Turkey Facing Large Gas Import Penalties As Political And Economic Crisis Deepens

VOL. XLV

No 28

15-July-2002

TURKEY

Turkey Facing Large Gas Import Penalties As Political And Economic Crisis Deepens

Political infighting and a string of ministerial resignations over the past week have turned international attention towards the prospect of new elections in Turkey, obscuring for the time being the economic chaos that has dominated Turkish public life since the banking sector collapse of 2000, writes MEES Mediterranean Editor Bill Farren-Price. However the country’s economic crisis is so profound that priorities such as the mounting public debt load, the future of the IMF support program and looming take-or-pay penalties for larger-than-required contracted gas imports are likely to reassert themselves once the dust settles. According to David Tonge of Istanbul-based IBS Research and Consultancy, the ongoing economic crisis has cut the domestic requirement for gas to such an extent that the country could find itself paying annual penalties equivalent to $0.7-1.0bn due to take-or-pay provisions in term gas supply contracts with Russia, Iran, Algeria and Nigeria. Mr Tonge’s estimates for Turkish gas demand are sharply lower than state pipeline operator Botas’ forecast of 55 BCM in 2010 and 83 BCM in 2020. IBS forecasts gas demand of 45.5 BCM in 2010 and 74.8 BCM in 2020 – 17% and 10% lower respectively than the Botas estimates.

Speaking at the CWC Associates conference Oil, Power and Gas: Near East Perspectives in Geneva on 8 July, Mr Tonge said that the earthquake of 1999 and the subsequent economic/financial crisis of 2000-01 had cost Turkey four-to-five years of economic growth, undermining energy and specifically gas demand projections. Moreover, the gas surplus situation could be exacerbated by the bureaucratic delays for credit approvals necessary for progress on gas transmission tenders that were issued in 2000, which will lead to probable network delays and the slow process of unbundling Botas’ various roles in a new deregulated gas and power market.

In recent weeks Turkey contacted its gas suppliers and requested that they cut import volumes this year to match lower-than-expected domestic demand (MEES, 8 July. For details of Turkey’s gas supply demand balance to 2020, see MEES, 28 January). Despite sticking with its longer-term forecasts for gas demand, Botas cut its 2002 demand forecast to 20 BCM from 25 BCM, requiring an average 20% cut in supply contracts for the year. Turkey’s over-supply situation in gas terms is about to be exacerbated by the planned inauguration in October of the Blue Stream pipeline, which will supply Turkey with some 16 BCM of Russian gas when used at capacity (MEES, 10 June). Meanwhile, it is widely recognized that with an annual investment requirement for power generation, transmission and distribution of $4-5bn that the state is incapable of fulfilling, the private sector will have to fill the gap. The prospects for that level of private participation have been dented by ongoing disputes between contractors and the state over build, operate, transfer (BOT) schemes that have damaged Turkey’s image as a destination for foreign direct investment in this sector however, Mr Tonge said.

Moreover, the gas release program that is due to start in 4Q 2002, whereby Botas will release its monopoly on gas supply to third parties, is likely to face constraints for several reasons on top of the projected surplus. Along with the unbundling of Botas, the gas release program is essential to the introduction of gas market competition in Turkey. According to Mr Tonge, new entrants to the gas market will not receive the state financial guarantees that have been afforded to Botas, which may mean that cross-border suppliers are less than willing to move Botas contracted supplies over to new, smaller buyers. This may mean that Botas has to continue to buy gas at the border, before selling down the supplies to the new entrants, which will limit the effectiveness of the whole gas release program. Additionally, Mr Tonge points out that problems relating to the need to split large gas supply contracts and the associated renegotiations over terms and the need to reassign take-or-pay obligations in an oversupply situation will also slow the entry of new players.

According to Mr Tonge, while Turkey can work to lift demand by improving economic growth, building new gas-fired power plants and finding new uses for gas, re-exporting gas to customers to the west of Turkey is the most attractive short-term solution to the imported gas surplus. However there are several important constraints to transiting the gas surplus to third-party buyers.

· First, Turkey as a gas transit route will have to establish a transit regime and legal framework that will allow for intergovernmental agreements between the gas supplier and the end-user country. Issues such as security of supply, domestic supply, tie-ins for local production, as well as rights of way, regional/federal permissions and tariffs will have to be agreed. Existing legislation on transit (Law 4586 of 29 June 2000 – Transit Passage of Petroleum by Pipelines Law) can be interpreted to apply only to pipelines whose sole function is transit – clearly problematic since that will not apply to most of the country’s gas pipeline infrastructure.

· Second, markets for transited gas are constrained in the short-medium term, both in terms of demand and in terms of transport infrastructure. While Greece has developed its ties with Iran and appears to be interested in importing gas via Turkey, there are major questions over volumes and prices. Greece consumed 2 BCM in 2001, below the contracted supply forcing Athens to negotiate a decrease in its take-or-pay obligations. As Greek demand is expected to rise to 6 BCM in 2010, Russia is also bidding to increase supply direct to the country. Italy meanwhile represents a much larger market for gas, with consumption of some 70 BCM in 2001, but there is no sub-sea pipeline between Greece and Italy and Italgas has indicated that it is not interested in financing the construction of such a pipeline. Turkey recently signed a pact with Austria, Romania and Hungary to study options for transiting gas from Turkey through the Balkans to western Europe.

· Third, assuming transit prices of $15-20 for every 1,000 cu ms per 1,000km of transit, negotiating commercial terms between suppliers and end-users will likely be a serious challenge. Also, destination clauses, which exist in Russian term contracts as well as the issue of who will market transit gas (Iran has indicated that it would prefer to market its own gas directly), may also be impediments to gas transit, in the absence of gas pooling arrangements.

Political Upheaval Leaves Prospects For Economic Recovery Uncertain

While this week’s political upheaval has led to volatility in Turkish capital markets, the long-term implication of political instability on the economy is less clear. The 11 June resignation of Economy Minister Kemal Dervis – and his subsequent return to the government on the same day – indicates that the government may not be as close to collapse as some observers have suggested. Mr Dervis is a former World Bank official who is widely credited as the architect of the $16bn IMF support program. If, however, the government does fall and new elections are called, the possible emergence of a new party formed from disgruntled deputies and ministers from ailing Prime Minister Bulent Eceivit’s Democratic Left Party, could adopt a more strident package of economic liberalization measures.

Some observers believe a new party, led by the recently resigned Foreign Minister Ismail Cem, former influential Ecevit aide Husamettin Ozkan and possibly Mr Dervis at a later date, could find favor with the electorate and bring new momentum to economic reforms aimed at drawing Turkey closer to the EU. Certainly, the continuation of the IMF program will be a key element in any attempt to drive economic reforms forwards. The IMF program requires Ankara to carry out reforms of the banking, energy and agriculture sectors. Turkey’s public debt surged in 2000 and 2001 as a result of a banking crisis which required the government to issue debt in order to bail out the banking sector. At the end of June, domestic debt stood at $76.4bn, while latest figures show foreign debt at $117.5bn.