Politics, Economics, and Energy Security: How Pipeline Negotiations Play a Key Role

Politics, Economics, and Energy Security: How Pipeline Negotiations Play a Key Role

By Felix Fallon

Pipelines are an important foreign policy consideration. The energy security concerns of fuel-importing countries are often at the center of political disputes, while petroleum-rich countries wield power through the strategic distribution of their energy wealth. A transit country can use its geographical location as a bargaining chip for political gain, yet in some cases can be vulnerable if the exporting country threatens to avoid its territory. Third party countries not directly involved with negotiations have also been known to take preventative measures in cases where a pipeline threatens their political or economic security.

Graham Coop, partner at Volterra Fietta and former General Counsel to the Energy Charter Secretariat, told Egypt Oil & Gas that politics has always been intrinsic to pipeline negotiations.

“I don’t think the days have yet come, and I wonder if they ever will come, where gas and electricity, but particularly gas, will be traded on a purely commercial and utilitarian basis,” he says. “Gas has always had and probably for the foreseeable future will continue to carry political connotations.”

The Transit Country

Examining the role of transit countries is crucial to understand the importance of pipelines to international relations. Transnational pipelines that cross borders of two or more countries introduce a host of jurisdictional challenges for construction, operation, and maintenance. All parties have to reconcile the interests of the others involved in the project, and establish a rent-sharing agreement. If the intermediary transit country is not satisfied with the terms and the fees paid, or the circumstances for the agreement change over time, it has the potential to disrupt the security of the energy supply. The same is the case with pipelines where the proposed transit country (if fortunate in its geographical position) can stop a project in its tracks to make a political stand against one of the other parties.

This is exactly what happened with the Qatar-Turkey natural gas pipeline, proposed in 2009 to transport Qatari gas from the South Pars field to Europe, passing through Saudi Arabia and Syria, and crucially bypassing Russia.  Syrian president Bashar Al-Assad refused to allow the pipeline to pass through Syrian territory; his rationale for which, an AFP report claimed, was “to protect the interests of [his] Russian ally, which is Europe’s top supplier of natural gas”.

For Syria, ensuring the dominance if its ally Russia in the European gas market proved more important than the economic gain of being a transit nation.

Transit countries can also exert power through what economists refer to as obsolescing bargaining. This is where bargaining power shifts from the investor to the host country after the initial investment has been made and the project has started commercial operation.

“The power dynamic certainly shifts between the time when a pipeline is being planned and the time construction is completed; this is a case of obsolescing bargaining. It is the same with any other investment project:  once the investment has been made it is normally no longer possible to unmake it, or to move it somewhere else,” Coop stated.

After investment is made, the bargaining power of the initial investor – the option of investing elsewhere – is diminished, and the transit country receiving the investment is subject to fewer constraints and gains a coercive ability.  The high fixed costs and low operational costs make pipelines very susceptible to obsolescing bargaining as the initial development costs make up the majority of investment needed.

“It is not so easy for the other country to force the transit country to respect [the initially agreed] terms once the construction is completed,” Coop added; however, this eventuality is often accounted for in the negotiations. “It’s not uncommon to have long-term contracts for 20-30 years with price clauses which are designed to operate so that both parties’ economic interests are taken into account. For there not to be a completely anarchic free-for-all, often there is the possibility of a three yearly or other price review.”

The Export Country

The Nord Stream Pipeline – running between Russia and Germany while bypassing central and eastern Europe – demonstrates how energy-exporting countries may attempt to weaken the position of transiting countries. Indeed, Moscow’s detractors have criticized the construction of the pipeline as a means of exerting political influence over its neighboring eastern European nations.

The subsea Nord Stream pipeline was laid in the Baltic Sea, thereby circumventing Ukraine and Belarus – the two main transiting countries for Russian gas to enter Europe. Prior to its construction in 2011, Russia had been involved in several energy supply disputes with both Ukraine and Belarus. In 2007, Russia reduced oil and gas supplies to Belarus following disagreements over energy sale prices, debts owed by Belarus and transit fees paid by Russia. Russian state-owned company Transneft terminated oil shipments down the major Druzhba pipeline, threatening Belarus’s energy security. Similarly, Russian gas giant Gazprom halted all natural gas supplies into Ukraine for nearly three weeks in 2009 after Gazprom and Naftogaz Ukrayiny failed to reach agreement over gas prices and outstanding debts.

The construction of Nord Stream pipeline stripped Ukraine and Belarus of a significant part of their power as transiting countries, and provided Moscow with additional political and economic leverage. “[Nord Stream] is born out of a strong desire by Russia to change the dynamic of its relationship with Ukraine in such a way that Ukraine no longer has any control over the transit to western Europe of that part of Russia’s natural gas exports that flow through that pipeline,” Coop said.

The Nord Stream pipeline is therefore designed to remove Ukraine’s ability to disrupt Russian natural gas exports. While Russia and Ukraine threatened each other’s respective energy interests, Ukraine’s power remained contingent on Russian gas transiting its territory. Taking advantage of its geographical position, Russia has created for itself an additional option for transit thereby diluting Ukraine’s power to threaten its exports.

Moscow is seeking to further decrease its reliance on Ukraine and Belarus as transit countries by constructing two additional lines between Russia and Germany, known as Nord Stream 2. The pipelines are expected to be completed in 2019, and will increase the total capacity to 110 billion cubic meters of gas per year.

Third Party Intervention

Pipeline politics is a game that is played, not just by exporting, importing or transiting countries, but also by third parties:  countries whose interests are affected by a proposed pipeline that intervene and attempt to turn events in their favor.

This is what happened during negotiations for the proposed Nabucco pipeline:  a project intended to transport gas from Iraq, Turkmenistan, Azerbaijan, and Egypt through Turkey to Europe. The pipeline would enable Europe to diversify its energy sources and lessen its dependence on Russian oil and gas.

“Russia, for some time until now has successfully preempted this pipeline by directly purchasing a large proportion of the available gas supplies from many of the states  which would have otherwise sold their gas to be fed into the pipeline, thus depriving the pipeline of some of its potential customers,” Coop said. Russia intervened because the pipeline represented a potential rival to its gas supply to Europe. Removing incentives for its construction therefore ensured the security of its own energy sales.

The interference of a third party in pipeline negotiations is also demonstrated in the proposed gas pipeline from Iran through Pakistan to India (IPI) that became entangled in a strategic contest between the US and Iran.

The proposed construction of the IPI defied Washington’s sanctions regime. It would have been a major setback to its ambitions of isolating the Islamic Republic, risking Pakistan and India becoming dependent on Iranian gas.

In May 2008, the Heritage Foundation – an influential right-wing think tank – published a paper that spelled out an integrated approach to the IPI from the US political standpoint, which included changing the domestic and regional conditions that had combined to make the IPI pipeline a potentially viable enterprise. Its list of recommendations included increasing political pressure on the two countries to exit the talks, encouraging an alternative pipeline between Turkmenistan and India, and assisting both countries to develop alternative sources of energy.

This list of preventative actions demonstrates the lengths which America was willing to go to prevent the construction of the IPI and maintain pressure on Tehran.

Some of the strategies recommended by the Heritage Foundation were implemented to good effect. For instance, American pressure on India resulted in the country increasing its LNG imports from 3.49 billion cubic meters (bcm) in 2004/05 to 12.31 bcm in 2009/10, most of which came from Qatar, a US ally. India was also influenced by its growing relationship with states opposed to Iran, specifically the Gulf countries and Israel. Saudi Arabia in particular had long pressed India to limit its economic ties with Iran, and increase its hydrocarbon imports from the Gulf.

Pakistan, however, remained keen on the IPI as it did not have the same energy flexibility as India; in 2009, natural gas accounted for almost a third (31.9%) of Pakistan’s energy mix according to the IEA.  Prospects of Pakistan-US cooperation were undermined by suspicions of collusion between Islamabad and the Taliban. Despite Pakistani efforts to secure the services of international oil companies such as Shell, Total and BHP, these companies were ultimately deterred by mounting US pressure against both Tehran and Islamabad.

Pipe-to-Pipe Politics

Pipelines are intrinsically political. For most countries in the world – whether exporters, energy-dependent importers, transit countries or third parties defending their national interests – pipelines are a key foreign policy tool and an essential means of economic development. Their importance is such that global powers such as Russia and the US will go to sometimes extreme measures in order to defend their economic and political interests.

Perhaps more than any other type of infrastructure, pipelines can provide several forms of economic and coercive power: transit nations can obtain a degree of power over the exporting and importing countries while receiving long-term economic benefits; exporting countries can establish new, reliable relationships with purchasers, while also using energy dependency as a source of political leverage; and importers can secure new sources of energy and ensure their needs are met.


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