VZCZCXRO1038
RR RUEHBC RUEHDE RUEHFL RUEHIHL RUEHKUK RUEHKW RUEHLA RUEHROV RUEHSR
DE RUEHAK #2955/01 3471533
ZNY CCCCC ZZH
R 131533Z DEC 07
FM AMEMBASSY ANKARA
TO RUEHC/SECSTATE WASHDC 4637
INFO RUCNCIS/CIS COLLECTIVE
RUEHZL/EUROPEAN POLITICAL COLLECTIVE
RUCNRAQ/IRAQ COLLECTIVE
RUEHIT/AMCONSUL ISTANBUL 3623
RUEUITH/ODC ANKARA TU
RHEHAAA/NSC WASHDC
RUCPDOC/DEPT OF COMMERCE WASHDC
RHEBAAA/DEPT OF ENERGY WASHINGTON DC
RHMFISS/CDR USEUCOM VAIHINGEN GE

C O N F I D E N T I A L SECTION 01 OF 03 ANKARA 002955 
 
SIPDIS 
 
SIPDIS 
 
USDOC FOR 4212/ITA/MAC/CPD/CRUSNAK 
EEB FOR A/S SULLIVAN 
EUR FOR DAS BRYZA 
SCA FOR MANN 
DOE FOR HEGBURG 
USTDA FOR DAN STEIN 
 
E.O. 12958: DECL: 12/13/2014 
TAGS: ENRG EPET TU EINV AZ
SUBJECT: TURKISH THINKING ON AZERI GAS VOLUMES AND TRANSIT 
ARRANGEMENTS 
 
REF: A. ANKARA 1945 
     ¶B. BAKU 1256 
     ¶C. ANKARA 2720 
     ¶D. ANKARA 2921 
 
Classified By: ECONOMIC COUNSELOR DALE EPPLER FOR REASONS 1.4 (B) AND ( 
D) 
 
¶1. (C) Summary: Turkey's energy priorities are increasing gas 
supply and diversity of suppliers, and reducing its energy 
costs. The Turkey-Greece-Italy Intergovernmental Agreement 
that allows Turkey to buy 15% of transiting gas at a netback 
price plays a central role in meeting these needs.  Netback 
pricing will reduce Turkey's gas costs not only by allowing 
it to buy Azeri gas at a Greek price less transit costs 
across Turkey, but also by triggering contractual clauses 
that will force Russia and Iran to meet the (presumably) 
lower Azeri price. The Turks adopted netback pricing from the 
U.S., where it is a standard pricing system in an admittedly 
more liquid and transparent market.  While Turkey says it 
understands the importance of moving forward on Nabucco and 
getting Turkmen gas to Europe, there is no sense of urgency 
to reach agreement with Azerbaijan on the 15% domestic 
takeoff or netback pricing model. While Energy Minister Guler 
has signaled some flexibility on the percentage and resale 
rights, the GOT will remain firm on that formula until they 
see a different model that meets their energy supply concerns 
at an equal or better price.  We do not believe the USG 
should involve itself in what are essentially commercial 
negotiations. Our interests are best served by understanding 
the driving forces and suggesting alternative formulas that 
bring the parties together.  End summary. 
 
Not just transit - Turkey's domestic consumption drives its 
energy policy 
--------------------------------------------- ----------- 
 
¶2. (SBU) Growing domestic demand for energy is driving 
Turkish insecurity about its natural gas supply.  For the 
last five years, energy demand has increased by 8% per year, 
slightly faster than GDP .  Turkey is on track to double 
natural gas consumption by 2015. (Note: Gas fired power 
plants provide a large and growing share of Turkey's energy 
supply). Electricity demand is expected to exceed supply as 
early as 2008, even if all new power projects are completed 
on time.  Building new gas-fired plants requires Turkey to 
assure itself of additional supply. 
 
¶3. (SBU) The new Justice and Development Party government's 
energy strategy calls not only for increasing Turkey's 
natural gas supply, but also for Turkey to diversify its 
supply sources so that it is not dependent on any one country 
for more than 30% of its supply.  Currently, Turkey relies on 
Russia for about 60% of its natural gas, under contracts that 
begin to expire in 2011.  To do this, Turkey will need to cut 
Russian volumes in half and increase volumes from other 
sources: the Caspian, Iraq, Egypt, the Gulf or Iran.  We have 
warned Turkey that further energy deals with Iran could 
trigger sanctions under U.S. law.  Their response has been 
that they are aware of our law and our concerns about Iran, 
but they expect the U.S. to understand their need for 
adequate energy supply. 
 
Intergovernmental Agreement with Greece and Italy: A 
Bird-in-Hand 
--------------------------------------------- ----------- 
 
¶4. (SBU) As reported ref A, the July 26 Intergovernmental 
Agreement (IGA) on the Turkey-Greece-Italy pipeline contained 
a provision allowing Turkey to buy up to 15 percent of the 
Azeri gas transiting Turkey at a net-back price.  This 
arrangement is important to Turkey because it secures 
additional gas for Turkey's domestic consumption.  The IGA 
did not specify whether the 15 percent could be used only to 
meet domestic demand or could be resold, and Turkey has not 
clearly articulated a position on this point.  In 
 
ANKARA 00002955  002 OF 003 
 
 
conversations with Minister Guler and others (ref C), we 
believe that Turkey is firm on maintaining the netback 
pricing formula, while it is indicating some flexibility on 
issues such as gas re-sale and the percentage for domestic 
offtake.   However, they see the IGA as a bird-in-hand and 
have firmly attached themselves to this provision as the 
means to reach their energy goals. 
 
What Net Back Pricing Is and Is Not 
----------------------------------- 
 
¶5. (SBU) Post has noticed that both within the USG and with 
other governments that there is confusion about what netback 
pricing is in the Turkish model.  The Turks adopted net back 
pricing from the U.S. natural gas market, where it is the 
standard pricing model used at the Henry gas hub.  To 
calculate a netback price (in a simplified way), you need to 
know the cost of production at the wellhead (X), the cost of 
transit (Y) and the sales price at a designated location (Z). 
 Net-back pricing is simply Z minus Y.  In a simple 
calculation, profit might be Z minus Y minus X.  Turkey is 
using this pricing formula even though it does not know the 
cost at the wellhead (X) or the price at which Azerbaijan is 
selling the gas to Greece (Z). 
 
¶6. (SBU) We have seen some email exchanges that assume that 
"net-back price" means "below market price."   This view 
appears to be based on two erroneous assumptions: first, that 
the price set by Gazprom in Europe is a market price (even 
though our Caspian energy strategy is based in part on 
Gazprom using its monopoly power to inflate gas prices in 
Europe); and second that transit costs should be the same for 
delivery to any country.  In the Turkish pricing model, the 
Gazprom price is assumed to be inflated (Turkey's Gazprom 
contracts have it paying $240 per tcm, a price akin to 
Western European prices), and that Turkey deserves to pay a 
lower price for Azeri gas than Italy or Greece because of 
lower transit costs. 
 
The Price of Azeri Gas matters -- a lot 
---------------------------------------- 
 
¶7. (C) Former Energy Undersecretary Sami Demirbilek told us 
that the price of Azerbajian gas is especially important to 
the GOT because it will affect all other Turkish gas 
contracts.  According to Demirbilek, the Turks have a "most 
favored nation" type clause in their contracts with Russia 
and Iran.  That is, the contracts state a price but also 
state that if Turkey obtains gas at a lower price, the 
supplier must reduce its price to match the price of the 
cheapest supplier.  If Turkey is able to get a net-back price 
(i.e. a price for gas that does not include the 
transportation across Turkey) from Azerbaijan, it will 
undoubtedly be cheaper than the price they are paying to 
Russia and Iran.  Consequently, a cheaper gas price from 
Azerbaijan also forces a cheaper price from Russia and Iran. 
(Comment: We have not seen the actual contract language and 
are unable to confirm that Demirbilek's analysis is correct. 
End comment.) 
 
Why is Turkey moving so slowly? 
 
------------------------------ 
¶8. (SBU) Turkey fully supports the Nabucco gas pipeline 
project and shares our view that Southstream is a competitor 
project.  On some of his first trips abroad, President 
Abdullah Gul visited Baku and Ashgabat with a delegation of 
Turkish businessmen to raise issues of investment and 
cooperation.  In Ashgabat, Gul emphasized the importance of 
delivering Turkmen gas to Europe (ref D).  While Turkey has 
told us they understand the urgency in moving Nabucco forward 
and they are ready to negotiate with Azerbaijan on transit 
terms, we have not any seen evidence of on-going talks nor of 
any effort to engage with Azerbaijan.  It may be that Turkey 
does not see the transit terms with Azerbaijan as the 
lynchpin of Nabucco.  It may also be that the Turks believe 
 
ANKARA 00002955  003 OF 003 
 
 
they have a strategic advantage in negotiations with the 
Azeris, that Azerbaijan need to use Turkish territory more 
than Turkey needs their gas.  Another obstacle to quick 
movement on transit negotiations may be lack of capacity 
within the Ministry of Energy and the state-owned pipeline 
company BOTAS.  At the Ministry, two of the top four 
positions are vacant and at BOTAS, two of five Board Member 
positions are vacant.  These positions have been vacant since 
September or October and it,s not clear when they will be 
filled. 
 
¶9. (C) Comment:  U.S. gas is sold on a net-back basis. 
Granted, U.S. markets are more liquid but it,s difficult to 
argue that moving toward a liquid, transparent market is 
undesirable.  Some worry that Turkey's demand for 15% of the 
transit volumes sets a negative precedent for future 
suppliers to the Southern Corridor as suppliers want to 
choose their market rather than having it chosen for them. We 
think it,s too early to judge how the commercial arrangement 
will be established for other Southern corridor projects.  At 
a recent presentation by OMV on the Nabucco project, it,s 
clear they are planning a very different gas marketing 
approach than TGI.  But Turkey is highly unlikely to move 
from its netback pricing approach unless they are presented 
with a more assured, diversified and cost-effective way of 
meeting their domestic energy needs.  We do not think it is 
in our interest to involve ourselves in a commercial 
negotiation between Turkey and Azerbaijan, even if we believe 
the terms might not be reasonable.  U.S. interests are best 
served by understanding the driving forces behind the demands 
and, where possible, suggesting alternative arrangements that 
bring the parties together.  We welcome any ideas that would 
advance negotiation between the Turks and Azeris on a gas 
transit agreement. 
 
 
Visit Ankara's Classified Web Site at 
http://www.state.sgov.gov/p/eur/ankara/ 
 
WILSON