ilham Aliyev on Jan. 15, in the presence of 16 soldiers dressed in ceremonial costumes representing various Turkic people in history. (Official website of the President of Turkey)

President Recep Tayyip Erdogan greeting Azeri President Ilham Aliyev on January 15, 2016, in the presence of 16 soldiers dressed in ceremonial costumes representing various Turkic people in history. (Official website of the President of Turkey)

With Erdogan’s democratic countercoup enforcing temporary order and the recent rapprochement with Russia and Israel, Turkey’s expected next step is to focus on its long-standing aspiration: to become a regional energy hub in the Eastern Mediterranean (East-Med). The US-Turkey negotiations for the conditional use of Incirlik Airbase by NATO forces, ongoing since 2003, and the recent EU-Turkey deal on migration have both reaffirmed that Erdogan’s Turkey would not miss an opportunity to extract political rents from the West and monetize its geographic monopoly with morally ambiguous political demands. Erdogan’s interpretation of a Turkish energy hub, coupled with Western inertia, has even allowed Islamic State to “enjoy Turkish money for oil for a very, very long period of time.”[1] But is a Turkish energy hub a realistic target that would help the West diversify its energy imports, or is it just another Trojan horse amplifying Western dependency on countries that use energy as a weapon?

Misconceptions and reality

During a period of great political asymmetry between Brussels and certain EU Member States, Europe’s heavy reliance on cheap and politically leveraged Russian gas provides the ground for Turkey to convert this Russian monopoly into a Turk-Russian duopoly. The new gas finds in the East-Med have initiated an intensive discussion on emerging regional gas hubs and Turkey has been proclaiming for years its readiness to take on such a role. Little do the prognosticators and their political cheerleaders though know, an energy hub and a transit country are two different things.

On January 28th, EU Energy Commissioner Cañete gave further political legitimacy to Turkey’s unbounded energy optimism during the Turkey-EU High Level Energy Dialogue meeting.[2] He defined Turkey as the perfect location for a potential energy hub, citing the country’s convenient geographic position for both liquefied natural gas (LNG) and regional gas pipelines.[3] However, as LNG cargo can be shipped easily to any country in the region — especially to those few with the necessary infrastructure in place — what remains to be seen is whether Turkey satisfies the primary conditions to operate as an energy hub.

Domestic ills:

First, a gas hub is a trading platform for either physical or financial transactions (or both) that facilitates gas-trading activities. It requires a liberalized and a deregulated market where suppliers are free to import or produce energy and customers are free to choose their preferred supplier. What’s essential for an energy hub to emerge is gas-on-gas competition.

Turkey, however, has a poorly regulated energy sector with its vertically integrated state-owned Petroleum Pipeline Corporation (BOTAŞ) — for many an Ottoman version of Gazprom — dominating the entire natural gas sector. According to the US Energy Information Administration, BOTAŞ accounts for approximately 80% of natural gas imports. It builds and operates pipelines, and controls most of the wholesale market and exports of natural gas.

Turkey’s lethargic liberalization agenda leaves no room for competition, which seriously hinders Turkish aspirations. The Natural Gas Market Law (NGML) 4646 enacted in 2001 required that BOTAŞ be legally unbundled and broken up into separate legal entities for natural gas transport, LNG terminals and storage facilities, trading and marketing. Despite the establishment of the supposedly independent Energy Market Regulatory Authority (EMRA), numerous drafts and laws dictating the unbundling of BOTAŞ, little has changed: Turkish policymakers neglected to set binding timelines for implementation, and to stop granting politicized extensions. Therefore, without an essential market liberalization policy, with protectionism in the form of entity-specific state-sponsored subsidies and institutional resistance to a cost-based pricing system, how can competitive markets be fostered and single hub pricing emerge?

The Russian/Gazprom dimension

BOTAŞ was required by the NGML to gradually transfer import contracts until its market share decreased to 20% of annual consumption. Yet as of 2015, the figure was immovably stuck at 80%. What BOTAŞ essentially did was transfer import contracts of Russian gas to seven companies in two waves.

Figure 1: Ownership of Companies Importing Natural Gas into Turkey[4]  

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      Initial transfer of 4bcma (first wave)

 

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Additional transfer of 6bcma via the Bulgarian border (second wave) 

Inner circle (in both figures above): Companies received import contracts of Russian Gas from BOTAS.

Outer cycle (in both figures above):  Company ownership — in black: Russian companies with or potential controlling interest.

* * *

Upon closer inspection, Russia’s state-owned Gazprom controls both Bosphorus Gaz (which retains roughly 5% of Turkish consumption) and Avrasya Gaz, while it filed an application with Turkey’s antimonopoly regulator to buy a controlling interest in Akfel Gaz  (which holds another 4.5% of Turkish gas consumption). The seven companies (Figure-1) were in January’s headlines following the Turko-Russian dispute, resulting from the downed Russian aircraft near the Syrian-Turkish border. In line with the resulting Russian economic sanctions, Gazprom notified the companies that they were no longer eligible to utilize the 10.25% discount in effect since January 1, 2015. When Turkish companies refused to pay the entire bill, Gazprom reduced gas supplies by 10%. For the record, that same discount was also promised to BOTAŞ, but Gazprom had been delaying implementation, insisting that Turkey first approve the proposed TurkStream project. This development compromised BOTAŞ’ effort to reduce the gas price Energy Minister Albayrak had announced. In summation, while BOTAŞ’ market share has barely moved over the course of fifteen years, the symbiotic relationship between Gazprom and BOTAŞ — along with its “remoras” — has grown into a parasitic one because of Turkey’s cronyism and its self-serving interpretation of liberalization.

Neottoman extractionism and Erdog-Anomics

Daron Acemoglu, the Turkish-born leading MIT economist and author of “Why Nations Fail” puts it this way: “the Turkish Republic … is very continuous with the Ottoman Empire.” He cites a persistent concentration of power in a small group, and the extractive political institutions that left the Turkish nation ill-equipped for economic and social growth.[5] The extractive nature of the state was built on monopolizing political power and on suppressing any form of contest for such power. In the absence of systematic institutionalization, these two factors create an enormous vacuum where checks and balances should be.

The striking economic growth that Turkey underwent in the early 2000s was the result of reforms mandated by the World Bank following Turkey’s 2001 economic crisis. With the weakening or reversal of many of these reforms, the pace of economic growth has slowed. Unlike the huge credit expansion, the spike of manufacturing production was not sustained because of the lack of investment due to cronyism. Economic institutions are embedded in political institutions, the infrastructure investments are under the monopoly of the right connections (e.g. Anatolian-tigers), and the judicial system is now completely politicized leaving no space for independent adjudication.[6].

Under Erdog-Anomics, the systematic politicization of the business sector hinders both innovation and the reallocation of resources from less to more efficient firms, thus not allowing new blood into the economy that would generate growth. “Gradually, the de jure and de facto control of the ruling cadre intensified, amplifying corruption and arbitrary, unpredictable decision-making.”[7] As a result, and regardless of the incentive package expected to be introduced soon,[8] foreigners no longer feel secure investing in Turkey long-term and consequently the extractive Turkish economy seems to be running out of steam.

Therefore, it remains highly doubtful whether Turkey has ever been committed to establishing a well-functioning legal and regulatory framework that could eliminate or at least contain the lack of transparency in the Turkish domestic market. Only such vital market reform can create the necessary deepening of its natural gas markets.

Existing contracts prolong status quo

Despite Washington’s preoccupation with liberating Brussels from Gazprom’s monopoly, Turkey is Russia’s second largest natural gas importer after Germany, while Russia remains Turkey’s largest gas supplier with sales worth around $6.5 billion annually. This formidable economic interdependency is not as fragile as initially thought. The relationship is built upon long-term gas contracts controlled via international regulations with heavy indemnity obligations for breach of contract without legal justification. Due to sizable upfront sunk costs associated with these capital-intensive investments, long-term contracts are signed for 20-25 years including a “take-or-pay” clause that hedges risk for the seller. Therefore, as Turkey cannot stop its gas purchases from Russia without paying the take-or-pay fee, Russia cannot cut gas to Turkey. Hence both countries — unfortunately for all the aspiring LNG suitors — will have to live with this unpleasant marriage. This explains why Erdogan is currently seeking normalization of ties with Putin.

Limits of Liquefied Natural Gas (LNG)

As for proponents who view LNG as a liberator for gas dependent countries, Turkey was until recently importing 4.4 billion cubic meters (bcm) from Algeria, 1.2bcm from Nigeria and buying a handful of additional LNG cargoes from spot markets.

Figure 2: Turkey’s natural gas supply by source, 2013

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The main reason that LNG never constituted a substantial part of Turkish gas imports is because its price is not competitive compared with piped Russian gas. According to the IEA,[11] Turkey’s annual LNG regasification and LNG storage capacity are substantially limited.  This underinvestment is mainly attributed to subsidies and to weak market competition, related to the entrenched regulatory advantages that BOTAŞ has accumulated over the years.

Could additional LNG imports be a catalyst for the liberalization of the Turkish market? After the downed Russian aircraft incident, a global chorus of strong voices was urging Turkey to exploit this opportunity and replace its imported Russian gas with LNG. In an ironic development on December 16th 2015, Turkey’s EMRA unjustifiably revoked the licenses of 13 companies issued for various activities, including LNG importing.[12] Two weeks prior to this event, BOTAŞ and the Qatari national petrol company urgently drafted a memorandum of understanding for a long-term LNG contract with an initial supply of 1.2bcma. According to Erdogan “Qatar Petroleum has had a bid to invest in LNG in Turkey for a long time… Both the private and public sector have LNG storage facilities. This one will be an investment between governments.”[13] BOTAŞ therefore remains the commercial arm of neo-Ottoman extractionism in the entire energy space.

Figure 3: Imports of Liquefied Natural Gas in Turkey, 2015

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No need for another Ukraine

What’s raising serious concerns today is the deep disconnect between political rhetoric and policy reality. At a moment where Turkey’s energy sector contrasts starkly to the European Gas Target Model (GTM) vision of liberalized EU Gas market, the EU Energy Commissioner observed “major developments to have taken place in the country since 2007,” concluding that “the point that Turkey has reached is very conducive with the opening of the energy chapter of Turkey’s EU accession process.”[14] But without the precondition of a liberalized market in place, how can a hub “boost competition and efficiency” when Turkey faces so many regulatory discrepancies and demonstrates no political will to do otherwise? Thus, the perception that an energy hub should be viewed as a simple real estate case based on the projected increase of domestic natural gas demand and a number of dubious projected pipelines are at the very least worrisome. Would the accomplishment of any of these projects justify Turkey’s role at a minimum as a transit country or will most of them be cancelled and follow Nabucco pipeline’s destiny, in full accordance with the Babylonian king’s lyrical remorse?

The evolution of Turkey’s doctrine of “zero problems with neighbors” into “zero neighbors without problems” remains gloomy, despite Davutoglu’s resignation and the recent rapprochement with Israel and Russia. Under these circumstances, the creation of a Turkish “Transit Gas Hub[15]” entails significant risks for both sellers and buyers that should be included in the cost calculus. Foremost, the recent pipeline attacks that led to costly interruptions in oil and gas supply are raising security costs for protecting such massively concentrated infrastructure. Second, the cost of peace between Kurds and Turks after the events in Syria is evolving into a “Lernaean Hydra” for the Turkish army Finally, the cost of political uncertainty under Erdogan’s administration is constantly rising, and can rise even further since he would never hesitate to extract heavy concessions from the West by using energy as a weapon.

The much-needed gas from the East (Near and/or Middle) will eventually reach its final European destination via alternative and less risky ways. As with Nordstream-1 and 2, the costs to contain these risks may be far greater for investors than the construction premium needed to avoid the trap of turning Turkey into another Ukraine. The Herculean task for the EU, though, is to first justify and then deal with the monopolistic character of neo-Ottoman extractionism. Primarily, it must deal with the lack of competition and transparency in the Turkish domestic market, and the breaking up of BOTAŞ’ monopoly. Would additional EU support and the opening of the Energy Chapter help? With Erdogan’s government at the helm, this remains doubtful.

[1] “Israeli defense minister accuses Turkey of buying IS oil”, BBC, 26 January 2016, Available here [Accessed: April 16 2016]

[2]  Joint Press Statement: ‘Turkey – EU High Level Energy Dialogue’ Meeting, January 28 2016, European Commission Official Website, Announcements. [Accessed: February 4, 2016]

[3] “Turkey seen as natural hub for Mediterranean gas,” Daily Sabah with Anadolu agency, January 31 2016.

[4] Gulmira Rzayeva, Natural Gas in the Turkish Domestic Energy Market: Policies and Challenges, Oxford Institute for Energy Studies,   (2014) Data retrieved from Table 8, page 32.

[5]  John Laidler, “Understanding Turkey,” Harvard Gazette, April 28, 2015. [Accessed: March 25 2016]

[6]  Daron Acemoglu lecture on “Turkey: Growing Pains Under the Long Shadow of History,” Minda de Gunzburg Center for European Studies at Harvard, Inauguration of the Özyeğin Forum on Modern Turkey, Apr 27, 2015.

[8]  Daron Acemoglu, Murat Üçer, “Why Turkish growth ended: An institutional perspective,” CERP’s Policy Portal, 18 November 2015. [Accessed: March 3, 2016]

[9] Mehmet Cetingulec , “Foreign investment in Turkey is rising, but not the type it needs,” Turkey Pulse, Al Monitor, December 4, 2015. [Accessed: June 3, 2016]

[10]  Oil and Gas Security, Emergency Response from IEA countries (2013), OECD/ International Energy Agency. [Accessed: February 28, 2016]

[11] Maksim Tsurkov, SOCAR’s LNG import license revoked by Turkey, Trend News Agency,  December 16 2015.

[12] Olgu Okumus, “Will Turkey be able to replace Russian gas with Qatari imports?Turkey Pulse, Al Monitor, December 4, 2015. [Accessed: March 15, 2016]

[13]Turkey seen as natural hub for Mediterranean gas,” Daily Sabah with Anadolu agency, January 31 2016, Available from:

[14]  Patrick Heather, “Continental European Gas Hubs: Are they fit for purpose?The Oxford Institute for Energy Studies, NG 63, page 5: Transit Gas Hub are those hubs that are actual transit locations, or physical points, at which market participants can choose to trade gas; however, their primary role is to facilitate the transit of large quantities of gas for onward transportation. [Accessed: March 5, 2016]