The Renewal of Turkey’s Long Term Contracts [GGP]
Turkey’s energy sector has been severely impacted by COVID-19. Demand for power decreased by 4.5% in the first five months, gas consumption in the industry sector fell by 16% and in the residential sector by 2%. The most affected months were April and May when natural gas demand fell by 20.6% (in April) and by 24.2% (in May). The power generation sector suffered the most with consumption falling by almost 46% in April and May. The country witnessed a rebound in June and July, however there were still effects on private consumption, which tend to be more long lasting. The economic downturn led to the annual inflation rate accelerating from 11.39% to 12.62% in May. The pandemic has also had negative impacts on Turkey’s trade and financial flows. The annualized surplus of 1.1% of the gross domestic product (GDP) in the fourth quarter of 2019 declined to 0.2% of GDP by the first quarter of 2020, and the current account was projected to have dropped further to an estimated deficit of 1.6% in the second quarter.
The situation created by the pandemic coincided with the time when Turkey was making the necessary market preparations for the impending renegotiation of long-term gas sales contracts with its current suppliers. The measures have been directed to structural changes in the market and its long-awaited liberalisation through freeing it from long-term contracts (LTCs), oil-linked prices, Take or Pay (ToP) obligations and destination clauses. The current market situation created by the pandemic, with the gas price falling below US$2/mmBtu in the major European liquid hubs and a surplus of both LNG and pipeline gas elsewhere in the world, will only accelerate this transition to a free, open, and transparent market. Turkey has long been unhappy with the high prices it pays for gas, relative to the rest of Europe, and wants to move away from the linkeage to oil and oil products. It has traditionally purchased gas on long-term, oil-price-related contracts and the government has taken all the price-related risk by subsidizing the BOTAŞ gas price for the population, justifying it with security of supply.
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Turkey’s new, present natural gas strategy is timely and coincides with the situation that all LTCs with the current pipeline suppliers will expire in the 2020s. In 2021 alone, 16 bcm/year of LTCs will expire, of which 8 bcm/year is Gazprom gas, half imported by BOTAŞ, and the other half by seven private sector importers. Consequently, the year 2021 is expected to be crucial in terms of market restructuring, with the new contracts expected to have more flexible and competitive terms, as has long been anticipated. Gazprom has already suffered from the situation of low spot gas prices and decreasing sales volumes as a result of demand stagnation; it has already lost 30% Turkish market share since 2017.
Changing market structures and liberalisation have had an impact on the development of spot markets and benchmarks in Europe and across the whole network of European gas hubs, with some of them becoming truly liquid. This process has changed the European gas market, causing it to function more on the basis of supply–demand economics rather than oil price fluctuations. In Europe this process started in the mid-2000s and has been successfully finalized in most European regions, but it needs to be mentioned that it has not been successful in the countries adjacent to Turkey, i.e. southeast Europe. Although liberalisation has not been successful there, the EU countries in the region – especially Bulgaria – have achieved hub prices through the DG COMP proceedings against Gazprom. Gazprom tried to escape reducing prices but reluctantly agreed to change its prices when Bulgaria threatened to take it back to the Commission. As spot and contract prices diverged significantly in Europe and elsewhere, customers for Russian gas in Turkey began to demand an end to oil-linked pricing. The trend away from oil-linked pricing in Europe and, more gradually, in Asia has led to the emergence of a significant divergence between spot and contract prices in 2019. This prompted BOTAŞ and privatesector companies to demand that Gazprom link the gas price to the TTF hub price. However, Gazprom refused to make any changes in the price formulations in the long-term contracts and this issue has been left for renegotiation in the extension of contracts for 8 bcm/year that expire in 2021.
Turkey has long been observing these developments and has a clear position that natural gas prices in Turkey do not reflect pure economic market fundamentals and that there must be a change toward short- and mid-term contracts, gas-to-gas indexation, and flexibility in contractual terms. Current longterm contracts with its pipeline and LNG suppliers have prevented such changes, although it has made some spot LNG purchases, and so far Turkey has failed to achieve better contractual conditions, as most European countries and companies did. Oil indexation, which still exists in Turkey’s natural gas pricing, destination clauses, and ToP, have hindered the ability of BOTAŞ and private sector importers to re-export unwanted volumes to neighbouring markets when faced with falling demand, high stocks and limited gas storage. ToP and oil indexation have made supply less responsive to demand shocks and falling prices, but have also long delayed liberalisation in this, Europe’s second biggest natural gas market.
This situation has resulted in premium prices in the Turkish natural gas market, with BOTAŞ and private sector importers paying gas bills 20% higher than those paid by Gazprom customers in Europe. Now, when the LTCs with Gazprom, Azerbaijan Gas Supply Company (AGSC) and Iran’s National Iranian Gas Company (NIGC) expire in the 2020s, beginning with the first 16 bcm/year of gas contracts in 2021, Turkey is keen to change the old-fashioned LTC terms in the upcoming renegotiations for renewed contracts.
Turkey feels confident in adopting an assertive position in negotiations with Gazprom and other suppliers because it has significantly strengthened its position thanks to the strategy of doubling the daily entry-point gas send out capacity. This has included increasing LNG import capacity but also decreasing import demand by significantly increasing the share of domestically produced energy such as coal, lignite, wind, solar, and hydro. This policy has borne fruit; the country produced 66% of its electricity from local and renewable resources in the first five months of 2020, and 62.08% from January through July this year, according to the data from the Energy and Natural Resources Ministry. Turkey is approaching its goal of producing almost 66% of its electricity from local and renewable sources annually, thereby reaping the fruits of long-term investments in renewable energy deployment. May 20th was a historic day, because 94% of the country’s electricity was generated from domestic sources. Turkey wants to become self-sufficient in energy, and domestically produced energy can help to wean the country from natural gas import dependence and inflexible LTCs. The following sections of this paper will try to analyse how realistic this objective is: it is a key factor in deciding on the duration of the renewed contracts.
This paper focuses on the position of Turkey in the renegotiation of the expiring contracts; its strengths and weaknesses in defending its position; and the reasons for the confidence of Turkey and BOTAŞ, in their negotiating positions with Gazprom, AGSC, and NIGC. It also reviews the implications of the revision of the contracts and possible longer-term perspectives for the positions of Gazprom, Azerbaijan, and Iran in the Turkish domestic natural gas market. It further analyses the consequences of the changes for regional markets, especially Turkey’s role as a transit country, and future gas exports from Turkey as a hub.
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