The Energy Charter's Role in the South Caucasus and Caspian

November 25, 2015 | 00:00
The Energy Charter's Role in the South Caucasus and Caspian
The Energy Charter's Role in the South Caucasus and Caspian

Contributing to regional energy cooperation, security and markets development

The geostrategic significance of the South Caucasus countries – Armenia, Azerbaijan and Georgia – can hardly be underestimated, for they are placed at the crossroads of major East-West and North-South energy corridors. Indeed, not only does the region form the avenue for transporting hydrocarbons from the Caspian and further east to Europe, it is positioned at the centre of the North-South axis between Russia and Iran. Opportunities brought about by these regional geopolitical advantages played an important role in attracting foreign energy investors over the past twenty years, and the practical realisation of these opportunities undoubtedly has led to some significant reforms carried out across the countries’ energy sectors and measures for protecting foreign capital. However, it is clear that further steps have to be taken by all countries concerned towards a more secure and balanced political climate and regulatory regime in the region, as conflicts and volatility were and remain a considerable hurdle for energy market development.

The volatility in the region was most acute after the break up of the Soviet Union, when the sovereign countries of the South Caucasus and Caspian were seized by political instability and simultaneously faced the need for capital intense investments in their energy sectors that could drive economic growth.

As enhancing energy cooperation between the East and the West and securing Western investments was the principal raison d'être of the Energy Charter’s Political Declaration and the Energy Charter Treaty (ECT) since their inception in the 1990s (see Article I), it is clear that - given the geopolitical position of the South Caucasus and the Caspian countries - this region was destined to become the “test case” [1] for the ECT’s application (Georgia signed the ECT in 1995, Azerbaijan in 1997 and Armenia in 1998). [2] To this end, the Energy Charter Treaty arguably provided a positive contribution, facilitating the improvement of national energy investment climates, as well as of the overall energy security in the region. Although the ECT was never intended to be the silver bullet for all of a region’s geopolitical challenges, it served as an international legal instrument for securing and promoting international energy investments in the South Caucasus and the Caspian. Hence, it has also provided useful legal mechanisms for facilitating energy trade, and an institutional framework for energy cooperation across the countries concerned.

In one of the previous publications (Article III) [3] we discussed the contribution of the Energy Charter and the ECT to unlocking the necessary investments in hydrocarbon reserves in the Caspian, as well securing oil transit routes through the South Caucasus. It has to be mentioned that the ECT’s “common principles” of fair taxation, non-discrimination and commitment of the signatories to facilitate free transit of energy products arguably influenced and served as a basis for the independent agreements signed to co-implement the construction not only of the Baku-Tbilisi-Ceyhan oil pipeline but also the Baku-Tbilisi-Erzurum gas pipeline. [4]

When it comes to the electricity sector, the potential role of Georgia as an electricity “hub” is particularly notable. Georgia is the only country in the region which is connected to all its neighbours: Armenia, Azerbaijan, Russia and Turkey. It became a net power exporter in 2010 for the first time, as it gradually replaced thermal generation with hydropower after a series of strong financial support packages from international donors [5] (to date, gas-fired generation in the country only accounts for 20% [6]). However, the character of hydro generation and supply-demand balance in Georgia is highly seasonal. Nowadays, in summer months Georgia exports excess power, while in winter it imports to meet internal demand. These imbalances are expected to be offset by putting on stream a new large hydropower reservoir, Khudoni, with 702 MW capacity by 2020 (the Georgian government plans to attract private investors in this project). [7]

One of the key power projects for the region was the construction of the Black Sea Transmission Network (BSTN) commissioned in 2013. The latter made Georgia “the first country in the Caucasus Region where the HVDC back-to-back links are installed” and contributed “significantly to improved stability of the national electric power network, more reliable power supply of the South Georgia’s regions, and reduction of electricity losses, as well as …[provided] effective opportunities for exporting to Turkey the surplus electricity generated in the country during summer period, and third countries’ electricity transit.” [8]

As studies point out, the next logical step would be to connect BSTN to Russia, Azerbaijan and Armenia to complete the regional power market, which would “facilitate […] flexible and mutually profitable cross-border energy exchanges.” [9]

Despite the above-mentioned opportunities for market integration in the region - which would facilitate energy flows and international investments – there are a number of regulatory improvements to tackle, such as establishing a transparent tariff for the transit system, capacity allocation and putting in place a robust congestion management mechanism. On top of that, the effectiveness of the bilateral trade agreements between the South Caucasus countries concluded in the 90s is debatable, as by the end of the day, there is no single legal framework setting out rules on transit and access to energy infrastructure and the vast energy potential of the region can only be unlocked through trans-national cooperation. A multilateral framework is needed in order to make use of full regional energy potential.

In addition, necessary mechanisms for securing investments and transit rules must be in place. The incremental evolution of regional energy systems was arguably facilitated by the ECT and subsequently paved the way to some important transnational energy initiatives across energy sectors: from oil and gas to electricity and energy efficiency. At the same time, as we can see today, the importance of the ECT is not diminished – on the contrary, it can serve as an important tool to facilitate market integration in the power sector with its transit and investment protection provisions.

During its Chairmanship of the Energy Charter Conference this year, Georgia put forward an ambitious initiative to foster electricity cooperation in the South Caucasus through the establishment of two Ministerial Level Task Forces, divided into two groups based on the geo-strategic map of the Caucasus region: 1) EWEC: East-West Electricity Corridor Task Force, comprising of Azerbaijan, Georgia, Turkey, Turkmenistan; 2) NOSEC: North-South Electricity Corridor Task Force, comprising of Armenia, Georgia, Iran, Russia, Turkey. It was also proposed that a Technical Task Force, comprised of representatives of regulatory bodies and TSOs, should be established to elaborate common principles on electricity transit tariff methodologies, develop regional network planning and scenarios, address regulatory principles and energy efficiency issues, as well as the methodology for calculation of losses during the transit and regime for compensation of losses for transit. This Technical Task Force should also develop a coordination guideline for emergency response in case of accidental or non-accidental interruptions, and other studies on issues such as transit cost calculation methodologies and technical regimes of power flows.

A better-interconnected market in the region can bring a number of mutual gains, including supply diversification, new export routes and easier gas-for-power swaps.

That said, there are some important projects in place already. For instance, on the East-West front, the Azerbaijan-Georgia-Turkey Energy Bridge project has the capacity to transport some 1,200 MW of electricity to Turkey (half of which is Azerbaijan's share). Furthermore, the project will facilitate up to 2,000 MW of electricity exports from Turkey to Europe. [10]

When it comes to the North-South corridor, as things stand, regional export opportunities for the Armenian power market are the most limited for political reasons. Despite the commercial sensibility of exporting electricity to Turkey, Armenia is mostly trading with Georgia. If construction of a planned nuclear power plant in Armenia takes place, it could well export excess capacity to Georgia, otherwise, import cheap hydropower from the latter. [11] Another option would be to re-export Georgian volumes from Armenia to Iran in summer, when the demand in Iran is surging. [12]

It also has to be mentioned that a complete North-South infrastructure network would allow Russia to export its electricity to Turkey (via interconnection of the Caucasus (Russia) - Georgia – Turkey).

Considering Georgia’s interconnections with the rest of the region, the state of its power sector and immense hydropower potential, studies suggest that the country is well placed to assume the role of regional electricity hub. The term “hub”, however, should not be interpreted through the EU prism. The “hub” envisaged in the region would be designed to facilitate power trade between the countries without necessarily requiring market integration and harmonisation of the regulatory regimes: “…[g]overnments of the states would nominate and authorize traders, who would be involved in the power trade through the agreement signed with the operator of the ‘hub’. No direct contacts and contracts between sellers and buyers would be needed. The major advantage is the opportunity for buyers and sellers to trade flexibly, as no special license or everyday trade is necessary, and occasional trade opportunities to sell, export, or cover deficits can be provided.” [13]

The upcoming Energy Charter Conference in Tbilisi in December 2015 will therefore inter alia take stock of the year-long work on the initiative championed by Georgia and look into the future. Initiatives like moving towards a more harmonised regulatory landscape in the region and ultimately connecting electricity markets could pay huge dividends not only economically, but also in providing impetus to draw the region together. Looking back at the story of regional market development and integration, it is hard to argue against the fact that the Energy Charter has made significant contributions to facilitating cooperation across the regional energy sectors – both in terms of regulatory provisions and the inter-governmental dialogue.

1. Terterov 2015
2. Ibid.
4. Terterov 2015
5. Such as the United States Energy Association (USEA), EU, World Bank, EIB, EBRD, and Asia Development Bank (Tsurtsumia, 2015).
6. Tamar Tsurtsumia, Occasional Paper, Energy Charter, 2015
7. Ibid.
9. Tamar Tsurtsumia, Occasional Paper, Energy Charter, 2015
11. Tamar Tsurtsumia, Occasional Paper, Energy Charter, 2015
12. Ibid.
13. Ibid.

The Energy Charter Secretariat monitors the implementation of the 1994 Energy Charter Treaty and provides support to the Treaty-based international organisation, the Energy Charter Conference (52 states). The Treaty strengthens the rule of law on energy issues, by creating a level playing field of rules to be observed by all participating governments, thereby mitigating risks associated with energy-related investment and trade. The Treaty focuses on: the protection of foreign investments; non-discriminatory conditions for energy trade; reliable energy transit; the resolution of state-to-state and, in the case of investments, investor-state disputes; and energy efficiency policies.

The International Energy Charter is a political declaration adopted in The Hague on 20 May 2015. It is designed to spread fundamental principles of international energy cooperation to new partner countries.

This series of materials is part of a wider awareness-raising campaign aimed at promoting the renewed role and creating further momentum behind the Energy Charter in today’s global energy markets.

Image: Offshore oil fields in Azerbaijan. By Bruno Girin. CC-BY licence.
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