The Gazprom Deal and Georgian Energy Security. What Should Georgia do Next?

The ISET Economist, a blog about economics in Georgia and the South Caucasus by the International School of Economics at TSU (ISET) 

By Levan Pavlenishvili and Norberto Pignatti

Every winter, one of the most actively discussed issues of energy policy - both on TV and in professional circles - is natural gas. Prices and supply conditions are frequently part of the political debate. The main reason behind such active discussion is energy security concerns. What is energy security? The International Energy Agency defines energy security as “the uninterrupted availability of energy sources at an affordable price.” Obviously, all countries around the world care about energy security, because interruptions in the availability of energy sources, or sudden increases in energy prices, can have dramatic economic and social consequences. But why is the security of the natural gas supply the most pressing energy security issue in Georgia?

There are several reasons. First, Georgia’s consumption of natural gas in total energy used has been rapidly increasing in the last couple of years, from 28% in 2013, to 33% in 2015. Second, Georgia imports 99% of the natural gas it consumes. Third, the country has only two sources of import: Azerbaijan and Russia. Finally, gas plays a vital role in electricity generation in winter.

Georgian customers experienced the importance of energy security during the 2006 energy crisis, when the sabotage of gas pipelines, and of the electricity transmission network in the North Caucasus, caused a countrywide blackout and left many Georgians without sources of heating during the snowy winter. After this incident, Georgia gradually switched to importing most of its natural gas from Azerbaijan. However, Russian imports are still in the picture, primarily because Georgia gets in-kind – volume based – transit payments amounting to 10% of total gas supplied to Armenia (in 2015, this covered 11% of Georgia’s total gas consumption). In addition, in the recent past, Georgia has been importing a small share of its natural gas imports (6% in 2015) from Russia (at the cost of USD $215 per 1000 cubic meters) to balance its peak demand in winter.

The deal

Over the last two years, the Russian Energy giant Gazprom has been requesting permission to monetize the payment of the transit fee, moving away from the existing in-kind payments. Early this year a final agreement between Georgia and Gazprom was reached, but the details are largely unknown, the lack of transparency about the deal being justified on the basis of “commercial confidentiality”. However, a few aspects have become known to the public. According to the Deputy Minister of Energy, the outcome of the negotiation is a two-year contract. During the first year (2017), the transit fee will be paid half in-kind and half as a monetary payment. From 2018, the transit fee will be fully paid in monetary form. Based on official sources, the agreement will also enable Georgia to import natural gas from Russia, paying USD $185 per 1000 cubic meters instead of the previous price of USD $215. While this development may seem very positive, it is important to note that the price of natural gas on the European market has declined considerably in the last four years, with the European Union Natural Gas Import Price more than halved since January 2013, and now very close to the price agreed between Georgia and Gazprom.

In addition, although the monetary transit fee amount has not been made public, there is a widespread concern that the amount received as a compensation for transit services after 2018 will not be sufficient to purchase the same quantity of gas from Russia that would have been obtained with the earlier deal. On the other hand, to be fair, it is not clear that a better deal could have been achieved.

What are the implications for energy security and what do we do now?

One of the simplest measures suggested to increase energy security comes from finance: diversify the supply portfolio to mitigate possible risks. The Georgian strategy over the last decade has not exactly been based on diversification. Over this period, in fact, Georgia has chosen to count on the mutually beneficial partnership with Azerbaijan to ensure its energy security. Still, the relatively smaller quantity of gas received every year from Russia continued playing an important role. If the new deal with Russian Gazprom leads to less diversification (or to higher average costs of importing gas from Russia, once the switch from in-kind to monetary payment takes place), this will imply a deterioration of Georgian energy security.

At this stage, the hope is that the partnership with Azerbaijan will consolidate and guarantee that, even with very limited diversification, energy security will be ensured. On this front, there are reasons for optimism. One is the expected completion of the South Caucasus Pipeline Expansion (SCPX) project in 2018. The SCPX will be part of the Southern Gas Corridor supplying Caspian gas to Europe, and its completion will enable Georgia to receive additional supplies from the Shah Deniz 2 Field in Azerbaijan. As a transit country, Georgia will become part of the European energy security agenda. This is expected to contribute to the long-term energy security of Georgia.

The Georgian government, however, could do more to improve Georgian energy security.

First, it could invest in relevant infrastructure. To stabilize seasonal supply and safeguard itself from short-term supply disruptions, Georgia needs an underground gas storage facility. Such an infrastructure would help the country better handle threats such as the 2006 energy crisis. A gas storage facility could also provide commercial services, supplying the market with natural gas during the peak demand and reducing price volatility. A feasibility study for such a facility, capable of storing from 210 to 280 million cubic meters of natural gas (9-12% of Georgian total annual consumption) has recently been prepared. As soon as the project is complete, Georgia will become more secure, and its natural gas market will become more stable.

Georgia should also actively take part in negotiations between European partners and Turkmenistan to increase its role as a transit country and encourage the development of its natural gas sector.

Finally, greater emphasis should be placed on monitoring and analysis of the trends characterizing the internal demand for natural gas and natural gas imports. Numerical models such as the Global Gas Model (Holz, Richter, Egging, 2016), the EUGAS Model (Perner and Seeliger, 2004), the TIGER Model (Lochner and Bothe, 2007), and/or others, should be used to simulate patterns of consumption and imports to find possible flaws and weaknesses in the system that need to be addressed. This, in parallel with infrastructure building, will facilitate anticipating (and coping with) possible mismatches between demand and supply, and reduce the risks to energy security stemming from the lack of diversification in natural gas imports.

To conclude, the Gazprom deal is likely to have negative effects on Georgian energy security, but its impact should not be overly dramatized. There are currently plenty of opportunities that could lead to a substantially more energy-secure Georgia. Pursuing this path will take a lot of work and resources, but the goal is definitely worth the effort.