On December 1, 2014, during a visit to Turkey, Russian President Vladimir Putin abruptly announced that Gazprom was cancelling the South Stream pipeline, which would have taken natural gas from Russia through the Black Sea to Bulgaria, and through Serbia, Hungary, and Slovenia to Austria. That same day, BOTAŞ, Turkey’s state-owned pipeline company, and Gazprom signed a memorandum of understanding for the construction of a new offshore gas pipeline named Turkish Stream, which would boast a capacity of 63 billion cubic meters (bcm) per year and would run from Russia, under the Black Sea, and on to the Turkish–Greek border. In the first phase of the project, starting in December 2016, Russia agreed to supply some 16 bcm to Turkey. In the second phase, the remaining 47 bcm would be delivered to the planned hub on the Turkish side of the Turkish–Greek border.

For Russia, the switch likely made sense for several reasons. For one, the South Stream pipeline was going to be very expensive and complicated from a regulatory point of view. The direct undersea pipelines to Turkey present far less of a challenge. In addition, Turkey is already Gazprom’s second-biggest market (Germany is the first), and it is the only European market with major expansion possibilities over the next decade. Finally, with tense relations between Russia and the rest of the world, Turkey might seem to Russia to be an appealing partner.

Russia and Turkey are at odds over Crimea, the Armenian genocide, and Syria. In fact, relations have recently deteriorated over the Russian intervention in Syria, with Turkish President Recep Tayyip Erdogan warning that Turkey could reevaluate its cooperation with the Kremlin on a number of key energy projects. Despite such sharp rhetoric, though, breaking Turkish dependence on Russian energy supplies is nearly impossible. And so, as of late, cooperation between Turkey and Russia in the energy field has been notable; Russia supplies two-thirds of Turkey’s natural gas. In 2010, Turkey brokered a deal with the state-controlled Russian company AtomStroyExport for the construction of Turkey’s first nuclear power plant, a project worth $20 billion. The Russian company will not only build the plant, but will also have a controlling interest in it.

Vladimir Putin in a joint news conference with Recep Tayyip Erdogan in Ankara, December 1, 2014. Putin said that Moscow could not carry on with the South Stream project if the European Union was opposed to it. Mikhail Klimentyev / Reuters But what has Turkey gained? It seems to have won itself some political leverage with Moscow, but also with the European Union, an institution that it still aspires to join. After the Ukraine gas crisis of 2006, in which Russia suspended the flow of gas to Ukraine in the wake of disputes over rising gas prices, the European Union officially recognized Turkey as a crucial transit corridor for non-Russian gas supplies to Europe. At the same time, Russia made Turkey an important stop along its new gas supply route to Europe that circumvents Ukraine. Turkey might try to use its leverage to win better gas prices (98 percent of its supplies are imported) and realize its ambitions of becoming a major energy-trading hub between Europe, the Middle East, and the Caspian region. A closer look at Turkey’s energy situation, however, reveals more modest gains ahead.

Two main features stand out. First, despite Ankara’s long-standing aspirations, Turkey has met none of the conditions that could make it a gas hub. Feckless domestic gas regulation (namely, a weak regulator appointed by the government), lack of competition, state subsidies, centralized control over the domestic gas sector, and the BOTAŞ monopoly over the gas transmission network are major obstacles. BOTAŞ manages 75 percent of all gas imports and 80 percent of domestic gas sales. Besides being the dominant market player, BOTAŞ also subsidizes natural gas prices by 15–20 percent, and resists implementing a cost-based pricing system. Other technical problems include Turkey’s lack of indigenous gas, a severe shortage of storage facilities, and only two LNG terminals. Taken together, these conditions prevent Turkey from developing a liquid natural gas market.

Given the overwhelming dominance of Russian gas in Turkey’s energy mix, many observers have urged Turkey to increase imports from its energy-rich neighbors.

Second, Ankara is disproportionately (up to 65 percent and rising) dependent on Russian gas. And its consumption is growing, reaching 51.8 bcm in 2014. The trend hasn't changed despite a recent economic slowdown.

GOOD DEAL

Given the overwhelming dominance of Russian gas in Turkey’s energy mix, many observers have urged Turkey to increase imports from its energy-rich neighbors. Diversification, the argument goes, is necessary to bolster the country’s energy security and to reduce the risk of gas shortages. And indeed, the countries in Turkey’s vicinity—Azerbaijan, Iran, Iraq, and the so-called Eastern Mediterranean countries—have, put together, more gas reserves than Russia.

Already, Turkey and Azerbaijan have launched the Trans-Anatolian Natural Gas Pipeline (TANAP), a pipeline across Turkey that will carry Azeri gas. Some have welcomed TANAP as a way to diversify away from Russian gas and also, supposedly, to bring cheaper gas into Turkey. TANAP, it is said, also carries key strategic benefits for Ankara because the West supports the project, and so Turkey’s involvement will enhance Ankara’s leverage with both Brussels and Baku.

According to most Turkish observers, however, TANAP is hardly a good deal for Turkey. Due to high transmission tariffs, the gas that will flow through TANAP will be both more expensive than Russian gas and even more costly than the Azeri gas supplied to Europe via the Trans Adriatic Pipeline, a pipeline that will transport natural gas from the Caspian Sea to Greece via Albania and from the Adriatic Sea to Italy. Moreover, it is by no means clear where sufficient gas for the second stage of TANAP (and Europe’s planned Southern Gas Corridor, for that matter) will come from.

Iran is another option for Turkey, but Iran first has to use its gas to industrialize itself, which leaves very little room for export. Meanwhile, Turkmenistan has offered to ship some of its gas via TANAP, but that will be hard for it to do, since Turkmenistan is fully contracted with China. Even if it weren’t, there are still disputes about the legal status of the Caspian Sea, which must be settled before any pipelines under it are built. In fact, to hinder such pipeline development, for the last 25 year, Russia has simply blocked negotiations to define the sea’s legal status. For the foreseeable future, then, Turkmen has no way of reaching Europe other than through Russia. Israel’s Leviathan is another potential supplier. Politically, however, Israeli gas is currently gas non grata in Turkey. Due to the tense regional political situation and disputes with the Iraqi central government, the Kurdistan Regional Government’s gas doesn’t appear to be a viable option in the short term, either.

Russia is determined to circumvent Ukraine en route to European customers and to remain a dominant player in Southeastern Europe. And here, it sees Turkey as an asset.

GAS ON THE ROCKS

Russia is well aware that there will be few options to feed TANAP in the second phase, and so it may try to quietly put the nail in Phase II’s coffin. For example, it can assure that Turkmen gas stays beyond TANAP’s reach. If that fails, it may well bid with the European Union to supply the gas itself. Hence, a pipeline that was designed to carry Russia-free gas to Europe may, for the lack of better options, need to tap into Russian gas to be commercially viable.

It is in this context that Putin put the Turkish Stream pipeline on the table on December 1, 2014. No binding contract has been signed as yet, but the planned Turkish Stream will consist of four lines—each 15.75 bcm—for a total of 63 bcm. The most significant difference, when compared to South Stream, is that it would stop at the Greek-Turkish border. The first line of Turkish Stream will likely be built at the end of 2016.

The aim of the first line is to replace the 14 bcm of Russian gas that Turkey gets through Ukraine via the so-called Trans-Balkan pipeline (which cannot meet Turkey’s rising gas demands, has technical problems, and has triggered much political controversy). Most Turkish observers insist that the first line will have a marginal impact on the Turkish market. But they are wrong. With the additional 15.75 bcm from Turkish Stream, Gazprom has already enhanced its market share by 1.15 bcm and with the upgrading of Blue Stream, an older pipeline that goes from Russia to Turkey, by 1 bcm. In other words, criticism that the pipeline will merely substitute for the Ukraine transit line is simply off the mark. Russia is crowding non-Russian gas out of Turkey's infrastructure.

To expedite the pipeline’s construction, Putin sweetened the deal by adopting the name Turkish Stream. Yet the pipeline is fully financed by Gazprom and the Russian government. Indeed, given that Turkey’s BOTAŞ is not a partner, calling the project the Turkish Stream is a mere rhetorical courtesy. In addition, Putin talked about creating a trading point on the Turkish-Greek border, or, in other words, a Russian hub on Turkey’s soil that BOTAŞ would not own.

A worker checks the valve gears of pipes linked to oil tanks at Turkey's Mediterranean port of Ceyhan, which is run by BOTAS, February 19, 2014. Umit Bektas / Reuters Turkey’s preferred option for the hub is to build it in Ahiboz, just over 30 miles away from Ankara. Ahiboz would ideally become the starting point for European deliveries. But such ambitions are unrealistic given the current government’s strategy: Turkey has no sufficient free gas in the market to export. Hubs usually rely on large storages and free competition. Plus, until at least 2030, Turkey’s gas needs are fully covered by long-term contracts. The Ahiboz hub is also unrealistic given that Gazprom opposes it.

Another point of contention has been the price of the gas in the Turkish Stream. Price talks between Gazprom and BOTAŞ started at the beginning of 2015. Gazprom asked permission to lay the seabed section for Turkish Stream in exchange for giving Turkey a gas price discount. BOTAŞ asked to set the discount at 20 percent, which Gazprom refused to do. After some negotiation, by June the Turkish Energy Ministry conceded to the Russian proposal of a mere 10.25 percent discount. The Turkish side, it seems, hardly has the leverage to push back against Russian demands.

NO COMPETITION

Russia is determined to circumvent Ukraine en route to European customers and to remain a dominant player in Southeastern Europe. And here, it sees Turkey as an asset. Many have speculated over Turkey’s supposed enhanced geopolitical role in the Mediterranean, especially after the European Union’s “stress tests” last year exposed the vulnerabilities of Southeastern Europe’s reliance on Russian gas. However, the West’s hopes of using Turkey as a bulwark against Russia’s assertive energy strategies are slipping away. An uncompetitive market environment, low regulated domestic gas prices, and other regulatory challenges are sobering. Turkey could, in principle, try to overcome its limitations by breaking apart BOTAŞ into smaller parts.

Far-reaching separation of gas supply from transportation services would attract competition, which is why BOTAS vehemently opposes such reforms. Yet, doing so is necessary, even though it will take time, especially due to Erdogan’s use of natural gas subsidies as way to win votes.

To break the current stalemate over BOTAŞ, Turkey would have to invest in LNG infrastructure. LNG gas supply infrastructure would increase Turkey’s options and give consumers more flexibility as the market moves away from long-term contracts toward more transparent natural gas pricing. Moreover, with the expansion of LNG infrastructure, the gas could be swapped between Turkey and other states, thereby bringing Ankara closer to becoming a crossroads for the transport of Caspian energy to Europe.

LNG development, however, is chronically limited due to subsidies and weak market competition, which is, in turn, related to the entrenched regulatory advantages that BOTAŞ has accumulated over the years. These can and must be undone. But until that happens, Turkey will be confined to rigid pipeline gas contracts and very little underground storage. In other words, Turkey’s gas policy is totally to Russia’s advantage.

For Turkey, replicating the European Union’s gas hubs is proving harder than expected. Ankara simply lacks the means to foster vigorous competition, coerce Russia, fully take advantage of its geographically favorable position, and realize its aspirations of becoming a critical bridge for the transport of Caspian gas to Europe. Despite Turkey’s slowly improving standing, its goal of expanding its geostrategic importance through energy is still beyond reach. And that is good news for Russia—not so good news for the West.