In recent days, energy diplomats on both the Azerbaijani and Turkish sides have revealed that an agreement in principle over the price that Turkey will pay for Shah Deniz gas from Azerbaijan has been reached. However, there are several ongoing sets of simultaneous negotiations over Shah Deniz, also taking place in the context of larger implicit bargaining games over other the Caspian Sea basin deposits of natural gas and indeed the geo-economics of their supply to Europe over the next several decades. These subtleties must be unpacked in order to understand the wide-ranging significance of even seemingly small agreements.

BACKGROUND: The developers of Azerbaijan’s offshore Shah Deniz deposit (a consortium led by BP holding 25.5 percent, and including Norway’s StatOil holding another 25.5 percent; other members are SOCAR, Elf Petroleum, LukAgip, and TPAO) originally expected to find mostly oil there a dozen years ago. Instead they found natural gas, in such quantities that the South Caucasus Pipeline (Baku-Tbilisi-Erzurum) was built for it, and plans for a Trans-Caspian Gas Pipeline from Turkmenistan, which had been encountering obstacles, were shelved.

The Shah Deniz deposit began production in 2005, and gas from its Phase One began flowing for international sale in 2007. Azerbaijan produces between 8 and 9 billion cubic meters per year (bcm/y) from this source, of which 6.6 bcm/y is sold to Turkey. The price agreed at the time of signature of the original contract between the two parties was US$ 120 per thousand cubic meters (tcm). In the meantime, the world price has reached well over double that figure. The contract between the two sides gives Azerbaijan the right to renegotiate the price but does not impose upon Turkey the obligation to renegotiate. After the original price agreement lapsed, Turkey still continued to receive gas but would pay for it only retroactively, after agreement on the price was reached. These are the negotiations that have been at an impasse for months.

Technically there is also another, formally separate set of negotiations involved for increased quantities of Azerbaijani gas putatively destined for Turkey, also from Shah Deniz but from its Phase Two development.  In mid-February, Turkish press reports suggested that Turkey had agreed to pay Azerbaijan between US$ 260/tcm and US$ 300/tcm (the price being made retroactive to April 2008) but that Azerbaijan hesitated to sign the deal until agreement was reached on the separate question of additional purchase of the expected first tranche of 4 bcm/y of gas from Shah Deniz Two, over which disagreement continued not only as to price but also as to transit fees. Turkey’s total take from Shah Deniz One and Two together is projected to ramp up to 22 bcm/y over the next dozen years.

IMPLICATIONS: While waiting for a successful conclusion to the negotiations with Turkey, Azerbaijan has diversified its customer base. Russia, which gave Azerbaijan a standing offer last year to purchase all of the country’s gas production at commercial prices (but which President Ilham Aliev declined, explicitly invoking geopolitical considerations), contracted to buy 500 million cubic meters (mcm) this year, a figure recently doubled, and to be doubled again to 2 bcm for 2011. Azerbaijan also agreed to sell 500 mcm this year to Iran, and perhaps more as the Baku-Astara pipeline is refurbished, but unlikely ever to approach the figure of 5 bcm/y that the Iranian ambassador mentioned last year in Baku. Azerbaijan also has agreed to sell 1 bcm/y to Bulgaria, the gas transiting the Black Sea from Georgia using the relatively new, and as yet untried over long maritime distances, compressed natural gas (CNG) technology.

Meanwhile Turkey remained patient, confident that Azerbaijan would be eventually constrained to recognize Ankara’s relative monopsony, and unable to find enough other customers to take the planned increased production from Shah Deniz. In this, Ankara appears to have been encouraged by Moscow at the highest levels of government. It was in mid-May last year, after Turkey’s Prime Minister Recep Tayyip Erdogan had agreed with the EU in principle on terms of pricing and legal regulation for the Nabucco pipeline and the gas it would carry, that he reversed course and re-raised the previously solved issues. This followed a meeting in Sochi with his Russian counterpart Vladimir Putin, to all appearances as quid pro quo for Russia’s agreement to sponsor the construction of the Samsun-Ceyhan (“trans-Anatolian”) oil pipeline and to consider two non-mutually exclusive variants for a “Blue Stream Two” gas pipeline extending the original Blue Stream to the south and/or west.

Thus Russia, besides implementing a "divide and conquer" strategy appealing to the national interests of selected EU members to the detriment of others, has countered Europe's emerging recognition of its situation by encouraging Turkey's relatively new ambitions to assert its status as a relatively autonomous regional power. In particular, this countermove has eventuated most recently in a diplomatic waltz where various figures on both sides variously endorse the idea that the Nabucco and South Stream projects may co-exist and even prosper together. The subtext to this concerted initiative is to the detriment of White Stream and similar projects. It is a replay of the situation ten years ago, when Russia induced Turkey to build the Blue Stream pipeline between the two countries under the Black Sea, in order to block at that time the project for the Trans-Caspian Gas Pipeline from Turkmenistan to Azerbaijan: a project that evolving political and economic conditions have over the course of the last few years again made feasible in principle, and which may also now be associated with White Stream.

CONCLUSIONS: Never before in the three centuries since both Russia and Turkey became major European Powers has there been an international system characterized, as it is today, by, at least an entente between the two countries when one or both were strong rather than weak states (with the exception of the late 1930s, when they had a common enemy and when both were still relatively weak). Today, regardless of how one characterizes the status quo that emerged from the post-Cold War transition, both Russia (at least under Putin) and Turkey (at least under Erdogan) have become revisionist states seeking to alter that status quo.

It is possible that this bilateral entente in the sector of energy geo-economics is developing to the point of institutionalization. The present situation is approaching not a military but a geo-economic alliance focused on energy yet also extending to other spheres of economic activity. That fact in turn reflects the nature of contemporary international affairs, where trade no longer follows the flag but rather the flag follows trade.

The novelty of this situation, and of a Russo-Turkish entente, may account for the failure of some major players in the European Union to seize more quickly the essence of the situation, yet it does not exclude the blindness of some of them, which has in some cases been willful. Those European countries historically most sympathetic to Great Power ententes are the ones that have done the most, until recently, to restrain concerted EU energy diplomacy in the region; yet this has been changing. Beyond the Azerbaijan-Turkey negotiations over gas from Shah Deniz One and Two for domestic Turkish consumption looms the Nabucco issue. In particular, the EU last year officially endorsed a so-called "Southern Corridor" strategy that includes not only the Nabucco project but also the White Stream pipeline project under the Black Sea from Georgia to EU member Romania. This is the only strategic option now open to Europe, if it wishes to avoid a dual chokehold by Russia and Turkey (who have shown they can cooperate on energy matters) on its own natural gas supply.

AUTHOR’S BIO: Robert M. Cutler (http://www.robertcutler.org) is educated at the Massachusetts Institute of Technology and The University of Michigan. He is a senior research fellow in the Institute of European, Russian and Eurasian Studies, Carleton University, Canada, and also consults privately in Eurasian energy security and other fields.